What Is an RRSP? Your guide to RRSP investing

First introduced by the Government of Canada in 1957, Registered Retirement Savings Plans (RRSP) are a tax-sheltered investment account, designed to encourage Canadians to save for their retirement. While they’ve been around for a while, the importance of RRSPs has only grown over the years, as employer pension plans continue to dwindle as do the number of company matching programs.

To make matters worse, Canadians today are saving less, taking on more debt, and maintaining that debt on their balance sheets for longer than any time in the past. But the problem doesn’t just lie with Canadians. These are issues that people are grappling with across the western world.

How do RRSPs work?

An RRSP is not an actual investment product, like a GIC, or a mutual fund. It is simply a tax shelter, inside which you can invest in any number of ways. We’ll get into the how of RRSP investing a bit later. Because RRSPs are tied to your individual taxes, they cannot be held jointly with a spouse. All RRSP accounts are individual. You can, however, designate a beneficiary who would receive the funds from your RRSP should you pass away. There are no restrictions on who your beneficiary can be.

Who can contribute to an RRSP?

Anyone who has earned income and files a tax return in Canada can contribute to an RRSP, however, there are contribution limits you must be mindful of. The annual contribution limit is the lower of 18% of income earned in the previous year, or the annual maximum contribution amount, which for 2020, is $27,230.

For example, someone earning $85,000 in 2019, would have a contribution limit of $15,300 for the 2019 tax year. On the other hand, someone earning $185,000 the same year would have a limit of $27,230, which is less than 18% of their annual income. Unused contribution room can be carried forward to future years, so if you haven’t been using all of the space that’s available to you, your total contribution room could be much higher than the annual limit.

What is the RRSP deadline?

You may have heard of the term, RRSP deadline. This refers to the last day you can make an RRSP contribution to be applied against your previous year’s income. Each year, the RRSP deadline is March 1st, unless it happens to fall on a non-business day. For example, in 2020, the RRSP deadline is March 2nd, because the 1st falls on a Sunday. Any contributions made to an RRSP between January 1st and March 2nd, 2020, can be deducted against your 2019 income.

RRSP over-contributions

While it is possible to over-contribute to your RRSP, it’s definitely something you want to avoid. The government does allow for a lifetime over-contribution of $2000, probably to deal with the small rounding errors that may occur from time to time. If you exceed that amount, you’ll be charged a hefty 1% penalty per month, until your contributions return within the limit.

RRSP advantages

RRSPs offer a few key benefits that continue to make them an attractive savings vehicle, even in the midst of alternatives like the TFSA. Here are a few of the advantages RRSPs offer:

1. Tax deductibility. Contributions made to an RRSP are 100% tax-deductible for the tax year in which the funds are deposited. That means that your taxable income is reduced by the amount that you contribute, resulting in immediate savings come tax time. Depending upon your marginal tax rate, you can save over $300 of income tax for every $1000 you contribute.

2. Tax-Deferred Growth. Savings and investments held inside an RRSP are not taxed as long as they remain inside the RRSP. That includes any interest, dividends or capital gains that accrue inside the plan until you withdraw the money. This can have a profoundly positive impact on your retirement nest egg throughout your working years.

3. RRIF conversion. While you will eventually be taxed when you withdraw funds from an RRSP, you have the option of converting your account to a Registered Retirement Income Fund (RRIF) after you retire. This allows tax-deferred growth to continue. Your RRIF is designed to pay you income, but you continue to have some control over the rate with which you withdraw.

RRSP vs. TFSA

Ever since Tax-Free Savings Accounts (TFSAs) first made their appearance in 2009, the debate has raged about whether it’s better to invest money in your RRSP, or your TFSA. When asked, my preferred response is that it will always depend on your individual situation. Generally speaking, those who are in a higher tax bracket will have more to gain from the tax-deductibility of an RRSP. But there are so many factors at play, including the amount of money you’re contributing, your anticipated income or marginal tax rate at retirement, and how you choose to spend your money in the future.

My best advice is to take advantage of both options, tailored to your own situation. This TFSA guide will give you everything you need to know about what is another great tax-sheltered investment option.

RRSP investing – other things to consider

Earlier, I mentioned the dangers of over-contributing to your RRSP. There are a few other things you should look out for when investing for retirement.

Fees – No matter how you decide to invest your RRSP, make sure that you understand what you’re paying in fees. RRSP investing can be a minefield of hidden costs, from high MERs on mutual funds, to expensive transfer and withdrawal fees. If you’re investing on your own in a discount brokerage, make sure you’re aware of the impact that trading fees will have on your overall returns.

Marital Status – If you’re married, or living common-law, it might be more advantageous to contribute to a spousal RRSP, in your spouse’s name. Or, perhaps they should be a contributor to your RRSP. I’ll detail spousal RRSPs more further down, but having the right type of plan can have a big impact on your retirement savings down the road.

Rebalance annually – It’s very important that you review your RRSP investment holdings at least annually, to make sure that you are properly invested. This means being invested according to your investment objectives ie. time horizon, risk tolerance etc.

Where do I go to buy an RRSP?

The short answer is, you can open an RRSP account at just about any financial institution where you do banking. Let’s take a closer look at what’s available.

Banks & credit unions

Historically, all of the big banks and credit unions offer RRSPs, with investment options ranging from savings and GICs, to mutual funds. If you prefer to deal with a human advisor in a brick and mortar location, this is probably your best bet. Credit Unions tend to have the best rates on GICs, while banks will have a large number of proprietary mutual funds available to choose from.

Online banks

More and more, people are choosing to deal with online banks, for convenience as well as cost savings. Financial institutions like Tangerine, and Simplii Financial, are making it easy for Canadians to do all of their banking from the comfort of their living room, and many of the services they offer come without fees. Both Tangerine and Simplii offer RRSP savings and investment options. If you’re already a customer, or you don’t want to visit a bank branch, an online bank can be a great option.

Discount brokerage

If you prefer to do your own investing, you’ll likely want to open an online brokerage account for your RRSP. Thankfully, there is no shortage of online brokers for Canadians to choose from. Discount brokers give the RRSP investor full control over the investment decisions.

Aside from the convenience aspect, you’ll benefit from lower fees, as a result of not having to deal with the middleman aka, big bank branch, or an investment broker. That cost savings is passed on to you, the investor. All of the big banks have their own discount brokerage, or you could choose from top independent offerings, such as Questrade, or ModernAdvisor.

Robo advisor

Robo-advisors use computer technology to help you choose a suitable portfolio of investments, based on your recommended asset allocation. The end result is a hands-off solution that requires little in the way of ongoing maintenance. The advantage to the investor comes in the form of lower fees, the result of not having to involve a human advisor in the transaction.

Insurance company

Many insurance companies provide retirement planning advice and offer various RRSP investments. Insurance companies also sell annuities, which is an alternative to transferring RRSP funds to an RRIF upon retirement.

How to invest your RRSP

There are almost endless ways you can invest your RRSP money, ranging from safety investments with almost no risk to market-based investments that are designed for long term growth. Let’s take a look at some of the options, and the advantages and disadvantages of each.

RRSP savings account

If you’re looking for the lowest risk, most liquid place to park your RRSP cash, an RRSP savings account is the way to go. Your deposit will be guaranteed by your financial institution and protected up to $100,000 through Canada Deposit Insurance Corporation (CDIC).

There is a big downside, however. Because you’re not exposing your funds to the markets, you will earn very little interest on your deposit. Most banks’ RRSP savings offer a fraction of 1% as an interest rate. That said, your best bet for RRSP savings may be to go with an online bank, like Tangerine. They currently pay 1.10% for RRSP savings, with an introductory offer of 2.75% for the first 6 months.

Typically, RRSP Savings should only be used when parking funds for a short period of time. Perhaps you’ve made an RRSP contribution, but you haven’t yet decided on a long term investment solution, or you’re waiting to withdraw funds from your RRSP in the near future. This is when an RRSP savings account will come in handy.

RRSP GICs

For the risk-averse, Guaranteed Investment Certificates are an alternative to RRSP savings accounts. Your money is guaranteed, and CDIC-insured. With GICs, your funds are locked in at a specific rate for a set period of time. GIC terms range anywhere from 90 days to 5 years. In most cases, the longer you lock up your money, the higher the interest rate you’ll receive.

I took a look at some current GIC rates online and found 5-year terms ranging between 2.2% and 2.6%. In my experience, the highest rates can be found at credit unions, as well as online banks like Tangerine or Simplii. As a general rule, the big banks are not as competitive with standard GICs.

Mutual fund RRSPs

For years, mutual funds have been a staple for RRSP investors who are looking for exposure to the markets. You can choose from thousands of mutual funds of varying risk levels, that align to your prescribed asset allocation Mutual funds can be a great way to get started with market investing, and you can open an account with a financial advisor at your local bank, or online, with a discount brokerage account.

There are drawbacks to actively-traded mutual funds, however. That is, Canadians pay amongst the highest fees anywhere in the world for actively traded mutual funds. A typical Canadian equity fund will charge a management fee (MER) of over 2.0%, which will have a negative impact on your returns over the long term. My advice, if you’re buying actively managed mutual funds, is to make sure that you understand the costs involved, and spend time researching other low-cost options, such as index mutual funds, or ETFs.

Index mutual funds

Index mutual funds are similar to their actively managed counterparts, in that they happen to be a pooled investment offering diversification across asset classes and geographic boundaries, as well as the convenience of low minimum investment amounts, and frequent purchase options. The difference is that index mutual funds are much less expensive because they follow a passive management approach.

Index funds are designed to mirror the performance of an underlying stock market index, rather than beat it ie. active management. MERs for index mutual funds can be as low as .25% and are usually not much higher than 1%. In my opinion, the two best ways to buy index funds are with Tangerine Investment Funds and TD e-Series Funds.

Exchange-Traded Funds (ETFs)

In recent years, improvements in technology have made it much easier to deliver low cost investment solutions to the masses. These advancements have seen the rise of investment vehicles like ETFs and robo advisors, both of which are now considered mainstream. For example, research firm ETFGI estimates that, as of 2018, there are now well over $4 Trillion dollars held in ETFs worldwide.

The main advantage of ETFs is their incredibly low fees. They follow a passive investment style, similar to index mutual funds, but MERs for an individual ETF can be as low as .07%. With fees this low, more of the fund’s returns are captured by the investor. I use Questrade to purchase ETFs, as they offer free ETF purchases, while other online brokers charge a fee of up to $9.95 for trades.

Robo advisor RRSPs

You can now invest your RRSP with a robo advisor. In case you’re wondering, you’re not handing your hard-earned dollars over to a robot. What a robo advisor does is use the latest in AI technology to build a customized ETF investment portfolio, using the personal information that you provide.

But while you can open an account and invest with a robo advisor RRSP without interacting with a human advisor, they are available whenever you need assistance. Not only that, the investments themselves are managed by real people. Wealthsimple is perhaps the best example of a robo advisor in Canada, as they have the most assets under management and a robust platform with which to manage your RRSP.

The importance of choosing the proper asset allocation

Before choosing an investment type, you need to create an investor profile to determine what your ideal asset allocation is. This will depend on a number of factors, including your investment knowledge, time horizon (short vs. long term), and your ability to take risks. For example, the higher your risk tolerance, the larger your concentration will be on stocks, or mutual funds and ETFs that contain stocks.

Bonds are less risky, but not risk-free. GICs and savings accounts are considered safe investments that contain the least risk. I always recommend that you seek professional advice to determine your asset allocation before choosing your investments. Your RRSP is made up of your hard-earned dollars, after all.

Withdrawing from your RRSP

Ideally, you won’t withdraw funds from your RRSP prior to retirement, with a couple of exceptions. This is because, while your RRSP is tax-sheltered, any money you take out of your RRSP will be added to your income at your marginal tax rate in the year you withdraw it. In other words, withdrawing from your RRSP can be very costly, if not done properly.

If you do make an RRSP withdrawal, you will be subject to a withholding tax at the following rates:

• 10% on any amounts up to $5000
• 20% on amounts between $5,001 and $15,000
• 30% on any amount over $15,000

Your financial institution will submit the withholding tax to the government on your behalf, and these rates are applicable to any Canadian resident living outside of Quebec. As I mentioned above, there are a couple of RRSP withdrawal exceptions in which you will not be taxed. They are, withdrawing from your RRSP to fund your post-secondary education, or to withdraw funds to go towards the purchase of your first home. Let’s take a closer look at these two situations.

Lifelong Learning Plan (LLP)

The Lifelong Learning Plan (LLP) makes it possible for Canadians to borrow funds from their RRSP to go towards the costs of their post-secondary education. The funds are withdrawn without any tax implications, but they must be repaid over a maximum period of 10 years. Up to $20,000 can be withdrawn (maximum of $10,000 per year), and funds can go towards the cost of your own education, or that of your spouse. You cannot utilize the program to fund your child’s education.

Home Buyers Plan (HBP)

The Home Buyer’s Plan allows a qualifying individual to withdraw funds from their RRSP for the purpose of purchasing their first home. There are no tax implications for the withdrawal, but, as with the LLP, the funds must eventually be repaid. In the case of the HBP, the maximum withdrawal amount is $25,000, with full repayment required after 17 years. There are no mandatory repayments in the first 2 years after withdrawal, but after the second year, the account holder must at minimum, repay 1/15th over the remaining 15 years, until the full balance has been returned to the RRSP.

What is a spousal RRSP?

If you are married, or in a common-law relationship, you may open a spousal RRSP. A spousal RRSP allows a higher-income earning spouse to contribute to a plan in the lower-income earning spouse’s name, with the expectation that withdrawals will be taxed in the hands of the lower-income spouse at retirement.

Meanwhile, the higher income spouse is able to benefit from the tax deductions during their working years. While the contributing spouse is funding the plan, account ownership, as well as investment decisions, are the responsibility of the plan holder.

Withdrawing from a spousal RRSP

If you are contributing to a spousal RRSP, it’s important to understand how withdrawals are treated, as it differs from a regular personal RRSP plan. When funds are removed from a spousal RRSP, they are taxed in the hands of the contributor (usually the higher income earning spouse), if he/she made contributions to any spousal RRSP in the year of withdrawal or either of the two previous years.

This is referred to as the spousal attribution rule, and would not be ideal in a situation where the contributing spouse is in a higher income tax bracket. Ideally, withdrawals for spousal RRSPs will be made at retirement, and taxed in the hands of the lower-income earner, presumably the planholder.

What happens to my RRSP when I retire?

You can contribute to your RRSP until December 31st of the year in which you turn 71. If you are contributing to a spousal RRSP, you can make contributions until December 31st of the year in which he/she turns 71. When it comes time to begin making regular withdrawals from your RRSP, you can either withdraw directly from the RRSP, convert the RRSP into a Registered Retirement Income Fund (RRIF), or purchase an annuity from an insurance company.

If the amount in your RRSP is very small, you may choose to simply withdraw it directly. Most will opt to convert to a RRIF, which is designed to pay income over the remainder of your lifetime. As far as annuities go, this is a less popular option, as they can be expensive, and aren’t suitable for everyone, but they are an option.

How RRIFs work

You can convert your RRSP to a RIF as early as age 55, if it makes sense based on your personal situation. A RRIF operates in a similar fashion to an RRSP, in that it is a tax sheltered account. The main difference, however, is that you cannot make contributions, only withdrawals. Because the purpose of a RRIF is to pay you an income for the remainder of your life, you are required to withdraw a minimum amount each calendar year. This amount is determined using a formula that is based upon your age, and the value of your RRIF at the beginning of each year. For more information, I recommend that you check out my full guide to RRIF investing.

Summary of RRSP investing

As you can see, there is much to consider when investing in RRSPs, and it can be a lot to take in. My advice is to just start. Open an RRSP account in the form that feels most comfortable to you, and consider setting up automated contributions on a regular basis from your chequing account. Once you get used to how everything works, you’ll be better informed to make the best decisions for the long term. Of course, before you start, make sure you know what your available contribution room is. This can be found on your annual CRA Notice of Assessment, or by contacting CRA by phone or online.