How does the Registered Retirement Savings Plan (RRSP) work? A guide for newcomers to Canada

As you settle into your new life as a newcomer in Canada, your continued financial security should be a top priority. Many newcomers postpone retirement planning, focusing instead on their immediate financial needs. However, government plans like the Registered Retirement Savings Plan (RRSP) offer tax benefits on contributions so you can plan for both the present and future at the same time.

If you have questions about whether the RRSP is the right savings plan for you, this article will shed light on how the Registered Retirement Savings Plan works, contribution rules, and how it can help you plan for retirement and other major expenses, including buying your first home in Canada.

In this article:

• What is a Registered Retirement Savings Plan (RRSP)?
• How do RRSP tax benefits work
• What type of investments can you make in an RRSP
• Who can contribute to an RRSP
• What is the RRSP contribution room?
• How to set up an RRSP
• What is the deadline for RRSP contributions?
• Withdrawing from your RRSP before retirement
• Withdrawing or receiving income from your RRSP at the time of retirement
• RRSP versus TFSA: Which is better?
• Should you invest in RRSP if you don’t plan to retire in Canada?

What is a Registered Retirement Savings Plan (RRSP)?

An RRSP is a savings plan that allows you to save a portion of your income for retirement. Unlike regular savings plans, the Registered Retirement Savings Plan is registered by the government and offers certain tax advantages, which make it a popular investment choice among Canadians. 

How do RRSP tax benefits work

To encourage people to save more, the government offers two key tax benefits on your RRSP contributions:

• RRSP contributions are tax-deductible, up to a certain limit. You can deduct your annual RRSP contribution from your taxable income and reduce your tax liability for the year or get a tax refund. This effectively means that you contribute to RRSP from your pre-tax income.
• Income earned on your RRSP is tax-deferred. This means you don’t need to pay income tax on capital gains or dividends until you start withdrawing funds or receiving income from your RRSP. At that time, both your contributions and earnings will be taxed. But, since your income tax rate is determined by your income in a particular year, you’ll likely be in a lower tax bracket after retirement and will have to pay less tax on your RRSP earnings.

What type of investments can you make in an RRSP

Depending on the type of RRSP account you choose, you may be able to hold a variety of investments in it. Some RRSP qualified investments include:

• Cash
• Guaranteed Investment Certificates (GICs)
• Savings bonds
• Bonds, including government and corporate bonds
• Eligible mutual funds
• Canadian and foreign stocks (or equities)
• Exchange-Traded funds (ETFs)
• Treasury bills
• Gold and silver bars
• Mortgage-backed securities
• Income trusts

The investments you can make depend on the type of RRSP account you have, so be sure to speak to a financial advisor for guidance on the ideal RRSP account for your needs.

Who can contribute to an RRSP

To be eligible to open an RRSP in Canada, you must:

• Be a tax resident and file income tax in Canada. In addition to Canadian citizens and permanent residents, temporary foreign workers and international students living in Canada may qualify as tax residents provided they were in Canada for at least 183 days during the year.
• Have an income.
• Be 71 years of age or under. There is no minimum age requirement.

You can typically contribute to your RRSP until December 31st of the year in which you turn 71. However, there’s a maximum limit to how much you can contribute in a particular year, so you must have RRSP deduction room available.

In addition to your own RRSP, you can also use your contribution room to contribute to a spousal RRSP until December 31st of the year in which they turn 71 years of age. 

When can newcomers to Canada start contributing to RRSP?

As a newcomer, you’re only able to contribute to an RRSP after you file your first income tax return in Canada. This means you won’t be able to contribute the year you arrive. 

Once you file your first tax return, the Canada Revenue Agency (CRA) will provide you with a Notice of Assessment, which will specify how much you’re allowed to contribute to the RRSP based on your prior year’s income.

What is the RRSP contribution room?

RRSP contribution room, also known as the RRSP deduction limit, is the maximum amount you’re allowed to contribute to your RRSP and deduct on your tax return each year, and it is different for everyone. After you file your income taxes, you will receive a notice of assessment from the CRA with information on your deduction limit for the next financial year.

How much can I contribute to RRSP?

According to the CRA, your contribution room is calculated as 18 per cent of your gross income in a particular year, up to a maximum annual limit. For 2021, the RRSP annual limit was $27,830 CAD and for 2022, the limit is $29,210 CAD.

It’s also important to note that the RRSP deduction limit is cumulative, so any unused contribution room carries over to the next year. 

What happens if you contribute more than your RRSP deduction limit?

There are penalties for exceeding the RRSP deduction limit, so make sure you don’t over-contribute to your RRSP. Usually, if you go over the deduction limit by $2,000 or more, you’ll need to pay 1 per cent tax each month on the excess contribution, unless you withdraw the extra amount.

While calculating how much you’ve contributed to your RRSP in a single year, you should also take into account your employer’s contribution (such as to pooled registered pension plans) and your contributions to your spouse’s RRSP.

Tip: If you accidentally made an excess contribution and are taking steps to rectify the situation, you can make a written request to the CRA to ask them to consider cancelling the punitive tax.

How to set up an RRSP

You can open a Registered Retirement Savings Plan account with a Canadian bank, credit union, insurance company, or trust. Financial institutions like the Royal Bank of Canada (RBC) offer different types of RRSPs, including ones you can trade in or have fully managed for you by a portfolio manager. You can speak to a financial advisor for information on the types of RRSPs available and the investments you can keep in them.

Your employer may also enrol you in a group RRSP or a Pooled Retirement Pension Plan (PRPP) as part of your benefits package. In this case, the employer will set up an account with a financial institution and make payroll deductions for your share of contributions. Some employers also fully or partially match employee contributions to the PRPP.

Note You can only deduct your own PRPP contributions on your income tax return. Contributions made by your employer are not tax-deductible.

What is the deadline for RRSP contributions?

RRSP contributions for a given year must be made by March 1 of the following year. For instance, for 2022, you can contribute to your RRSP within the limit indicated in your 2021 notice of assessment, between March 3, 2022, and March 1, 2023.

Withdrawing from your RRSP before retirement

Even though the RRSP is a retirement savings plan, you are allowed to withdraw funds from it earlier unless you are in a locked-in plan. However, in most cases, the money you withdraw is subject to a withholding tax of between ten to 30 per cent, depending on the amount you withdraw. You will also need to include this as ‘income’ in your tax return.

However, there are certain eligible expenses for which you can withdraw funds from your RRSP without paying tax. These include the Home Buyers’ Plan (HBP) and Lifelong Learning Plan.

What is the Home Buyer’s Plan (HBP)?

The Home Buyers’ Plan allows you to withdraw up to $35,000 from your RRSP to buy or build a home. You’ll need to repay the amount to your RRSP within 15 years.

As a newcomer, if you plan to buy your first home in Canada, the Home Buyer’s Plan is a great way to fully or partially fund your down payment. You can even use the HBP to put down a larger down payment and reduce your mortgage amount.

You may qualify for the HBP if meet all of the following criteria:

• You’re a first-time home buyer.
• You have a written agreement to buy or build a home for yourself or for a family member with a disability.
• You’re a resident of Canada when you make the withdrawal and when you buy or build the home.
• The home will be your principal residence (or that of the related disabled person) within one year of purchase or construction.
• The funds you intend to withdraw have been in your RRSP for at least 90 days.

When you withdraw funds under the Home Buyer’s Plan, the CRA will send you an HBP Statement of Accounts listing the amount you need to repay the following year. Typically, your repayments will be split equally across the 15-year repayment period, so if you withdraw $35,000 under the HBP, you’ll have to repay $2,333.33 per year. If you pay less than the required amount in a given year, you’ll have to declare the difference as ‘income’ and pay tax on it. 

What is the Lifelong Learning Plan (LLP)?

As a newcomer, the Lifelong Learning Plan may be beneficial if you (or your spouse) plan to pursue further education in Canada.

The LLP allows you to withdraw up to $10,000 per year from your RRSP to fund full-time education or training for yourself, your spouse, or common-law partner. You need to repay the amount you withdraw within 10 years. 

To qualify for the LLP, you must:

• Be a tax resident of Canada.
• Be enrolled or have received an offer to enrol as a full-time student in a qualifying study program at a designated learning institution (DLI) before March next year.

If you become a non-resident of Canada for tax purposes after making an LLP withdrawal, you need to include the remaining LLP balance in your tax return and pay income tax on it.

Note You cannot use the LLP to finance your children’s education. Read our article on Registered Education Savings Plans (RESPs) for more information on saving for your children’s education.

Withdrawing or receiving income from your RRSP at the time of retirement

Note You cannot continue to hold an RRSP account beyond 71 years of age.

When you retire, you can withdraw the funds in your RRSP as a lump sum or in the form of regular income. You can choose to start these withdrawals or payments as early as you want. However, since the withdrawals from your RRSP count as income, you will have to pay taxes on them.

The year you turn 71 years of age, you’ll have the option to withdraw the entire amount and close the account, transfer your RRSP to a Registered Retirement Income Fund (RRIF), or use the funds to purchase an annuity.

Withdrawing funds from your RRSP

You can withdraw funds from your RRSP before or after retirement, until you turn 71 years of age. However, your financial institution is required to withhold tax from your withdrawals and you’ll need to declare the amounts as income on your tax return. 

Registered Retirement Income Fund (RRIF)

Your bank or financial institution can transfer your RRSP assets to a Registered Retirement Income Fund. Once you set up an RRIF, you can no longer contribute to the plan and your RRIF cannot be terminated except in the event of your death.

Receiving income from your RRIF

From the year your RRIF is set up, you will receive a minimum yearly payment from it for your entire life. This minimum amount will be determined by your financial institution, depending on your age, the balance in your RRIF account, and the expected rate of return. You can choose to withdraw more than the minimum required amount.

The income you receive from RRIF is taxable, so you need to declare it in your tax return and pay tax on it each year. Upon the death of an RRIP holder, the remaining amount can be transferred to the RRSP, RRIF, PRPP, or annuity account of an eligible beneficiary.

Using RRSP funds to purchase an annuity

An annuity is a financial product that guarantees an income for a certain term or for life. Depending on the product you choose, you may receive a fixed or variable payment throughout your term, or for the rest of your life. With some types of annuities, you may also have the option to continue your annuity to support your spouse or beneficiary after your death.

Many financial institutions provide the option of transferring your RRSP funds directly to an annuity when or before you turn 71. Your financial institution will not withhold taxes from the RRSP funds being used to purchase an annuity, but you’ll need to pay taxes on the annual income you receive from the annuity.

RRSP versus TFSA: Which is better?

One of the questions newcomers to Canada commonly ask is whether an RRSP is better than a Tax Free Savings Account (TFSA). There are several differences between TFSA and RRSP and each plan has its advantages. However, if you do need to choose between the two, keep the following in mind and select the plan that fits your situation better:

Should you invest in RRSP if you don’t plan to retire in Canada?

If you plan to move abroad or return to your home country before retirement, you can still continue to benefit from the RRSP. You are not required to close your RRSP account if you leave Canada permanently and your savings in the plan can continue to grow. 

However, RRSP withdrawals by non-residents are subject to a 25 per cent non-resident withholding tax. Make sure you calculate the projected return on your RRSP savings and make a decision that works for you.

Investing in an RRSP is a great way to get a head start on your retirement planning in Canada. Not only will your savings continue to grow till the time you turn 71, but the money you put into the RRSP can significantly lower your tax liability throughout your working life. Moreover, RRSP offers you the flexibility of borrowing funds for some major life expenses, such as purchasing a home or continuing your education, making it an investment plan of choice for financially prudent Canadians.