401(k) vs RRSP: What’s the Difference?
Tiffany Woodfield, Senior Financial Advisor, Associate Portfolio Manager, CRPC®, CIM®, TEP®
Summary of Key Points
Both 401(k) plans and RRSPs were created to help people save, grow their investments, and defer tax until withdrawals, with government-set contribution limits.
A 401(k) is set up through an employer or as an individual 401(k), while an RRSP can be employer-based as a group RRSP or opened individually.
Canadians have RRSPs while Americans have 401(k)s.
RRSP contribution room is based on 18% of prior-year earned income up to a Canadian maximum, while 401(k) limits are set amounts by the IRS.
Unused RRSP contribution room can be carried forward until age 71, while 401(k) plans do not allow carry forward but offer extra room after age 50.
RRSP withdrawals are penalty-free but are taxable, and you permanently lose contribution room.
401(k) withdrawals before age 59½ generally face a 10% penalty.
Note: Contribution room and withdrawal rules may change. Make sure you check the latest information on the CRA website before making any investment decisions.
Video Script
In this video we’re going to walk through the difference between a 401(k) and an RRSP and how to know if you can contribute to an RRSP.
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As a cross-border financial advisor I often work with clients who want to understand the difference between an RRSP and a 401(k).
There are five things you need to know about 401(k)s and how they are different from RRSPs.
1) Both plans were created by their governments to help people invest and grow retirement savings.
RRSPs are Canadian while 401(k)s are American. But they do have some basic similarities. They both allow you to grow your investments while deferring the tax until you take money out. They both allow multiple types of investments including stocks, mutual funds and bonds. And they both have contribution limits, meaning you can’t just put as much money into them as you like.
2) But there are some differences between a 401(k) and an RRSP.
A 401(k)is always set up through your employer and contributions are deducted from your paycheck. In Canada an RRSP isn’t set up through your employer. However, we do have a Group RRSP, which like a 401(k), is set up through your employer.
3) Now, let’s talk about the contribution room i.e. the amount you can invest.
The amount you can contribute to an RRSP is based on earned income from the year prior. To be allowed to put money into an RRSP you need to have earned income the year before. Earning income is what earns you contribution room. You may also have unused contribution room from previous years.
With a 401(k) what you can contribute is a set amount. It is set by the IRS regardless of your income in the previous year. The amount you can contribute to your 401(k) increases after age 50.
4) Another difference between 401(k)s and RRSPs are the carry forward rules.
If you didn’t fully use all the contribution room you earned in a RRSP that extra room is carried forward to the next year. You can put in more money in future years. But with a 401(k), the contribution room cannot be carried forward to future years.
5) Finally let’s talk about penalties! There are no penalties for withdrawing money from an RRSP.
Of course you do have to pay tax on the amount you withdraw. With a 401(k) there are some exceptions, but typically you have a 10% penalty if you withdraw before age 59.5.
Are you trying to figure out if you can contribute to an RRSP?
If you have worked in Canada I recommend you register for an online account at the government of Canada website to see how much RRSP contribution room you have.