What is RRSP and how does it work?
RRSP refers to a registered retirement savings plan designed as a saving vehicle toward one’s retirement years.
At present, the maximum pension one can get is just above $10,000. While pensions under the Canada Pension Plan
are hardly sufficient, one can opt for a RRSP and secure a better standard of living upon retirement. Registered retirement savings plans come with reduced income tax
, and taxes
are paid only on the money one withdraws. RRSPs are typically available through trust companies, Canada’s chartered banks
, and other financial institutions. The type of investments one may have in a RRSP
include common and preferred shares, mutual funds
, fixed income securities such as bonds
, strip bonds, notes, and debentures, term deposits, Canadian Treasury Bills, and others.
Only earned income that is taxable in Canada
can go toward contributions to the retirement savings plan. This includes one’s salary, self-employment income, net rental income, alimony and maintenance payments, and some other types of income. When a person turns 71, the retirement savings plan is converted to a retirement income. Most Canadians choose a Retirement Income fund because the amount of investment continues to grow after the needed income is withdrawn. If the holder of a retirement savings plan passes away, the remaining amount is paid to a designated beneficiary.
If one's beneficiary is the surviving spouse (or alternatively, one's common-law partner) the registered savings plan can be transferred to him or her.
There are several types of registered retirement savings plans: individual, spousal, and group RRSP
. The individual plan is associated with one account holder who is referred to as the contributor. With spousal RRSP, one is entitled to put contributions into the retirement savings plan of one’s spouse. When both partners withdraw their savings after retirement, they may pay a lower combined income tax (in comparison to what one would pay if savings were on a single account). The spousal RRSP is especially beneficial if one of the spouses will otherwise have a smaller retirement income while the contributing spouse will enjoy a significantly larger amount of retirement income. In a group retirement savings plan, it is the employer who arranges contributions on behalf of his employees, making payroll deductions. Employees decide on the amount of their annual contribution. The employer deducts the amount which is then handed to an investment manager who administers the group account. The manager is responsible for depositing the contributions into the individual accounts of the employees.
It is best to contribute to a retirement savings plan on a monthly, biweekly, or weekly basis as a way to budget one’s contributions. This is a good choice because one can earn a larger amount of tax-deferred income.
In fact, a major advantage of the registered retirement savings plans is that the money placed into the RRSP is deducted from the income of the account holder. The Notice of Assessment sent by the Canada Revenue Agency
determines the maximum amount of contribution for the next year. Persons who do not contribute the maximum allowable in a given year may carry the unused amount forward for as many years they decide to. The Notice of Assessment reflects the amounts that are carried forward.