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Your retirement plans are a crucial component when it comes to creating a financial plan. While it’s fine to plan for all the fun activities you’ll be able to do during retirement, you need to ensure you’ll have enough income at your disposal to live comfortably.
Various financial products are available to help you successfully create a sound retirement plan, each with its own unique features and benefits. If you’ve explored retirement planning even briefly, you’ve likely come across terms such as RRSP and RSP. But what exactly are an RRSP and RSP, and how are they similar or different?
What’s The Difference Between an RRSP and an RSP?
An RRSP is an acronym for Registered Retirement Savings Plan. It’s a government-registered savings account administered by the Canada Revenue Agency (CRA) and designed to help you save for retirement. RRSPs are notable for their tax-shelter feature, which allows you to grow your investments tax-free until you decide to withdraw the funds.
An RSP is an acronym for Retirement Savings Plan. It refers to a number of different accounts whose purpose is to help you save money for your retirement. People sometimes use the terms RSP and RRSP interchangeably, and they are correct to do so, depending on the context. An RRSP is, in fact, a type of RSP. But an RSP is not necessarily an RRSP, as there are others, such as Registered Pension Plans (RPP) and Tax-Free Savings Accounts (TFSA). It’s best to think of RSP as an umbrella term that encompasses all types of retirement savings accounts.
Types of RSPs
There are several different kinds of RSPs available in Canada. Below are details of the most popular ones.
Registered Retirement Savings Plan (RRSP)
An RRSP is a registered retirement account that offers appealing tax advantages. Funds you contribute to the account can be deducted from your taxable income. Any earnings generated are not taxable until you cash out the funds.
RRSPs are sold by financial institutions that are approved by the CRA. You can invest in a wide array of financial assets through an RRSP, including mutual funds, savings accounts, exchange-traded funds, stocks, GICs, and bonds.
The amount of money you’re allowed to contribute to your RRSP every year is set by the CRA and is the lessor of the following two values:
- 18% of your pre-tax income for the previous year, or
- The CRA limit for the current year ($27,230 for 2020)
For example, if your pre-tax income for 2019 was $50,000, the most you can contribute to your RRSP for 2020 is $9,000. When you file your taxes, you can deduct the $9,000 to reduce your taxable income for the year.
However, there is no requirement for you to contribute the maximum each year. You can carry forward any unused contribution room to future years. Using the example above, if you decide to contribute only $7,000 to your RRSP, rather than the maximum of $9,000, you’ll have an additional $2,000 of contribution room available for any year in the future.
Filing Your Income Tax
You can also choose not to deduct the contributions against your taxable income for the current year and defer them to a future year where it’s more advantageous to use them. This is an option to consider if you anticipate that your income will increase substantially in the future, thus bumping you up to a higher tax bracket.
As noted, the earnings inside your RRSP are not taxable. However, any funds you withdraw early will be subject to a federal withholding tax. The amount you can expect to pay in withholding tax is as follows:
- 10% if you withdraw up to $5,000 (for Quebec residents, the rate is 5%)
- 20% if you withdraw between $5,001 and $15,000 (for Quebec residents, the rate is 10%)
- 30% if you withdraw over $15,000 (for Quebec residents, the rate is 15%)
Learn how you can avoid paying capital gains tax.
Reporting Withdrawals as Income
In addition to the withholding tax, you’ll also have to report the withdrawal as income on your tax return. It will be taxed at your combined marginal tax rate (the tax paid on any additional dollar at both the federal and provincial levels). Due to the potentially massive tax liability, you should refrain from withdrawing funds from your RRSP for as long as possible. Ideally, you should plan on only accessing the funds when you retire.
By law, you must withdraw the money from your RRSP by December 31 in the year in which you turn 71. All withdrawals will be subject to income tax, though it’s likely you’ll be in a lower tax bracket by this time. You can opt to convert your RRSP into a Registered Retirement Income Fund (RRIF). A RRIF is a tax-advantaged account that functions like an RRSP, but you’re required to withdraw a prescribed amount each year and report it as income.
A Registered Pension Plan (RPP) is a type of registered RSP that companies set up for their employees. Like an RRSP, you can deduct your contributions on your tax return. Any earnings are tax-sheltered provided you don’t make a withdrawal.
There are two types of RPPs:
- Defined benefit (DB): A defined benefit pension plan promises to pay you a certain monthly wage when you retire. This amount varies from company to company and is determined by factors such as your age and years of service. Your employer is usually responsible for the contributions under a DP plan, but sometimes they may ask you to contribute as well.
- Defined contribution (DC): A defined contribution pension plan will pay you a monthly wage based on the amount contributed to the plan and the performance of the investments therein. Unlike a DB plan, it’s common for both the employee and employer to contribute to a DC plan.
The amount you can invest into an RPP depends on whether it’s a DB plan or DC plan. There’s no limit to how much you and your employer can contribute to a DB plan. For a DC plan, the total contribution is limited to the lesser of the current year limit ($27,830 for 2020) and 18% of your earnings for the year. All RPP contributions are tax-deductible.
While both types of RPPs offer tax breaks, they’ll lower your available RRSP contribution room. This reduction is referred to as a “pension adjustment.”
You can begin collecting payments from your RPP upon retirement, where they’ll be subject to income tax. Alternatively, you can transfer your pension’s commuted value into a Locked-In Retirement Account (LIRA) or another RPP.
Find out if you should invest in your RRSP or pay down debt first.
A Tax-Free Savings Account (TFSA) is a registered savings account. A TFSA allows you to save money for any purpose, unlike RRSPs and RPPs, which are explicitly geared toward retirement planning. Contributions to a TFSA are not tax-deductible, but earnings are tax-sheltered.
CRA-approved financial institutions offer TFSAs and, much like RRSPs, can hold a variety of financial assets.
The CRA sets the maximum amount you can contribute to your TFSA on an annual basis. For 2020, the contribution limit is $6,000. Though contributions are not tax-deductible, withdrawals are not taxable, which is a feature that makes TFSA distinct from RRSPs. You can carry forward any unused contribution room to future years.
Learn how you can invest in your TFSA using a robo advisor.
Non-registered accounts differ from RRSPs, RPPs, and TFSAs in that they don’t provide you with a tax-sheltering benefit. In other words, earnings you generate inside a non-registered account must be reported as taxable income in the year they’re earned. However, if you borrowed money to invest, you may be permitted to deduct the interest charges.
Despite offering no tax-saving advantages, there’s no limit to how much you can contribute to a non-registered account, and they offer more investment options compared to registered accounts like RRSPs and TFSAs. You can also withdraw your money anytime you wish.
Non-registered accounts are ideal if you’ve maxed out your tax-advantaged accounts but still have funds available to invest.
New to investing? Check out our beginners guide on investing.
Overview on Types of RSP Accounts
|Type of plan||Are contributions tax deductible?||Contribution limits (2020)|
|RRSP||Yes||18% of earnings up to $27,230|
|RPP||Yes||For a DC plan, 18% of earnings up to $27,830; no limit for a DB plan|
What is the contribution limit for an RRSP?
Is my RRSP taxable?
Should I invest in a TFSA or an RRSP?
An RRSP is an attractive investment vehicle that allows you to grow your retirement nest egg. However, an RRSP is only one type of RSP that’s available. There are other options to explore, which may be more suitable based on your income, age, lifestyle, etc. Be sure to conduct your research to determine which type of plan is best for you and your goals.
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