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With just weeks left before the contribution deadline, a Certified Financial Planner rounds up key facts and common RRSP myths.
Registered retirement savings plans (RRSPs) have been around since 1957, and each February is commonly referred to as “RRSP season.” The banks and financial media used to make a bigger deal about RRSPs in the new year, but ever since Tax-Free Savings Accounts (TFSAs) were introduced in 2009, RRSP season has seemed a bit watered down. That does not mean RRSPs are not good tax and investment options, it just reflects the fact that Canadians now have alternatives.
Maybe you’ve run some preliminary numbers on your 2020 tax return software, and discovered that you owe the CRA; or perhaps life simply got in the way of your organizing a contribution earlier (and if that’s the case, here are some tips on making last-minute RRSP contributions). Whatever the reason, if you are planning to make an RRSP contribution before the deadline, here’s a quick-reference roundup of key facts and myths to guide you.
RRSP deadline for the 2020 tax year: March 1, 2021.
Maximum RRSP contribution for 2020: $27,230 (requires $151,278 of earned income in 2019 and no pension adjustment), plus any accumulated RRSP room the contributor has from past years.
Maximum RRSP loan: Typically up to $50,000.
Maximum Home Buyers’ Plan (HBP) withdrawal: You can take up to $35,000 tax-free from a RRSP for the purchase of an eligible home for a first-time home buyer (up to $70,000 for a couple).
Maximum Lifelong Learning Plan (LLP) withdrawal: $10,000 per calendar year, and $20,000 in total for qualifying post-secondary education for you or your spouse.
RRSP contribution tax savings: At $75,000 of taxable income, it generally ranges from 27.5% (Nunavut) to 37.9% (Manitoba). This is the savings on the first dollar of RRSP contributions deducted; keep in mind that significant contributions may cause a change in tax brackets and a lower tax refund on the incremental amount.
Last chance to make an RRSP contribution: Dec. 31 of the year a contributor turns 71, unless they have a spouse under the age of 72. Contributions to a spousal RRSP for a spouse or common law partner can continue until Dec. 31 of the year that spouse turns 71, subject to the contributor’s RRSP room.
Last chance to convert a RRSP to a RRIF: Registered retirement income fund (RRIF) conversion must happen by Dec. 31 of the year the contributor turns 71, with minimum withdrawals beginning the year the contributor turns 72.
RRSPs are risky: The truth is, RRSPs may or may not be risky. A RRSP is just a tax-deferred account that holds investments. You can hold cash, guaranteed investment certificates (GICs), bonds, stocks, mutual funds or exchange traded funds (ETFs). Mutual funds are the most common investment choice, but mutual funds themselves can range from savings accounts (money market mutual funds) to bond funds to stock funds, with varying levels of risk.
You should contribute to an RRSP as early as possible: You can contribute to a RRSP as soon as you have earned income, such as employment income, to create RRSP room. There is no age limit, but investment accounts are difficult to open until a minor child attains the age of majority (18 or 19, depending on their province or territory of residence). RRSP tax deductions may not be advantageous for a young person with a low income, and TFSAs may provide more flexibility for deposits and withdrawals for a teenager or someone in their early 20s, anyway.
You should contribute to your RRSP every year: RRSP contributions and the tax deductions they provide are more advantageous in higher income years. Someone with a low or moderate income may be better off contributing to a TFSA. Someone with a low investment risk tolerance may be better off paying down debt.
RRSPs are taxed heavily on withdrawal: RRSP withdrawals are fully taxable in the year of withdrawal, except for the above-mentioned HBP and LLP withdrawals. But RRSP contributions are tax-deductible, and RRSP investments grow tax-deferred. Ideally, a contributor deducts contributions in a high-income year, benefits from many years of tax deferred growth, and takes withdrawals at a lower income and tax rate in retirement. Many full-time workers will benefit from RRSP contributions.
TFSAs are better than RRSPs: Actually, TFSAs are different from RRSPs. TFSAs may be better tools for young people who are just starting to save, and may be making deposits and taking withdrawals from their account. TFSAs may be a better option for a saver with a low income, or someone who expects their income to rise in a subsequent year. TFSA withdrawals can be used to fund RRSP contributions in the future. Taxpayers with no earned income do not accumulate RRSP room and may not be able to contribute to a RRSP, but TFSA room accrues for any Canadian resident who is 18 or older.
RRSP withdrawals can be split with your spouse: Pension income-splitting allows RRIF withdrawals to be split up to 50%, starting when the account holder turns 65, with a spouse or common law partner, regardless of the spouse’s age. RRSP withdrawals are not eligible for pension income-splitting.
RRSPs are fully taxable on death: RRSPs or RRIFs that are left to a spouse or common law partner can be transferred to that surviving spouse’s RRSP or RRIF on a tax-deferred basis. There are also exceptions for a financially dependent minor child or grandchild, or a child or grandchild with a disability. Otherwise, the value of a RRSP on the date of death of an account holder is added to their income on their final tax return and is fully taxable.
You cannot hold real estate in your RRSP: While it’s true that you cannot buy a rental property in your RRSP, you can buy publicly traded real estate investment trusts (REITs), some private REITs, real estate stocks, real estate mutual funds, or real estate ETFs. Whether you should do so is a more important question, given most homeowners have a lot of real estate exposure in the first place. Real estate makes up only 3.1% of the S&P/TSX Composite Index and just 2.4% of the S&P 500. I have written more about investing in real estate in your RRSP here.
You cannot hold your mortgage in your RRSP: You can hold an eligible mortgage in your RRSP, but it may not be advisable to do so. It is difficult to find an institution that will allow you to hold a mortgage in a self-directed RRSP even though the Canada Revenue Agency approves mortgages as eligible RRSP investments. More importantly, it is expensive, you may need a large RRSP to do it, and if you hold your mortgage in your RRSP, you may pay a higher interest rate than you need to on your mortgage and earn a lower rate of return on your RRSP than you could otherwise. I have written more about this concept here.
There are plenty of RRSP facts, myths and considerations for Canadians to contemplate as they save and plan for retirement. Education is always the most important tool in financial planning. Learning about when to contribute, when to withdraw, and what investments to own will help you to become financially independent. as well as to prepare for and fund your retirement.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever.
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In an RRSP, it’s my understanding that investments grow tax-free, not tax-deferred. The taxes you pay upon withdrawal simply equal the amount of tax refund you’ve received from the government over the years and the growth on that money. Your own contributions and their growth are entirely tax free. In fact, if you ignore any future change in marginal tax rate just for argument’s sake, the tax benefits of an RRSP and a TFSA are the same.
Opening a TFSA on reaching the age of majority means that in BC and some other jurisdictions where that age is 19, not 18, banks cannot open a TFSA for you. However, accrual still begins at 18, so that on reaching 19, a person may open a TFSA with up to a two-year maximum. Only in Canada.
Using a Big Contribution Room Helps to Offset Capital Gains Payable on Sale of a big Asset
My RRSP withdrawals are taxable. I am using the withdrawals as retirement income before age 65, when I plan to start CPP. It does not matter where the money came from in the RRSP, the withdrawal is part of my taxable income.