What is an RRSP?

A Registered Retirement Savings Plan (RRSP) is a tax-sheltered investment registered with Revenue Canada. RRSPs were set up by the federal government in 1957 to encourage Canadians to save for retirement In effect, if you save through an RRSP, the government agrees to tax the money — and the interest it earns -- when you receive it rather than when you earn it. 

Why do need one?

An RRSP lets you save for retirement and save taxes at the same time. Not only do you avoid paying income tax on the money you contribute but you postpone paying tax on your investment earnings until you take the money out of your plan later on. And because you’ll earn interest on the interest, the tax-free compounding will make a huge difference in the amount of money you’ll be able to save for retirement.

How much tax will I save by contributing to an RRSP?

Provided your RRSP contribution is within your allowable contribution limit, you may deduct the entire amount from your taxable income when you make the contribution. The amount of tax you save will depend on your marginal tax rate. For example, if you contribute $1,000 to an RRSP and your taxable income is less than $29,590, your tax savings will be 27 per cent of the contribution, or about $270. If your taxable income is between $29,590 and $59,180, your tax savings would be 41 per cent, or about $410. And if your taxable income is more than $59180, your tax savings would be 50 per cent, or $500. In other words, the higher your income, the more tax you will have by making a $1000 contribution to your RRSP. Of course, you will also save tax because the earnings on your RRSP investments will not be taxable, as long as the money stays inside your plan.

Can anyone invest in an RRSP?

As long as you have earned income in Canada and you pay Canadian taxes, you can invest in an RRSP in your own name until the end of the year in which you turn 69.

Can a child have an RRSP?

A child can invest in an RRSP if she or he has earned income and a Social Insurance Number. But since children under the age of 18 may not legally enter into contracts, a parent or other adult would have to set up an RRSP in trust for the child.

Where can I buy an RRSP?

You can buy an RRSP at any financial institution, such as a bank, trust company or credit union. These institutions offer a variety of plans based on different kinds of investments -- in effect, a selection of ‘off-the-shelf” RRSPs. You can also invest in an RRSP through a broker or financial adviser or buy RRSP investments directly from a mutual fund company.

 What is a self-directed RRSP?

You can set up a self-directed RRSP, where you choose the investments yourself. This enables you to invest directly in the stock market, as well as in a wider range of investments such as stripped bonds and mortgage-backed securities for your RRSP. With a self-directed RRSP, you can even invest the mortgage on your own home. You’ll need a trustee who will register the RRSP with Revenue Canada. Financial institutions and brokers can help you set up a self-directed RRSP. They may charge a set-up fee, as well as an annual fee to administer the plan for you.

How much can I contribute to my RRSP?

The amount you’re allowed to deduct for tax purposes is often referred to as your “contribution room” or ‘deduction room.” The limit for any tax year is 18 per cent of your earned income from the previous year, minus any pension adjustment, up to a dollar maximum of $13,500. The dollar maximum is scheduled to increase in the year 2004 and to reach $15,500 in 2005. The exact amount you’re entitled to contribute for this tax year -- which will include any unused contribution room carried forward from previous years -- is shown in a separate section of the Notice of Assessment you received from Revenue Canada after you filed last year’s tax return.

What is my “earned income?”

Your “earned income” includes:

• your earnings from employment

• net income from any business you carried on alone or with a partner

• any disability payments you received from the Quebec or Canada Pension Plan

• royalties

• net rental income you received

• alimony or maintenance payments you received

• net research grants and

• employment insurance benefits, if any, you received during the year.

From this total, you have to deduct business losses, losses on rental income property and any alimony or maintenance payments you made. The end result is your ‘earned income,” on which your RRSP contribution room will be based. You’ll find a form to help you do the calculation in a free booklet on RRSP5 available from your local tax office. ‘Earned income” does not include investment income.

What if I have a workplace pension plan?

If you belong to a workplace pension plan, you will have a “pension adjustment” (PA), which reflects the amount of the pension you built up in the pension plan during the year. Even it your employer pays for the pension and you are not required to contribute yourself, you’ll still have a PA. Your employer is required to notify you of your PA each year. You’ll find the amount on your T4 or T4A slip. Your PA has to be deducted from your “earned income” to determine the amount you may contribute to an RRSP for the coming tax year. In tact, Revenue Canada does these calculations for you and will have indicated on your Notice of Assessment from last year what your RRSP limit will be for this year.

Can I contribute to an RRSP for my spouse?

You can use all or some of your RRSP contribution room to contribute to an RRSP in your spouse’s name. This kind of RRSP is referred to as a “spousal RRSP.” You claim the tax deduction for the contribution, but the RRSP belongs to your spouse. Contributing to a spousal RRSP is a good idea if you think your spouse will have less income in retirement than you will and will therefore be an a lower tax bracket. That way, as a couple, you will save on taxes because your spouse will declare the retirement income provided by the RRSP. As long as you continue to have earned income, you will have RRSP contribution room that can be used to contribute to a spousal RRSP until the end of the year when your spouse turns 69. That’s true even though you will not be able to contribute to your own RRSP after the end of the year you yourself turn 69. This is an advantage if your spouse is younger than you are.

What happens if I accidentally contribute too much to my RRSP?

If you exceed your RRSP contribution limit, you will have no problem as long as the amount of your excess contribution does not exceed $2,000 at any point in time. But if your over-contribution is more than this, you’ll be charged a penalty tax of one per cent of the excess per month as long as it remains in the plan. If your over-contribution was a genuine mistake, you may be able to withdraw the excess and avoid the penalty. Check with your financial institution.

Should I deliberately over-contribute to my RRSP?

If you have spare cash this year, you may want to consider an over-contribution to your RRSP, within the $2,000 limit. This year’s earned income will generate more RRSP contribution room next year, when you could deduct the over-contribution you made this year.

If you’re reaching 69, when your RRSP has to mature, but you know you will continue to have earned income for a few years, it may even he worth considering an over-contribution in excess of the $2,000 limit. Even though you will have to pay the penalty tax, you will be able to deduct the amount of the over-contribution in following years -- as more contribution room becomes available. The benefits of tax-deferred investment earnings from getting more money into your plan now may outweigh the amount you’d have to pay in penalty taxes.

The rules do not allow you to contribute to your RRSP after the end of the year you turn 69, but they do not prevent you from deducting contributions made before that deadline, as long as you continue to have earned income after age 69 that generates more contribution room.

What is the contribution deadline for this tax year?

The contribution deadline for RRSP contributions in any tax year is 60 days after the end of the year. For the Canadian tax year, the contribution deadline is on or before the last day of February. But if you’re turning 69 after December of this year, you would have had to make your contribution before the end of the calendar year.

If I contribute to an RRSP for this tax year, do I have to deduct the contribution on this year’s tax return?

When you file your tax return, your RRSP contribution is deducted from your taxable income. But if you don’t have enough taxable income to deduct the entire amount of your RRSP contribution, you can carry it forward and deduct in a subsequent year when you have enough taxable income to make it worthwhile.

Will I lose my contribution room if I don’t contribute to my RRSP this year?

If you have RRSP contribution room this year but can’t use it all, you may carry unused room forward to following years indefinitely. On your Notice of Assessment, Revenue Canada will calculate this year’s contribution room, plus unused amounts carried forward from previous years, to show you the total amount of contributions you could deduct for the current year. Anything you don’t use this year will automatically be added to the new contribution room that will become available for the next taxation year.

Should I borrow to maximize my RRSP contribution?

If you don’t have enough cash on hand to make your RRSP contribution before the deadline, financial institutions will probably be only too happy to lend it to you. Be aware that, unlike interest on money borrowed to invest, interest on money borrowed to invest in an RRSP is not tax deductible. But contributing to your RRSP will generate a tax refund, which could be used to pay down the amount you borrowed. In fact, many financial institutions will structure a special RRSP loan for you with no payments for the first couple of months to allow time for you to get your tax refund before you have to start making loan payments. If you think you can pay back the loan within a year, and you feel you can comfortably manage the monthly payments, borrowing money so you can use up your RRSP contribution room may be a good idea.

Should I pay down my mortgage or invest in an RRSP?

There’s no easy answer to this question. It may depend on your age and your own personal priorities. One strategy is to contribute to your RRSP and use your tax refund to pay down the mortgage. A better idea might be to set up a monthly payment plan for your RRSP so you don’t have to scramble for a lump sum to make your annual contribution before the deadline each year.

When is the best time of year to make my RRSP contribution?

Many people leave it to the last minute to make their RRSP contributions. It’s probably much easier and certainly less stressful to set up a pre-authorized monthly payment plan. Financial institutions, brokers and mutual funds can all handle monthly RRSP contributions through pre-authorized monthly debits to your bank account. They’ll send you your tax receipt at the end of the year. Meanwhile, your RRSP contributions will start earning much sooner than if you left it until the contribution deadline to put your money into your plan.

What investments can I hold in my RRSP?

All kinds of investments are eligible for an RRSP, including:

• savings accounts

• Guaranteed Investment Certificates (GIC5)

• term deposits

• government treasury bills

• Canada Savings Bonds

• shares of Canadian companies and of some foreign companies if they are listed on a recognized Canadian stock exchange

• Canadian corporate and government bonds

• mutual funds that invest in eligible securities, and

• certain types of mortgages.

You can’t hold tangible assets such as gold, bullion, jewelry or real estate in your RRSP -- but you can invest in mutual funds that invest in real estate or precious metals. If you set up a self-directed plan, your trustee will make sure your plan holds only eligible investments.

Can I contribute “in kind” to my RRSP?

If you have a self-directed RRSP, you may contribute shares you already own to your plan, as long as they are investments that are eligible for an RRSP. The current market value of the shares when you contribute them to the RRSP will be the amount you’ll be able to deduct as your RRSP contribution.

Can I hold my own mortgage in my RRSP?

You can also hold your own mortgage in your RRSP if you have a self-directed RRSP. But there are strict rules that must be followed and some advisers believe the cost of setting it up is not worth it. The mortgage must be insured, for example, and you will have to pay interest at market rates to your RRSP, once it holds your mortgage. Some financial institutions will consider a half-and-half arrangement, where they hold half the mortgage and your RRSP holds the other half.

Can I hold foreign investments in my RRSP?

You can hold foreign investments in your RRSP as long as the book value -- that’s the purchase price and not the current market value -- of those investments does not exceed 20 per cent of the cost of all the investments in your RRSP. However, you can increase the amount of foreign investments in your RRSP by also investing in Canadian mutual funds which have 20 per cent of their portfolio in foreign investments, since such funds are not considered “foreign content.”

You can also get exposure to foreign markets and diversify your RRSP portfolio by investing in federal and provincial government bonds denominated in foreign currencies. These bonds also do not count as “foreign content.” In addition, insurance-company segregated funds, as well as mutual funds based on derivatives, are not considered “foreign content,” because they invest largely in Government of Canada Treasury Bills and use them to buy contracts or options on foreign stocks and foreign indexes. But note that the 20 per cent foreign content limit applies to each separate RRSP you may have.

What happens if I exceed the limit for foreign investments in any RRSP?

If you exceed the 20 per cent limit on foreign content, a penalty tax of one per cent of the excess per month applies.

Can I take money out of my RRSP?

You can withdraw funds from your RRSP at any time, as long as you are 18 or older. But amounts you withdraw must be declared as income and will be taxable in the year you take out the money. As well, if you make a lump sum withdrawal, the financial institution administering your RRSP is required to withhold a portion of the tax you owe and send it to Revenue Canada.

If you withdraw $5,000 or less, 10 per cent will be withheld. If your withdrawal is between $5,001 and $15,000, 20 per cent will be withheld. And for withdrawals of more than $15,000, the withholding tax will be 30 per cent. In Quebec, different rates of withholding apply. For amounts of $5,000 or less, the withholding tax is 21 per cent; for amounts between $5,001 and $15,000, 30 per cent will be withheld, and for amounts over $15,000, the withholding tax is 35 per cent. You may owe additional amounts of tax when you file your tax return and declare the withdrawal.

What happens if my spouse takes money out of a spousal RRSP?

Withdrawals from a spousal plan have to be declared as income by the spouse who is the holder of the plan. However, if you contributed to any spousal plan in the year of the withdrawal -- or in either of the two preceding years, even if it was not the particular spousal plan from which the funds are being withdrawn -- you will have to declare the amounts withdrawn by your spouse and pay tax on them. This rule does not apply if you and your spouse are separated and living apart because of marriage breakdown when the withdrawal occurs.

Can I take money out of my RRSP to buy a house?

Under the Canadian Mortgage and Housing Corporation’s Home Buyer’s Plan, if you are a first time homebuyer, you can borrow up to $20,000 from your RRSP tax-free to buy a home. Couples who both have RRSPs may each withdraw up to $20,000 tax-free for the purchase of a home. But the home purchase has to be carefully documented on special forms and the funds must be paid back within t~ years through annual contributions. If you fail to make the required annual repayment, the amount you should have paid back will have to be included in your income for that year and will be taxable.

Can I get my RRSP contribution room back if I leave my workplace pension plan?

If you belong to a workplace pension plan, your annual pension adjustment (PA) will limit the amount you can contribute to an RRSP each year. But if you quit before retirement and end up without a pension, you may be able to get back some of the RRSP contribution room you lost through a Pension Adjustment Reversal (PAR). Your employer will calculate your PAR when you quit and the amount will be added to your available RRSP contribution room. If you don’t make use of the additional room that year, it can be carried forward in the same way as other unused RRSP contribution room. The PAR was introduced only recently and it doesn’t cover RRSP room lost before 1990.

Can I contribute to my RRSP after I retire?

You can continue to contribute to your RRSP until the end of the year you turn 69. And since your contribution room is based on your earned income from the previous year, you could contribute to your RRSP after you’ve retired -- as long as you haven’t reached the age cut-off.

When does an RRSP mature?

An RRSP matures at the end of the year in which you reach age 69. At that time, the funds must be used to purchase an annuity or transferred to a Registered Retirement Income Fund. If you fail to select one of these options, the entire amount in your plan will be considered income and you will be taxed on it.

What are my options when my RRSP matures?

Essentially, you have three options when your RRSP matures:

• You can take all the funds out and declare it as income -- generally not a good idea, since you’ll pay tax on the whole amount at your top tax rate.

• You can use the funds to purchase an annuity from an insurance company, or

• You can roll over the amount into a Registered Retirement Income Fund (RRIF).

Is it better to choose a RRIF or an annuity when my RRSP matures?

Most financial advisers recommend transferring your RRSP funds to a RRIF at maturity. You continue to control your investments, so they continue to earn a return and the funds remain tax-sheltered until they are withdrawn. While some people prefer an annuity because they know exactly what their monthly income will be, the amount of monthly income you can purchase with your RRSP funds will be lower in times of low interest rates.

You could also decide to use some of your RRSP funds to purchase an annuity to give yourself a basic guaranteed income and then roll the rest into a RRIF. If you opt for a RRIF, you can always use the remaining RRIF funds to purchase an annuity later, if you wish.

What is a RRIF?

A Registered Retirement Income Fund (RRIF) is similar to an RRSP except that you are required to withdraw a minimum amount each year. The minimum is established by Revenue Canada and depends on your age. At age 71, for example, you must withdraw 7.38 per cent of the funds remaining in the plan, while at age 81, the minimum withdrawal is 8.99 per cent and at age 91, it is 14.73 percent. By the time you get to age 94, you will have to withdraw 20 per cent of your remaining RRIF funds each year.

There’s nothing to prevent you from taking more than the minimum out of your RRIF. In fact, you can withdraw the entire amount at any time, but you will then have to declare the funds as part of your income that year and pay tax on them. And, of course, the amounts you withdraw from your RRIF each year must also be declared as income. You can set up a RRIF any time before the end of the year that you turn 69. But the earlier you establish your RRIF, the earlier you will have to start depleting your retirement funds. You may want to consider postponing this as long as you can, so you have a chance to build up a bigger nest egg. And you can set up your RRIF at the same financial institutions that sell RRSPs.

What is an annuity?

You may decide to use the funds in your RRSP at maturity to purchase an annuity from an insurance company. In exchange for your lump sum, the insurance company agrees to provide you with a regular income for the rest of your life. The insurance company will invest the lump sum to provide you with the income. So, the higher interest rates are when you purchase an annuity, the higher the monthly income you will be able to purchase.

You may choose a guarantee period--say 10 or 15 years--so that if you die before that time is up, the insurance company will continue to make the payments or to provide an equivalent lump sum to your named beneficiary. The advantage of an annuity is that it provides a consistent stream of income and you don’t have to continue making investment decisions. The down side is that an annuity reduces flexibility, since you are locked in for the duration of the contract.

What is a locked-in RRSP?

If you leave a workplace pension plan before you reach retirement age and the terms of your pension allow it, you may be able to transfer your accumulated pension benefits into a locked-in account. The funds can then be invested in the same way as you would invest an RRSP. But there are a number of other restrictions. Because funds in a locked-in RRSP come from a workplace pension plan, locked-in accounts are regulated by pension authorities, who set the terms and conditions of these plans. To minimize confusion between a regular RRSP and a locked-in account, locked-in RRSPs are now generally referred to as Locked-In Retirement Accounts (LIRAs).

Pension authorities require that funds in a locked-in RRSP be used to provide a lifetime income for the holder. That means you can’t make a lump sum withdrawal from a locked-in plan, nor can you cash it in at any time.

What is a LIRA?

A Locked-In Retirement Account (LIRA), sometimes called a locked-in RRSP, contains accumulated pension benefits transferred out of a workplace pension plan. It is subject to rules and regulations made by pension regulatory authorities at federal and provincial levels. If the funds in your LIRA come from a pension plan in Ontario, for example, it will be subject to Ontario’s pension regulations. If your workplace pension plan fell under federal jurisdiction -- as it would if your worked for a bank, communications or transportation company, for instance -- your LIRA will be subject to federal pension regulations. Generally speaking, funds in a LIRA may be invested in the same way as an RRSP -- although some provinces do not allow a LIRA to contain the holder’s mortgage. The financial institutions holding your LIRA should be able to give you information about this if you need it. Like an RRSP, a LIRA must be converted to a stream of income by the end of the year in which the holder reaches age 69. But pension regulators do not allow a LIRA to mature until you are within 10 years of the normal retirement age provided in the pension plan form which the funds. That’s generally age 55. However, your options when your LIRA reaches maturity are limited. You may convert your LIRA to an annuity or to a Life Income Fund (LIF). In some provinces, you also have the option of converting a LIRA to a Locked-In Retirement Income Fund (LRIF). You may not cash in your plan or take out a lump sum.

What is a LIF?

When your Locked-In Retirement Account (LIRA) matures you have the option of converting it to a Life Income Fund (LIF). This operates in the same way as a RRIF, except there is both a minimum and maximum annual withdrawal amount. The minimum withdrawal is based on the minimum withdrawal for a RRIF, while the maximum is set by the pension regulatory authority. The objective is to make sure your LIF provides you with an income for the rest of your life. A LIF must be converted to an annuity by the end of the year in which you turn 80.

What is an LRIF?

A Locked-in Retirement Income Fund (LRIF) is an alternative to a LIF, which can be used when your LIRA matures. It operates like a LIE, except that it does not have to be converted to an annuity at any point. To date, LRIFs are only available for locked-in funds from pension plans in Alberta, Saskatchewan, Manitoba and Quebec.

Can I transfer funds from my RRSP to my spouse?

Generally, funds may not be transferred from the RRSP of one spouse to the RRSP of the other. However, an exception is made if three conditions are met:

• You and your spouse are living apart at the time of the transfer

• The transfer is made under a written separation agreement or under a decree, order or judgment of a court, and

• The transfer is made to settle rights arising out of your marriage or on the breakdown of your marriage.

Can my spouse claim a share of my RRSP if we get divorced?

Funds in your RRSP may be considered part of the family assets you have to share with your spouse on the breakdown of your marriage or common-law relationship.

What happens to my RRSP if I die?

When you die, the value of the funds in your RRSP will be included in your income and will be taxed when your final tax return is filed. However, if you have a surviving spouse, the RRSP may be rolled over tax-free to the survivor, who then becomes the annuitant, or holder, of the RRSP. This provision can also apply to a common-law spouse. If there is no surviving spouse, a tax-free rollover may be made to a dependent child or grandchild, who may use the funds to purchase an annuity with a term not exceeding 18 years minus the age of the child.

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