Investing in an RRSP: Contribution Room and How to Use the RRSP

Investing in an RRSP
Investing in an RRSP.  I must admit that when my girlfriends tell me they “invest in an RRSP” it drives me up the wall.  I think because they don’t realize that an RRSP is just a holding vault for the investments inside the RRSP but they just blanket-statement say that they already ‘invest in an RRSP’ (but don’t know what the composition is within the RRSP, e.g. mutual funds, ETFs, bonds, US paying dividend stocks etc.).

Registered Retirement Savings Plans (RRSP) is actually a basket of investments that are invested before income taxes but will be taxed when you take the money out of it. The RRSP is a tax deferral strategy. You take money out of the RRSP when your income is low (e.g. in retirement years).

With pre-tax dollars, that means that when you invest in an RRSP you get a tax refund back at your marginal rate for the amount you contributed. In an RRSP, the money you earn in it will also be free of taxes as long as you don’t take it out of the RRSP. Finally, it works as a tax shelter and a way for you to defer your taxes. When you withdraw from the RRSP then you will pay taxes, but the hope is that when you withdraw, your income will be low because you’ll be retired, so you will pay fewer taxes.

How Much Can You Contribute

With an RRSP, you can contribute up to 18% of your earned income, up to a maximum of around $25,000 or so per year. For the most recent rates and contribution maximum, check out the Canada Revenue Agency site. If you are part of a defined benefit pension, your RRSP contribution is affected by the pension adjustment. If you are part of a defined contribution plan your RRSP contribution amount is also affected. You won’t be able to contribute the maximum.

For an easy answer, It tells you on your Notice of Assessment each year (you know that letter you receive from the Canada Revenue Agency after you file your taxes) how much you are allowed to contribute to your RRSP.  To check your latest Notice of Assessment (if you lost your physical copy for example) you can go to CRA My Account for Individuals.

The deadline for contribution is March 1 of the calendar year. The first 60 days of the current year can be used for the previous year’s taxes. It’s best to contribute earlier so that you can take advantage of the tax shelter for the year.

Of course, you have to be careful if you over contribute. If you over contribute by more than $2000, you will have to pay taxes on the over contribution. It is 1% per month on the excess amounts (similar to TFSA over-contribution).

What You Can Do With Your Contribution

You can use your contribution to pay less tax. If you know that you’ll be having more income in future years, you can also carry forward your contribution to next year so that you can use it as a deduction.  All the meantime, you continue to be investing in an RRSP.

For example, let’s say you are in school for your MBA and only working part-time. While you can still contribute to your RRSP, it makes sense to use that RRSP deduction for when you are working full-time again at that six-figure job fresh out of MBA school, instead of while you are not earning very much. Remember you get a refund based on your marginal tax rate and the higher your marginal tax rate the more bang for your RRSP buck you’ll get.

You can buy US Dollar stocks within the RRSP, and in fact, this is usually the best place for dividend-paying USD equities because of the shelter from taxes on your USD investments.

Related:  How to Convert CAD to USD for $6 in Questrade

                             How to Use a Dividend Yield Spreadsheet

Just like with other registered accounts like the TFSA, you can hold different types of investments in an RRSP (GIC’s, mutual funds, bonds, exchange-traded funds, equities etc.).

How You Can Use your RRSP

Other than saving for retirement, the RRSP is flexible in that if you need to take money out of your RRSP’s for purchasing a home or if you decide to go back to school, you can.

Home Buyer’s Plan (HBP)

  • you can borrow $25,000 from your RRSP to pay for building or buying your first home, I know it’s not very much considering the cost of housing is ridiculous right now in Canada, but it’s better than nothing! And how many avocado toasts did you sacrifice to save up this $25,000? 🙂
  • You have to be a first time home buyer (did not occupy a home you own for the past four years)
  • You also have to live in the home you built or you live in for one year after withdrawing funds from your HBP
  • After the first year, you are required to pay back the amount you borrowed in the second year of owning your home, the minimum amount is 1/15 of the amount you borrowed.
  • You have to pay it back within 15 years

Life Long Learning Plan (LLP)

  • You can also withdraw or borrow $20,000 from your RRSP to fund yourself or your spouse or common-law partner’s education
  • To be eligible for the Life Long Learning Plan, it has to be full-time enrolment
  • Enrolment has to be done before March of the following year
  • You have to pay it back within 10 years, at 1/10 of the amount you borrowed at minimum
  • You can use the Life Long Learning Plan over and over again as long as you pay back completely the balance owed to your RRSP

In addition, you can use your RRSP to lower your net household income so you can qualify for increased Canada Child Benefit, which is a monthly ‘supplement’ that the government of Canada provides for young children under the age of 6.

Related: Child Tax Benefit Payment Dates

What Happens if You Take Money out of the RRSP Before you Retire?

If you take money out of the RRSP before you retire, you will have to pay a withholding tax AND you will have to pay the tax according to your marginal rate for that year (of course, if you’re low income that’s okay).

If you withdraw more than $15,000 you will have to pay a withholding tax of 30%. Ouch! If it’s $5000 to $15000, it’s 20% and if it’s under $5000, it’s 10%.

This harsh penalty for taking money out of the RRSP encourages Canadians to save for retirement and not touch their RRSP money.  Instead, they encourage you to keep investing in an RRSP.

What Happens When you Turn 71

71 is sure a long way from now so it’s definitely difficult to think about for us millennials. Current laws in Canada state that when you turn 71, you have to turn your RRSP into an RRIF (Registered Retirement Income Fund).

Instead of putting money into the RRSP, you will now withdraw money with an RRIF.

Readers, are you a fan of investing in an RRSP or do you prefer the TFSA?

What do you do when you are investing in an RRSP?

Contribution room RRSP

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21 thoughts on “Investing in an RRSP: Contribution Room and How to Use the RRSP”

  1. I am actually a fan of both the RRSP and the TFSA and I try to max my contribution for both accounts. My goal for every year is to use my tax refund that I get for contributing to the RRSP account to maximize my TFSA account.

    The best way to build wealth in the long-term and saving for your future are these two accounts. About 40% of my net worth is invested in these two accounts. If you want to keep more money in your pocket, use these accounts to the fullest.

  2. It drives me crazy when people say they’re investing in an RRSP too! Especially when they’re likely getting less than 2% interest. I love that you mentioned U.S. stocks for RRSP. A lot of people miss this point. There is no withholding tax on U.S. dividends in an RRSP but there is tax on the dividends if you hold U.S. stocks in a TFSA. Overall I’m a fan of the TFSA first because of the control. But I think a TFSA and RRSP are good for different reasons. Thanks for sharing!

    • @Reverse the Crush- Thanks for visiting RTC! Yes, the best way is to look at the TFSA/RRSP both holistically instead of just solely focusing on one vs the other. They are best used in tandem/ and best used together.

  3. Great summary Gym!
    It also drives me crazy when people say they invested in an RRSP! And many do!
    And so many people don’t understand the future tax liability of their RRSP.
    I am a big fan of both RRSP and TFSA but I don’t think RRSP is necessarily for everybody, depending on your income.
    Also when you look into future benefits and potential clawbacks, sometimes it is better to start withdrawing your RRSP before 65. The withholding tax shouldn’t hold people back, it gets squared away when you file your taxes.
    Obviously, when you decide to withdraw on your RRSP is very personal and depends on what you will be entitled to when older: CPP, OAS, GIS and maybe company pension

    • @Caroline- Oh good not just me! Then it must be very common. I’m still maxing out my RRSP even though I have a defined benefit pension (the cadillac of the pensions) because maybe I might leave work before my full pension, or maybe I will not qualify for a full pension, so I want to keep that flexibilty available.

  4. Hi GYM, I’m curious. Is RRSP provided by the government, or each employer? Does everyone have the same investment options in RRSP?

    It sounds like the 401K in US. Federal government set up the rules. But the 401K is employer specific, in terms of investment options. Some small companies may not offer 401K.

    • @Helen- Everyone has the same investment options in the RRSP (though some may have company sponsored RRSPs). The RRSP is like the 401K. People have different RRSP contribution room too, depending on your previous income or if you have pension contributions already.

  5. This was such an easy-to-understand guide! I’ve also seen many people say they invest in a certain account, but turns out they didn’t allocate the money. So the money was just sitting there in cash. Huge mistake!

    Do you guys also get employer matches?

    • @The Luxe Strategist- Oh, so it’s not just Canadian specific! So many commonalities between the US and Canada! I don’t have an employer match as my employer doesn’t do that, but yes, that is available definitely from a lot of employers- though one would want to watch that if the employer just focuses on their own company (asset allocation would be off in that case).

  6. I wish the 401K here in the US wouldn’t have a complicated name for a retirement account. RRSP sounds so much simple because it stands for Registered Retirement Savings Plan but with a 401K it goes by a code by the IRS in which many wouldn’t understand. Same goes for the 529(college fund) account as well.
    Great summary for the RRSP, you made it easy to understand! Does it have many investing options to choose from or does it depend on the employer on how many investing options their employees can select from?

    • Many employers have group RRSP plans; that is, they have a financial management like Sun Life or Manulife provide a set of (almost always exclusively) mutual funds that employees can invest in. Some employers even provide matching programs where they will match a certain percentage of your contribution (usually up to a specified dollar amount).

      However, the RRSP program itself is a government run program and employees are not required to invest through their employers; they can invest in any RRSP eligible investment. Here are a few pros and cons to investing through an employer:

      * contributions are deducted automatically at source
      * if there is matching, you are basically getting free money

      * almost always limited to mutual funds so higher MERs.

    • @Kris- Hah, it took me a few years to figure out the ‘synonyms’ for RRSP/TFSA and the 401K and 529! The 529 is our RESP. Thanks for reading Kris! Anyone can open up an RRSP anywhere, doesn’t need to be just with their employer. They can open one up with their employer AND have a separate RRSP with another investing institution (but should be cognizant that they don’t over contribute as there are penalties for that).

  7. You will be surprised to find that so many people do not understand the RRSP and TFSA accounts.

    I am a strong supporter of the RRSP investing and here are the main points to consider:
    -If you need the money invested in RRSP before your retirement then put the money into a TFSA account
    -If the tax margin when you contribute is similar to when you will withdraw then go for TFSA (the difference should be higher then 10%)
    -!!!! If you intend to spend the tax return then do not contribute to RRSP, go for TFSA. Best is to put the tax return back in RRSP or TFSA.
    -!!! If you have a RRSP plan from your company (the company is doing some contributions as well) them make yourself a favor and sign for it. I know that you will be limited to mutual funds but the free money will override any mutual fee.
    -As mentioned, no withhold taxes on USA dividends.
    -Some people can be in situations of clawbacks in retirement but this means that they managed their money proper and know what they have to do to limit the taxes. The problem is with most of the working middle and poor class which didn’t have anybody honest to open their eyes …
    -For USA fellows, you have similar accounts in USA (401, IRA) and personal tax margin is much lower then Canada

    • @Cris- “You will be surprised to find that so many people do not understand the RRSP and TFSA accounts.”
      — that breaks my heart it really does!! I love these accounts!!

      Free money from your employer is great- employer matching is great for the RRSP. Not only do you get free money from your employer towards your RRSP but you get to lower your tax bill!

      Thanks so much for your succinct summary and thanks for visiting.

  8. Just a quick question if you can help clarify.

    You wrote, “If you know that you’ll be having more income in future years, you can also carry forward your contribution to next year so that you can use it as a deduction.”

    How does one do this?

    Let me see if I understand, for example, let’s say that I’ve maxed out my RRSP contribution limit, and let’s say that I want to over contribute in the same investment calendar year. Besides the $2K over-contribution grace “buffer”, whatever the excess amount is, how can I file/tell the CRA I’d like to move that excess amount for a future year contribution, so that I don’t get penalized for over-contributing in the same calendar year?

    • @moneyhelp- There’s an area on your tax return where you can put how much you contributed, and how much you want to deduct (e.g. two different terminology, so that you can carry forward the unused amounts).


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