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Registered retirement savings plan

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A registered retirement savings plan (RRSP) (French: régime enregistré d'épargne-retraite, REER), or retirement savings plan (RSP), is a Canadian financial account intended to provide retirement income, but accessible at any time. RRSPs reduce taxes compared to normally taxed accounts. They were introduced in 1957 [1] to promote savings by employees and self-employed people.

They must comply with a variety of restrictions stipulated in the Income Tax Act.[2] Qualified investments[3] include savings accounts, guaranteed investment certificates (GICs), bonds, mortgage loans, mutual funds, income trusts, common and preferred shares listed on a designated stock exchange, exchange-traded funds, call and put options listed on a designated stock exchange, foreign currency, and labour-sponsored funds. Short call contracts covered by long stock ("covered calls") are eligible, however, cash secured puts (short put contracts covered by cash) are not eligible. Rules determine the maximum contributions, the timing of contributions, the assets allowed, and the eventual conversion to a registered retirement income fund (RRIF), or an annuity, or the withdrawal of all funds within the RRSP, at age 71.[4]

Taxation

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Contributions to RRSPs are deductible from income, reducing income tax payable for the year in which the contributions are claimed.[5] The holder of the RRSP (the "annuitant") can defer the deduction due to the contribution to a later year.

Taxable income of qualified investments of the trust is not taxed, as set out in section 146(4) of the Income Tax Act.[6]

If the RRSP earns business income, the business income is subject to taxation on the basis of the business income less the amount of business income arising from the sale of qualified investments. The effect of this rule, set out in section 146(4)(b)(i) and (ii) of the Income Tax Act, is that business income on qualified investments, earned within an RRSP, is subject to zero tax while the income remains within the RRSP. This means that business income, for example, due to day trading within the RRSP, is not taxed, so long as the business income is due entirely to the sale of qualified investments. This is an important tax carve-out unique among registered accounts to the RRSP and the Registered Retirement Income Fund (RRIF), as, for example, in the case of the Tax Free Savings Account (TFSA), business income is taxable as personal income earned by the TFSA holder.

All withdrawals except for withdrawals due to participation in the Home Buyers' Plan and the Lifelong Learning Plan are taxed as income when they are withdrawn. This is the same tax treatment provided to Registered Pension Plans established by employers.[7][8] Preliminary tax may be withheld at withdrawal.[9]

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 benefit with a group plan is that the employee-contributor realizes the tax savings immediately, because the income taxes his or her employer must deduct on every paycheque can be reduced. By contrast, if a taxpayer making a private contribution is not expecting to owe more than $3,000 ($1,800 in Quebec) at the end of the year, then he or she will have to wait until the end of the tax year (or even not until after that in the case of taxpayers expecting a refund) before realizing the benefit.
  • 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.[10]

Benefits from tax savings

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The RRSP's benefit comes mainly from the same benefit as a TFSA (permanently tax free profits on after-tax savings), plus a bonus/penalty from changing tax rates.

There are a few benefit factors that add to a total.[11][12] The only benefit that everyone always gets is from permanently tax-free profits on after tax savings. This is the same and equal benefit as from a TFSA. The conceptual understanding[13] is that the contribution's tax reduction is the government investing its money alongside the saver's, for him to invest as he likes. They become co-owners of the account. The government's share of the account (funding plus the tax-free profits earned by it) at withdrawal fully funds the account's withdrawal tax calculated at the contribution's tax rate. So the contribution's tax reduction is never a benefit, and profits are never taxed. The withdrawal tax is conceptually an allocation of principal between owners, not a 'tax', and there is no benefit 'from deferral'.

Example: Taxpayer has a 30% combined federal-provincial marginal income tax rate and makes a $10,000 contribution to a registered account. Assume in this example that the taxpayer's marginal income tax rate is the same at time of withdrawal from the registered account as it was at the time of contribution:

To TFSA:

$10,000 - $3,000 in income tax paid = $7,000 to contribute to TFSA as the contribution to TFSA is with after-tax income.

$7,000 invested in TFSA. After 10 years, say the $7,000 has grown to $14,000.

Taxpayer withdraws $14,000, tax-free.

To RRSP:

$10,000 invested in RRSP as the contribution to RRSP is with pre-tax income.

After 10 years, say the $10,000 has grown to $20,000.

Taxpayer pays 30% tax on withdrawal, or 30% of $20,000 = $6,000.

Withdrawal net of tax = $20,000 - $6,000 = $14,000.

It is clear from the example, above, that so long as the taxpayer's marginal income tax rate does not change, the TFSA and RRSP produce the same results.

It is also clear that the TFSA will be advantageous to the RRSP if the taxpayer's marginal income tax rate is higher at the time of withdrawal than at the time of contribution.

It is also clear that the RRSP will be advantageous to the TFSA if the taxpayer's marginal income tax rate is lower at the time of withdrawal than at the time of contribution.

Additional benefits may result from drawing funds using the Home Buyers' Plan or the Lifelong Learning Plan.

Contributing

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Any resident of Canada who filed a tax return for the year prior to the year of the contribution, can contribute to an RRSP, up until December 31 of the year in which the RRSP annuitant (holder) turns 71. Contributions and deductions are two different things. Contributions are usually deducted from taxable income in the same tax year but may be deferred by the annuitant to future years. 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 Canada Revenue Agency.

The 'deduction limit' is a running total calculated for the next year and printed 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).

Since 1991, contribution limits are calculated at 18% of the prior year's reported earned income (from employment or self-employment), up to a maximum. The maximum has been rising[14] 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
1991 $11,500 2008 $20,000
1992 $12,500 2009 $21,000
1993 $12,500 2010 $22,000
1994 $13,500 2011 $22,450
1995 $14,500 2012 $22,970
1996 $13,500 2013 $23,820
1997 $13,500 2014 $24,270
1998 $13,500 2015 $24,930
1999 $13,500 2016 $25,370
2000 $13,500 2017 $26,010
2001 $13,500 2018 $26,230
2002 $13,500 2019 $26,500
2003 $14,500 2020 $27,230
2004 $15,500 2021 $27,830
2005 $16,500 2022 $29,210
2006 $18,000 2023 $30,780
2007 $19,000 2024 $31,560

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).[15]

RRSP contributions can be made up until and including the 60th day following December 31 of the tax year of the contribution. For example, contributions for the 2023 tax year can be made up until and including February 29, 2024. Unused contributions carry forward until December 31 in the year the annuitant reaches 71 years of age, at which point the unused contributions are cancelled.

Prior to 1991, contribution limits were calculated at 20% of the prior year's reported earned income, up to a maximum of $7,500 for taxfilers without an employer-sponsored registered pension plan, or $3,500 for taxfilers who had an employer-sponsored registered pension plan. Furthermore, any unused portion of the contribution limit could not be held for future use, and was therefore lost forever if not contributed before the 60 first days of the year.[16]

Withdrawals

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See also: Registered retirement income fund

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 Buyers' 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.[17] Until 2007, account holders were required to make this decision at age 69 rather than 71.

Investments held in a RRIF continue to grow tax-free, though an obligatory minimum RRIF withdrawal amount is cashed out and sent to the account holder each year.

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.[18]

Special withdrawal programs

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Home buyers' plan

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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 Buyers' Plan (HBP).[19] An RRSP holder can borrow, tax-free, up to $35,000[20] from their RRSP (and another $35,000 from a spousal RRSP) towards buying their residence.[21] 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. Originally introduced in the 1992 federal budget, the initial amount that could be borrowed was $15,000.[22] Seventeen years later the amount was raised to $25,000 in the 2009 budget.[23] The 2019 budget raised that amount again to $35,000.[24]

Lifelong learning plan

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Similarly to the home buyers' 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.

  1. 60 days after the fifth year following the first withdrawal
  2. the second year after the last year the student was enrolled in full-time studies[25]

Account structure

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Both individual and spousal RRSPs can be held in one of three account structures. 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 accounts

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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

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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

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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.

RRSP rollover

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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 affects the overall estate plan and often the distribution of the estate.

Acquiring this asset may also affect 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.

Foreign content

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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.

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.[26][27][28][29][30]

Similar accounts in other countries

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See also

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References

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  1. ^ "RRSPs: Tax-assisted retirement savings" Statistics Canada, Perspectives, Winter 1990.
  2. ^ Canadian Income Tax Act, Section 146 – RRSP via CanLII
  3. ^ "Qualified Investments". Retrieved 2024-07-29.
  4. ^ "Registered Retirement Savings Plan (RRSP)". Retrieved 2024-07-29.
  5. ^ "RRSP - Contributing". Retrieved 2024-07-29.
  6. ^ "Income Tax Act, Definitions, No tax while trust governed by plan".
  7. ^ Finance, Government of Canada, Department of. "Archived – Summary Report on Retirement Income Adequacy Research". www.fin.gc.ca. Retrieved 2017-02-28.{{cite web}}: CS1 maint: multiple names: authors list (link)
  8. ^ "Saving for retirement: RRSPs and RPPs" by Ernest B. Akyeampong, Statistics Canada, Perspectives, Summer 1999
  9. ^ "Tax rates on withdrawals".
  10. ^ Bill Curry (2011-11-17). "Ottawa hopes pooled pension spurs retirement saving". The Globe and Mail. Retrieved 2011-12-02.
  11. ^ "What are net benefits ... same applies in Canada".
  12. ^ "Excel spreadsheet calculating different benefits".
  13. ^ "Different Choices Maximize the RRSP Net Benefit". SSRN 3240046.
  14. ^ "MP, DB, RRSP, DPSP, and TFSA limits and the YMPE". Government of Canada. 17 November 2022. Retrieved 2023-08-26.
  15. ^ CRA. "Excess contributions". Retrieved 2012-02-08.
  16. ^ StatCan. "RRSPs: new rules, new growth" (PDF). Retrieved 2022-03-29.
  17. ^ "RRSP Withdrawals". Retrieved 2024-07-29.
  18. ^ Directorate, Government of Canada, Canada Revenue Agency, Taxpayer Services and Debt Management Branch, Taxpayer Services. "Death of an RRSP annuitant or a PRPP Member". www.cra-arc.gc.ca. Retrieved 2017-02-28.{{cite web}}: CS1 maint: multiple names: authors list (link)
  19. ^ Directorate, Government of Canada, Canada Revenue Agency, Taxpayer Services and Debt Management Branch, Taxpayer Services. "What is the Home Buyers' Plan (HBP)?". www.cra-arc.gc.ca. Retrieved 2017-02-28.{{cite web}}: CS1 maint: multiple names: authors list (link)
  20. ^ "March 2019 budget increase". 11 October 2005.
  21. ^ "Home Buyers Plan: What is the HBP?". Canadian Finance Blog. 2016-03-24. Retrieved 2017-02-28.
  22. ^ "The Budget 1992" (PDF). Department of Finance Canada. 25 February 1992. p. 142. Retrieved 17 September 2020.
  23. ^ "Canada's Economic Action Plan - Budget 2009" (PDF). Department of Finance Canada. 27 January 2009. p. 131. Retrieved 17 September 2020.
  24. ^ Golombek, Jamie (29 March 2019). "Ottawa raised the Home Buyers' Plan limit to $35,000 — here's how to take advantage of it". financialpost.com. Postmedia Network Inc. Retrieved 17 September 2020.
  25. ^ Directorate, Government of Canada, Canada Revenue Agency, Taxpayer Services and Debt Management Branch, Taxpayer Services. "Repayments to your RRSP under the LLP". www.cra-arc.gc.ca. Retrieved 2017-02-28.{{cite web}}: CS1 maint: multiple names: authors list (link)
  26. ^ End of RRSP limit on foreign content a test of fund firms' greed GlobeAdvisor.com, 1 March 2005
  27. ^ Foreign content rule gets tossed National Post, 28 February 2005
  28. ^ Feds scrap foreign content rule, raise RRSP limits Advisor.ca, 23 February 2005
  29. ^ CIBC International Index RRSP Fund - semiannual report, 30 June 2008
  30. ^ CIBC U.S. Index RRSP Fund - Annual report, 31 December 2007
  31. ^ "KiwiSaver - KiwiSaver". www.kiwisaver.govt.nz. Retrieved 2018-10-10.
  32. ^ "MPFA". www.mpfa.org.hk. Retrieved 2018-10-10.
  33. ^ "CPFB Members Home". www.cpf.gov.sg. Retrieved 2018-10-15.
  34. ^ "KWSP – Home – KWSP". www.kwsp.gov.my (in Malay). Retrieved 2018-10-15.
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