The 2020 RRSP deduction limit (contribution room) has increased to $27,230. This is up from the 2019 limit of $26,500. That is the main change you need to know for planning your 2020 RRSP contributions this year.
Are you new to RRSPs or have some questions on what they are and how they work? Wondering why your parents keep talking about setting up an RRSP account? Our goal in this article is to help simplify the information for you. Here is your one-stop shop for everything you need to know about your 2019 RRSP!
What is an RRSP?
An RRSP, or “Registered Retirement Savings Plan,” is a retirement account used by Canadians to help save for retirement. RRSPs are typically set up as investment accounts, or high-interest savings accounts. As a “registered” account, the federal government tracks the activity of it. Don’t worry, they aren’t looking too closely. Basically, they track the activity so they can keep track of the benefits associated with the account.
Why You Need an RRSP Account
Employers do not offer pensions like they used to. According to Statistics Canada, the proportion of workers with pension plans has been declining for decades. Employers are simply not funding retirement for their former employees as much as they used to. There is no sign of this trend stopping. You need to make sure that you have your own retirement savings stored up for life after work. RRSP accounts make building up your retirement nest egg easier.
Why Are RRSPs so popular?
If your parents are of the “Baby Boomer” generation, you have likely come across someone who has prompted you to look into opening an RRSP account. RRSPs come with some interesting benefits:
- They have Tax Deferred growth.
- The money put into RRSPs is Tax Deductible.
- There are Spousal RRSP benefits.
What does that mean exactly?
RRSPs provide tax-deferred growth
Tax-deferred growth means that you can put money into the account and not pay any tax on growth in the account until you withdraw funds. The money in the account is allowed to grow without any taxes applied until the money is withdrawn from the account. Taxes are “deferred” until you withdraw funds from the account.
This differs from a “non-registered” account. In a “non-registered” investment account, you are supposed to claim how much your investments made or lost each year for tax purposes.
Why does tax-deferred growth matter?
Tax Deferred RRSP Investments Can Grow Faster!
By not having to pay investment-related tax every year, there is a bigger pot of money able to earn MORE money. The increased value gained during the course of the year allows your investment to grow faster. If the taxes incurred were taken out every year, it would slow down the growth. Over a short period of time this may not amount to much difference. Over a long time frame, the benefit of tax-deferred growth becomes much more noticeable!
Here is a simple example using a comparison calculator (RRSP vs Non-Registered Account comparison calculator):
Consider an initial $10, 000 investment, growing at an annual rate of 8%. With monthly contributions of $500, in 30 years the RRSP would grow to $809,779. Assuming a 30.5 % tax rate, this RRSP would actually be worth about $562,796 to the owner (because the tax upon withdrawal would lower the actual value). Assume the same conditions for a non-registered account and it would grow to $503,098.
Almost a $60, 000 difference just for checking off a box and using the Registered Retirement Savings Plan!
RRSPs are Tax Deductible
The money you contribute to an RRSP is tax deductible. Put $10,000 into an RRSP and your total earned income for tax purposes would also decrease by $10, 000.
For example, say you earned $100,000 this year. You were wise and put $10,000 into RRSPs. Here, your income tax adjustment would change and be based on $90,000 of income. Since you have already paid income tax on $100,000 you would get a tax refund because you had “overpaid” by $10,000 on your taxes throughout the year.
Why does the government give you the tax refund for investing in an RRSP?
RRSP Withdrawals are Taxable Income
RRSP contributions receive a tax break because the government taxes the full amount upon withdrawal. Contributions into an RRSP use “before tax” money. Tax-deferred accounts can benefit the government. A larger nest egg means a greater amount for the taxman when the funds are finally withdrawn. This differs from a TFSA which uses “after-tax” dollars that the government has applied tax to.
How much does the government tax your RRSPs? The same amount as your marginal tax bracket for the year you withdraw the funds. RRSP withdrawals are considered income just like income earned from a job. Upon withdrawal, the government finally takes its “cut” in the form of income tax.
If the government gets its fair share anyway, why use RRSPs for tax purposes?
Using RRSPs Can Lower Your Income Tax
The tax deduction from RRSP contributions is especially powerful if it lowers your income to a lower tax bracket. Say your annual income is $5000 over one of the marginal tax bracket limits. If you contribute $5000 into an RRSP account your income stays at the threshold.
Hopefully, you will not need to access your RRSPs until retirement. When you start to withdraw funds from your RRSP you will ideally be in a lower tax bracket than when you initially contributed. Contributing to RRSPs is especially beneficial for individuals in higher tax brackets because of the potential tax breaks.
Spousal RRSPs Can Lower Family Taxes
A great feature for tax planning involves the spousal RRSP. Spousal RRSPs can be set up so that either spouse (this includes common-law partners) can contribute, as well as withdraw from the account. Why is this important?
If one spouse works, and the other does not, they will have different marginal tax rates. The higher-earning spouse can contribute to a Spousal RRSP plan, and receive the tax break. At retirement, the lower-income earning spouse can withdraw the funds at a lower tax rate. Less taxes! Furthermore, dividing withdrawals between spouses can help prevent either spouse from entering a higher tax bracket.
RRSPs have “Deduction Limits”
TFSAs have “contribution limits” while RRSPs have “deduction limits.” Deduction limits work with RRSPs because it describes the maximum tax deduction allowed. “Deduction limit” is the same as the “contribution room.” Most people refer to it as the contribution limit.
You can put up to 18% of your annual income into RRSP accounts, up to a specified maximum, without penalty. The caveat is that you may only contribute up to the LOWER of the two limits. Canada Revenue Agency changes the maximum deduction limit regularly. You can view the limits for previous years here.
Additional Factors can Affect Your Deduction Limit
Any unused contribution room carries forward indefinitely if you do not maximize your contributions. Essentially, your total contribution room is 18% of your total earned income for as long as you’ve been working.
Interesting point: You do not have to claim the tax deductions the same year you make the contribution. Savvy planners expecting a raise down the road will sometimes take the tax deduction after reaching a higher tax bracket.
Contributing to another pension plan (such as public sector workers having work pensions) can affect your deduction limit as well.
2020 RRSP Deduction Limit Has Increased
For 2020, the maximum RRSP deduction limit has increased to $27,230. This is an increase from the 2019 limit of $26,500.
Want to find out your own personal maximum deduction limit? You can do so on the Canada Revenue Agency website HERE.
RRSP Over-Contribution Penalty
Over-contribute by $2,000 and you can face a penalty of 1% per month on the excess. For this reason, it’s very important you pay attention to your RRSP contribution limit.
Withdrawals from an RRSP Affect Contribution Room
You can withdraw money from an RRSP at any time (unless it is a “locked-in RRSP“), but there are a few things to consider before doing so. When you withdraw money from a TFSA you re-claim the contribution room the following calendar year. RRSPs are not given this reset. When you make a withdrawal from your RRSP account, that money is taxed, and you do not regain that contribution room ever again.
The exception to this rule is if a person withdraws funds using:
Repaying funds using these programs does not affect your contribution room, because it is a “repayment.”
Who Can Open an RRSP?
Any Canadian with employment income, a SIN number, and who has filed a tax return can contribute to an RRSP account. Unlike a TFSA, you do not need to be 18 years old to open an RRSP, you just need employment income. A person may contribute to their RRSP until the end of the year they turn 71. For couples who have a Spousal RRSP in place, contributions can continue until the end of the year the youngest turns 71.
Age 71 is an important year for RRSP holders because that’s the age you can no longer contribute to an RRSP.
What Happens to my RRSP at age 71?
When a person turns 71, they have 3 options for their RRSPs:
- Cash it all out (ou will have a big tax bill if you do this with a large nest egg)
- Transfer the RRSP to an Annuity.
- Switch the RRSP into a RRIF (Registered Retirement Income Fund)
Nevertheless, unlike the TFSA the RRSP has a very definitive “end date”. You can make contributions to your RRSP up until 71, but after that, you will be forced to start making withdrawals. You can make contributions to your TFSA for your entire life.
How Do You Open an RRSP?
Opening an RRSP account is like opening any bank account. All you need is Government ID and your SIN number. Have internet access at home? You can open an RRSP at home in your pajamas because of the good ol’ internet! You will still need your ID and SIN number handy because your information needs to match your documents exactly.
What Type of Investments Can Go in an RRSP?
You can put most standard types of investments into your RRSP, such as stocks, bonds, mutual funds, ETFs, cash, etc.
Most financial institutions would love to get your business and offer some type of investment that can go in an RRSP. Your local bank or insurance agency is sure to have some investment products. While some people prefer traditional brick and mortar facilities there are some great reasons to shop around online for your RRSP investment account.
Be Mindful of Fees!
Hidden account costs and fees can quickly eat into your investment returns. Do not put your retirement in financial risk by neglecting to compare fees! Some of the fees you will need to watch out for include:
- account fees (many institutes require a minimum balance before waiving account fees)
- management fees
- inactivity fees
- commissions and/or trading fees
Ideally, you will want an account that has no minimum balance requirement, no account fees, and low management fees (around 1% or less).
3 Top Choices for your 2020 RRSP
Different companies are suited for different types of investors. Here are three companies that stand out for 3 different investing styles:
- Questrade – has great benefits for self-directed investors who like to manage their own portfolio. They offer low trading fees on stocks and ETFs that can be purchased for free!
- Wealthsimple has some of the lowest fees in the industry, and the simplest fee structure. They offer innovative portfolio management at an amazingly low rate.
- Tangerine is great for anyone looking at more traditional investments. GIC’s through Tangerine have some of the highest rates in the industry, while their mutual funds have some of the lowest management fees.
You’ll notice that all of these Top-picks are accessed online. Online-based companies have less overhead costs than brick and mortar businesses, so they can pass the savings on to you.
Want an instant 100% Rate of Return on your RRSP?
Employer-Matched RRSP Contributions are Free Money
Though rare, some employers still have programs to match employee RRSP contributions. Take full advantage! It is literally free money, and earns you an instant 100% return on your investment!
Action Plan for Your 2020 RRSP
It is now time to make real change happen. Here are the action steps for you to take immediately! Seriously, if you do not follow these now, at least put a reminder in your phone to have it done ASAP! Future you will be grateful.
The most important step: open one! 2020 won’t be young for long. While you are still fired up to get your life on track, open an RRSP!
Automate your RRSP for every payday. You should aim to put 10%-20% of your gross pay into your RRSPs. The government gets their cut first through automatic income tax deductions. Pay yourself before the taxman gets his full share.
Build your contributions up over time. If stocking away 10% into an RRSP is too much of a stretch for you right now, just start with something! Just make sure you contribute EVERY pay cycle and increase the amount over time.
2019 RRSP Contribution Deadline: March 2, 2020
The contribution deadline for the 2020 RRSP is actually the 60th day of 2021! Yes, next year. You have until March 2nd of this year to keep contributing to your 2019 RRSP. Fortunately, you can open an RRSP account now, and still get some tax advantages on your 2018 tax return.
Your 2020 RRSP
The 2020 RRSP deduction limit has increased to $26,500. Few people will be maxing out their RRSPs, so don’t feel bad if you are not one of them! The important thing is to make sure you have an RRSP, and contribute regularly to it. Find a low-fee financial brokerage, and get your retirement on track. Between the lower taxes and bigger pot of cash stored away, your future self will thank you!