I have had discussions with a number of people where it became evident that there is some confusion about what an RRSP or a RRIF is or is not. As a result I am going to take a stab at explaining the fundamentals of these financial instruments. Many seem to think its an investment. It’s not an investment.
RSP – (Retirement Savings Plan)
Let’s tackle this in two parts. RSP or Retirement Savings Plan defines a program for retirement saving. You can have numerous plans. What you put into the Retirement Savings Plan can be almost anything that can be set aside for use as a source of income during your retirement years. It can be your home; Condo, cottage; stocks, bonds, jewellery, art, mutual funds, segregated funds, antiques etc.
RRSP – REGISTERED Retirement Savings Plan
In 1957 the Canadian Government introduced a tax incentive program for Canadian residents, who had no access to pension plans through work, to save on their own for retirement and they labelled it a Registered Retirement Savings Plan, or RRSP. Many of the same assets you use in an RSP may be put inside an RRSP. The effect on Canadians that set up and make contribution to an RRSP are:
- Taxes on earned income, i.e., income from employment or self-employment to the extent contributed to the plan, are deferred until the eventual withdrawals from the RRSP plan. Taxes are deferred through a deduction claimed in calculating taxable income, i.e., amounts contributed are not subject to income tax in the year they are contributed.
- Income earned inside the plan is not taxed while within the plan.
- The contributor’s marginal tax rate when withdrawing funds may be higher (or lower) than the tax rate the contributor paid when making the original contribution.
- Canada has a variety of programs available to retired people whose benefits decrease as their income increases. By deferring the income until retirement, the additional income created at that time may reduce those benefits. Advanced planning is important.
RRSP programs have a statutory limit on the amount you can contribute annually. RRSP legislation is managed by Canada Revenue Agency and there are specific rules that issuers of RRSP programs must comply with, in regards to the handling of such registered funds. Institutions that typically offer RSPs that qualify as RRSPs are banks, trust companies, credit unions, and life insurance companies.
The annual contribution limit is the lesser 18% of your earned income and a flat dollar amount as shown below.
|Year||Contribution Limit||Year||Contribution Limit|
You can have as many RRSP plans from as many financial institutions as you please. Revenue Canada Agency only tracks the aggregate of all the plans you own and considers this aggregate total as one RRSP program and as such the maximum in total in any given year from all RRSP plans cannot exceed the prescribed maximum for the year. There are sizeable penalties for over contributions.
What you categorize as retirement savings and how much of your total goal is allocated to each type of asset in your retirement savings plan (RSP) or RRSP usually becomes a joint venture exercise with you financial advisor.
The easiest way to differentiate between RSP and RRSP is to consider an RRSP as a Box into which you can place certain RSP assets. The RRSP box creates benefits and restrictions. The benefits are the tax advantages afforded on assets in the Box. The restrictions are the limitations on what can go into the box and the amount you can place in the box annually and lastly the restrictions and tax consequences at the time you withdraw funds.
RIF and RRIF
RIF (Retirement Income Funds) is the label attached to funds that are used from your RSP for income purposes upon retirement. Similarly, RRIF is the income generating phase of an RRSP which was the savings phase. One hundred per cent of money coming out of an RRIF is currently taxable at a rate equal to earned income from employment or self-employment. While there is no annual maximum, there is an annual minimum that you must take in total from all your RRIF plans.
Self-Directed RRSP or RRIF Plans
Each issuer of and RRSP or RRIF plan has a basket of investments they offer to be placed into a RRIF or RRSP but not necessarily all that may be utilized for such purpose. Self directed programs are offered by what are called a “third party administrator” who merely administer on your behalf, for a fee, RRSP/RRIF plans from multiple financial institutions reducing the paperwork to one statement and one set of transaction documentation.
An RRSP or RRIF is NOT an Investment but a notional BOX created by the Canadian Federal government for Canadian residents to place earned income into the box tax deferred. Funds in the box may be invested into a large selection of investible assets. Further, any income on those assets that might otherwise attract tax is also deferred. You can set up an RRSP from numerous institutions so long as the total contributions you make do not exceed the annual limit.
Withdrawals or Income coming from either plan (RRSP RRIF) is considered interest income (similar taxable rate to earned income). The maximum age contributions to a RRSP (savings phase) is age 71 at which point the RRSP automatically has to be converted to a RRIF (the income phase) and a prescribed minimum annual amount must be taken. Payments may be annually, quarterly or monthly. Any amount left unused upon death may be transferred to a surviving spouse, tax deferred, otherwise there is a deemed disposition for tax purposes and tax must be paid on the entire lump sum value of the remainder RRSP/RRIF. The after tax remainder may be gifted to any beneficiary of the owner’s choice.
Is an RSP program for everyone? Certainly! (Unless have or plan to inherit sufficient wealth) Is an RRSP for everyone? That analysis is beyond the scope of this post. You need to speak to your financial adviser to get a proper answer that speaks to your circumstance. ~