The Millennial’s Ultimate RRSP Guide
I just realized that although I have written many articles on how great RRSP is when it comes to allowing your dividend investment grow tax-deferred, I have never provided any information on the RRSP. So I decided to write this millennial’s ultimate RRSP guide. Another reason for writing an RRSP guide is because when I first started working and started receiving earned income, the Registered Retirement Savings Plan (RRSP) was something that caused a lot of confusions for me. I didn’t understand how the contribution room was calculated, I didn’t know the RRSP contribution and withdrawal rules, and I didn’t know anything about RRSP tax implications . It wasn’t until after spending lots of time reading books and articles, I finally figured out why the RRSP is so sexy and awesome. As an “older” millennial myself (Although I still get ID’d, so I guess I still look like I’m 19 ha!), I hope the millennial’s ultimate RRSP guide will be helpful.
What is the RRSP?
The Registered Retirement Savings Plan (RRSP) is what the name suggests, it is a retirement savings account that you establish with a financial institution. Any RRSP contribution that you or your spouse or common-law partner made can be used to reduce your tax.
Note: During RRSP season (every February) a lot of people would say that they are “buying RRSP.” Sorry this is completely wrong. RRSP is not an investment. RRSP is simply an account that holds other investments. So you can’t buy RRSP, instead you can buy an investment in the RRSP account to which you contribute. A lot of people get this mixed up, I hope this is now clear.
RRSP Contribution Guideline
- The amount of RRSP contribution room you have is calculated based on your previous year’s earn income. You can find out this information by logging on your CRA account, calling the Tax Information Phone Services (TIPS) at 1-800-267-6999, or check out your Notice of Assessment.
- If you are one of the lucky ones that have a pension plan at work, your annual RRSP contribution room is reduced.
- Your RRSP contribution room is either 18% of your previous year’s pre-tax earned income less your previous year’s pension adjustment, or the annual maximum of $25,370 in 2016, whichever is lower. The annual maximum is adjusted each year.
- RRSP contribution room can be carried forward to subsequent years. If you are unable to maximize your contribution, the unused room can be carried forward indefinitely. This is a way to grow your RRSP contribution limit (It’s usually best to maximize your RRSP contribution which I will talk about later in the article).
- You have 60 days after the end of the year (usually until March 1, or February 29 in a leap year) to make your RRSP contribution for the previous year. Therefore, for the 2016 tax year, March 1, 2017 is the RRSP deadline.
- There’s no minimum age to set up an RRSP and you can continue contributing to an RRSP until the end of the year in which you turn 71 (wow that seems very far out for me). Once you hit 71, you must convert your RRSP into one or a combination of the three follow options:
- A Registered Retirement Income Fund (RRIF). If you set up an RRIF, there are specific withdrawal rules.
- Buy an annuity. This will allow a set amount of monthly income for life.
- Withdraw it in cash. This is highly undesirable as you will be taxed for your entire RRSP portfolio value.
Different Types of RRSP
Before we dive deeper, please note there are 4 different types of RRSP accounts.
- Individual RRSP – This is registered in the name of the contributor. Typically managed by a financial institution.
- Self-directed RRSP – This is similar to individual RRSP but it’s a DIY account which allows you to hold a wide range of investments. Be careful when you open a self-directed RRSP with financial institutions. Some financial institutions charge an annual “maintenance” fee unless you reach their minimum amount requirement.
- Group RRSP – If you don’t have a pension at work, typically you would have a Group RRSP available. The employee could contribute money to the group RRSP from their pay cheques and the employer would match the contribution up to a certain amount. When you do this, you see tax savings immediately. There are some limitation to Group RRSP though as typically you can only invest in mutual funds or GICs.
- Spousal RRSP – If one of the spouses has a higher income, spousal RRSP is great vehicle to use for future retirement income splitting. Basically the higher-income spouse (A) would make the contribution and get tax deduction. The money in the spousal RRSP would be owned by the other spouse (B) and cannot be withdrawn until 3 years after the contribution. When money is withdrawn from the spousal RRSP, it’s taxed at the spouse’s (B) rate that owns the spousal RRSP. Why is this a good idea? For example, consider you’re the only one with an RRSP account. Imagine in retirement you withdraw $50,000 from your RRSP and get taxed at say 30% ($15,000 tax). If spousal RRSP is utilized, both of you would withdraw $25,000 each from your RRSP and the spousal RRSP and get taxed at a lower marginal rate.
RRSP Tax Benefits
- You make RRSP contributions using pre-tax dollars. Whatever you contribute, you will get a tax credit at your marginal rate. For example if you contribute $1,000 and your marginal tax rate is 25%, you will get a $250 tax credit/refund.
- All investments within an RRSP account can grow tax-free until you withdraw from the RRSP. At time of the withdraw, the amount is taxed as earned income.
What Can I Invest in my RRSP?
I thought you would never ask! For the average person, most investments can be held in an RRSP so this include:
- Mutual Funds
- Option contracts
- Investment grade gold & silver bullion
- Shares of small business corporations
Since RRSP is for long-term investment, I would recommend not hold cash or buy GIC’s with your RRSP contributions. Think long-term, so typically people tend to buy mutual funds, ETFs, stocks, and bonds with their RRSP contributions.
RRSP Withdrawal Rules & Limitations
To utilize RRSP effectively, we need to understand the withdrawal rules.
- There are only two ways to withdraw money from RRSP without paying taxes.
- The Home Buyer’s Plan (HBP). In HBP you can withdraw up to $25,000 from your RRSP to buy your first house tax-free. You’ll have 15 years to pay back whatever amount you withdrew into your RRSP in equal annual installments. Unfortunately you won’t get tax refunds for these annual re-payment contributions.
- The Lifelong Learning Plan (LLP). In LLP you can withdraw up to $20,000 from your RRSP to head back to school. You then have 10 years to pay back whatever amount you withdrew into your RRSP in equal annual installments. Again you won’t get any tax refunds for the re-payment contributions.
- If you decide to withdraw from your RRSP before age 71, you will get hit by a withholding tax upon withdraw. Table below shows the different tax rates. One important thing to remember is the amount after withholding tax is then taxed again at your marginal tax rate. Hence early withdrawals are highly undesirable.
|Withdraw Amount||Withholding tax rate (except Quebec)||Withholding tax rate in Quebec|
|Up to $5,000||10%||5%|
|Between $5,000 and $15,000||20%||10%|
|More than $15,000||30%||15%|
When Should You Not Contribute to an RRSP?
I think about 95% of the time it makes sense to contribute to an RRSP. It’s a great idea to have money growing tax-free in your RRSP and take advantage of the power of compound interest. Now what are the 5% of time that makes sense to not contribute to an RRSP?
- If your income is low that you won’t see any benefit of the tax reduction. For example in 2016 if you make less than $11,635 ($11,474 in 2017) you won’t benefit in RRSP tax reduction.
- If your income in a year or two will put you in a higher tax bracket. As indicated earlier, RRSP contribution provides you with a tax credit that you can use to reduce your overall taxable income. For example, if you will move from 20.5% to the next tax bracket of 26% in a couple of years, it might make sense to save your RRSP contribution room. Even if you’re in this category, it might be tough to decide whether to contribute RRSP now or wait. You definitely need to do some calculation in terms of tax savings vs. investment rate of return.
- If you have too much money in your RRSP already. Remember that RRSP withdrawals are taxed as earned income and you must convert your RRSP into RRIF once you turn 71? RRIF has specific withdraw rules so if you have too much money in your RRSP, you will be forced to withdraw a large amount of money each year. This, of course, can result in clawback on your Old Age Security (OAS) payments so you won’t receive as much money from OAS.
What Happens If I Over Contributed RRSP?
If you automatically contribute to your RRSP every pay cheque then top up the remainder of your RRSP contribution room by the RRSP deadline, it could happen that you end up contributing more than you are allowed (i.e. calculation error). Unlike TFSA where there’s a hard contribution limit (and you will heard from the CRA if you over-contributed TFSA), there’s a bit of buffer for RRSP. There’s an over contribution limit of $2,000 for RRSP. This limit is there to provide some buffer in case you make a honest mistake.
Believe me, this $2,000 buffer has come in handy as I have accidentally over contributed in my RRSP a few times. I believe it’s actually a good idea to use this $2,000 over-contribution limit to take advantage of the tax-free growth and power of compound interest. But watch out that you don’t go over the $2,000 over contribution limit or you will get charged a 1% penalty tax for each month you are in excess of the contribution limit. You must withdraw the over contribution amount immediately (note: this will trigger withholding tax, double whammy!!!) then fill out a T1-OVP Individual Tax Return for RRSP Excess Contributions. Lesson learned? Don’t ever go over the RRSP $2,000 limit.
If you decide to utilize the $2,000 RRSP over contribution room, make sure you have some sort of earned income in future years because if your available contribution room is a negative amount, you may have to pay tax on any excess contributions.
How You Should Use the RRSP
Ah… we have finally got to the meat of this millennial’s ultimate RRSP guide. I believe RRSP is best to use for retirement savings as the name suggests. A few points:
- While the idea of withdrawing money from your RRSP to pay for your first house (HBP) or education (LLP) is attractive, I would recommend against withdrawing for HSB or LLP. Why? Because you will be losing many years worth of compounding. See table below for a visual illustration of the difference you will see at end of 30 years. Note: We are assuming you will contribute the same amount each year for both scenarios. At end of 30 years you will see a difference of over $86k.
|Not withdrawing for LLP||Withdrawing for LLP|
|Initial RRSP Amount||$20,000||$0|
|Years to grow||30||30|
- Use RRSP as a savings vehicle for your retirement. Think long-term rather than short-term. Try to maximize your RRSP contribution every year if you can.
- When you make RRSP contribution, you get a tax refund from the government. Best way to use this tax refund? Put it in your RRSP as part of your next year’s contribution.
- If your work offers Group RRSP matching, SIGN UP!!! Never, ever say no to free money!!! I am always shocked to hear people that do not sign up to take advantage of employer’s RRSP matching. Imagine getting your employer contributing $1,500 extra each year over 40 years. At 5% interest rate, that will result in $190,259.64, that’s over $130,000 worth in interests alone! Don’t be a dummy, always say yes to free money!
- I highly recommend setting up self-directed RRSP accounts (for you and your spouse), especially if you have a significant amount of money in your RRSP. Why do I recommend self-directed RRSP?
- Lower management fee. If you are enrolled in individual RRSP and invest in mutual fund, switching to a self-directed RRSP and invest in index ETF or dividend stocks will result in a much lower management fee.
- Financial education. Since this is your retirement and not mine and not your financial advisor’s, I think it’s important that you take some accountability for your own retirement. The first step is do learn a thing or two about investing. Best way to do this is managing your own RRSP. If you’re uncomfortable with managing your own RRSP, you can utilize a robo-advisor like Wealthsimple to lower your fees first and still learn about investing.
- Product selection. There are more products/investments available for a self-directed RRSP compared to a Group or Individual RRSP. Self-directed RRSP simply gives you more choices.
- Asset management. This is related to the previous point. A self-directed RRSP makes it easier to keep track of your investments and also allows you to maintain your desired asset mix (for example, having 5% in cash, 20% in bond, and 75% in stocks).
- If you have a spouse, work together on your RRSP investments. Utilize Spousal RRSP to ensure that the both of you have roughly equal amount of income in retirement. With some simple planning, you can effectively reduce both of your income taxes in retirement and ensure that you can both receive maximum allowable OAS without clawback.
My RRSP Story and Plans
- Since I started working full-time 10 years ago, I have made the tradition of maximizing my RRSP contribution room every year. Although I knew my earned income would increase overtime, I didn’t delay my RRSP contributions. To make life easier I would just claim the entire RRSP contribution amount in my income tax filing. I never bothered to save the contributions for later use.
- I’ll be honest, I didn’t realize how powerful spousal RRSP is until recently. Since I’m the high-income earner in our household, after some quick calculations, I realized how important it is to ensure our retirement income is roughly the same (especially when we will be tapping into RRSP once we are financially independent). Therefore I have started a spousal RRSP under Mrs. T’s name. The goal is to have my RRSP and her RRSP values to be roughly the same once we start withdrawing.
- RRSP and TFSA will big part of our income once we are financial independent. We plan to withdraw less than $5,000 from our accounts each year. For that reason, we probably will collapse our RRSPs prior to age of 71.
- Whenever we get a tax refund from our RRSP contributions, we put the refund back into our RRSPs. I want my money to work hard for me now instead me having to work hard for money now and later.
What do you think about this millennial’s ultimate RRSP guide? Did I miss anything? Do you have any other tips I should include?