A registered retirement savings plan (RRSP) is a smart way to invest money. Anyone with qualifying income (which includes salary, wages, alimony and rental income) may contribute to an RRSP and may also select the type of investment. The federal government allows an individual to contribute up to 18% of the previous year’s income (with a dollar ceiling) to an RRSP eligible investment, which is tax-sheltered until the money is withdrawn. Contributions are tax-deductible. Withdrawals are generally treated as taxable income.

People often delay making their RRSP contributions until the last moment (February of the following tax year). However, saving one’s pay in an RRSP as the money is earned is not only good investment discipline, but it also accomplishes the following two money-saving tasks:

  1. It shelters the money from tax (whereas, if the money were parked in another investment, tax would have to be paid on the interest).
  2. It makes your money grow faster by taking advantage of the concept of compound savings.

In using an early/continuous investment strategy, it’s also possible to reduce the tax, which is automatically deducted from your paycheque.

If you have not had an RRSP before, the following guidelines may help you.

  • You can open an RRSP with almost any financial institution. Each sells many different kinds of plans, which include daily interest accounts, guaranteed investment certificates (GICs), certain securities, mutual funds and mortgage funds. The government provides a list of qualified investments.
  • A guaranteed plan guarantees a fixed interest rate for a specified time period. The time period may be as short as 30 days or as long as five years.
  • Many people are investing in mutual funds. Although most mutual funds are not guaranteed, these funds have the potential to provide higher long-term investment growth than guaranteed plans. Mutual funds that are balanced funds (that is, they invest in stocks, bonds and treasury bills) have less volatile rates of return than those that invest in, for example, only stocks or foreign equity.
  • If there is a possibility that you may need the money later in the year, you should consider holding enough money in investment products that allow you to take the money out on a few weeks or days notice (such as a money market fund).
  • If you wish to trade securities yourself, such as stocks or bonds, you may open a self-directed RRSP. Self-directed RRSPs have administration fees that are not tax-deductible.
  • Canada Revenue Agency also allows you to have a Canada Savings Bond (CSB-RRSP).
  • In certain circumstances, you are now allowed to hold gold (bars, coins and so on) in your RRSP.

Carry Forward

It makes sense to take advantage of every opportunity to invest money in an RRSP due to its tax-sheltering advantage. Since the 1991 tax year, Canadians are allowed to “carry forward” unused RRSP contributions. If you have not contributed to your RRSP up to the maximum limits allowed in any of the years since 1991, you may carry forward these amounts that constitute your “unused” RRSP contributions up to age 71. Generally, taxpayers, in a high marginal tax bracket, should maximize their RRSP annual deduction limit.

Consider making additional contributions to use up any previous carry forward room. One strategy is to divide this amount by the number of years to retirement. Then, try to save that amount each year (on top of your annual limit), so you can maximize your contributions by retirement.

If in any year you maximize your current year’s RRSP contribution and make an additional contribution for a previous year’s unused contribution, you may deduct the full amount that you contributed from your taxable income. By putting a plan in place to use up your carry forward room, you are able to capitalize on the greatest advantage of an RRSP, which is the compounding effect of the tax-sheltered income.

You can also carry forward your deduction. Depending on your marginal tax rate, if you make a large contribution in any one year,  it may not make sense to deduct all of it in that year. Evaluate if you’d be better off to carry forward the unused deduction to a future year. 

How Does an RRSP Work?

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