How Do RRSPs Actually Work?
John Woodfield, Senior Wealth Advisor, Portfolio Manager, B.Comm, CFP®, CIM®, FMA, FCSI®
Summary of Key Points
RRSP contributions are deductible in the year made, reducing taxable income immediately.
RRSPs allow a wide range of investments, including GICs, term deposits, mutual funds, stocks, bonds, and real estate investment trusts.
Withdrawals from an RRSP are fully taxable and added to income in the year the money is taken out.
RRSP withdrawals are not mandatory until the year after age 71, when the RRSP converts to a registered retirement income fund, which requires withdrawals.
RRSPs are recognized under the Canada-US Tax Treaty, so they do not create IRS issues for American or dual citizens living and working in Canada.
Video Script
In this video we’re going to walk through the top 3 things you need to know about RRSPs and how they actually work. You’ll also learn that proper planning with an RRSP is important because without it you could face a large tax hit.
If you find this video useful, make sure you subscribe to the channel below and visit our website for more articles and videos on cross-border financial planning.
As a financial advisor licensed in both Canada and the US many clients come to me not knowing how RRSPs actually work.
1) Understanding RRSPs
Here’s how you understand an RRSP: picture an RRSP as an empty box where the money that you placed in that box is removed from taxable income in the current year. For example if you made $100,000 and place $20,000 in the RRSP box you are taxed as if you only made $80,000. It is an immediate benefit because it reduces your taxable income and therefore your tax bill.
There are some rules with RRSPs. You can only contribute 18% of your previous years salary up to a maximum which is decided each year. As of 2020 the maximum RRSP contribution per year was $27,230.
2)What investments can you hold in a RRSP?
They can be set up at financial institutions and can hold anything from cash, mutual funds, bonds, ETFs, GICs, and REITS. In other words, they are extremely flexible.
3)RRSP Withdrawals & Tax Rates
When you withdraw money from an RRSP you pay taxes at your current tax rate. The aim is that when you’re retired, your tax rate will be lower than when you were working because you aren’t earning a lot of additional income. At 71 your RRSP needs to be converted to a RRIF, and you need to start taking money out the following year.
The main thing you want to remember is that an RRSP is a tool, and you want to contribute in your higher earning years. Then you want to take money out when you are earning less and are in a lower tax bracket. You don’t have to wait until you are 71 to take the money out, but you will owe taxes when you withdraw and you lose this contribution room forever.
Always remember that because your RRSP is taxable in the future, proper planning of when you take the money out is very important.
4)Canada US Tax Treaty and RRSPs
Lastly, as RRSPs are recognized by the Canada/US Tax Treaty, if you are a US person living in Canada you can contribute to an RRSP and benefit from tax deferred growth.
Are you maxing out your contributions to your RRSP each year?
If you’re in your highest earning years, but you’re not sure if you’re maxing out your RRSPs, then you should speak to a financial advisor or take a look at your last year’s tax return to calculate how much room you currently have.