The RRSP may be an oldie when it comes to retirement savings.
But the Registered Retirement Savings Plan never falls out of fashion.
Canadians have multiple ways to fund their retirement, from workplace pension plans and group RRSPs to TFSAs (tax-free savings accounts) to individual pension plans (IPPs) for professionals like medical doctors and lawyers.
The RRSP, however, stands out as Canadians’ investment account workhorse to fund their retirement.
Indeed, it’s been around a while…
The RRSP was introduced in 1957 to help Canadians save for retirement, especially those without workplace pension plans, which were growing in availability at the time. Back then, the contribution limit was 10 per cent of the previous year’s income to a maximum of $2,500 per year. The key benefit of the plan was and continues to be that money inside the RRSP can be invested with interest, dividends and capital gain income accumulating tax-sheltered. Equally, attractive has been the ability to deduct the value of annual contributions against taxable income. This allows individuals to reduce taxes in their working years, deferring those taxes until retirement. At which point, the retirement savings can presumably be withdrawn and taxed at a lower rate.
The RRSP grows more valuable with each passing year
Annual contributions may have started out small. But they have grown with each passing year to keep pace with inflation. Today, the maximum contribution limit is 18 per cent of income to a maximum of $31,560 (based on 2024’s tax year). Statistics Canada data show about 6 million Canadians contribute about $50 billion annually, or an average of $3,600 per contributor. But the statistics also show only about one in five RRSP account holders make regular contributions. Fortunately for them, that unused contribution room accumulates with each passing year until after the year an individual turns 71.
A different beast than the TFSA, but a great companion for smart investing
The TFSA offers tax-free growth and tax-free withdrawals, while the RRSP offers tax-sheltered growth, but withdrawals are fully taxable. In fact, without proper planning, RRSPs can even become a tax liability for some retirees. When guided by a comprehensive financial plan, the RRSP can be a foundational generator of income along with CPP (Canada Pension Plan) and OAS (Old Age Security) for retirees. As well, they can control how much they want to withdraw from their RRSP prior to converting it to a RRIF (registered retirement income fund). Individuals can convert to a RRIF as early as age 55, which affords them a pension income tax credit if they do not have a workplace plan. Otherwise, they must convert to a RRIF by the end of the year they turn age 71. In both instances, RRIFs involve mandatory minimum withdrawals (about 3 per cent at age 55 and about 5 per cent at age 72). These withdrawal minimums increase with each passing year until topping out at age 95 at 20 per cent of the capital in the RRIF. While not as tax-efficient as a TFSA, RRIFs and RRSPs pair well with the tax-free plan. The RRSP/RRIF withdrawals can cover set expenses while TFSA funds can pay for larger and unforeseen expenses as withdrawals have no impact on marginal tax rates. Furthermore, many successful professionals often have other investment accounts, including non-registered investment accounts, that also provide more tax-efficient retirement income that can complement income from a RRSP or RRIF.
A versatile investment vehicle
The RRSP is a go-to, tax-sheltered investment account for most Canadians, able to hold stocks, bonds, GICs (guaranteed investment certification), options, mutual funds, foreign currencies and exchange-traded funds (ETFs). Of course, the choice of investment strategy should be based on your appetite for market risk. Some individuals are more comfortable with conservative strategies favouring interest-bearing investments like GICs, while others are fine with equity market risk and the potentially much higher returns over the long-term. In retirement, however, RRSPs and RRIFs are generally better suited for bonds and other interest-producing investments because interest, like RRSP withdrawals, is fully taxable. In contrast, non-registered accounts may be better places to hold stocks and other securities producing capital gains and dividends, which receive preferential tax treatment that would be lost if these investments were held in an RRSP.
The tax deduction is the RRSP’s secret sauce
Perhaps the biggest advantage of the RRSP is the tax deduction on contributions. This is particularly helpful for high income earners as the tax savings become all the more lucrative. In Alberta, for example, the highest income earners receive a deduction worth 48 per cent of their contribution based on the highest marginal tax rate. In contrast, lowest income earners, those with taxable income under about $55,800, only receive a 25 per cent deduction—Alberta’s lowest taxable bracket–against taxable income. With this in mind, professionals starting out may want to abstain from contributing to their RRSP, letting contribution room grow over time while their income is lower. At the same time, they can instead focus on investing in a TFSA, their business or other investment accounts. Then, once their taxable income is significantly higher, they can make more sizable RRSP contributions to reduce their tax burden. Of course, all of this speaks to the value of having a well-designed financial plan.
Planning makes perfect
Getting professional advice isn’t merely a good idea for developing a financial plan that incorporates the RRSP to your greatest advantage to build wealth for retirement. It’s also important throughout retirement to have a plan to minimize taxes strategically while alive, and to grind down capital in the RRSP and RRIF over time to limit its tax burden for the estate. Although a $1-million RRSP or RRIF looks great on paper, upon the death of the last surviving spouse, roughly half that sum will go toward income tax. In turn, thoughtful retirement income and estate planning is fundamental to wealth creation and preservation, with concerns around RRSPs and RRIFs being central to any developed strategy. It’s particularly important for individuals seeking to leave legacies, from helping children to supporting charities. Of course, all of this speaks to the importance of working with a financial professional adept in the various aspects of the RRSP, from investing for long-term growth to generating tax-efficient retirement income to an equally tax-efficient estate plan.
