Registered Retirement Savings Plans (RRSPs)￼￼
A registered retirement savings plan (RRSP) is a type of registered savings plan set up under the Income Tax Act and registered with the Canada Revenue Agency. An RRSP is not an investment, you cannot buy an RRSP. Instead, an RRSP is a registered investment vehicle within which investors can deposit various types of investments. In order to contribute to an RRSP, an individual must have earned income.
An individual may only contribute to his or her own RRSP up until December 31 of the year in which they turn 71 years of age. After that date, they may contribute to a spousal plan up until December 31 of the year in which the spouse turns age 71.
Contributions to an RRSP may take the form of cash or in-kind (non-cash) contributions. A cash contribution is made for its cash value. On the other hand, in-kind contributions are made at their current market value. If the market value exceeds the purchase price, the investment income must be reported on the investor’s tax return when the asset is transferred into the RRSP.
Freddie owns 500 units of the Ultima Canadian Equity Fund. Freddie purchased the units for $8,000 and they have a current fair market value of $10,000. If Freddie makes an in-kind contribution to his RRSP using these fund units, his RRSP contribution will be valued at $10,000 and he will have to report a capital gain of $2,000, calculated as $10,000 – $8,000, on his income tax return, which is taxable.
RRSP Contribution Limits
|The annual RRSP contribution limit refers to the maximum amount that an individual can contribute into his or her RRSP each year. The RRSP contribution limit for the current year is based on five components, and is calculated as:|
(1) Refers to the current year’s RRSP contribution limit
(2) Refers to the carry forward of unused RRSP deduction room
(3), (4), and (5) Refers to adjustments for participants in a Registered Pension Plan (RPP) or Deferred Profit Sharing Plan (DPSP)
The annual RRSP contribution limit is not a straightforward calculation. In order to make it easier to determine the amount that an individual can contribute to his or her RRSP, the Canada Revenue Agency provides each person with a notice after they have assessed that person’s tax return. Among other things, this Notice of Assessment (NOA) reports the RRSP contribution limit for the tax year following the tax year to which the NOA applies.
Annual RRSP Contribution Limit
RRSP contribution room can be calculated each year based on the lesser of:
- 18% of the previous year’s earned income
- the maximum annual RRSP contribution limit
Earned income generally includes net income from employment, business, and rental property, but does not include investment income (except for net rental income from property).
The maximum annual RRSP contribution limit changes every year with changes in the average industrial wage, a statistic reported annually by Statistics Canada.
Mario has earned an income of $50,000. The current maximum annual RRSP contribution limit for the year in question is $27,830. Mario’s annual RRSP contribution limit is $9,000, the lesser of:
- $9,000, calculated as ($50,000 x 18%)
- $27,830 (CRA Maximum)
Carry Forward of Unused RRSP Room
|If an individual does not contribute the maximum to their RRSP, they can carry forward the remainder of the annual contribution to another year. The individual can contribute at a future date based on this carry forward amount. RRSP contribution room can be carried forward until the end of the year in which the individual reaches age 71.RRSP overcontributionIn order to protect individual investors who may miscalculate their maximum contribution limit, investors are allowed to over-contribute to their RRSPs by up to $2,000. This is a lifetime maximum, not an annual allowance. Anyone who over-contributes to an RRSP by more than $2,000 may be subject to a penalty tax of 1% of the excess for each month that they are above the $2,000 limit. In general, the penalty tax may be avoided if they take steps to withdraw the excess contributions from the RRSP account. Any RRSP withdrawals must be reported as income on an individual’s tax return.|
Adjustments for RPPs and DPSPs
|For participants in a registered pension plan (RPP) or deferred profit-sharing plan (DPSP), there may be adjustments to their RRSP contribution limit based on these plans. They will be in the form of pension adjustments past service pension adjustments pension adjustment reversals|
RRSPs & Tax Deductions
|Your clients can deduct RRSP contributions from their total income. This reduces the amount of income tax they pay. The total income tax deduction that an individual may claim for a calendar year is determined by his or her RRSP contributions during the year and the first 60 days of the following year. Contributions made in the first 60 days of a given calendar year can be applied to the previous year rather than the year in which they were made. Investors can also carry forward unused deductions if they do not deduct RRSP contributions from their total income in the current year. This enables them to reduce their total income in future tax years. If your client expects his or her income to increase significantly in the future, it may make sense to carry forward his or her income tax deductions.|
RRSPs & Tax Deferral
|The growth of money invested inside an RRSP is not subject to tax until it is withdrawn. In other words, the tax payable on investment growth is deferred until the future. Since income earned inside an RRSP is tax-sheltered, RRSP investments grow much faster than non-registered investments held outside an RRSP.When advising your clients about tax deferral strategies, it is essential that you as a dealing representative consider your client’s future tax obligations, as well as the tax savings, in order to ensure the best possible return for your clients in the long term.|
The Income Tax Act restricts the types of investments allowed in RRSPs. Some of the investments that qualify to be held within an RRSP include:
- cash, guaranteed investment certificates (GICs), term deposits, treasury bills, and other short-term deposits
- Canada Savings Bonds, Canadian government bonds, and bonds and debentures of corporations listed on an exchange
- Canadian mortgages and mortgage-backed securities
- publicly listed stocks traded on a stock exchange
- mutual funds, exchange-traded funds
- segregated funds
- rights, warrants, and call options (if they are covered call options)
- investment-grade bullion, coins, bars, and certificates
- royalty and limited partnership units
|Group RRSPs are a collection of managed RRSPs grouped together for administrative purposes. Group RRSPs are typically sponsored by an employer, union, or professional association. Group RRSPs are administered by a financial institution, securities dealer, or insurance company.The table below summarizes the advantages and disadvantages of group RRSPs:|
|With a self-directed RRSP, the investor selects from a wide variety of investment options. Unlike a managed account, which may only allow an investor to hold mutual funds offered by the plan sponsor/administrator; a self-directed RRSP allows an investor to mix-and-match any combination of investments, such as stocks, mutual funds, bonds, or investment-grade bullion. Investors can customize the plan to meet their needs. Self-directed RRSPs still require a trustee, such as a trusted company, bank, investment company, or broker that sponsors and administers the plan. Typically, the trustee charges a fee for this service.|
|A spousal RRSP allows one spouse to be the contributor while the other spouse is the annuitant. Historically, spousal RRSPs were set up to allow couples to split their RRSP contribution such that their income at retirement was more evenly balanced. This would have the effect of minimizing their income tax liability. The tax benefit of a spousal RRSP is maximized when the higher-income spouse or common-law partner contributes to a spousal RRSP where the lower-income spouse or common-law partner is the annuitant. In this case, the higher-income individual can claim the RRSP contribution as a tax deduction. Presumably, the lower-income individual, who is in a lower tax bracket, will be able to withdraw money at retirement from the spousal RRSP. If the lower-income spouse or common-law partner has an RRSP contribution room, they can also contribute to a managed RRSP.|
Tax Benefits of Contributing to a Spousal RRSP
|Under Canada’s progressive tax system, spouses or common-law partners with significantly different incomes will benefit financially if they are able to build two pools of savings that will produce two similar income streams during retirement. Under Canada’s progressive tax system, they would pay less tax on the two streams of income than if the majority of the RRSP withdrawals were taxed in the higher income earner’s hands. A progressive tax system is defined as a system in which the tax payable on your client’s next dollar of earned income increases as their income increases. In other words, it is better, from an income tax perspective, if a couple earns $50,000 each rather than one person earning $100,000 while the other person earns $0.|
NOTE: An individual who is over 71 may still contribute to a spousal RRSP if they still have earned income and their spouse (the annuitant of the spousal RRSP) is not yet 71 years of age.
Spousal RRSP Attribution Rule
|The Canada Revenue Agency has special attribution rules regarding withdrawals from spousal RRSPs. If your client’s spouse or common-law partner makes a withdrawal from a spousal plan in the year in which they contribute to that spousal plan, or in the preceding two calendar years (also known as 2+ years), the withdrawal is taxed in the contributor’s hands. After that time period, any withdrawals are taxed in the annuitant’s hands.|
Withdrawing from RRSPs Introduction
|Although most of your clients will be saving for retirement, it is important to understand the alternatives available to help them make the right choice when taking money out of their retirement plans.|
Terminating an RRSP
|A registered retirement savings plan (RRSP) can be terminated at any time, provided it is not a locked-in plan. However, the primary purpose of an RRSP is to provide individuals with a tax-deferred retirement savings option using before-tax dollars. Although your client would benefit from allowing their RRSP deposits to earn interest that compounds over many years, they do have the flexibility to withdraw money early and/or wait until the RRSP matures. Your client may decide to withdraw money from their RRSPs before they mature, for any reason. Although a lump sum withdrawal is an option, the federal government has created two programs that allow investors to use RRSP savings to buy a home or to pay for training or education. On the other hand, individuals who decide to maintain some or all of their RRSP deposits must terminate or convert their RRSPs by December 31st of the year in which they turn age 71.|
All money withdrawn from an RRSP is subject to income tax. The Canada Revenue Agency requires that the financial institution that sponsors the RRSP to apply a withholding tax before any funds are deposited into a person’s bank account. As per the table below, the amount of the tax depends on the amount withdrawn and the province of residence.
Yasmine lives in Ontario. Her finished basement was badly damaged in a flood. She did not have homeowner’s insurance and the basement repair bill is estimated at $12,000. Yasmine has no savings other than her RRSP. In order to fix her basement, she decides that she has no choice but to withdraw money from her RRSP. However, in order to get the $12,000 she needs now, she must withdraw enough to also cover the withholding tax. Yasmine must withdraw $15,000, calculated as $12,000 ÷ (1 – withdrawal rate of 20%).
The gross amount that Yasmine withdrew from her RRSP is then added to her annual taxable income, and the 20% tax deducted ($3,000) will be added to the tax she has paid. If the $15,000 pushes Yasmine into a higher tax bracket, and her marginal tax rate becomes higher than 20%, she may owe more taxes during income tax time.
Home Buyers’ Plan (HBP) Withdrawals
|The Home Buyer’s Plan (HBP) allows individuals to make tax-free withdrawals from their RRSPs in order to purchase a principal residence. An individual can withdraw up to $35,000 from their RRSP under the HBP for any qualified withdrawal made after March 19th, 2019. Prior to this date, maximum withdrawals were $25,000. Before participating in the HBP, the individual must have entered into a written agreement to buy or build a qualifying home. They must complete the transaction by October 1st of the year after the withdrawal. If they buy the qualifying home together with their spouse or common-law partner, or other individuals, each person can withdraw up to $35,000.To qualify as a first-time homebuyer, the individual must not have owned and lived in a home as their principal residence in any of the four calendar years prior to the year of withdrawal. Furthermore, the individual must not have occupied a home that their current spouse or common-law partner owns. In order to maintain the tax-free status of the withdrawals, the money withdrawn must be repaid into the individual’s RRSP account. The repayment period begins in the second year after the year of withdrawal. Repayments must be made in equal annual installments, and repayments made within 60 days after the calendar year-end qualify as repayment for the previous year. In general, the amount of the repayment is 1/15 of the total amount withdrawn. Any missed or incomplete payments are considered income by the Canada Revenue Agency (CRA) and subject to tax. Repayments in excess of the minimum are allowed. The HBP is not available for RRIFs, or any locked-in accounts such as LIRAs, LIFs, RLIFs, LRIFs, or PRIFs.|
Adam and Joanna were married in 2020 and are looking forward to purchasing a new home together. Since Adam had owned a home as a principal residence the year prior to getting married, he is not eligible for the HBP program. However, Joanna has never owned a home and did not live with Adam in his home during the period he owned it. She is, therefore, able to withdraw the full $35,000 from her RRSP. If Joanna withdrew funds sometime during 2020, they must acquire a home by October 1, 2021. Joanna can make her first annual repayment for the 2022 calendar year any time before March 1, 2023. The amount of her repayment will be 1/15 of $35,000, or $2,333.33.
Lifelong Learning Plan (LLP) Withdrawals
|The Lifelong Learning Plan (LLP) allows individuals to make tax-free withdrawals from their RRSPs in order to finance full-time training or education for themselves, their spouses, or common-law partners. The maximum total withdrawal is $20,000, subject to a yearly maximum of $10,000. In order to qualify for a withdrawal, the student must meet all four conditions: The student has an RRSPThe student is a resident of CanadaThe LLP student is enrolled (or has received an offer to enroll before March of the following year)As a full-time student in a qualifying educational program at a qualifying educational institution. if you have made an LLP withdrawal in a previous year, your repayment period has not begun withdrawals may take place over a period of four calendar years provided the total does not exceed the maximum. In order to maintain the tax-free status of the withdrawals, the money withdrawn must be repaid into your RRSP account within 10 years. Repayments must be made in equal annual installments, and the first repayment must be no later than the earlier 60 days after the end of the fifth year following the year of the first withdrawal the second year following the last year in which you or your spouse were enrolled on a full-time basis any missed or incomplete annual repayments are included in your income and subject to tax.|
RRSP Maturity Options
|Investors must terminate, or convert, matured RRSP by December 31st of the year in which they turn age 71. In that year, they must choose among the following four options for their RRSPs:withdraw the funds as a lump sumpurchase a registered life annuitypurchase a registered term annuitytransfer the RRSP funds to a registered retirement income fund (RRIF)Recall that all money withdrawn from an RRSP is subject to income tax. If an individual takes a lump sum withdrawal of his or her entire RRSP, taxes are due immediately on the full amount. From a tax perspective, it is better to spread out the tax effect by purchasing an annuity or transferring RRSP funds to a RRIF. In addition, the options listed above are not mutually exclusive, so investors can customize their matured RRSP options to suit their lifestyle needs. Potential OAS and other benefit claw backs should also be considered whenever making withdrawals. Your clients will come to you for advice and direction on the myriad of options available to them. You must be able to determine which option (or combination of options) is most appropriate for your client based on their individual financial situation, risk tolerance, and lifestyle. Having a solid basis of understanding will help guide you towards making these recommendations for your clients.|
|A matured RRSP can be used to purchase a registered life annuity or a registered term certain annuity.A registered life annuity provides a lifelong, steady stream of income to the annuitant, the main advantage being that the annuitant cannot outlive his or her retirement income payments. On the other hand, once an investor purchases a registered life annuity, they no longer have control over the investments. As a result, they must be prepared to make decisions with respect to the registered life annuity at the time of purchase.|
A registered term certain annuity provides a steady stream of income to the annuitant for a specified number of years. For example, a 10-year term certain annuity provides income payments for 10 years. The main disadvantage of this type of annuity is that an individual can outlive his or her retirement income payments.
Other Considerations for Registered Annuities
|The value of the annuitant’s RRSPs, the annuitant’s age, sex, and health, and the current interest rate offered by the financial institution are also important factors in the calculation of a registered life annuity payout. The annuitant’s age, sex, and health are used to estimate how long the insurer will be paying out funds. For example, a younger annuitant would receive lower payments than an older annuitant. Women can expect moderately lower payments than men of the same age since women on average lives longer than men. Also, an individual with a medical condition, which reduces his or her life expectancy, would qualify for an impaired annuity and receive increased payments. Interest rates are critical since the financial institution buys interest-bearing investments to offset its payment obligations to the annuitant. Consequently, annuity rates reflect long-term interest rates.|
Registered Retirement Income Fund (RRIF)
|A registered retirement income fund (RRIF) is essentially a mirror of an RRSP. Whereas an RRSP is used to save money for retirement, a RRIF is used to withdraw the money accumulated as a retirement income payment. A RRIF can hold the same qualified investments as an RRSP. Like an RRSP, the growth of your investments in a RRIF is tax-sheltered and you control the investment decisions.The major differences between an RRSP and a RRIF are that: 1) a RRIF must distribute assets in the form of a retirement income, and 2) contributions to a RRIF are not allowed.Once an individual transfers their RRSP to a RRIF, they must withdraw a minimum amount each year. In the initial year of a RRIF, the individual is not required to withdraw a payment. When a RRIF is established, the annual minimum can be based on the annuitants age, or his or her spouses age. Once this designation is made it cannot be changed except by transferring to a new RRIF. They may delay the withdrawal until the following year. The amount of the minimum withdrawal is based on the RRIF balance as of December 31st of the previous year and age of the annuitant or their spouse, depending on how it was established. While there is no minimum age for starting a RRIF, an individual can postpone establishing one until the end of the year in which they turn 71. In some cases, additional or off-schedule withdrawals may be permitted. Since there is no maximum withdrawal limit, individuals are free to withdraw any amount they wish. However, RRIF payments are taxable and must be recorded as income on their income tax returns.|
Dag, age 71, transferred all his RRSP assets to an RRIF in November 2020 through an in-kind contribution. On December 31st, 2020, the market value of his RRIF assets was $400,000. Dag must make a minimum withdrawal from his RRIF by December 31st, 2021. The amount of his withdrawal will be based on the $400,000 market value established at the end of the previous year and his current age of 72.
Qualifying versus Non-Qualifying RRIFs
|Prior to age 71, the minimum withdrawal from an RRIF is determined as follows:|
|minimum withdrawal = market value of RRIF assets ÷ (90 – age)|
|As of 71 years old the minimum withdrawal from a RRIF is determined as follows:|
|minimum withdrawal = market value of RRIF assets x RRIF Factor|
|Starting at age 71, the minimum withdrawal required depends on whether the RRIF is a qualifying or non-qualifying RRIF. A qualifying RRIF is one that must have been set up in 1992 or earlier, and that contains no assets transferred or contributed to it at any time after the end of 1992 except from another qualifying RRIF.All other RRIFs are non-qualifying RRIFs.|
Locked in RRSPs (LRSPs) and Locked-in Retirement Accounts (LIRAs) provide a vehicle that enables employees who leave a company with pension benefits to transfer the funds.
Locked-In RRSPs (LRSPs) and Locked-in Retirement Accounts (LIRAs)
|Recall that a registered pension plan is a benefit program offered by some employers to provide their employees with a pension at retirement. However, some employees will leave their company before retirement. In this case, the employee has several options with respect to their registered pension plan (RPP). Employees could: forfeit the employer contributions, and receive their own contributions plus any investment earnings on those deposits leave their money in the plan, and collect a pension from the pension plan when they reach normal retirement age, often defined as age 65. In addition, if the individual’s new employer has an RPP, the employee may be able to transfer his or her money to the new employer’s RPPif the employee is under age 55, they may be able to transfer the pension benefits to a locked-in RRSP (LRSP) or a locked-in retirement account (LIRA) depending on legislation employees can transfer the money they have contributed to the plan plus any investment earnings on those deposits. In addition, employees will be able to transfer the employer’s deposits plus investment earnings if they have been with the employer for a certain length of time, usually two years. An employee’s right to the employer’s deposits and investment earnings is known as vesting. Vesting refers to the employee’s right to keep any employer contributions made and investment growth earned on behalf of the employee.Benefits from a registered pension plan must be used to provide employees with a retirement income when they reach normal retirement age, defined as age 65. LRSPs and LIRAs are similar to RRSPs, with two key differences. First, deposits to a LRSP or a LIRA can only come from a transfer of RPP assets. Employees cannot make regular contributions to these account types. Second, withdrawals from an LRSP or a LIRA are restricted since pension legislation requires that these account types be used for the sole purpose of providing employees with an income at retirement.Although LIRAs were introduced to replace LRSPs, LRSPs are still available in federal jurisdictions. Otherwise, LIRAs and LRSPs are virtually identical in structure.|
Life Income Funds (LIFs) and Locked-in Retirement Income Funds (LRIFs)
|Individuals must convert their LRSP or LIRA by December 31st of the year in which they turn age 71. In that year, they must choose among the following four options for their LRSPs or LIRAs:purchase a registered life annuitytransfer your LRSP or LIRA funds to a life income fund (LIF)transfer your LRSP or LIRA funds to a locked-in retirement income fund (LRIF)transfer your LRSP or LRA funds to a prescribed retirement income fund (PRIF)Recall that withdrawals from an LRSP or a LIRA are restricted since pension legislation requires that these account types be used for the sole purpose of providing individuals with an income at retirement. As such, most of the transfer options mentioned above include a provision that places a maximum limit on the amount that you may withdraw during a calendar year. The PRIF option is the only option where an individual can withdraw the entire account balance at any time. In other words, registered pension plan assets that end up in a PRIF account may be cashed in.|
Transfer Options LIFs, LRIFs and PRIF
|The transfer option you choose depends on the provincial or federal jurisdiction within which the plan was set up. The table below provides an overview of the provincial and federal jurisdictions in which each option is available.|
The calculation for the minimum withdrawal amount that must be made from a LIF, LRIF, or PRIF account is identical to the minimum withdrawal calculation for a non-qualifying RRIF. The maximum withdrawal amount for a LIF or LRIF is determined by the provincial or federal jurisdiction within which the plan was set up. In addition, the maximum withdrawal amount will vary according to the owner’s age, current long-term interest rates, and the previous year’s investment returns for the fund. In some jurisdictions, a LIF must be converted to a life annuity at age 90.
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