RRSP may sound weird as an abbreviation, but the meaning here is simple: RRSP is just a Registered Retirement Savings Plan. Here are all the details about this loan type — with benefits and drawbacks.
Registered Retirement Savings Plans are retirement savings accounts just like your TFSA, RPPs, etc. But the thing is, they differ from these because they are only tied to retirement (note: not necessarily old age).
An RRSP is an account where you save for retirement. You can make contributions throughout the year (you can even make “over-contribution” or “over-contribution room,” which you’ll learn later on).
Now, the special feature is this: when you contribute, it gets deposited in the RRSP. Then, when you retire, you can “take all or some of your contributions out”.
RRSP is like having a little trust fund in place (and it is in some cases).
Who Can Apply for RRSP?
First of all — make sure you actually CAN apply for an RRSP (not to waste your time choosing it if you can’t):
- You have an open RRSP account in good standing with the CRA;
- You are in good financial standing with the CRA (meaning that your debt to monthly income ratio is under 80%);
- You maintain consistent documented credit history in the past five years (this means you don’t have any delinquencies or defaults);
- You are over 18 years of age (or age 25 or more);
- Your credit score is high enough for this type of loan (it’s not the same for everyone, so you need to check).;
- And finally, if you are in a stable job.
Benefits of RRSP
So, why not put the retirement savings in a “traditional” savings account or just keep your cash in a jar? Here are some of the unique RRSP benefits:
- When you make a contribution to your RRSP, the government offers you a tax refund. This is why they are called “tax-free savings account” or TFSA. You get all that money back by April 30. So, in the end, it’s just like you’re getting free money when you deposit into your RRSPs;
- Then, when you retire, you can withdraw a certain amount from your RRSP. The money is called “RRSP withdrawals” or “RRSP withdrawals from age 55”. Here’s how it works: You must be 59 1/2 at the time of the withdrawal to qualify for the early retirement. But still, you can withdraw up to 75% of everything you had accumulated in your RRSPs (but not your RIF). Or you can withdraw it all if you are 62 or older;
- If you are putting money into your RRSPs “through payroll deductions”, then your income for that year gets lower. Obviously, if your income is lower, you are paying fewer taxes;
- An RRSP is an asset for yourself, not just retirement, because, after retirement, you can still withdraw money (or take it out) even though the tax rate might go up (usually because you need to pay for living expenses);
In general, RRSPs are good for you because “you own them”. They are not tied to your job. The final but most important benefit is that an RRSP gives the freedom to choose the best time to make a withdrawal (typically after you retire or after it’s most needed).
Downsides of RRSP
With all those upsides, there are some drawbacks as well:
- You can’t access your RRSPs until about 5 or 6 years after you retire. This is due to the rules of grandfathering (so that all the older people don’t withdraw everything at once, which would create a huge deficit for the government);
- Thus, all the money you put into your RRSPs is not accessible till you retire (unless you withdraw it all at once);
- People do not need to take the money out of their RRSPs right away. So, this creates a possibility that your investments might decrease in value due to inflation and other factors (like the stock market);
- And just like your RSPs, you cannot contribute more than 18% of your income on an annual basis;
- Lastly, if you take money out of your RRSP before the age of 59 1/2, then it is considered a “withdrawal before the age of 59 1/2” or an “early withdrawal”, and you will be charged a tax.
Now it doesn’t look THAT perfect, right? However, there’s a pretty good chance you still can use these to your best advantage.
Types of RRSPs
In case the benefits outweigh the downsides for you — congrats, about 6 Million Canadians would agree. By the way, they keep around $112.000 on their accounts — on average, according to the 2020 statistics.
Now — to practice. First, you need to understand what types of RRSPs are available now.
The three main types are the following:
Unregistered Unrevised RRSP — This is an old-style RRSP discontinued in 2008/2009 – no questions asked, the money is yours. Not available anymore.
Rollover Unrevised RRSP — This type of RRSP was introduced in 2009 to prevent people from “stashing their retirement savings away”. So, you could not deposit money into your existing account while opening a new one for yourself. You had to roll it over. But with time, the rules have been relaxed so that you can deposit money into them now—still a good choice for people with plenty of cash.
Registered Unrevised RRSP — This is a new-style RRSP with a few restrictions.
Registered Revisions RRSP — These are the most common type of RRSPs in use today because they offer all the advantages of an RRSP and rollover account simultaneously (you can deposit money into them and withdraw it without any problems).
Unregistered Revisions RRSP — This is a rollover RRSP revised from the old-style “Unregistered Unrevised RRSP,” meaning that all your money is yours. The only problem with the Unregistered revisions RRSP is that they are a bit more complicated to manage.
How to Choose the Best RRSP
Let’s go further into details. There are a lot of factors you should consider when choosing the best RRSP from the list I’ve given you. Here are some of them:
Most financial advisors recommend contributing about 10% to 15% of your income annually. Also, make sure you contribute to whichever fund will add up most by the end of the year — if you can’t decide, just go with the one that is EASIEST to withdraw (which might not be your best one).
Rolling over your money from an existing RRSP to a new one is also a good idea. But make sure you know all the rules and regulations when rolling over your money. Some banks will charge you a fee for doing it (e.g., TD charges $100). So, make sure the new banks charge the same — if not — ask them to waive it.
Ensure you know all the tax implications of your choices in detail (if in doubt, refer to your financial advisor or tax professional). Some banks might be somewhat complicated to work with if the tax implications are not calculated properly. So, make sure everything is clear from the start.
The Withdrawal Amount
NOT considering it is the most common mistake people make when choosing an RRSP. The amount of withdrawals you can make from it is directly connected to the number of contributions you make. So, consider this when choosing your best RRSP.
These are the benefits you get if you decide to withdraw the money before retirement (usually after turning 59 1/2). It depends, but most financial advisors would recommend leaving 20% of your retirement fund untouched (leave it in your RRSP). This would leave you with enough money that you can withdraw in case of emergency (e.g., if you need a car to work).
The Bottom Line on RRSPs
In general, RRSPs will help you save a lot of money on taxes and give you a lot of benefits for your retirement and other expenses. So, don’t forget to use them and let them work for you — do not just stash your money somewhere and hope that things will work out.