401(k) Equivalent in Canada

Many employers in the United States offer a retirement plan called a 401(k), which is a defined contribution plan. That means that the retirement benefit available to the plan participant will be a function of the amount they contribute to the plan, any amounts matched or contributed by the employer and how well the investments they choose perform over time.

With the trend toward many U.S. employers freezing or eliminating their defined benefit pension plans, defined contribution plans like the 401(k), the 403(b) and others have become the predominant retirement savings vehicle for many U.S. workers.

For 2020, the salary deferral contribution limits will be $19,500, with those who will be 50 or over at any point during 2020 eligible to use catch-up contributions to contribute a total of $26,500 for the year.

What is the equivalent of a 401(k) in Canada?

The Registered Retirement Savings Plan is a tax-deferred retirement plan that is analogous to the traditional IRA in the United States. Each year, individual Canadians can contribute funds to their RRSP account up to a maximum limit. This limit is based on a maximum percentage of your prior year’s earnings, up to a certain dollar maximum limit for contributions.

For 2020 the limits are 18% of your 2019 earnings, with a maximum dollar limit of $27,230. Contributions can be made until age 71. If the money remains in the account, it can grow tax deferred. The money is taxed when withdrawn.

The annual contribution limits for the RRSP account are much higher than for an IRA account in the U.S. For 2020, the contribution limits are $6,000 for those under 50 and $7,000 for those who will be 50 or older in 2020.

The Group RRSP (sometimes referred to as a Group Retirement Savings Plan or GRSP) is an RRSP offered by an employer as a tax-deferred retirement savings vehicle, the closest tax-deferred retirement to the U.S. 401(k) plan. GRSPs are employer sponsored retirement plans offered by employers as a workplace benefit. The GRSP and the RRSP are very similar and you can have both as long as you don’t exceed the combined maximum contribution limits (which are the same for both types of plans). One advantage of a GRSP over an RRSP is that many employers match their employee’s contributions. This is free money and an additional return on the money you might invest in the plan.

Differences and similarities between a GRSP and a 401(k)

The GRSP is similar to the 401(k) plan in several ways:

• Employees can select their own investment choices from a menu of options offered by the employer. They will be responsible for selecting and monitoring these investment choices.

• Contributions can be made both by employees (members) and by the company. Employee contributions are made on a pre-tax basis—any company contributions will provide the company with a tax deduction. As with a 401(k), employee contributions will have some payroll tax implications.

• Money contributed to both types of plans grows on a tax-deferred basis until it’s withdrawn at retirement or some other point in time.

• Money in the GRSP is subject to taxes when withdrawn from both types of plans. In the case of a 401(k), there will be no tax liability on any after-tax contributions, including contributions to a Roth option if available in the plan.

• Canadian employers can offer a Roth-like option to their GRSP plans called a group TFSA, which stands for Tax Free Savings Account.

• If U.S. employers elect to do so, participants can borrow money from their 401(k) plan balance. Loans are also permitted in GRSPs, but they work a bit differently. Participants can borrow from their plan balance for the Home Buyer’s Plan and the Lifelong Learning Plan. The Home Buyer’s Plan is a Canadian program that allows GRSP participants to withdraw up to $35,000 each year toward buying or building a home for themselves or a disabled relative. The Lifelog Learning Program allows for the withdrawal of $20,000 with a maximum of $10,000 each year to cover the cost of full-time or part-time education or training.

There are some differences between a GRSP and a 401(k) though:

• A 401(k) plan with an employer match will usually have a vesting requirement for participants to become fully vested in the employer match. Vesting means that after this period, the employee essentially owns the amount the employer has provided as a matching contribution. A typical vesting period is five years. The employee is 20% vested each year until they reach the full vesting period. Under this type of vesting arrangement, an employee leaving the company after three years of employment would only be entitled to roll over 60% of the amount of the employer matching contributions in their 401(k) account. GRSPs don’t use vesting requirements.

• Unlike a 401(k) plan, unused contributions to a GRSP, defined as contributions under that maximum contribution for that year, can be carried over to subsequent years with no time limit.

• Annual contribution limits to a 401(k) are a set amount each year. The annual contribution limit for a GRSP account is based upon a percentage of your income from the prior calendar year up to a set maximum amount.

• GRSPs allow for a spousal account whereby some of the member’s contributions can be directed to an account for their spouse. The maximum contribution limits remain the same, but this can be a way to set up plan for a spouse who may not be covered or who earns less.

Advantages of contributing to a GRSP

Those employees who have access to a GRSP via their employer enjoy several advantages to contributing.

• The investment choices are selected by the company, often with the help of a professional investment advisor. This can, in some cases, lead to a better menu of investment choices than you might be able to access on your own.

• Larger employers’ buying power can help gain access to lower cost investment options than those available to many individual investors on their own.

• Many employers offer a match for employee contributions at some level. This is like getting free money and can enhance the amount you are able to accumulate for retirement.

• Money is contributed on a pre-tax basis and can serve as a major tax break for employees who contribute.

• Money contributed to the plan grows on a tax-deferred basis while it’s invested within the plan. As your investments grow due to appreciation, capital gains, dividends and other means none of this income is subject to income taxes until the money is withdrawn down the road in retirement. This is a powerful feature of a GRSP and other tax-deferred retirement plans, this allows investment gains and income to compound without having to pay current taxes over the time the money is invested.

Note there are also advantages for the employer offering the GRSP.

• Any employer contributions made to the plan will be considered as a business expense and are therefore tax deductible to their income. Likewise, with any costs they incur for administering the plan, engaging the advice of an outside financial advisor and other plan costs that the employer pays from company funds.

• As with a 401(k) plan, offering a GRSP helps employees reach their retirement goals. While this is certainly a plus for the plan participants, this can also help improve employee wellness. Financial stress is a major drain on productivity in the workplace. Stress regarding their ability to retire in a financially secure way is often a major cause of the stress. A vehicle like the GRSP can help alleviate this stress.

Options when leaving an employer

Upon leaving their employer, GRSP participants have several options.

• They can convert or rollover their GRSP balance to an individual RRSP account. If they go to work for a new employer who offers a GRSP there is the possibility that this money can become part of that plan as well.

• If they withdraw the funds, the money will be subject to taxes.

• GRSP funds must be converted out of the plan by age 71. You can enroll in a Registered Retirement Income Fund or RRIF or into some other similar type of tax sheltered account.

Limitations of GRSPs

Many GRSPs are administered by large financial institutions where the investment menu might be limited and/or the plan expenses might be high.

Recently, some robo-advisors have begun offering lower-cost portfolios with innovative products, including socially responsible portfolios.

Unlike with an individual RRSP, your choices will be limited to what the plan offers. In the case of a sub-par GRSP you might consider contributing enough to receive the full employer match, then using the rest of your contribution limit for the year to fund your individual RRSP.