Financial Anatomy 101: Registered Retirement Savings Plans (RRSPs)

From: Anatomy – Descriptive and Surgical by Gray et. al, 1887.

If TFSAs are like the brain – complex and kind of mysterious to many, then RRSPs are more like the well known face of retirement planning.

Every little kid can point to their eyes, ears, mouth, and nose. However, a little look beneath the surface shows facial anatomy to be a bit more complex. Same with RRSPs.

Let’s start in on the surface anatomy

RRSPs are well recognized because they have been around since 1957. The other side of that is that it has given plenty of years for governments to diddle with them and the face of RRSPs has changed over time. Surprise, surprise – they have become more complex with more special rules. Well, let’s peel back the skin and have a look.

Ugh. That was Hannibal-Lecter-Silence-of-the-Lambs moment. Hello Clarice……

Main Features:

  • RRSPs can come in a few different flavours: Individual RRSP, Spousal RRSP, Group RRSP, and Pooled RRSP.
  • Anyone 18 or older (16 in Quebec) can open one
  • You accumulate contribution room each year based on 18% of your earned income, up to a maximum limit set each year by the government, and adjusted downwards to account for other pensions you may have (more below).
  • When you make a contribution, it then gives you a tax deduction that you can apply against your taxable income.
  • You don’t need to claim your deduction in the year of the contribution. You can carry it forward to use in a year when you are in a higher marginal tax bracket.
  • Investments in the RRSP account can grow tax-free.
  • When you withdraw from the RRSP, it is taxed as earned income (the least favourable tax rate, but hopefully in a lower tax bracket than when you contributed).
  • You can no longer contribute after Dec 31 of year you turn 71 and it needs to have been cashed out, converted to a Registered Retirement Income Fund (RRIF), or annuity before then.

Let’s dissect each of these features in some more detail.

What are the different flavours of RRSP

Individual RRSP:  This is an RRSP for an individual into which they make the contributions for which they get the tax deduction.

T2 – “I’ll be back….. for your taxes.”

Spousal RRSP: This is an RRSP into which an individual contributes to a plan for their spouse out of contributor’s contribution limit. The contributor gets the tax deduction and if the money stays in for 3 years, it is taxed in the spouse’s hands when it comes out. Don’t tell Trudeaunator 2, but it is another form of income splitting like what they just harassed small business owners about 🙂

Group RRSP: This is an RRSP arranged via an employer where the employer has contributions deducted directly from your paycheck and put into your RRSP. The main advantage is that it reduces your tax deduction from your paycheck right away instead of annually at tax filing time. The employer may also make contributions, but that is not mandatory and they would be a taxable benefit. It also means you are stuck with whoever is managing the group RRSP and their associated fees. Be careful, fees kill. Sometimes you may have lower fees from the efficiency of a larger plan and a great manager, but you may not, depending on who the plan is administered by. The group plan could also limit your ability to withdraw money from the fund.

Pooled RRSP: These were introduced in 2011 by the Federal Government as an RRSP option for the self-employed and small businesses too small to warrant the costs of group RRSP on their own. It is a group RRSP administered via an institution, like a bank, rather than an employer. This makes it portable between employers. They have not really taken off as an option at this point. Only Ontario, Alberta, Saskatchewan, and Nova Scotia have passed the legislation to enable them so far.

How to open an RRSP

It is opened via a financial institution such as a bank, brokerage, credit union, or trust. This would be via your work’s plan administrator if a group RRSP. I don’t endorse any specific institution, buy generally an investment account is the way to go – either self-directed (if you decided to be your own portfolio manager) at a discount brokerage or via your advisor’s brokerage. An RRSP is not a special mutual fund sold by an institution. It is an account and you can put all sorts of investments into that account.

What you can have in your RRSP

An RRSP can hold anything that a TFSA can hold. This includes cash of any currency, equities, bonds, trusts, preferred shares, and certain debt obligations (like some fancy mortgage maneuvers).

How to figure out your contribution room

You accumulate contribution room each year based on 18% of your earned income (T4 income, non-CPCC self-employed income, CPP disability, net rental income) to a maximum set each year by the government. The max for 2017 is $26,010 which corresponds to an income of $144,500.

If you have a Registered Pension Plan (RPP) or Deferred Profit Sharing Plan (DPSP) at work, the amount contributed gives you a pension credit and reduces your RRSP room by the same amount, called the Pension Adjustment. Basically, this means you have the same tax deferral with a pension contribution as an RRSP.

In contrast to the TFSA, when you take money out of an RRSP, you do not get that as contribution room to put it back in. The exceptions to that are the Home Buyer’s Plan and Lifelong Learning Plan withdrawals where you can access money for these specific purposes and have to pay them back in order to avoid triggering the taxes.

To find out your actual room accounting for your previous contributions and withdrawals, you can look on your Notice of Assessment from the CRA that you get after doing your taxes each year or you can use the My CRA Tool.

Contribution Deadlines

To get the tax deduction for a given tax year, you need to have made your contributions either in that tax year or the first 60 days of the following tax year. While you can wait until the deadline, procrastination costs you. That money could have been growing tax-free for the previous year. To make that even more of a shame, that difference compounds over time. If you get a regular paycheck, consider making monthly contributions. If you get paid in erratic lumps sums, like I do in my business, consider contributing as early in the year as possible.

Certified Couch Divers

If you made a one time contribution of $26,010 at the beginning of the year you turn 30yrs old rather than the end of that year, that one extra year of compound returns of 8% (6% after inflation) would be a difference of $37K in today’s dollars at age 65.

If you have the money, then get off your butt and do it. If I dropped $37K down the crack of my couch, I’d get off my butt, and couch dive for it faster than my dog after a lost piece of aging cheddar. You can also use your tax refund to supercharge your retirement saving as Master Yoda will demonstrate in a future post.

The One-Two Punch of an RRSP

The Jab – Tax Deferral

At its core, retirement planning is about deferring the spending of some of your income today to have it to spend later when you aren’t working. The RRSP is well matched to that goal and is basically a tax deferral vehicle.

When used to maximum advantage, you are deferring taxes from a time when you make higher income and pay a higher marginal rate to one where you make less and pay a lower rate.

  • This can be in or close to retirement when you are working less or not at all.
  • It could be to help with a parental leave or sabbatical.

The other aspect of tax deferral is that it allows your investments to grow in your RRSP without paying tax annually.

  • This allows for more compounding over time for investments that would trigger frequent taxes like interest and dividends for example.
  • It also avoids the eating away of capital gains if you sell investments and realize those gains frequently.
Sylvester Stallone in Rocky IV, United Artists, 1985.

The Hook – Tax Credit

The item that hooks people into the RRSP is that you get some money back right away as a tax credit.

  • When you contribute, you get a dollar for dollar tax credit deduction from your taxable income.
  • You can carry the deduction forward to use in a year when you are in a higher tax bracket. For example, if a resident doctor contributes to their RRSP, they should delay claiming the credit for a few years until they are an attending and in a much higher tax bracket.

The Secret Move – Income Splitting

Trudeau vs MacDonald – Truro Daily, 2014.

Shhhhh! Don’t tell T2, seen here in a boxing match with a Halifax businessman, but the spousal RRSP is actually a tool for income splitting. I would love to see a redo of this match now after JT and Mourneau’s recent attack on small businesses for their “unfair” ability to income split.

A higher income spouse can contribute money to a spousal RRSP for a lower income spouse. After three years, that money can be removed by the lower earning spouse and taxed in their tax bracket. Voila! Income sprinkling! I love sprinkles.

Special Moves – Home Buyer’s Plan (HBP) and Life-long Learning Plan (LLP)

The HBP is a way to remove money from your RRSP to help with the purchase of your first home:

  • You need to follow a specific procedure and you can withdraw up to a maximum of $25K.
  • The withdrawal does not trigger income tax.
  • Your are required to start making a minimum annual payment after the 2nd year and it must be repaid before 15 years. You can repay it faster than that.
  • If you do not make the annual repayments, then the amount owing gets added to your income and taxed that year.

The LLP is available to remove money from your RRSP for full-time enrollment in an eligible programme:

  • You need an offer of acceptance from a qualifying programme and institution before March of the following year.
  • You can withdraw up to $10000 in a calendar year to a maximum of $20000.
  • If you contributed to your RRSP in the 90 days before using the LLP, you will not get deduction credits for those contribution. This is to prevent people from setting up an RRSP to use for the LLP.
  • When you are no longer a full-time student, you need to repay 10% of the loan amount per year and have it paid back you 10 years.
  • If you do not make the repayments, then the amount owing gets added to your income and taxed.

Sometimes bad stuff happens that you didn’t plan for – like you die. Well, hopefully you do plan for it just in case.

  • If you die and the heir to your fortune is not your spouse, common-law partner, or a financially dependent or disable child/grandchild, then when you die, your RRSP is considered sold and tax is paid as if it was all income. This would likely be a big tax bill to eat up your RRSP savings.
  • If you have one of the above named eligible beneficiaries, then your RRSP can be rolled over to the beneficiaries RRSP without using the beneficiary’s contribution room and the tax is deferred. If you did not name them as your beneficiary on your RRSP registration, it can still be rolled over, but is a more involved process – best to take care of this in advance.

Be careful not to punch yourself in the face.

Why are you hitting yourself? Why are you hitting yourself? Why are you hitting yourself…

The are a few potential situations where the tax treatment of RRSPs can hurt you or at least attenuate some of the RRSP advantage.

  • If you buy and hold investments with capital gains without selling them, then you may not gain as much advantage from this tax deferral since you aren’t triggering tax anyway.
  • In fact, if you make a capital gain in an asset in your RRSP, then when you take the money out of your RRSP, you are actually paying the full marginal tax rate rather than the half marginal tax rate for capital gains. This may or may not be an issue depending on a number of factors that we will explore in a future post.
  • If you claim your RRSP deduction in a low income year and then take the money out of your RRSP at a higher tax rate later, you pay more tax than you would have otherwise. Generally, people are in a lower tax bracket when they take the money out later in life, but that is not a guarantee. General wage inflation over time can bump you up. Promotions and career advancement can bump your income. Marginal tax rates can go up even if your income does not (mine went from 48% a few years ago to 54% now). Do we think the government will be needing more tax revenue or less in the long-term future?
  • How you hold foreign investments that pay dividends in your RRSP can also have a small impact due to the withholding taxes, depending on the country. This one is complicated, but fortunately small. We’ll explore it in another post.

Given the above potential pitfalls, how and when you withdraw from your RRSP is critical.

  • You want to “melt down” your RRSP rather than take it out in big chunks.
  • If you still have money in your RRSP at age 71, you need to roll it into a Registered Retirement Income Fund (RRIF) that will pay out at least 7% of your RRSP balance per year.
  • That income may bump you up into higher tax brackets and/or affect your Old Age Security benefits.
  • These may or may not be issues for you, but thought and planning of your exit strategy is required in advance. T2 warned you that he’d be back for your money. Be prepared.

Bet the last two sections surprised you, given how strongly RRSPs have been promoted for retirement planning.

  • Like the Force, there is both a Light and a Dark Side to RRSPs.
  • Soon, spend some time with Master Yoda, we will.
  • Wise in the ways of the Force he is and RRSP Jedi Mind Tricks will we learn.



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