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You've probably heard that RRSPs are a great way to save for retirement but if you're like plenty of other Canadians out there, you might not understand exactly what they are or how they work.
Below, we discuss some of the top questions that are usually asked about RRSPs so you can decide if this is the right type of investment for you.
An RRSP, or Registered Retirement Savings Plan, is an investment account that's designed exclusively to help you save funds for retirement. If you deposit cash into an RRSP it can earn tax-free interest. You can also place investments into your RRSP, which can earn tax-free gains and dividends.
It's important for Canadians to keep in mind that while RRSPs do come with benefits, such as a reduction in income taxes, they also come with steep penalties if cash is withdrawn.
With an RRSP, you deposit cash or investments into your account and the value is held for you in trust by your financial institution. The balance then gains interest, gains or dividends which is added to your account. The year you turn 71, you must collapse your RRSP, at which point it will pay you a retirement income and contributions are no longer accepted.
Most investments can be deposited to RRSPs. That includes:
Some investments, such as held debts, personal property, precious metals, and real estate can not be held in an RRSP.
There are three main types of RRSP in Canada:
In Canada, there are several major benefits to opening an RRSP account. The most substantial benefit to consider is that your contributions are tax-deductible, meaning that your overall tax owing each year is reduced by depositing cash or investments to your RRSP.
If you're young or just new to the real estate market, you can also benefit from the First-Time Home Buyer Incentive, which allows you to withdraw funds from your RRSP without penalty to use toward the purchase of your first home.
And of course, when you retire, your RRSP will ensure that you have a substantial nest egg to rely on when your employment income stops.
RRSP contribution limits are the maximum amount that a person is permitted to contribute to their RRSP annually. This limit for every Canadian is the same and increases each year. The 2020 contribution limit is $27,230 and in 2021, the limit will be set at $27,830.
Each year, the Government of Canada sets an RRSP contribution deadline. For the 2019 tax year, the deadline was set at March 2, 2020. Canadians who are aged 71 or older must complete all contributions before December 31 the year they turn 71.
If you have a locked-in RRSP, you won't be eligible to make withdrawals from your account until after you've turned 71. If your RRSP isn't locked in, you can make withdrawals on your account. However, it's important to remember that these withdrawals are subject to fees from your financial institution as well as income tax.
All Canadians who earn employment income are eligible to open an RRSP. They're a great idea for those who are interested in saving money for retirement and who don't intend to withdraw funds from their savings. Those who require regular access to their savings may want to consider alternative options, such as a TFSA.
TFSAs and RRSPs have many similarities; however, each offers different contribution limits and flexibility levels. The type of account you choose depends mostly on your financial situation and personal preferences.
Both TFSAs and RRSPs are registered with the Government of Canada and both can be used to hold cash and investments. Each account earns similar interest, gains and dividends - all of which are tax-free. Each type of account also has contribution limits, as well. With TFSAs, these limits carry over from year to year when a portion is unused, with RRSPs, they don't.
When it comes to withdrawals, this is where TFSAs and RRSPs differ dramatically. An RRSP limits you substantially when it comes to withdrawals. You are only permitted to take out up to 18% of your income when withdrawing from an RRSP account and each withdrawal is taxed. With a TFSA, you are permitted to withdraw funds as needed without being subjected to fees and taxes.
These two investment types differ when it comes to tax-savings as well. While all RRSP contributions are tax-deductible, TFSA contributions aren't.
When choosing the type of investment that works best for you, it's important to weigh the pros and cons of opening an RRSP account. Overall, if your primary goal is to build up savings for retirement, speaking with your financial institution about an RRSP is probably the way to go.