A Registered Retirement Savings Plan (RRSP) is a popular registered account in Canada with over $50 billion in contributions in 2020.
This account is designed to help Canadians save for their retirement by getting a tax waiver on investment growth.
No doubt, RRSP is one of the must-have accounts in Canada. But before opening an RESP account, it’s important to understand its pros and cons.
This article covers RRSP advantages and disadvantages as they relate to other registered accounts.
Table of Contents
What is RRSP?
RRSP stands for Registered Retirement Savings Plan. It is a tax-advantaged account that allows Canadians to save for retirement while reducing their tax bill.
RRSP was introduced in Canada in 1957 and has since become an important part of many Canadians’ financial planning.
Contributions you make to an RRSP grow tax-free until you withdraw them, at which point they are taxed as income at your marginal rate
The idea is that you will be in a lower tax bracket when you retire, so you will pay less tax on your RRSP withdrawals than you would have paid when you made your contributions.
In Canada, anyone can open an RRSP as long as they have earned income and filed a tax return.
You can contribute up to 18% of your earned income to your RRSP each year, up to a maximum of $31,560 in 2023.
If you don’t use up your contribution room in a year, you can carry it forward to future years.
Exceeding your RRSP contribution room by over $2,000 will attract a 1% penalty on the excess amount.
1. Tax Growth
The major advantage of RRSP is tax growth. Your contributions, savings interest, and investment earnings on the account are tax-free until withdrawal.
In other words, as your investments grow within an RRSP, you won’t pay taxes on the growth until you withdraw the money in retirement.
This can result in significant savings on taxes and allow your investments to compound more quickly than if you were paying taxes on the growth.
2. Tax Refund
Contributions made to an RRSP are tax-deductible, meaning they can be deducted from your taxable income in the year they are made.
For example, if you earned $80,000 and made a $10,000 contribution to your RRSP, your taxable income for the year would be reduced to $70,000.
As a result, you would pay less tax that year, and you might receive a refund from the government when you file your tax return.
3. Carry-Forward Unused Contribution Limit
The government sets an annual limit on how much you can contribute to your RRSP based on your income.
As noted earlier, the 2023 RRSP limit is 18% of your earned up to a maximum of $31,560.
But if you don’t use your entire contribution limit this year, you can carry it forward to future years.
Carrying forward unused contribution rooms can be especially useful for individuals whose income fluctuates from year to year.
4. Spousal Plan
Unlike a Tax-Free Savings Account (TFSA), RRSP provides access to a spousal plan. A Spousal RRSP is a retirement savings plan that is set up by one spouse for the benefit of the other.
This account allows the higher-earning spouse to contribute to their partner’s RRSP and receive a tax deduction for the contribution.
The Spousal RRSP provides several advantages, such as income splitting and income tax reduction.
In addition, a Spousal RRSP can help to equalize retirement income between partners.
5. Creditor Protection
Another advantage of RRSP is creditor protection. RRSPs are considered a protected asset in the event of bankruptcy or legal action.
This means that if you encounter financial difficulties and are forced to declare bankruptcy, your RRSP funds will generally be safe from creditors.
In Canada, the Bankruptcy and Insolvency Act (BIA) provides creditor protection to RRSPs. However, it’s important to note that there are some exceptions to this protection.
For example, if you contribute your RRSP within 12 months of declaring bankruptcy, that contribution may be considered a fraudulent conveyance and could be subject to seizure by creditors.
Creditor protection can be especially important if you operate a business or work in a high-liability profession.
6. Investable in Many Securities
RRSPs can be invested in a wide range of securities, including:
- Mutual funds
- Exchange-traded funds (ETFs)
- Government and corporate bonds
- Guaranteed investment certificates (GICs)
Investing in a diverse range of securities can help you mitigate risk and potentially increase your returns over the long term.
Unlike TFSAs, you can invest in options and do day trading in your RRSP account.
The ability to invest in many securities makes RRSPs a versatile and flexible tool for retirement savings.
7. Unrestricted Withdrawal
You can withdraw funds from your RRSP account at any time, for any reason, without facing any penalties.
However, it’s important to note that any withdrawals from an RRSP are subject to income tax.
Additionally, any amount withdrawn from your RRSP cannot be re-contributed at a later date, unlike a TFSA account.
Unrestricted withdrawals can be useful in situations where you need to access your savings quickly, such as in the event of a financial emergency.
However, it’s generally recommended that you avoid withdrawing funds from your RRSP unless it’s absolutely necessary, as doing so can have a significant impact on your retirement savings.
1. Withdrawal Taxes
One of the major disadvantages of a Registered Retirement Savings Plan is that withdrawals from the account are subject to income tax.
When you withdraw funds from your RRSP, the amount withdrawn is added to your taxable income for the year, and you will be taxed at your marginal tax rate.
This means that the more you withdraw from your RRSP, the higher your tax bill will be.
Additionally, if you make a withdrawal from your RRSP before you retire, you may be subject to a withholding tax.
The withholding tax rate depends on the amount withdrawn and your province as shown below:
|Withholding Tax Rate
|Up to $5,000
|10% (5% in Quebec + 15% provincial income tax)
|$5,000+ to $15,000
|20% (10% in Quebec + 15% provincial income tax)
|30% (15% in Quebec + 15% provincial income tax)
However, there are exceptions on pre-retirement RRSP withdrawal taxes. You can withdraw funds on your RRSP before retirement tax-free for any of the following purposes:
- Buying your first home through the Home Buyers Plan (HBP).
- Funding education through e Lifelong Learning Plan (LLP).
Note that these programs have limits on withdrawals and require repayment over 15 years.
2. Withdrawals Affect Income-Tested Benefits
Another disadvantage of an RRSP is that withdrawals from the account can affect your income-tested benefits.
Income-tested benefits are government programs that are designed to provide financial assistance to individuals with low or modest incomes. This includes:
- Canada Child Benefit
- Old Age Security (OAS)
- Guaranteed Income Supplement
When you withdraw funds from your RRSP, the amount withdrawn is added to your taxable income for the year.
This means a large withdrawal could increase your income and potentially reduce or eliminate your eligibility for income-tested benefits.
3. Income-Based Contribution Room
The RRSP contribution room is set annually based on your income from the previous year.
This means that if your income is low, your RRSP contribution limit will also be low, and vice versa.
Additionally, if your income fluctuates from year to year, your RRSP contribution limit may also fluctuate, making it difficult to plan and save consistently.
It’s important to consider this factor when planning for retirement and to explore other savings options, such as Tax-Free Savings Accounts (TFSAs), that are not based on your income.
4. Contributions End at the Age of 71
Your RRSP contribution must end on December 31 of the year you turn 71. At this point, you are required to either:
- Withdraw your RRSP contributions,
- Convert your RRSP into a Registered Retirement Income Fund (RRIF) or
- Purchase an annuity with the funds.
Ending your RRSP contribution at the age of 71 can be a significant drawback, as it limits your ability to save for retirement and can reduce the amount of retirement income you have available.
It’s important to plan accordingly and explore other registered accounts such as TFSA that don’t have expiry dates.
Should You Open an RRSP Account?
RRSP is arguably a must-have for everyone that wants to save cost on retirement.
If you expect to be in a lower tax bracket in retirement, an RRSP can be an effective way to save for retirement and reduce your tax bill at the same time.
Perhaps you have already maxed out your contributions to other retirement savings vehicles, such as a workplace pension plan or a TFSA, an RRSP can be a good option to supplement your retirement savings.
However, it’s important to note that there are some drawbacks to RRSPs, such as the taxes you’ll owe on withdrawals and the limits on contributions.
Overall, opening an RRSP account can be a good idea if you’re looking to save for retirement and reduce your taxable income in the current year.