What is an RRSP?

A registered retirement savings plan ( RRSP) is an individual retirement savings account. The federal government first introduced RRSPs back in 1957 to encourage or assist individuals earning an income to save towards their retirement.

RRSP accounts are registered with Canada Revenue Agency (CRA). Any contributions made are tax-deductible against any earned income in the year the contribution is made or within 60 days from the year-end.

While contributions are tax-deductible, there is a limit on how much a person can contribute to the plan each year. An individual’s maximum allowable tax-deductible contribution is the lesser of 18% of their previous year’s earned income or the maximum RRSP dollar limit set for the year ($27,830 for 2021). That number is then subtracted from any prior year’s pension adjustment and current year’s past service pension adjustment, plus any unused RRSP contribution an individual might have from any previous years.

How to Calculate RRSP Contribution Amount

Step 1: Calculate your total income earned from the previous tax year

Step 2: Multiple your earned income by 18%. If this amount exceeds the annual RRSP limit set for the year (for 2021, the annual limit is $27,830), then take the lower amount.

Step 3: Deduct any pension adjustments reversal (PAR) for the previous year and your net past service pension adjustment (PSPA). Your PAR is the amount of contribution made to your pension plan at work, while PSPA is retroactive contributions to your pension plan. Both PAR and PSPA reduce your RRSP contribution limit.

Step 4: Add any unused contribution room from the previous year

There are many benefits to opening an RRSP account. For starters, it’s an excellent vehicle for saving for your retirement. Contributions made to the account can grow tax-free until withdrawn. While investments do grow tax-free, there are some important tax considerations to be mindful of if pulling money from your RRSP account.

Depending on the dollar amount, the money withdrawn from an RRSP account may incur a withholding tax from 10% to 30% at the source. In addition to withholding tax, the money has to be declared as additional income in the year it’s withdrawn and could result in additional taxes.

The type of investment allowed in an RRSP account can vary from simple cash to mutual fund products. RRSPs are also portable as they are not impacted by you moving from one employer to another.

All accounts registered with CRA have to be closed or, more accurately, be de-registration by December 31, the year you turn 71. At that age, you’ve got a couple of options. You can pull out the entire money, convert your RRSP funds into a registered retirement income fund (RRIF), purchase an annuity, or a combination of all three options.

Canadians can also make a one-time over-contribution above their contributions limits of $2,000. You cannot deduct this amount against your taxable income, but it will benefit from growing tax-free while in the account.

Having an RRSP account is a must for retirement planning. The benefits of offsetting your payable taxes today while at the same time being able to grow your investment tax-free make this account the perfect retirement savings vehicle