All You Need to Know About RRSPs: Contribution Limits and Deductions

Many hard-working people assume that they have already paid a significant amount of tax to the government. Most people will expect a large tax return as a result. To play it safe, we would suggest that you go over your Registered Retirement Savings Plan (RRSP).

It is important to note that RRSPs are actually tax-advantaged accounts. Put another way, you can look at your RRSP as a gift from your government, as you will receive a generous tax break when you open one. As well, any profits that are generated or accrued will be tax-free. Your RRSP contributions will also continue to grow in perpetuity until you actually start withdrawing money.

RRSPs are designed so that a hard-working person can enjoy the fruits of their labour once they have retired. Here, we will break down everything there is to know about RRSPs, including contribution limits and deductions.

What is an RRSP?

An RRSP is a convenient and effective retirement savings plan for forward-thinking individuals. You can open an account at a financial institution near you, such as a local bank. There is an annual maximum amount that you can contribute to your account, and the federal government will keep detailed records of all of your contributions.

As mentioned, an RRSP is designed for people to have a nest egg when they retire. There are also 4 different types of RRSPs that you should be aware of.

The 4 Types of RRSPs

An individual RRSP is registered in the name of the contributor of the account. All tax advantages and investments will belong to you. The maximum amount that you can deduct when you file your taxes will depend on where you live. In Canada, for example, it is possible to contribute up to $2,000 as soon as you turn 18. There is also no minimum age required in order to make a conventional contribution either.

A spousal RRSP will involve contributions that are made by you even though the plan is registered under the name of your husband or wife. With a spousal RRSP, you will qualify for the tax deduction, as you will be deemed the contributor. However, the actual investment will belong to your wife or husband.

As for contributions, the total amount that is given to your spouse’s and your RRSP must not surpass the deduction to which you are permitted. Contributions can also continue to be made until your husband or wife reaches the age of 71. Spousal RRSPs are recommended if you expect your spouse’s retirement earnings or nest egg to be lower than yours.

A group RRSP is a deposit savings plan. If you are an employee, then it will allow you to build capital that can be put towards your eventual retirement. To do so, you will need to make contributions that are deducted from your salary.

One way of looking at a group RRSP is as a collection of individual RRSPs. This is because each employee that participates in the plan will have their own individual contract. Conditions will also differ depending on where you are employed. Eligibility requirements may be more stringent at your company, and fund withdrawal conditions will likely apply.

A self-directed RRSP is one that is either established and managed by a mortgage broker or by you. Some investment-savvy individuals prefer to take matters into their own hands, and may opt to manage their securities portfolios themselves.

Self-directed RRSPs are designed for people who want to invest their contributions into shares instead of equity funds. Self-directed RRSPs also have one caveat that you should be aware of: administrative charges. So, if the investment that you select serves as an investment fund or term savings exclusively, then they may not be the best choice for your situation.

What are RRSP contribution limits?

The limits refer to the maximum amount that you are able to legally contribute into your savings plan annually. The contribution limit will differ from person to person. The amount is calculated by the present year’s deduction limit and contributions that were made in previous years.

The RRSP contribution limit is the lesser of 18% of last year’s generated income or your government’s maximum yearly contribution limit. Contribution limits can sometimes be hard to understand or calculate, so if you have any doubts, please do not hesitate to speak to a financial advisor.

What is an RRSP deduction?

An RRSP deduction refers to the maximum amount that you can invest in your account and deduct from that same year’s taxes. In most cases, the maximum amount will be 18% of last year’s earned salary. The cap is usually revised every year.

You can also contribute less than the maximum amount if you wish. However, we would suggest that you do invest the maximum amount possible, as doing so will allow you to enjoy the highest possible tax break. As for those who own both a spousal and individual RRSP, the discount limit will be the maximum amount that you can contribute to all of your accounts combined.

Start Early In Order to Reap the Rewards

The federal government created the RRSP so that people would be able to have a large nest egg to live off of during their twilight years. An RRSP incentivizes hard-working taxpayers to contribute to their own long-term financial well-being so that they can live long, fulfilled, and independent lives.

The money that is invested into your RRSP will continue to grow over the years and decades without being taxed by the government. It is only until the money is withdrawn that you will have to think about such matters.

RRSPs also do not involve any startup costs in most cases. Simply make an appointment with a financial advisor in your area and they will help you fill out all of the paperwork. You can also speak to family and friends to learn about the RRSP type or types that they have joined.