What is RRSP and How Does it Work?

Are you searching for the perfect way to secure your future? Are you looking for a great investment you can rely on when you retire? An RRSP may be the right solution for you. If you already have a financial advisor, chances are you have heard them mention it before. If you haven’t, no matter as we will be introducing you to RRSPs below:

What is RRSP? 

RRSP is the acronym for Registered Retirement Savings Plan. It is an account specially designed to help Canadians save for their retirement. Contributions are made to the account every year to build up long-term savings, to be used for retirement. 

RRSPs have been around in Canada since 1957. The account benefits from tax deferment until retirement. RRSP was created by the government to give tax breaks to individuals that invest money in RRSP, as motivation to save for their retirement.

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How Do RRSPs Work? 

The most significant feature of RRSP is how it is taxed. Contributions made into your RRSP are tax-deductible. As long the money remains in the account, it grows tax-free. But when the money is withdrawn, taxes will be paid as if it is income. The benefit of this is when it comes time for retirement, your annual income will most certainly be lower than it is currently.

For instance, if you earn $78,000 per year and you decide to save $14,000 to the RRSP. When it comes to taxation, the CRA will tax you as if you earned $64,000. Although the tax deferment does not mean tax-free, you will pay the tax eventually when you withdraw the money from your RRSP. However, the tax payable on these funds will surely be lower compared to paying income tax at the time when earned. 

What Is the RRSP Contribution Limit?

As a registered account, RRSPs are regulated by certain rules. One of the rules guiding running an RRSP account is the amount of money you can contribute in any given year. The maximum amount you can save is either 18% of the previous year’s income or a maximum amount, whichever is smaller. 

The Canada Revenue Agency usually regulates and specifies the maximum RRSP deduction limit allowable for each year. For 2020, the limit allowed was $27,230 while $27,830 is allowed for 2021. The limit is set to avoid excess contributions.

 

If you want to minimize the effect of taxes on your income and save for retirement, an RRSP may be a good option. Speak with your financial advisor for guidance on how to open an RRSP account and how to make contributions to the account without hassles. 

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