Registered Retirement Savings Plan
A Registered Retirement Savings Plan (RRSP) is a type of Canadian account for holding savings and investment assets. RRSPs have various tax advantages compared to investing outside of tax-preferred accounts. They were introduced in 1957 to promote savings for retirement by employees and self-employed people.
They must comply with a variety of restrictions stipulated in the Canadian Income Tax Act. Approved assets include savings accounts, guaranteed investment certificates (GICs), bonds, mortgage loans, mutual funds, income trusts, corporate shares, foreign currency and labour-sponsored funds. Rules determine the maximum contributions, the timing of contributions, the assets allowed, and the eventual conversion to a Registered Retirement Income Fund (RRIF) at age 71.
- 1 Taxation
- 2 Disputed net benefits
- 3 Types
- 4 Contributing
- 5 Withdrawals
- 6 Special withdrawal programs
- 7 Account structure
- 8 RRSP rollover
- 9 Foreign content
- 10 See also
- 11 References
- 12 External links
Contributions to RRSPs are deductible from taxable income, reducing income tax payable for the year in which the contributions are claimed. No income earned in the account is taxed (including interest, dividends, capital gains, foreign exchange gains, mortality credits, etc.). Most withdrawals are taxed as income when they are withdrawn. This is the same tax treatment provided to Registered Pension Plans established by employers.
Other countries provide similar treatment of tax-deferred accounts established by individual investors, i.e., contributions are considered to have been made with savings from before-tax income and tax is paid when amounts are withdrawn: Individual Retirement Accounts in the United States, and Self-invested personal pensions in the United Kingdom.
Disputed net benefits
Net benefits are measured by the difference in outcomes between saving in a taxable account versus saving in an RRSP account. All official sites provide a list of benefits similar to the following:
- Contributions are tax deductible.
- Savings grow tax-free, but are fully taxed on withdrawal.
- Taxes are deferred until withdrawal.
- The contributor's marginal tax rate when withdrawing funds may be lower than the tax rate the contributor paid when making the original contribution.
- There are possibilities for income splitting.
- The inclusion of RRSP withdrawals in taxable income may reduce benefits otherwise received from other programs.
Others dispute that understanding. A Canadian economist and two American tax papers on the American equivalent account support this view. They provide a model and the math proofs that the tax deduction on contribution is not a benefit, there is no benefit from tax deferrals and that profits are not taxed on withdrawal.
Instead they see the RRSP's benefits as:
- A benefit from tax-free growth that is not taxed on withdrawal.
- A bonus (or penalty) from a decrease (or increase) in the tax rates between contribution and withdrawal.
- A possible loss of other government benefits when withdrawals increase taxable income, and a possible increase in benefits when contributions reduce taxable income.
- A loss when there is a delay between contribution and claiming the tax deduction.
RRSP accounts can be set up with either one or two associated individuals:
- Individual RRSP: an Individual RRSP is associated with only a single person, called an account holder. With Individual RRSPs, the account holder is also called a contributor, as only they contribute money to their RRSP.
- Spousal RRSP: a Spousal RRSP allows a higher earner, called a spousal contributor, to contribute to an RRSP in their spouse's name. In this case, it is the spouse who is the account holder. The spouse can withdraw the funds, subject to tax, after a holding period. A spousal RRSP is a means of splitting income in retirement: By dividing investment properties between both spouses each spouse will receive half the income, and thus the marginal tax rate will be lower than if one spouse earned all of the income.
- Group RRSP: in a Group RRSP, an employer arranges for employees to make contributions, as they wish, through a schedule of regular payroll deductions. The employee can decide the size of contribution per year and the employer will deduct an amount accordingly and submit it to the investment manager selected to administer the group account. The contribution is then deposited into the employee’s individual account and invested as specified. The primary difference with a group plan is that the contributor realizes the tax savings immediately, instead of having to wait until the end of the tax year.
- Pooled RRSP: legislation was introduced during the 41st Canadian Parliament in 2011 to create Pooled Retirement Pension Plans (PRPP). PRPPs would be aimed at employees and employers in small businesses, and at self-employed people.
Contributing and deducting are two different things. Contributions are usually deducted from taxable income in the same tax year but may be held for future use. Because Canada has a progressive tax system, taxes are reduced at the individual's highest marginal rate. For individuals who always claim the same deduction amount as their yearly contribution, their maximum contribution is the ' Deduction Limit' calculated by the CRA.
The 'Deduction Limit' is a running total calculated for the next year and printed it on every Notice of Assessment or Reassessment, provided the taxpayer is aged 71 years or younger. It is reduced by tax deductions claimed and increased by the year's Contribution limit, minus any pension adjustment (PA) and past service pension adjustment (PSPA), plus pension adjustment reversals (PAR).
Contribution limits are calculated at 18% of earned income (from employment or self-employment), up to a maximum. The maximum has been rising as shown in the table below. Since 2010 it is indexed to the annual increase in the average wage.
|Year||Contribution Limit||Year||Contribution Limit|
While it is possible to contribute more than the contributor's deduction limit, it is generally not advised as any amount $2,000 over the deduction limit is subject to a significant penalty tax removing all benefits (1% per month on the overage amount).
RRSP contributions within the first 60 days of the tax year (which may or may not be the calendar year) must be reported on the previous year's return, according to the Income Tax Act. Such contributions may also be used as deduction for the previous tax year.
An account holder is able to withdraw dollars or assets from an RRSP at any age. Withholding tax is deducted by the institution managing the account. Amounts withdrawn must be included in the taxable income of that year. The tax withheld reduces the taxes owing at year end. There are two exceptions to this process - the Home Buyer's Plan and the Lifelong Learning Plan.
Before the end of the year the account holder turns 71, the RRSP must either be cashed out or transferred to a Registered Retirement Income Fund (RRIF) or an annuity. Until 2007, account holders were required to make this decision at age 69 rather than 71.
Investments held in a RRIF can continue to grow tax-free indefinitely, though an obligatory minimum RRIF withdrawal amount is cashed out and sent to the account holder each year. At that time individuals hope to be taxed at lower tax rates, but may actually end up paying higher rates than were recovered from contributions.
On death the assets remaining in the account are withdrawn and distributed directly to the named beneficiary. They do not flow through the estate. The account is closed. Like other withdrawals, the value of the assets is included in the taxable income of the account's owner. This large lump sum may result in much of its value being taxed at the top tax bracket. The liability to pay the tax lies with the estate, no matter who received the account's assets.
There are exceptions. When a spouse is the named beneficiary, the account continues, without triggering taxes, in the name of the spouse. There are also provisions for the tax-free transfer of assets to minor children, grandchildren and dependents.
Special withdrawal programs
Home Buyer's Plan
While the original purpose of RRSPs was to help Canadians save for retirement, it is possible to use RRSP funds to help purchase one's first home under what is known as the Home Buyer's Plan (HBP). An RRSP holder can borrow, tax-free, up to $25,000 from their RRSP (and another $25,000 from a spousal RRSP) towards buying their residence. This loan has to be repaid within 15 years after two years of grace. Contrary to popular belief, this plan can be used more than once per lifetime, as long as the borrower did not own a residence in the previous five years, and has fully repaid any previous loans under this plan.
Lifelong Learning Plan
Similarly to the Home Buyer's Plan, the Life-Long Learning Plan (LLP) allows for temporary diversions of tax-free funds from an RRSP. This program allows individuals to borrow from an RRSP to go or return to post-secondary school. The user may withdraw up to $10,000 per year to a maximum of $20,000. The first repayment under the LLP will be due at the earliest of the following two dates.
- 60 days after the fifth year following the first withdrawal
- the second year after the last year the student was enrolled in full-time studies
Both Individual and Spousal RRSPs can be held in one of three account structures. It should be noted that one or more of the account types below may not be an option depending on what type of investment instrument (example stocks, mutual funds, bonds) is being held inside the RRSP.
Client-held, or client-name accounts, exist when an account holder uses their RRSP contributions to purchase an investment with a particular investment company. Each time that an individual uses RRSP contribution money to purchase an investment at a different fund company, it results in a separate client-held account being opened. For example, if an individual buys investment #1 with one company and investment #2 with another, the individual would have separate RRSP accounts held with two different companies.
The main benefits of client-name accounts is that they do not generally incur annual fees or "exit fees", the investment is registered with the trustee in the client's name instead of the "dealer's" name and therefore, client-name investments are not subject to bankruptcy issues if the dealer goes bankrupt. Another benefit is that a Dealer Statement generated quarterly by the Mutual Fund Dealer; and Exempt Market Dealer contain all investment activity (buy, sell, switch) through that dealer for ease of tracking investments. The Dealer Statement contains all types of plans for registered investments (RRSP, RRIF, Tax-Free Savings Account, Locked-in Retirement Account, Life Income Fund) and non-registered investments thereby making it easy to track investments in one place.
Generally, client-held accounts are for mutual funds and exempt products only; therefore, if an investor holds stocks and bonds along with mutual funds or exempt products, a Nominee or Intermediary account is most beneficial for ease of tracking all types of investments in one place.
Nominee accounts are so named because individuals with this type of account nominate a nominee, usually one of Canada's five major banks or a major investment dealer, to hold a number of different investments in a single account. For example, if an individual buys investment # 1 with one company and investment #2 with another, both investments are held in a single RRSP account with the nominee, a chartered bank.
The main benefit of a nominee account is the ability to keep track of all RRSP investments within a single account. The main detriment is that nominee accounts often incur annual fees.
A "self-directed" RRSP (SDRSP) is a special kind of nominee account. It is essentially a trading account at a brokerage that has tax-sheltered status. The holder of a self-directed RRSP instructs the brokerage to buy and sell securities on their behalf as with any brokerage account. The reason that it is described as "self-directed" is that the holder of this kind of RRSP directs all the investment decisions themselves, and does not normally have the service of an investment advisor.
Intermediary accounts are essentially identical in function to nominee accounts. The reason investors would have an intermediary account instead of a nominee account has to do with the investment advisor they deal with, as advisors not aligned with a major bank or investment dealer may not have the logistical ability to offer nominee accounts to their clients.
As a result, the advisor will approach an intermediary company which is able to offer the investor identical benefits as those offered by a nominee account. The two main Canadian financial institutions that offer intermediary services are B2B Bank and Canadian Western Trust.
The main benefits and detriments of intermediary accounts are identical as those offered by nominee accounts.
It is possible to have an RRSP roll over to an adult dependent survivor, child or grandchild, as it would to a spouse. This was made possible in 2003 and there are various Income Tax Act (ITA) requirements to allow this to take place. The new registered asset could result in provincial benefits being cut off. In many cases a court application to have someone appointed guardian of the child’s property and person would be necessary to provide a legally authorized party to manage the asset if the child is deemed incompetent to do so. This possibility has an impact on the overall estate plan and often the distribution of the estate.
Acquiring this asset may also impact the adult dependent child’s eligibility for provincial assistance programs. A Henson trust may be useful for enabling the adult dependent child to receive RRSP rollovers and still be eligible for provincial social assistance programs such as Ontario Disability Support Program (ODSP). A Lifetime Benefit Trust (LBT) is a new option that may be valuable for leaving a personal trust in a will for a special needs, financially dependent child, grandchild or spouse. It has the added benefit that RRSP assets dedicated to the LBT could be protected from creditors.
Originally, RRSPs were limited to mostly domestic content, that is, Canadian based investments such as GICs, bonds and shares of Canadian corporations, and mutual funds holding such assets. Non-Canadian content was limited to 10% of the plan's assets, originally measured by market value, and in 1971 changed to 10% of book value.
In 1994, the foreign content limit was raised to 20%. However, by then, mutual fund managers found a way to get around this limitation and offer unitholders exposure to foreign markets without using up any of the foreign content quota. They typically did this by holding all fund assets in Canadian treasury bills or similar cash equivalent assets, and using foreign equity index futures or forward contracts with a similar notional value to obtain equivalent market exposure. Since derivatives are generally considered off-balance-sheet items for accounting purposes, these synthetic foreign funds qualified as 100% Canadian content.
In 2001, the foreign content limit was raised yet again, this time to 30%, but the prevalence of synthetic foreign funds was such as to make the limit a matter of form only. In 2005, the law was changed to remove foreign content limit altogether.
- Retirement Compensation Arrangements (RCA)
- Retirement plan
- Registered Retirement Income Fund (RRIF)
- Henson trust
- Saskatchewan Pension Plan
- Locked-In Retirement Account (LIRA)
- Locked-in Retirement Savings Plan (LRSP)
- Life Income Funds (LIF)
- Locked-In Retirement Income Funds (LRIF)
- Registered Education Savings Plan (RESP)
- Prescribed Retirement Income Fund (PRIF)
- Taxation in Canada
- Tax-Free Savings Account (TFSA)
- Canadian Income Tax Act, Section 146 - RRSP via CanLII
- Canada Revenue Agency: Registered Retirement Savings Plan
- Canada Revenue Agency - RRSPs
- Tax Rates on Withdrawal - CRA
- Jack Mintz, "Summary Report on Retirement Income Adequacy Research" for the Research Working Group on Retirement Income Adequacy, Department of Finance Canada
- "Saving for retirement: RRSPs and RPPs" by Ernest B. Akyeampong, Statistics Canada, Perspectives, Summer 1999
- Getting Smarter About Money, "3 Tax Advantages" (Ontario Securities Commission)
- Getting Smarter About Money, "5 Reasons to Open" (Ontario Securities Commission)
- Chartered Professional Accountants of Ontario, "RRSP Basic", accessed December 13, 2013
- Financial Consumer Agency of Canada
- TD Canada Trust
- Scotia Bank
- Royal Bank
- "Nitty Gritty of RRSP", 2009
- Golumbek, "Blinded By The Refund", 2011
- "Tax Free Investing", Jamie Golombek, 2011
- Don Pittis, 2013 "Essentially, there are two ways to win from an RRSP. The first is a straight bet that you will one day be poorer than you are now. The other is a tax break on your sheltered earnings."
- "Two Key Concepts for Wealth Managagement and Beyond", Reichenstein, Horan, Jennings, 2012 "A tax-deferred account is analogous to a limited partnership ... We can conceptually separate each dollar in a tax-deferred account into (the) investor's after-tax funds plus (the ...) government's share of the current principal."
- Jack Mintz, "Retirement Income Adequacy""Governments also regulate pensions, and provide tax incentives to encourage people to accumulate wealth for their retirement. By exempting the return on savings from income tax, people who save for retirement pay the same tax over their lifetime as those who do not save. This provides a neutral tax treatment of consumption and saving, which helps improve both fairness and efficiency in the tax system." In other words (editor's comments), profits earned by savings are never tax, and there is no cost/benefit from the different timing of taxes on employment income.
- "Retirement Policy", page 24 and 25
- Joint Committee on Taxation, pages 6-8
- Bill Curry (2011-11-17). "Ottawa hopes pooled pension spurs retirement saving". The Globe and Mail. Retrieved 2011-12-02.
- CRA. "Rates for Money Purchase limits, RRSP limits, YMPE, DPSP limits and Defined Benefits limits". Retrieved 2012-08-30.
- CRA. "Excess contributions". Retrieved 2012-02-08.
- CRA, "Death of an Annuitant"
- End of RRSP limit on foreign content a test of fund firms' greed GlobeAdvisor.com, 1 March 2005
- Foreign content rule gets tossed National Post, 28 February 2005
- Feds scrap foreign content rule, raise RRSP limits Advisor.ca, 23 February 2005
- CIBC International Index RRSP Fund - semiannual report, 30 June 2008
- CIBC U.S. Index RRSP Fund - Annual report, 31 December 2007
- Canadian Income Tax Act, Section 146 - RRSP via CanLII
- Canada Revenue Agency
- fin.gc.ca: RRSP information
- retailinvestor.org - alternative perspective on RRSP tax benefits
- Blinded by the “Refund”: Why TFSAs may beat RRSPs as better retirement savings vehicle for some Canadians Jamie Golombek, Tax & Estate Planning, CIBC Private Wealth Management
- Just do it: The case for tax-free investing Jamie Golombek, Tax & Estate Planning, CIBC Private Wealth Management