The Magic Story Of The RRSP
- by Monica J. Weissmann, CFP, CIM, MEE
Once upon a time … In a land far away from here … fisherman lived in the small village. He did work hard, day and night, catching fish to feed his family - times were difficult, and the money was little.
One late autumn day, fisherman came home empty handed just with story to share: he had caught a big fish, very shiny and heavy, and she spoken to him in a sweet voice, asking him to spear her life and throw her back into the sea: “I will reward you”, said the fish, “I promise!”
Fisherman took pity on the fish and returned her back to the deep blue waters.
That evening was no dinner on the table. Everybody went to sleep with an empty stomach.
“Why did I do that?” – was fisherman thinking, while lying in bed beside his wife,” Why am I foolish enough to trust beautiful and shiny fish?”
The next morning, as usual, he picked up the bucket by the door and poured himself a glass of cold and fresh water. When put the bucket down, something shiny caught his eye: he frowned – did he see it right? At the bottom of the bucket was a shiny coin of gold …
He picked it up not believing his own eyes… YES, it was a real coin - gold coin! Unbelievable! Fisherman woke up his wife and kids and what evening dinner table was full.
Next morning … Yes, you guessed right! He found another coin when he drank his glass of fresh water. And the next morning another one. And the next morning another one!
The name of this wonderful bucket is … RRSP!
RRSP stands for Registered Retirement Savings Plan. In Canada it was introduced in 1957 with the amendments in Tax Act which allowed individuals to make deposits to the personal plan for future retirement and receive tax advantages immediately. One of the biggest advantages of RRSP is Tax deferring. It works like our story about fisherman and a magical bucket: if you treat it correctly and believe in promise that “shiny and heavy fish made” it will reward you!
How does it work in real life?
RRSP is your personal Future Pension Plan. In a nutshell: you are saving while you are working, account grows in tax deferred manner and pays you when you retire.
Advantages of RRSP account:
• RRSP contributions are tax deductible - the amount you contribute to your RRSP account every year reduces the amount of income you earn. This means you can reduce your income tax bill or even have a sizable return. (You need to talk to your accountant to find the optimal amount to contribute and maximum advantage to use).
• Tax free compounding - investment in RRSP account grow tax free: you don’t pay taxes until you make a withdrawal from the account; it means all gains on the investment stay in the account to be reinvested and grow.
• Contribution room grows – if you are not filling in contribution room for one year, contribtution room is not disapearing, it will be carried forwrd and added to your next year’s contribution limit.
• Creditors protection - The Bankruptcy and Insolvency Act says that RRSPs contributions made 12 months before declaring personal bankruptcy are protected from creditors. This means that if you filed for personal bankruptcy, creditors could seize only contributions made in the last 12 months before filing.
• Special features of RRSP – you can use special programs to withdraw money form your RRSP without paying withdrawal tax and use it for your advantage: The Home Buyers’ Plan and The Lifelong Learning Plan is worth looking into if you planning to buy your first home or decided to go back to school.
• Variety of investments available – you can choose from a variety of investments options to invest in RRSP: mutual funds, stocks, bonds, ETF, GIC, annuity and others.
• Spousal RRSP – employing spousal RRSP can reduce overall family taxes: you would contribute to RRSP of your lower income spouse and reduce your taxes and your spouse would pay less tax on withdrawal during the retirement.
Disadvantages to mention:
• Contribution limit is limited to 18% of your income or established RRSP contribution limit for the year (whichever is smaller).
• Withdrawals are taxed and are counted as your income.
• If you are low-income earner, and you are in the lowest tax bracket, RRSP would be too cumbersome to use, you should look into TFSA
• After converting RRSP to RIF (Retirement Income Fund) you must take money whether need it or not.
Talk to Financial Advisor about your situation – maybe it’s time to start a magic bucket!
___________
References:
“Are your investments protected from creditors?(national edition)”. Manulife, 14 February 2024,
https://www.manulifeim.com/retail/ca/en/viewpoints/estate-planning/are-your-investments-protected-from-creditors
Registered Retirement Savings Plan (RRSP). Government of Canada, 15 January 2024,
https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/rrsps-related-plans/registered-retirement-savings-plan-rrsp.html
“5 reasons to open an RRSP”. Get Smart About Money, 4 October 2023
https://www.getsmarteraboutmoney.ca/learning-path/rrsps/5-reasons-to-open-an-rrsp/
