Lisa MacColl is a writer, investor and former compliance consultant in the group retirement and individual wealth management fields. Lisa has written about personal finance for 14 years and currently writes about investing and investment providers for Wealthsimple. Lisa's past work has been published in Canadian Money Saver, Advisor’s Edge, CBC, and CreditCards.ca. She was a nominee for the 2015 Oktoberfest Women of the Year, Professional Category. Lisa holds an M.A. and B.A. from the Wilfrid Laurier University.
Conversations about saving for retirement often include terms such as RSP, RRSP and the likes. What is an RSP and an RRSP? Is there a difference? Rest assured you'll be able to wipe that puzzled look off your face once you've heard from us.
The difference between RSP vs RRSP
An RSP is an acronym for Retirement Savings Plan. It can refer to any number of financial products designed to help you save for retirement. An RRSP is a specific type of account with two stand out characteristics. The first — it has tax advantages in that any contributions can be deducted from your income. The second — you can only invest a limited amount of money in RRSP each year. While an RSP can refer to a number of retirement accounts an RRSP refers to one type of account specifically. Sometimes people will refer to an RRSP as an RSP (because it is) but so too are many other retirement accounts — here's a look at some common Retirement Savings Plans (RSPs).
Types of RSPs
There are many different types of retirement savings plans that come with a set of very nice tax advantages! Here's a look at each of these accounts.
Registered Retirement Savings Plan (RRSP)
A Registered Retirement Savings Plan (RRSP) is the most famous of the RSPs. An RRSP is a retirement product that has several tax benefits associated with it. Often, when a financial institution refers to an RSP, they mean RRSP.
An RRSP can only be sold by financial institutions approved by the Canada Revenue Agency (CRA). If you aren’t sure if your financial institution is permitted to sell RRSPs, ask the financial representative for the Specimen Plan number (only registered plans have one.) If the plan isn’t registered, you won’t be able to make use of those nice tax benefits that come with registered retirement savings plans.
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RRSP contributions are tax deductible to a specified deduction limit every year, normally 18% of the pre-tax earnings from the previous calendar year or the limit set by CRA, whichever is less. Unused contribution room is carried forward every year and added to the next year’s contribution limit.
You'll receive a contribution receipt from your financial institution and you must claim the contributions on your income tax. They reduce the amount of income tax you will have to pay — which is the very nice part about opening an RRSP.
Any investment earnings are tax-sheltered until the funds are withdrawn. In other words, as long as the funds remain in the account, you do not have to declare investment earnings on your income tax. (If you have investment losses on investments held in an RRSP, you cannot use them to offset investment gains.) You can use the power of compounding to build your retirement nest egg.
You can contribute to an RRSP in your name or your spouse’s name until December 31 of the calendar year you/your spouse turns 71. Then the plan must be converted to an RRIF and you must start to draw income.
Any funds you withdraw from an RRSP must be declared as part of your income for the calendar year in which you withdraw them. Depending on your personal circumstances, that can lead to a hefty tax bill. When most people think of Retirement Savings Plans, they probably mean an RRSP.
Tax-Free Savings Account
Tax-Free Savings Accounts (TFSA) have been around since 2009. You're not limited to saving for retirement with this account, although it can absolutely be used for that purpose.
The CRA sets a contribution limit for TFSA every year, but unused contribution room carries forward from one year to the next — you can check this year's limit here. If you don't already have a tax free savings account — lucky you! You're going to have a ton of contribution room when you decide to open a TFSA. A word of warning, don't dare over contribute. You'll be taxed on the excess right until you take it out of your account.
Contributions are not tax deductible, in other words, they don't reduce the amount of taxes you pay. That said, any money you make within your TFSA is not taxed which is why it gets the name TFSA. Financial institutions must report TFSA contributions to CRA. It’s your responsibility to keep track of your contributions; you won’t receive a formal receipt at year-end like you do for RRSPs. Many investment providers will track your contributions for you when you open a TFSA which makes it easy to stay within the yearly limit.
The earnings on investments held in a TFSA are tax-sheltered and do not have to declare on your income tax. If you have investment losses on investments held in a TFSA, you cannot use them to offset investment gains. Withdrawals are non-taxable. They do not need to be included in your income and declared on your T1 General Income Tax Return (the form you complete to file your taxes every year).
Registered Pension Plans
Many employers set up pension plans for their employees. There are 2 types: Defined Benefit (DB) Plan which promises to pay a set pension amount based on a formula including age, years of service and earnings history. Most DB plans do not allow employee contributions. Defined Contribution (DC) Plans provide pension benefits based solely on the contributions and investment earnings. Many DC plans allow employee contributions.
Contributions to an RPP have an impact on RRSP contribution limits. RPP contributions are listed in box 20 on your T4 income slip and are declared on line 207 of your income tax return.
Pension plans are governed by rules in the province the company is located (PEI does not currently have pension legislation). Federal employees or companies with employees in more than one province (multi-jurisdictional) have special rules. If you have questions about your employer pension plan, ask your human resources department or talk to your plan administrator.
The rules set out conditions for:
Eligibility: how long an employee must work for the company before joining the pension plan, what type of employee can join—most plans allow only full-time, permanent employees.
Vesting: when an employee can also receive employer contributions if they leave the company before retirement. For example, if a plan has 2 years’ vesting, if an employee leaves before 2 years, they will forfeit any employer contributions. If the plan allows employee contributions, the employee will always receive those contributions back.
Locking-in: The point at which funds cannot be withdrawn from the plan until the retirement age specified in the plan documents. If the employee is terminated, funds must be transferred to a Locked-In Retirement Account (LIRA). In the event of a marriage breakdown and the pension funds are transferred to a former spouse, those funds must remain locked-in under the same plan rules that would apply to the employee.
Normal Retirement Age (NRA): The age an employee can retire from the company and begin receiving a pension plan. Early retirement is generally 10 years earlier than NRA date.
Non-registered accounts are similar to a savings account in that you don't receive tax benefits and investment earnings and losses are fully taxable. Remember, different types of investments have different tax consequences. The advantage of non-registered accounts is that they're permitted to hold a wider array of investments than a registered account. They're also perfect for using after you've maxed out accounts with tax advantages.
Registered accounts such as RRSP, RPP and TFSA have strict rules about what types of investments can be held in the account. The accounts are limited to:
Mutual funds, segregated funds, exchange-traded funds
Securities listed on a designated stock exchange (derivatives may be excluded)
Non-qualified investments for registered plans include:
Investments that trade on over-the-counter markets
A non-arms length transactions, such as a debt to the account holder, shares in a company the account holder has more than a 10% interest in
Private mortgages, syndicate mortgages, angel investor arrangements and other types of 3rd tier investment arrangements.
You must be 18 years old to open a non-registered account. Unlike RRSPs, there is no age limit (you don't have to close or the account at a certain age) or contribution limit on non-registered accounts. You can deposit as much as you want and hold the accounts for as long as you want.
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