You probably have a registered retirement savings plan because you heard that an RRSP helps you save on taxes. While that’s true, for the most part, you only defer your taxes with an RRSP.
Here’s how it works.
What is the RRSP
The registered retirement savings plan, mostly known as the RRSP, is a registered account that allows you to save and invest for retirement purposes. The catch with the RRSP is you can get a tax deduction for saving through your account.
A tax deduction reduces your taxes dollar for dollar, so when you contribute your after-tax dollars to an RRSP, the Canada Revenue Agency (CRA) will refund the taxes you paid on the contributed amount only.
However, if you have an employer group RRSP and your payroll deduction includes a pre-tax dollar contribution to your RRSP, you will not get a refund on that contribution, because you did not pay taxes on it anyways.
Whether you contributed pre-tax dollars or after-tax dollars to a registered retirement savings plan, all your contributions impact how much you can put into an RRSP the following year. This limit is called the RRSP contribution room. Keep reading to find out more about your RRSP contribution room and limit in 2023.
RRSP contribution room 2023
Every Canadian who works and pays taxes should have an RRSP contribution room, at least until they max it out in the year. The RRSP contribution room is a limit to how much money you can put in a registered retirement savings plan.
Your annual RRSP contribution room should change every year. Your contribution limit depends on four main factors, any unused RRSP deduction room, your previous year’s income, the current year’s RRSP dollar limit, and any applicable pension adjustments.
Generally, you will have an unused RRSP deduction room if you did not contribute up to your RRSP limit for the year. The good thing is you can carry forward the remaining balance.
In addition to your unused contribution room, you will have an additional amount that is the lower of 18 percent of your previous year’s income and the RRSP contribution limit for the year. The 2023 RRSP contribution limit is $30,780.
So if you earned $100,000 in 2022, your additional RRSP deduction room for 2023 should be $18,000 (which is 18 percent of $100,000). Your additional RRSP room can be as high as $30,780 if you earned at least $171,000.
What happens to over-contributions in an RRSP
Every registered savings and investment account has rules. The RRSP contribution room limits how much you can put in your account each year.
If you put in more money over your contribution room into your RRSP, the CRA will tax your over-contributions at 1% for every month you leave the money in your account.
However, there is a wiggle room of $2,000, which the CRA allows before applying the over-contribution room tax.
If you realize that you have over-contributed to your registered retirement savings plan, contact your financial institution and request to withdraw the excess amount.
What’s the RRSP tax deduction anyways?
Tax deductions reduce your taxable income. What this means is that if you earn $100,000 and claim a tax deduction of $5,000, the Canada Revenue Agency will tax only $95,000 of your income.
Contributing to a registered retirement savings plan and saving for retirement makes the contributed amount non-taxable. Therefore, the more your RRSP contributions, the lower your tax. This is why it is recommended that people with high income, maximize their RRSP contributions to reduce their taxes.
However, one key thing to note about RRSP deductions is that they are temporary. When you withdraw money from your RRSP, you will eventually pay taxes on the withdrawn amount.
Essentially, you only defer your taxes when you contribute to a registered retirement savings plan. This is a key difference between the RRSP and a tax-free savings account (TFSA), which allows you to save and make investment earnings without paying taxes.
The RRSP is mainly beneficial if you expect to earn lower in retirement and fall within a lower tax bracket. If your tax bracket remains high in retirement, you will still pay similar taxes in the future as you would have now.
How to invest in a registered retirement savings plan
You can buy stocks, exchange-traded funds (ETFs), real estate investment trusts (REITs), bonds, and guaranteed investment certificates in a registered retirement savings plan. Assets like cryptocurrency are not currently allowed.
A self-directed RRSP is one of the best ways to manage your registered retirement savings plan, only if you have investment knowledge. You can buy your financial assets and avoid portfolio managers’ fees.
With a self-directed RRSP, you need to know how to purchase financial assets and balance your portfolio.
If a self-directed RRSP is too much hassle for you, you can open a registered retirement savings plan with any financial institution that offers this product. Financial institutions will usually invest your funds in a mutual fund that meets your retirement goals.
Alternatively, some financial institutions offer Robo-advisors, which is a hands-off approach to investing. There are no active portfolio managers with a Robo-advisor, but the financial institutions have financial experts who purchase more passive financial assets (usually exchange-traded funds). Robo-advisors help you re-balance your portfolio and may help you re-invest your dividends.
Can I withdraw from my RRSP?
You can withdraw from an un-locked RRSP anytime. However, you must know that the CRA will apply your marginal tax rate on your withdrawal, so you will pay taxes on the amount.
You can keep your registered retirement savings plan until you turn 71, after which you must withdraw your money, transfer it to an annuity, or convert it to a registered retirement income fund (RRIF).
When you convert your registered retirement savings plan to an RRIF, for example, there will be withdrawal rules.
The RRSP is a great tool you can use to save and invest for retirement purposes.
If you are a high-income earner, leverage tax deductions using your RRSP contributions. However, you need to remember that when you withdraw from your account in the future, you will pay taxes at your marginal tax rate (which should be lower).