What is an RSP?
The abbreviation “RSP” stands for “retirement savings plan”. Canadian citizens have access to two different types of RSPs:
Registered retirement savings plans (RRSPs). RRSPs are legal trusts that are registered with the Canadian Revenue Agency. Funds placed in RRSPs are subject to certain limitations, but get a number of tax advantages.
Non-registered retirement savings plans. Non-registered RSPs have no contribution or income limits, but they don’t get the full tax benefits of RRSPs. Non-registered RSPs can be opened by anyone in the form of savings, checking and money-marketing accounts.
The focus of this article is on RRSPs, though you may want to familiarize yourself with the best way to use both types of accounts to supplement retirement benefits that may be available through the Old Age Security (OAS) program and the Canadian Pension Plan (CPP).
Rules and Restrictions
RRSPs come with the following rules and restrictions:
Contributions to RRSP accounts can be made until age 71, using funds earned through salaries, self-employment income, maintenance and alimony payments, rental income and other sources (though not from pensions or investments).
Contributions made to an RRSP offset the account holder’s annual taxes due, up to a certain point. Called the deduction limit, this threshold was set to $24,270 or 18% of employment income, whichever is lower, in 2014 (contributions made in excess of this amount could have tax implications for account holders). Money invested in RRSPs is allowed to grow, tax-deferred, until it is withdrawn in retirement.
Account holders may be able to contribute more to their RRSPs if they did not use up their allowed deduction limit in previous years. There is currently no limitation on the amount of potential contributions that can be rolled over, unused, from year to year.
Upon reaching age 71, account holders must either cash out their RRSPs or roll them over into annuities or registered retirement income funds (RIFs). Withdrawals can be made at any point before this, but may be subject to taxes and early withdrawal penalties as a result.
How Can an RRSP Help Me at Tax Time?
When assessing your annual tax burden, pre-tax RRSP contributions are counted against your income. For instance, suppose a self-employed database administrator named Brian lives in Ontario and earned $48,000 in 2014. If he contributed $10,000 to an RRSP, he could deduct this from his taxable income, moving him from the 22% to the 15% federal tax bracket and from the 9.15% to the 5.05% provincial tax bracket. That’s a pretty big tax savings!
But that’s not all… In addition, the growth of Brian’s investments is tax-sheltered, meaning that he will not be assessed any capital gains, dividends or income taxes on his gains as long as his contributions remain in the account. Instead, Brian will be taxed on the income he generates when he starts withdrawing from his retirement accounts, when he will (ideally) be in a lower tax bracket as he is no longer working.
Given the complexities associated with RRSPs and freelance investing, it’s a good idea to consult with an accountant or investment advisor to determine what types of accounts to establish and how much to contribute – but don’t wait. Although 2014 has passed, you may still be able to take advantage of unused contribution limits from previous years that can help offset the amount of tax you owe for 2014.