Hello! This week we'll be learning about Registered Retired Saving Plans (RRSP). Once again, there is a lot to cover but I'll do my best to keep the information short and easy to understand. Let's go!
How Does It Work?
RRSP is a great option for Canadians to save for retirement. I see lots of people using their RRSPs for the tax deduction but they don't invest in anything and lose out on the opportunity to grow their savings. It offers 4 great benefits to help you:- Tax-Deferred Growth - Your money grows tax-free until you take the funds out.
- Contributions are Tax-Deductible - You can reduce your taxes by depositing money in your RRSP.
- Lifelong Learning Plan (LLP) - You may borrow funds from your RRSP to pay for schooling.
- Home Buyer's Plan (HBP) - You may borrow funds from your RRSP to buy a home.
Similar to the TFSA, there is an overcontribution penalty of 1% on the excess amount for each month it's over. There is a slight difference though. Did you know that you're allowed to overcontribute to your RRSP to a maximum of $2,000. The penalty will only apply if you contribute over the $2,000 threshold. It gives you a bit of breathing room but make sure you watch your limits for your RRSPs. You may also make contributions for the first 60 days of the new year towards the previous year.
As of 2020, your RRSP annual contribution room is 18% of your earned income up to a maximum of $27,230. You could also think of it as the lesser of 18% of your income or $27,230. Any amount that you don't use for the current year can be used for future years. A key point is understanding that it only considers earned income. These include any income from a job, self-employment, and rental property. They do not include earnings from your investments, EI and other government benefits.
Upon retirement, you may choose to convert your RRSP into a Registered Retirement Income Fund (RRIF). At this point, you may start withdrawing on your savings to fund your retirement. You will be forced to convert your RRSP into a RRIF at the end of the year you turn 71. When you withdraw from your RRSP, outside of the LLP and HBP, you will be subject to withholding taxes. Depending on how much you withdraw, a percentage ranging from 10%-30% of your funds will be taxed. In addition, they will also be subject to income taxes because they will be added to your overall income for the year. These are the rates for withholding taxes:
It's almost as if it's designed to punish you by taxing you twice for taking money out of your savings. Isn't that interesting? I'll expand on this more in next week's post!
Upon retirement, you may choose to convert your RRSP into a Registered Retirement Income Fund (RRIF). At this point, you may start withdrawing on your savings to fund your retirement. You will be forced to convert your RRSP into a RRIF at the end of the year you turn 71. When you withdraw from your RRSP, outside of the LLP and HBP, you will be subject to withholding taxes. Depending on how much you withdraw, a percentage ranging from 10%-30% of your funds will be taxed. In addition, they will also be subject to income taxes because they will be added to your overall income for the year. These are the rates for withholding taxes:
It's almost as if it's designed to punish you by taxing you twice for taking money out of your savings. Isn't that interesting? I'll expand on this more in next week's post!
Paying for School
Did you know about the Lifelong Learning Plan (LLP)? You can use this plan for yourself or your spouse to help fund your education. As of 2020, the government allows you to withdraw $10,000 per year to a maximum of $20,000 per individual without taxes to help pay for full-time schooling. You must meet the conditions for full-time schooling which is 15 hours per week or taking 3 full credit courses as a student. You must also receive a letter of enrollment before March of the year you withdrew. You have 10 years to repay the funds back into your RRSP. You will need to pay 10% per year of the total amount withdrawn from your RRSP. If you do not pay it back, the amount will be added to your income and taxed. Your start date for your payment varies based on personal circumstances but you can read more about it 'here'.
Buying a Home
The RRSP also has a second plan to help you buy your first home. It's called the Home Buyer's Plan (HBP). You may actually use this plan numerous times to buy multiple homes but you must meet the eligibility of being a 'first-time home buyer'. The requirement is, you did not live in a home that you or your spouse owned in the last 4 years. In addition, you have to buy the home before October 1st of the year after the year you withdrew. As of 2020, under this plan, you're allowed to withdraw a maximum of $35,000 per individual or, $70,000 per couple. Similar to the LLP, the amount is tax-free. You have 15 years to repay this plan. Your first required repayment is 2 years after your first withdrawal. You can read more about the HBP 'here'.
Spouses
Other than the Registered Retirement Income Fund (RRIF), which will have its own post, I wanted to quickly cover some rules regarding RRSP with spouses. The attribution rule plays an important role when it comes to taxes but is often not understood by many. I will explain with the following example:- Peter & Mary have a spousal RRSP in 2020
- Peter contributes to Mary's spousal RRSP in 2021
- Mary takes funds out from her spousal RRSP in 2022
What happens?
I've already established that money in an RRSP is tax-deferred until you withdraw the funds. In this scenario, Peter will be taxed on the funds that Mary withdrew. This is because of the attribution rule. Since Peter made contributions in 2021, there is a waiting period of 3 years until he is free of any tax consequences on a withdrawal made during that time. If Mary took the funds out in 2024, she would be liable for the taxes on the withdrawal from the RRSP instead. This is important when it comes to tax planning to avoid owing unexpected taxes. Additionally, because Peter made the contribution, he would receive a tax deduction. Mary would receive nothing.
Upon Death
What do you think happens when you die? If you guessed taxes, you're correct. Your funds will be taxed, and whatever remains will go to your named beneficiaries. With RRSPs/RRIFs, there are 3 exceptions where the funds don't get taxed right away upon your death. The beneficiaries must be one of the following:- Your spouse/common-law - The funds become tax-deferred until the spouse takes the funds out.
- Your financially dependent child under the age of 18 - The funds become tax-deferred until the child takes the funds out. May be held by a guardian or trust until they become 18.
- Your financially dependent infirm child (mental or physical) - The funds become tax-deferred until the child takes the funds out.
Rules to Remember
- As of 2020, your maximum annual limit is 18% of your earned income up to a maximum of $27,230. This dollar amount will increase every year.
- Your money grows tax-deferred until you take money out. If you take funds out of your RRSP, it will subject to withholding and income taxes
- If you withdraw from your RRSP, you lose your contribution room
- Your contributions during the first 60 days of the new year may be applied to the previous year
- You may borrow from your RRSP for the HBP & LLP
- Your RRSP must become a RRIF by December 31 in the year you turn 71
- You have the option to buy an annuity with your RRSP instead of converting into a RRIF
- There is an attribution rule of 3 years for spouses
- The spouse that contributes to a spousal RRSP receives a tax deduction. The other spouse does not get the deduction
- You may overcontribute a maximum of $2,000 over your limit
- The penalty for overcontribution is 1% of the excess amount over the extra $2,000 for each month
These posts just keep getting longer! I think I did a good job condensing all the important information. The links are also found in the 'Resources' tab. See you next week!
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