One of the most common questions people ask when thinking about retirement planning is: “What’s the difference between a TFSA and an RRSP, and do I need both?”
If you’ve already opened a Tax-Free Savings Account (TFSA,
discussed in Post 2), you’re off to a great start. But there’s another
essential tool in the Canadian retirement planning toolkit: the Registered
Retirement Savings Plan, or RRSP. And if you’re married or in a common-law
relationship, a spousal RRSP can be a powerful strategy to help reduce
taxes in retirement and build savings as a team.
What Is an RRSP?
An RRSP is a registered account designed to help Canadians save
for retirement. You contribute money to your RRSP, and that money can be
invested in a wide range of financial products, mutual funds, ETFs, stocks,
bonds, GICs, etc. Many of my friends invested in the RRSP at their bank using
term deposits. I used mutual funds for the money invested in our RRSPs.
Investing in a bank term deposit is safe, while investing in a mutual fund may
be riskier. So, before you choose your vehicle consider your risk tolerance.
The big benefit? Your contributions are tax-deductible.
That means you reduce your taxable income in the year you contribute. And as
long as the money stays in your RRSP, the growth (interest, dividends, and
capital gains) is tax deferred. You only pay tax when you withdraw the funds, ideally
when you're retired and in a lower tax bracket.
RRSP Contribution Limits
You can contribute up to 18% of your previous year’s earned
income, to a maximum set by the Canada Revenue Agency (CRA). Here are
recent limits:
- 2022:
$29,210
- 2023:
$30,780
- 2024:
$31,560
- 2025:
$32,490 (projected)
Unused room carries forward. You can find your personal
contribution limit on your latest Notice of Assessment from CRA or
through your CRA My Account.
When Should You Contribute?
The RRSP contribution deadline for the previous tax year is
usually 60 days into the new year, typically around the end of February
or early March. This gives you a chance to make contributions that count toward
reducing the taxes you owe for the year just ended.
RRSP vs TFSA – Which Is Better?
It’s not a question of either/or, it’s often both. Here's
a quick comparison:
|
Feature |
RRSP |
TFSA |
|
Tax on Contributions |
Deductible (reduces taxes) |
Not deductible |
|
Tax on Withdrawals |
Taxed as income |
No tax |
|
Effect on Benefits |
May reduce income-tested benefits |
Does not affect benefits |
|
Contribution Room |
Based on income |
Flat annual limit for everyone |
If your income is higher now than it will be in retirement, an
RRSP makes a lot of sense. You get the tax break today, and pay less tax later.
For lower-income earners, a TFSA might be a better first option.
What Is a Spousal RRSP?
A spousal RRSP allows one partner (typically the higher earner)
to contribute to a retirement account in the name of the other (typically the
lower earner). The contributor gets the tax deduction, but the funds eventually
belong to the spouse. I did this and was able to maximize the amount of money
invested in RRSPs for us.
This strategy helps with income splitting, a way to
reduce your total household tax bill in retirement. Here’s how:
- The
higher earner contributes to the spousal RRSP.
- The
lower earner withdraws the funds in retirement, taxed at their (likely
lower) rate.
- This
keeps both partners in lower tax brackets.
There are rules to watch out for, especially the three-year
attribution rule, which can cause the contributor to be taxed if the money
is withdrawn too soon. The rule applies to withdrawals made in the year of
contribution and the two preceding taxation years. A spousal RRSP is best used for long-term
planning. Here is how this rule works Example:
If Spouse A (the contributor) makes a $10,000 contribution to
Spouse B (the annuitant)'s spousal RRSP in 2025, and Spouse B withdraws $5,000
in 2025, 2024, or 2023, Spouse A will be taxed on that $5,000, not Spouse B.
When to Start With an RRSP
If you're in your 30s or 40s and earning a stable income, an
RRSP is a smart way to:
·
Save for retirement while reducing current taxes
·
Build up investment gains without paying annual
taxes
·
Create a down payment with the Home Buyers' Plan
(HBP)
·
Go back to school with the Lifelong Learning Plan
(LLP)
That’s right, RRSPs aren’t just for retirement. They can also
help with big life goals.
Where to Open an RRSP
You can open an RRSP at:
- Your
bank or credit union
- A
financial advisor
- An
online brokerage (e.g. Questrade, Wealthsimple, RBC Direct Investing)
- A
robo-advisor (like Wealthsimple or Justwealth)
Make sure to choose an investment approach that matches your
goals and risk tolerance.
Tips to Make the Most of Your RRSP
1. Start
small, start early – Even $50/month makes a difference. Most financial
institutions will help you start even with a small amount of capital. I set up
an automatic withdrawal program, so I had a monthly amount going into my RRSP
savings. Automating the withdrawal was effective for us.
2. Reinvest
your tax refund – Use your refund to increase your TFSA or RRSP.
3. Be
consistent – Set up automatic contributions to stay on track.
4. Review
annually – Revisit your plan each year as your income and goals evolve.
5. Coordinate
with your partner – Consider spousal RRSPs to reduce long-term taxes.
Where to Learn More
- Canada.ca
- RRSP Basics
- Financial
Consumer Agency of Canada – Spousal RRSPs
- TurboTax
RRSP Calculator
Takeaway: RRSPs offer a tax-smart way to
build retirement savings. They work best when you contribute while earning
more, and withdraw when you're earning less. If you're in a relationship, don’t
overlook spousal RRSPs, they can help you retire with more money and pay less
tax,
No comments:
Post a Comment