If you frequent Canadian personal finance blogs, you’re already familiar with the Registered Retirement Savings Plan (RRSP). However, while members of the personal finance community might be privy to the perks of the RRSP, the average Canadian is not.
Only about 38% of Canadians contribute to an RRSP. The ones that don’t complain about lack of funds, market volatility and feeling that it simply wasn’t “important” to make a contribution. Source.
I didn’t start my RRSP until I was 25. I put $2,500 in that year, and this year (two years later) is the first time I’ve claimed the deduction. Last year and the year before, I contributed to my employer’s mandatory pension plan, and claimed those deductions, which also counts towards my RRSP contribution room. Despite having a retirement plan through work, I’m contributing to my RRSP for a few reasons:
primarily for the income tax break
secondly because putting money in now means it will earn interest and compound for decades
and lastly, because there’s the opportunity to use that money to achieve other financial goals other than retirement.
That last one is something I think most 20-somethings don’t know about. Maybe if they did, they’d start building their retirement funds a lot sooner.
RRSP Fast Facts:
- your annual contribution limit to your RRSP is 18% of your gross income to a maximum of $23,820 (for 2012, this limit generally increases every year).
- unused contribution room can be carried forward to future years
- you can contribute to your RRSP but claim the contribution in a future year (this gives time for your contribution to compound and you can still use the deduction for taxes when you’re earning more in a later years)
- you can keep your RRSP savings in any savings or investment vehicle, including: savings account, GICs, mutual funds, stocks, etc.
The First Time Homebuyer’s Plan
The first time Homebuyer’s Plan (HBP) will allow you to withdraw up to $25,000 from your RRSP for a down-payment on your first home. If you’re purchasing with a partner, they can also withdraw up to $25,000 from their RRSP. This can give a couple up to $50,000 to put down on their first home. The catch is this is just a loan: you will need to put back the money you borrowed from your RRSP. You have 15 years to pay back the amount you withdrew. If you borrowed the full $25,000 this is about $139/mo. But hopefully if you had $25,000 in the RRSP in the first place, you’re a good enough saver to work $139/mo of saving into your budget ;)
Remember: in your 20′s, time is nearly as valuable as capital. The sooner you put your borrowed money back, the longer it has to compound which means a greater nest-egg when you actually do need it for retirement.
The Lifelong Learning Plan
Like the First Time Homebuyer’s Plan, the Lifelong Learning Plan (LLP) will allow you to withdraw an amount tax-free from your RRSP that you will later need to pay back. The limit for the Lifelong Learning Plan is $10,000. You have 10 years to pay this amount back, which works out to $1000/yr or about $83/mo. Again, no big deal if you’re a good saver! This is a great option if you’re seeking to increase your education to boost your income. High paying degrees like an MBA or an MD can justify the investment, but I’d discourage you from borrowing from your retirement nest-egg just to study something for interest sake.
Remember: if you borrow under the LLP, you have to actually go to school. If you withdraw the money but fail to enrol in an accredited program, you’ll have to pay the money back in less than 10 years.
Can you withdraw from your RRSP for other non-retirement reasons?
Technically, yes — but you shouldn’t. When you withdraw from your RRSP outside the Homebuyer’s or Lifelong Learning plan, not only is your withdrawal taxed, you never get back the contribution room. If you’re in absolute dire straights, ie. jobless with no other source of income, withdrawing from your RRSP might be worth the the drawbacks, but in any other circumstances it’s likely to do more harm than good.
I think Canadians have a great tool!
Not sure what the Roth IRA or 401K rates for Americans are, but I bet it’s not much better.
So many young people end up fixated on saving money in their RRSPs when they really ought to be paying off higher cost things. This is especially true when you add wage increases into the mix. Take me for example… I was much better off saving my contribution room when I was making 50K/yr, knowing that within a few years I would end up in a much higher tax bracket. Likewise for my spouse. In our fields, there is a steep increase in wage rates and then it levels off, over the first five years or so.
Anyhoo, the moral of the story is that most young people should be contributing to their OTHER debts before paying into an RRSP. The return on your RRSP needs to outweigh tthe *negative* return on your other debts, otherwise you’ve got a negative overall return, effectively canceling out any compounding gains from contributing. (Obvious exceptions apply, like employer matching, etc).
Would your 2012 annual contribution limit be 18% of your 2012 gross income or 2011?
Your 2012 contribution limit is 18% of your 2012 gross income =)
I’ve read that it’s 18% of earned income from the previous year, so your 2012 limit would be on your 2011 Notice of Assessment. Is that incorrect? (I’m just a little unclear as I’ve heard/read different things and want to ensure that I don’t over contribute) Thanks!
My understanding is your deduction limit for the year is based on the income for the same year. So your 2012 limit is based on your 2012 income — which is why you probably have the first 3 months of the new year to top up unused RRSP room.
CRA website says this:
“We determined your limit from information on your 2011 and previous year’s returns, and from information we keep on record. If your earned income changes, your 2012 RRSP deduction limit may also change. In most cases, we will inform you of any change to your 2012 RRSP deduction limit.”