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Have you ever been at some type of gathering and heard people discuss RRSPs?
Were you thinking “what is an RRSP” while praying nobody asked you to contribute to the conversation? Yeah, me too.
This article will go more in depth into what is an RRSP, what is the RRSP deduction limit and what is the RRSP contribution limit.
Financial acronyms such as “RRSP” are too often thrown around in conversation with the misconception that everybody understands what they are and what it stands for.
In short, RRSP stands for Registered Retirement Savings Plan.
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What is an RRSP?
Think of an RRSP as a special type of savings account that is primarily used for your retirement savings.
A common question people ask is “ what is an RRSP and how can I invest in one?”
But here’s the thing…
An RRSP in itself is not an investment, but it is a vehicle in which you can hold your investments to get special tax advantages to save for retirement.
If you were interested in opening up an RRSP, check out my article here on why I recommend Wealthsimple and how to go about opening an account. I’ve been using Wealthsimple myself since 2016 and I love it. If you’d rather just skip to the sign-up process, you can do so here and get a $50 bonus.
What Tax Advantages does an RRSP offer?
Reduces Your Taxable Income
While there is a specific limit to how much you contribute to your RRSP (which we will discuss later), contributing to your RRSP directly reduces your taxable income.
For example, let’s say you make $65,000 a year, by contributing $10,000 to your RRSP your new taxable income is only $55,000 as opposed to $65,000.
In other words, the government will tax you as if your income was $55,000 as opposed to $65,000, lowering your tax burden.
Not only does making RRSP contributions set you up for retirement nicely, but by regularly contributing to your RRSP, you will often overpay in taxes each year and in return receive a generous tax return come tax season.
Investments Grow Tax-Free
If you make investments outside of a registered savings account such as an RRSP, TFSA or RESP, all income generated from these investments are taxable.
However, as long as you keep your money within your RRSP, all of your investments will grow tax free and they are 100% protected from government taxation until you withdraw it.
While you can withdraw money from your RRSP before you turn 65, I would not suggest it. Not only does withdrawing from your RRSP come with a heavy tax burden, but your money won’t grow as fast in the future as there is less money for compound interest.
For more benefits of the RRSP check out my article, Top 9 Benefits of Investing in an RRSP.
Common RRSP Investments
As mentioned earlier, RRSPs are similar to bank accounts as they help you store money, however they differ in the sense that you can make investments within your RRSP accounts unlike in your standard cheqeuing or savings account.
Here are some of the most common investments people make within their RRSP account:
- Index Funds (ETFs)
- Mutual Funds
- Individual Stocks
What is the RRSP Contribution Limit?
Your RRSP contribution limit simply refers to the amount of money you can put into your RRSP each year.
As of 2020, you can contribute a maximum of 18% of your income from the previous year plus any unused contribution room from years past.
For example, your RRSP contribution limit for the 2020 tax year would be 18% of your 2019 earned income plus any unused contribution room from previous years.
There is also a limit to how much one’s RRSP contribution is. Regardless of how much you make, the federal government puts a maximum amount on how much you can contribute to your RRSP for each year. The maximum contribution limit was $26,500 for 2019 and $27,230 for 2020.
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This prevents high income earners being able to donate hundreds of thousands of dollars each year to avoid high tax brackets.
Your total RRSP contribution amount may also be lowered if you have an employer sponsored pension, but we will discuss those details in another article, for now, just remember your RRSP contribution limit is either 18% of your income, or roughly $27,000, whatever is lower.
Lastly, it is important to note you can contribute to your RRSP upto and including 60 days in the next year. For example, the last day Canadian residents could contribute to their RRSPs was March 2nd, 2020 for the 2019 calendar year.
What is the RRSP Deduction Limit?
People often confuse the RRSP deduction limit with the RRSP contribution limit. Typically, these amounts will be the same however they have slightly different meanings.
Your RRSP deduction limit refers to how much you can deduct from your taxable income for a given year while your RRSP contribution limit refers to how much you can put away in your RRSP each year.
Related Financial Geek Article: Retire Early as a Canadian | 15 Tips and Tricks
While there are a few more things we could discuss about RRSPs, the purpose of this article is to give you a high level overview of RRSPs.
The bottom line is, if you are Canadian who earns an income, you should open up an RRSP if you haven’t already.
If you are in fact interested in opening up an RRSP for yourself, I’d recommend doing so with Wealthsimple for the 10 reasons I talk about in my article here.
If wanted to get started right away, sign-up for one here and get $25 bonus for doing so.
Think of an RRSP as a gift from the federal government – these rarely come along so take advantage when they do!
How to Open an RRSP with Wealthsimple
If you are interested opening up an RRSP for yourself, check out The Financial Geek’s Step-by-Step Guide on how to do so with Wealthsimple.