What is an RRSP and how does it work?
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What is an RRSP and how does it work?
It’s never too soon to start thinking about your future. So how can you start building up savings for future retirement income? An RRSP may be the answer. Here’s an overview on this type of investment account to help you get started.
What is an RRSP?
A Registered Retirement Savings Plan (RRSP) is a type of investment account that allows you to reduce the tax payable on your current income when you save it for the future.
How does an RRSP work?
An RRSP can be opened by anyone under the age of 71 who has earned and reported income in a previous tax year.
An RRSP can help you get a head start on reaching your retirement income goals. The money you invest in an RRSP is tax-deducible, and you defer tax on your investment income until it’s withdrawn. Withdrawals are taxed as ordinary income in the year withdrawn, except for withdrawals for the Home Buyers Plan (HBP) and Life Long Learners Plan (LLP).
Like Tax-Free Savings Accounts (TFSAs), RRSPs can hold a wide range of investment options, including mutual funds, exchange-traded funds, stocks and bonds. There are also different types of plans you can set up, like a spousal or common-law partner RRSP, that may offer varying benefits.
Pros
The money you invest is tax-deductible, reducing your current taxable income, and you may end up with a tax refund. Keep in mind that you don’t have to claim deductions on your RRSP contributions in the same year that you make them. This may be beneficial when it comes to maximizing your tax refund, if you’re expecting a future increase in taxable income that will push you into a higher tax bracket.
An RRSP offers tax-deferred growth. You defer tax on your investment income until it’s withdrawn. Withdrawals are included in your taxable income, and usually this is in retirement, when you’re in a lower income-tax bracket.
Invest early to benefit from compound growth. If you invest in an RRSP well before retirement, your money has more time to benefit from tax-sheltered earnings and growth.
Cons
At age 71 an RRSP must be matured into a Registered Retirement Income Fund, at which time you will have to withdraw annual minimum amounts. This may reduce your government old age benefits.
RRSPs are intended for long-term investing. If you need to take money out, you’ll have to pay income tax on those withdrawals (unless they are qualified withdrawals under programs such as the HBP or LLP). Unlike with a TFSA, the amount of the withdrawal is not added to your unused contribution room in the following year. This makes an RRSP less flexible if you are investing with short- or medium-term goals in mind.
Contribution room is based on your income, so in your lower-income-earning years you’ll accumulate less contribution room.