What is an RRSP?

What is an RRSP?

A registered retirement savings plan (RRSP) is a government-approved account that allows Canadians to plan for retirement. First introduced in 1957, RRSPs provide a way for individuals to save and invest their money in a tax-efficient manner. Annual contributions to an RRSP can be used as a tax deduction, which reduces the amount of tax a person will pay on their income. In addition, all capital gains and dividends aren’t taxed a long as the money remains in the RRSP.

How does an RRSP work?
Every year, Canadians with “earned” income (salaries or wages from a job) who file a tax return may contribute money to an RRSP. The contribution limit is defined as either 18% of your previous year’s earned income or a specified amount set by the Canada Revenue Agency (CRA), whichever is less.

This contribution may then be used as a deduction when filing for the previous year’s taxes. For example, if you contribute $2,000 to your RRSP, your income is then reduced by $2,000 for the purpose of calculating the tax you owe.

Canadians are permitted to hold a wide variety of investments in their RRSPs. Some common RRSP investments include GICs, stocks, bonds, mutual funds, ETFs, cash and more.

There are three main benefits of having an RRSP:

1. You get a tax deduction—Contributing to an RRSP gives you a deduction when you file your taxes. What this means is that your taxable income is reduced, which lowers the amount of tax you’ll pay. It may also put you into a lower tax bracket.

2. Money grows tax-free—As long as the money remains in your RRSP, all capital gains and dividend/interest income won’t be taxed. This allows your RRSP to grow significantly until such time as you either withdraw money or reach the age of 71.

3. Tax deferral—Money held in an RRSP (both the contributions and investment gains) won’t be tax-free forever. You’ll pay tax on the money when you withdraw it, presumably at retirement. However, for most people their marginal tax rate will be lower in retirement, so by deferring the tax until you’re older, you will end up paying less.

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