A registered retirement savings plan — RRSP for short — is an account sanctioned by the government and designed to help Canadians save for retirement. You deposit money into your RRSP. You use that money to invest in any of a whole host of investments — mutual funds, ETFs, stocks, bonds, practically any kind of asset imaginable. And then watch that money grow over time. The amount you’re allowed to contribute changes annually — in 2017, the maximum contribution was either 18% percent of your income or $26,010, whichever number is smaller.
One huge advantage to an RRSP is that it lowers your tax bill in the near term. All contributions are considered pre-tax. That means that every dollar you contribute can be subtracted from your income, so you pay less in taxes. For example, if you made $60,000 and you contributed $10,000 to your RRSP, you’ll only be taxed on $50,000. Another big benefit is that your investments also grow tax-free. As long as they money is in your account, you don’t have to pay a cent of taxes on any interest, dividends, or capital gains you earn. Not bad, right?
One thing to remember before you think you pulled one over on the government: you’ll eventually have to pay taxes when you withdraw your money. But the idea is that by the time you’re ready to take that money out, you’ll be retired and you’ll probably be earning less as a retiree than you were when you were working, meaning that your tax rate will be lower. And another important caveat: unless it’s for a sanctioned reason, like going back to school or buying a house, the government will fine you mightily for early withdrawal at a rate of anywhere from 10 to 30%.
For all these reasons, experienced financial planners (including Wealthsimple) suggest that most people invest the full amount allowable by the government in their RRSPs — or as much as they can afford.