What is an RRSP?

RRSP stands for “Registered Retirement Savings Plan”. It is a type of savings or investment account which was designed for Canadians to facilitate retirement savings. It is “Registered” with the Canadian Revenue Agency.

Many people think that they “buy” RRSP’s every year – that the RRSP is the investment. NO – think of an RRSP as an “account”. You can hold a wide variety of investments INSIDE this account so long as they meet the definition of a “qualifying investment” as listed by the CRA (The Canadian Revenue Agency). But don’t worry, almost everything is a qualified investment.

You can of course use non-RRSP accounts to save for retirement, but the reason most Canadians choose the RRSP option are for tax purposes. There are three main tax advantages that exist:

1. Immediate Tax Relief

You can get a refund at tax time if you put money into your RRSP. The government will basically allow you to deduct your RRSP contribution from your total income for the year. Refer to the post on “What is a tax write off?” as this is the same principle.  If you were in a 50% marginal tax bracket (for example purposes) then your $10,000 RRSP contribution will give you a $5,000 tax refund (all else being equal – assuming you don’t owe back taxes, and the normal amount of tax is deducted from your paycheque).

2. Tax Sheltering

While your investments remain inside your RRSP they are not subject to tax like your non-RRSP investments – that means that they can grow faster since there is no tax deducted from the value every year. And when your investments grow faster, you have more money when you are ready to retire – perhaps you can even retire earlier…

3. Tax Deferral

You only pay tax on the RRSP funds when you withdraw them. This really is just an extension of tax-sheltering, but you will find it listed as the third tax advantage for RRSP’s. The real reason it is listed as a stand-alone third advantage is that they assume that you are in a lower tax-bracket when you are ready to withdraw the funds. So if you were in a marginal tax bracket of 50% when you put it in, you got half your contribution back in the form of a tax refund. If your income is lower in retirement (usually) then perhaps you are in a 30% tax bracket. So when it comes time to finally pay money on that tax you earned when you were in a 50% tax bracket, they only charge you 30%.

I need to point out that while these tax advantages look very appealing on the surface their are many opponents to RRSP’s out there.  Many have argued that your net overall tax bill will actually be higher over the course of your lifetime with RRSP’s versus non-RRSP’s. This debate is VERY complex and I will address it in a future Advanced Level posting.  I can tell you that there is no clear divisor and that it really boils down to your personal financial situation – variables such as how much you have saved, how you plan to withdraw it, if you can split income, etc. all come into play.

But for beginners – remember: ANY savings is good savings.  If you are just getting started and don’t know what to do, feel confident to start an RRSP account. Once you get more experienced with your finances and do some reading you will be able to determine yourself if you should continue to save to RRSP’s when you get older, or if you should switch to non-RRSP savings for retirement.  Many people have both types of accounts.

Preet Banerjee
Preet Banerjee
...is an independent consultant to the financial services industry and a personal finance commentator. You can learn more about Preet at his personal website and you can click here to follow him on Twitter.
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