A Registered Retirement Savings Plan was created by the federal government to give individuals the incentive to save towards their retirement. This incentive comes in the form of tax deductions. Any contributions that are made to an RRSP are deductible from your income for tax purposes, so they have the effect of reducing tax for the year.
RRSP’s are ideal for:
• individuals who don’t belong to a pension plan,
• individuals whose pension plans are inadequate
• individuals who want a higher retirement income than their pensions can provide
The income that is earned within the RRSP is grown UNTAXED; therefore, the RRSP investments grow at a much faster rate than non-registered investments that are subject to tax. All contributions accumulating in an RRSP, including capital gains and interest income earned is left untouched by Revenue Canada.
Investors with RRSPs will eventually pay taxes on their growth upon withdrawal. When the money is withdrawn from an RRSP, it becomes taxable income. When income is withdrawn at retirement, the investor’s tax rate is lower than during his/her peak earning years.
The maximum contribution is 18% of the previous year’s earned income minus any contributions made to a pension. This contribution amount is deducted from your taxable income which reduces the tax you pay.
You can carry forward unused RRSP contribution room indefinitely. Despite of this carry forward provision, you should always make your maximum annual RRSP contribution, even if you do not wish to use the tax deduction until a future year. If you start missing contributions now, you may not be able to catch up later, and you will be delaying the opportunity to earn tax-free compounding returns.
Investors have the opportunity to contribute up to your maximum RRSP contribution in any given year but you do not have to use your tax deduction in that same year. In other words, you can contribute now, and immediately benefit from the tax-free compounding of investment returns, but defer the tax deduction to a future year when it might be more advantageous.
You may become eligible for new RRSP contribution room based on your previous year’s earned income at the beginning of each particular tax year. You may only claim an RRSP deduction for this amount in the tax return for that particular tax year if you make your RRSP contribution sometime during that tax year, or within the first 60 days of the following year.
You may make a partial or full withdrawal from your RRSP, but you must be aware of the tax consequences. All financial institutions are required by Canada Customs & Revenue Agency (CCRA) to charge applicable withholding taxes for all portions of the monies withdrawn from the RRSP.