Tax Season

RRSPs: What you need to know

The RRSP has become an annual ritual for millions of Canadians. We spell out the ins, the outs and the rules attached to the popular retirement savings vehicle.

The rules, the reasons, the rationale

If the surveys are to be believed, the current RRSP season finds Canadians more confident and optimistic than they were a year ago.

That's not too surprising, given the continuing improvement in the economy and a stock market that delivered double-digit returns in 2010 for the second straight year.

But it remains to be seen whether the optimism will translate into more interest in RRSPs.

Figures from last year show that, as usual, most people didn't make a contribution. The number of Canadians who contributed to an RRSP in the 2009 tax year actually fell about four per cent from the previous year to 5,967,000 — about a quarter of all tax filers. 


RRSP quick facts

Number of Canadians who contributed to an RRSP in 2009: 5.97 million

Total contributions: $33 billion
Median contribution (half contributed more, half less): $2,680
Average age of contributors:  45
Median income of contributors: $51,570 
Source: Statistics Canada

That could be because there's growing competition for Canadians' disposable income. Household debt is at an all-time high, so debt paydown is a top priority for many. Tax-free savings accounts are entering their third year of existence and are grabbing an ever bigger share of the investing pie. And a significant group of Canadians say they've just got no cash to spare for RRSPs.

That won't stop Canada's financial industry from doing its best this year to grab your attention with its annual ad barrage about the various products they'd love you to stuff into your RRSPs.

The RRSP forces are in blitz mode, trying to persuade you that they — the financial planning firms, mutual fund companies, discount brokers, banks, insurance companies and credit unions — are the ones that can best nurture your precious retirement money (and reap some fees and commissions in the process).

How it all began
The first RRSP — then called a registered retirement annuity — was created by the federal government in 1957. Back then, Canadians could contribute up to 10 per cent of their income to a maximum of $2,500.

So what are you going to do this year? First, let's take a look at the nuts and bolts of what's become an annual rite of financial passage for millions of Canadians.

Why should I RRSP?

Old Age Security payments and Canada Pension Plan benefits will together provide only a bare bones retirement income. In the absence of a company pension or other savings, the gap between a basic and a more comfortable retirement can often be made up with an RRSP.

Since RRSP contributions are tax-deductible, significant upfront tax savings can result. For instance, a $5,000 contribution from someone with a taxable income of $60,000 generates tax savings of $1,450 to $1,919, depending on the province of residence. 

CIBC tax expert Jamie Golombek, in a January 2011 report entitled "Blinded by the Refund," points out that the RRSP refund "should not be considered a windfall but rather the present value of the future tax payments that will have to be made on the ultimate RRSP withdrawal."     

Starting early

Amount in an RRSP at age 65, assuming an initial contribution of $2,000, subsequent annual contributions of $2,000 and compound annual growth of six per cent:

— If started at age 25: $330.095
— If started at age 35: $169.603
— If started at age 45: $79,985
Source: Fiscal Agents

Because funds in an RRSP grow in a tax-sheltered environment, they can balloon to an impressive figure without the nuisance of having to pay tax every year on all that growth. For instance, depositing $5,000 a year each year for 25 years into an RRSP will eventually yield an account worth almost $300,000, assuming six per cent annual compounded growth. Make it eight per cent, and your nest egg grows to almost $400,000. 

Of course, the effects of 25 years of inflation will mean that the nest egg's buying power in 2035 won't be as dramatic as it was in 2011. And when it comes to time to convert that RRSP into a RRIF or annuity, those payouts will be taxable. 

That's why RRSPs are really appropriate for people who want to defer income (and, therefore, taxes) from a period of higher income (during one's working life) to a period of expected lower income (in retirement). 

And while there seems to be enormous pressure for everyone to contribute to RRSPs, keep in mind there may well be better ways to use your money. For younger workers just starting out or for low-income seniors, it may make more sense to have contributed to a tax-free savings account. For those with a lot of high-interest credit-card debt, it may be better to pay that off first. For young families with mortgages, it may just be too difficult to come up with RRSP money. Don't fret. After all, unused RRSP contribution room can be carried forward indefinitely. 

Types of plans

Individual RRSP — As the name implies, this account is registered in the name of the contributor.

Self-directed RRSP — Do-it-yourself investors set up self-directed plans that can hold a wide range of investments together in one plan. Annual trustee fees of up to $150 are often waived for those with at least $25,000 in plan assets, but transaction costs are the holder's responsibility.

Group RRSP — These are set up at work. The employee and/or the employer contribute money to individual RRSP accounts. Contributions are deducted from paycheques so the tax savings are immediate.  Investment choices may be limited.   

Spousal RRSP — With spousal RRSPs, the higher-income spouse makes a contribution to the other spouse's RRSP. The contributor gets the tax deduction, but the money is now owned by the other spouse. So when the money is withdrawn from the spousal RRSP, it's taxed at the lower-income spouse's rate. This is a form of income-splitting that is especially useful when one spouse has a significantly higher retirement income than the other.

How much can I contribute?

For the 2010 tax year, people can contribute up to 18 per cent of their earned income in 2009, up to a maximum of $22,000.

But the contribution calculation isn't that simple. From that figure, you must subtract your pension adjustment amount (PA). If you're a member of a pension plan at work, you'll have a pension adjustment. This takes into account the money you and/or your company contributed to an employer-sponsored pension plan. Your T4 slip records the pension adjustment figure. 

RRSPs: By the numbers
Percentage of families with RRSPs: 60
Median value: $25,000
Median value for families earning over $85,000: $80,000
Source: Statistics Canada Survey of Financial Security (2005)   

To this figure, you must then add the total carry-forward of unused RRSP contribution room since 1991. For some taxpayers who haven't been stuffing their RRSPs, this can amount to more than $100,000.

There's an easy way to find this figure without doing all the calculations. Just check the Notice of Assessment you received from the Canada Revenue Agency last year, or phone the tax department's T.I.P.S. line at 1-800-267-6999. You will be asked to provide your social insurance number, your month and year of birth, and the total income you reported on line 150 of your 2009 return.

What can I invest in?

With a self-directed RRSP, you can put money into a wide variety of investments — all inside a single plan. These can include guaranteed investment certificates (GICs), mutual funds, government and corporate bonds, exchange-traded funds (which track market benchmarks like the S&P/TSX 60 composite index), mortgage-backed securities, gold and silver bullion and stocks. You can even invest in your own mortgage.

Or you can just stick your cash in an interest-bearing account while you figure out what to do. The old foreign-content rule, which used to limit the amount of money you could put into foreign investments, has been scrapped.

What's the deadline?

Well, that's a bit of a trick question. You can make a contribution at any time. The only RRSP deadline you face is if you want the tax break applied to your 2010 income. In that case, the deadline is midnight, Tuesday, March 1, 2011. But you can carry forward unused RRSP contribution room to next year, or the year after that, and so on.

What are the age limits?

There's no minimum age to set up an RRSP, but it's better to contribute early and often to maximize growth. You can continue to contribute to an RRSP until the end of the year in which you turn 71, provided you still have earned income (or the end of the year in which your spouse turns 71 in the case of spousal plans).

Once you hit that deadline, you have three choices: 1) convert your RRSP into a registered retirement income fund (the most popular option), 2) buy an annuity (best payout when interest rates are higher), or 3) withdraw it in cash (generally not a good idea as you'll pay tax on the whole amount and won't have a retirement income). You can also opt for some combination of the above choices.

Are RRSPs only for retirement?

While RRSP stands for registered retirement savings plan, the federal government has brought in two provisions that allow Canadians to get access to RRSP money for reasons other than their golden years.

The Home Buyers Plan (HBP) has been enormously popular in Canada, with almost 1.4 million people taking advantage of it as of 2004, the latest available figures. The plan allows individuals to withdraw up to $25,000 from RRSPs to buy or build their first home (the limit was raised from $20,000 in the 2009 federal budget). Since 1992, more than $14 billion has been withdrawn. As long as the money is used to buy a qualifying home, no tax is paid on the withdrawal. The catch is that the money must be repaid to your RRSP over the next 15 years or the minimum annual payment will be added to your income and you will pay tax on that. And the repayment is not tax-deductible because you got the tax break the first time you put in the money. 

The Lifelong Learning Plan (LLP) allows Canadians to pull up to $20,000 from their RRSPs to head back to school. The withdrawals can be a maximum of $10,000 in any one year and can be spread over four years. Repayment is on a 10-year schedule. About 49,000 people have withdrawn $363 million since the LLP began in 1999.

Financial experts also point out that by raiding your RRSP for either of these plans, you lose much of the tax-free compound growth you could have made on that money, so you might want to repay the money quicker than the prescribed schedules.

Of course, you can withdraw money from an RRSP for any reason, like taking a year off to have a child or travel. But that kind of early raid will result in having to pay tax on every penny withdrawn and the contribution room will be lost forever.  In most cases, it would make more sense to use a tax-free savings account for such short-term cash needs as there are no tax consequences when making withdrawals.