What is an RRSP? | ETFs

By Harvest ETFs

‘It’s RRSP season!’ ‘Better start investing in your RRSPs.’ ‘Have you set up your RRSPs yet?’ If you’re new to investing you probably hear plenty of lines like those from advertising, friends, and even your own families. That’s because in Canada, Registered Retirement Savings Plans (RRSPs) are among the most popular tools people use to save for their retirement.

But, what are RRSPs, what are they good for, and what are their limits?

In this article we will explain how RRSPs work, what their advantages and drawbacks are, and lay out what the RRSP contribution limits and deadlines mean for your savings plans.

What does an RRSP do for you

Put simply, an RRSP gives you a tax break as you save for your retirement. The money you contribute to your RRSP account each year is exempt from income tax on the year it was contributed. If you hold investments such as ETFs in your RRSP, any capital gains or income paid by those investments is also not taxed so long as that money is still held in your RRSP account.

Each year the federal government sets a contribution limit and a deduction limit for RRSPs. The contribution limit sets the maximum amount you as a Canadian taxpayer can put into your RRSP account each year. That number is specific to each individual, and is determined by when you began earning income as well as any extra contribution room you may have had from the last year.

The deduction limit is far more important to most investors, as that is the amount you can deduct on your income tax. That limit is either 18% of your earned income from the previous tax year, or the hard limit of $30,780 for 2023 – whichever number is lower. The contribution deadline to claim for the 2022 tax year is March 1^st of 2023. Any money contributed after March 1^st can be claimed in your 2023 tax year filings.

RRSP Deduction Limit by Year

Source: Canada Revenue Agency

The limits and drawbacks of an RRSP

RRSPs are designed to incentivize long-term savings. The tax deductions they offer would be more accurately described as tax deferral. That’s because any money withdrawn from an RRSP will be taxed. If you take the money out before you turn 71, the withdrawal is subject to a withholding tax, which is determined by the amount you pay and where you live.

That means for shorter-term savings goals, you may want to consider a different kind of registered account such as a Tax Free Savings Account (TFSA).

When you turn 71 your RRSP converts to a Registered Retirement Income Fund (RRIF), at which point they are subject to mandatory withdrawals on a schedule set by parliament. When that money is withdrawn it is taxed as income.

The other potential drawback of an RRIF is that the mandatory withdrawals may force you to sell some of the investments you hold in that account. Income-generating investments held in an RRSP can eventually help offset those withdrawals when the RRSP becomes an RRIF.

Despite these potential limitations and drawbacks, the short-term tax incentives of an RRSP make them a very popular and useful tool for many Canadian investors. It’s important, however, to learn how RRSPs work, what their deadlines are, and what they can and can’t be used for.

To learn more about how ETF investments can fit into both RRSPs and TFSAs, click here.