Benefits of investing in an RRSP

If you want grow your money, investing in RRSP or Registered Retirement Savings Plan is a great idea. It is true that an RRSP is like a gift from the government of Canada to its citizens that allows you to postpone your tax bill while you save your hard-earned money, both at the same time.

In this article we’ll understand what is an RRSP and what are the benefits of investing in an RRSP.

What is an RRSP?

It is a tax-advantaged savings and investment account available in Canada. It is designed to help Canadians save for their retirement by providing a tax-sheltered environment for investments. RRSP was started in 1957 and ever since the people of Canada are making use of this program to save for their retirement.

Any contribution you make, which is the money you deposit, into your Registered Retirement Savings Plan (RRSP) serves to diminish your total income for the purpose of calculating your "taxable income." In other words, the amount you contribute to your RRSP helps reduce the income on which your taxes are calculated. Therefore, each dollar you allocate to your RRSP, whether in a savings or investment account, effectively lowers the portion of your income subject to taxation as per the regulations of the Canada Revenue Agency (CRA). This tax reduction mechanism underscores the incentive for individuals to contribute to their RRSP, as it not only facilitates retirement savings but also offers immediate tax benefits by lowering the overall tax liability.

There are 4 types of RRSPs –

1. Individual RRSP
2. Spousal RRSP
3. Group RRSP
4. Self-directed RRSP

RRSP benefits

Some of the top benefits of RRSPs include the following –

1. RRSP contributions reduce your taxable income

The primary benefit of contributing to your RRSP is the reduction of your net taxable income with each contribution.

All funds retained in your RRSP, which include your own personal savings and any investments earnings remain tax-sheltered until cash-out. This is because you will probably be in a lower tax bracket upon retirement when you start making withdrawals from your RRSP accounts, hence attracting fewer taxes.

There is no time like now when it comes to making contributions and therefore, good timing plays a key role in this case. CRA provides two extra months per year, making a total of one more month, in which RRSP contributions can be used to support a prior tax year’s deduction amounts. Take the deadlines for the RRSP contribution in 2022 as an example. Thus, making the most appropriate contribution at the appropriate time, enables you to enjoy the best tax incentives as well as utilizes the whole contribution window.

2. RRSP contributions can be carried forward

You can easily carry forward your RRSP contributions. Unused contribution room can be transferred to next year’s contribution if you are unable to contribute the maximum possible quantity of donation in one year. That means that you may have a chance to contribute more in the future, thus enabling you to obtain tax benefits on such contributions.

Unused RRSP contribution room compounds year after year. CRA provides the relevant statement to an individual every year detailing on his/her RRSP contribution limit for that particular year inclusive of any carried forward contribution room.

You can transfer your RRSP contribution room and this way you get more control over your timing of payment. Alternatively, you could make a higher contribution in the higher income years so as to save more taxes.

3. Unused contribution room won’t be lost

Another benefit of RRSP that a lot of people don’t know is that your unused contribution room would not be lost. The RRSP contribution room, also known as the contribution limit, represents the maximum sum you can contribute to your RRSP accounts within a specific year. Eligible RRSP contributions can be declared as a deduction on your annual tax return, serving to decrease the total amount of taxes you are required to pay. This mechanism allows you to strategically manage your contributions to optimize tax benefits while saving for retirement. After you turn 71, your contribution room can only be used to contribute to a spousal RRSP for your younger spouse if they’re under 71.

4. RRIF income can be split with your spouse

In Canada, individuals who have Registered Retirement Income Fund (RRIF) accounts have the option to split their RRIF income with their spouse or common-law partner. This is known as the "pension income splitting" strategy.

The income that is eligible for splitting includes qualified pension income, which encompasses certain types of income, including income from a RRIF. The maximum amount of pension income that can be split is 50%. This means that you can allocate up to half of your eligible pension income to your spouse. Pension income splitting can be beneficial for tax purposes. It allows you to allocate income to your spouse who may be in a lower tax bracket, potentially resulting in a lower overall family tax liability.

5. RRSP savings earn compound interest

Making regular payments into your RRSP over time has the benefit of maximizing upon compound interest. The strategy allows you to have all your initial investments and interest earning while staying with the plan and then re-investing the rate of return to an expanded balance which results in faster growth over time.

Starting the RRSP contributions early gives longer time your contributions and the associated interest to compound. Compounding of this occurs on no-tax basis whereby your investment may develop freely without any tax obligation while still in service until you are retired where you can get these out at will. Make sure that you start paying them as early as possible, so that they have more time to accumulate and compound wealth before your retirement.

6. Make use of Home Buyers’ Plan

Planning to buy your first home? Take advantage of Home Buyers’ Plan as one of the advantages of RRSP investment. Home Buyers’ Plan allows you to use your RRSP funds as part of a down-payment on your home. If you’re looking forward to retirement, you can withdraw as much as $35,000 or $70,000 if you are a couple, without facing any tax penalties. For you to qualify, you must have lived in the house for at least one year before buying it and that it should be your main home.

Withdraw the money and spend it on the down payment or other approved house purchase or construction expenses. Within 30 days, after taking possession of the home, they have to use the money.

Under the Home Buyers’ Plan, the individual should return the amount that they have withdrawn to his/her RRSP over 15 years. They generally commence on the second year after leaving. It will be added into your income as of the year you didn’t repay the required amount.

7. Use Life Long Learning Plan to resume school

Lifelong Learning Plan (LLP) is operated in Canada and allows an individual to withdraw money from their Registered Retirement Savings Plan (RRSP). The Lifelong Learning Plan only applies to residents of Canada who demonstrate enough accumulation within their RRSPs. The other party to contribute can be your spouse who can also make the contribution in addition to combining funds to pay for any approved educational expenditures. Under the Life Long Learning Plan, withdrawals are only allowed on an annual basis up to a maximum of $10,000 per annum for a lifetime total of $20,000. Allowed withdrawals per person, a couple of them can pull out about $40,000 as being school expenses.

The funding must be repaid from the fifth year after the first LLP withdrawal if is not a qualifying student anymore. The entire payback term spans ten years and every year, you should repay at least one-tenth of a borrowed sum. The payments become deposits into your RRSP account, which cannot be deducted for taxes. However, the money paid back is treated as an old contribution and therefore does not affect your RRSP contribution room.

8. RRSP deductions are deferrable

You're not obligated to declare your RRSP contributions in the year they are made. Depending on your specific situation, it might be advantageous to delay claiming them.

For instance, if you anticipate earning a higher income in the future, potentially placing you in a higher marginal tax bracket, it could be a strategic decision to defer claiming the contribution. By doing so, you can maximize its impact in a subsequent tax year. However, it's crucial to ensure that you have sufficient contribution room available to implement this strategy.

9. Customize your RRSP portfolio

When you make contributions to an RRSP, you have the flexibility to select both the financial manager and the specific investments held within your RRSP. This stands as a notable distinction between RRSPs and Registered Pension Plans (RPPs) offered by certain employers.

An RRSP essentially acts as an umbrella, allowing you to include a diverse range of investments that are eligible under the program. Whether it's Guaranteed Investment Certificates (GICs), stocks, Exchange-Traded Funds (ETFs), or any other qualified investment, your RRSP can hold various types of assets similar to those you might include in a standard investment account. This flexibility empowers individuals to tailor their RRSP portfolio to align with their financial goals and risk tolerance.

10. Contribute to your RRSP even when you are semi-retired

Even if you've already entered retirement, you retain the option to make contributions to your RRSP until you reach the age of 71. Upon reaching this milestone, it becomes mandatory to close your RRSP and transform it into either a Registered Retirement Income Fund (RRIF) or an annuity. This transition must be completed by December 31st of the year in which you turn 71.

However, if you happen to be 71 years old and possess remaining contribution room, there is still a viable avenue for contributions. You can contribute to a spousal RRSP, provided your spouse is below the age of 71. This option allows for continued financial planning and the potential for tax advantages, even beyond the age at which you are required to convert your own RRSP into income-generating vehicles.