Many of us understand the value of the Registered Retirement Savings Plan (RRSP): almost six million Canadians make RRSP contributions every year.1 Most of us also know about the tax benefits of RRSP contributions and that it’s an extremely versatile and effective retirement planning tool.
RRSPs are typically used for long-term savings, with the money we contribute bringing us a tax deduction. Contributed funds can also grow on a tax-deferred basis until we take those dollars out in retirement. We’re then taxed based on our personal income tax rate in the year we withdraw the money (which, in retirement, should be lower than when we contributed and got the original tax break). Contribution room is based on earned income levels (up to 18% of earned income from the prior year, to a maximum amount of $29,210 for 2022),2 with unused contribution room carried forward to future years. Those who contribute generally see a tax refund due to the available tax deduction.
Here are a few lesser-known benefits of RRSPs that you might not be aware of:
1. You can (and maybe should) delay taking your RRSP tax deduction
People tend to claim their RRSP deduction immediately, because they want to receive a tax refund as soon as possible. But if you anticipate being in a higher tax bracket in the next few years, you might want to wait. Your savings will still grow, but you’ll claim your deduction in the future, when your income is higher. This way, when you’re in a higher income bracket, you’ll receive a higher tax refund.
For instance, in Manitoba, a taxpayer with an income of $30,000 who claims a $5,000 RRSP deduction would save $1,290 in tax (with a savings rate of 25.80%).3 If they wait until a later year to claim the deduction, when their income is $70,000, the tax savings on the $5,000 deduction would be $1,662 (with a savings rate of 33.25%). These additional tax savings are a result of the tax deduction reducing income because of the higher marginal tax rate in the later year.
2. In certain situations you can take money out of RRSPs early without a tax hit
While withdrawing money early from your RRSP would normally bring immediate tax consequences, one of the benefits of RRSPs is that there are two instances when you can withdraw funds early with no tax penalty. The Home Buyers’ Plan (HBP) allows you to take up to $35,000 out of your RRSP to buy a home, without paying tax on the amount withdrawn. You do, however, have to repay the amount in instalments over a 15-year period.
You can also take out money under the Lifelong Learning Plan (LLP), which is designed to help adults pay for their full-time education. However, with the LLP, you can only withdraw up to a maximum of $20,000, with a limit of $10,000 per calendar year, and it must be repaid in instalments over a 10-year period.
3. You can transfer investments into an RRSP
Another of the key benefits of RRSPs is the flexibility in what you can transfer into them. If you have stocks, bonds, GICs, mutual funds or ETFs in non-registered accounts, you can transfer them into an RRSP. A non-registered account is one that isn’t registered with the government and therefore has no tax benefits.
If your investments have made a gain since you bought them, you may have to pay capital gains tax when you transfer them into your RRSP. When you transfer these assets into an RRSP, they are deemed to have been “sold” at a fair market value and therefore taxable. Conversely, if the investments you’re transferring have made a loss, you can’t claim a capital loss when you file taxes if you transfer them into an RRSP.
It may make more sense to cash them in, claim the loss and then buy new investments with the cash that you contribute into your RRSP. Speak to your accountant about superficial loss rules if you anticipate buying back the same investment within your RRSP.
4. There is an over-contribution limit
Making the exact RRSP contribution amount that you’re allowed in any given year can be a tricky process, so another of the benefits of RRSPs is that the CRA allows for an excess RRSP contribution of $2,000. If you contribute any more than this, you will start paying a 1% tax per month until you withdraw the excess amounts. This excess amount is supposed to act as a buffer in case people accidentally contribute too much, but some use it to maximize the tax benefits.
While that excess $2,000 contribution will avoid the 1% penalty, it is not tax deductible. You should talk to your accountant to discuss the possible tax repercussions of over-contributing.
5. Spousal benefits of RRSPs/RRIFs
For many years, the spousal RRSP benefit was the only way to provide income-splitting opportunities for couples with a registered plan. However, in 2007, the Canadian government introduced a really useful extra benefit of RRSPs: pension splitting on payments from Registered Retirement Income Funds (RRIFs) — which RRSPs are eventually converted into — when the recipient is at least 65.
This change was designed to benefit families where one spouse earns significantly less than the other. Spousal RRSPs continue to provide for income-splitting opportunities, given that 100% of spousal RRSP withdrawals can be reported on the lower income spouse’s tax return. However, any RRSP, once converted to a RRIF, allows for income splitting after age 65 of up to 50% of the withdrawal.
6. Your RRSP shouldn’t be your only savings account
While the benefits of RRSPs make saving in them a no-brainer for many Canadians, they work best alongside TFSAs to cover short- and long-term savings needs. While RRSPs are great for long-term savings plans, it can be fairly costly to withdraw funds from them to pay for unexpected costs. It’s not designed to be an emergency fund, so if you suddenly need $10,000, take it out of your TFSA. There are no tax implications from withdrawing from a TFSA, plus your TFSA contribution room is restored by the amount of the withdrawal in the following year.
It usually makes sense to invest in an RRSP when your current income is taxed at a higher marginal tax rate compared to what you expect it to be in retirement. If you’re in a lower income bracket, you may want to use your TFSA as your main savings account. A financial advisor can help you decide which is right for you, but the ideal option is to have both an RRSP and a TFSA, as they can work together to fund your retirement goals.
Making the most of RRSPs
Your IG Consultant can help you to understand the key advantages of RRSPs, work out the most tax-efficient ways to invest in them and which kinds of investments will help you to reach your retirement savings goals. Contact your IG Consultant today to arrange an appointment. If you don’t have an IG Consultant, you can find one here.