What is an RRSP and Why Do I Need One?

The RRSP deadline is coming up on March 1st; here is everything you need to know!

What is an RRSP, really?

RRSP stands for 'Registered Retirement Savings Plan' (...😴).

You can save on taxes and keep more money in your pocket by putting your investments inside an RRSP account (💸💸💸).

You can think of an RRSP as a place to hold your investments - the most common investments are:

1. Cash

2. Bonds (also known as Fixed-income)

3. Equity (investments in companies that participate in the stock market).

The difference between a regular investment account and an RRSP investment account is how you are taxed on the money that is invested.

Why Should I Invest, anyways?

The earlier you contribute to your retirement, the more likely you're going to meet your retirement goals. Especially if you are a woman. Most women will earn less money during their lifetimes, but if you start investing early, you can make your money work for you.

We'll illustrate this with an example, in a perfect world where your money earns 6.1% each and every year:

Investing $100 at 25, leads to $1000 at 65. BUT, investing that same $100 at 45, leads to only $300 at 65. That is roughly a third of the money than if you had started earlier.

*In real life, your returns will fluctuate every year.

Why should I open an RRSP?

A benefit of RRSPs is that you don't get taxed on your contributions until you take them out when you're retired.

With a regular investment account - you put money in that you've already paid taxes on. And when you earn dividend income you pay taxes on those dividend earnings. And when you sell your investments for a profit, you pay taxes on your profits (this type of tax is called Capital Gains tax). Regular investment accounts are often called Non-Registered Accounts.

With an RRSP investment account - you technically are using money that the government hasn't taxed you on (that's why they give you a refund - they're giving you back the taxes that you paid on the money you're using to invest). As your money grows inside an RRSP account, your dividends and capital gains are not taxed, and you accelerate your retirement savings.

This is really important because nobody seems to tell us just how expensive a retirement is -- it's SUPER expensive, so the earlier we start, the better!

One more important thing about RRSPs: remember when you got your taxes back as a refund? Well, it's actually because the government makes you pay those taxes later. When you tax money out of your RRSPs, you will need to pay tax on that money. Most people pay less taxes in retirement because they have less income...

(retirement income is a combination of: the money you take out of your RRSP + your CPP (Canadian Pension Plan) + your OAS (Old Age Security) + perhaps GIS (Guaranteed Income Supplement) + potentially your pension),

...so you are often in a lower tax bracket, and it saves you money 💰.

Let's look at an example:

Let's say that you want to invest $10,000 into your RRSP. On your income you pay a tax rate of 29%. When you invest the $10,000 into your RRSP, you will receive $2,900 back on your tax return, which is the tax that you paid when you earned the $10,000. However, when you take the $10,000 (which has hopefully grown over time, but for this example we'll pretend it stayed the same), out of your RRSP, you will need to pay taxes on that money. Since you are likely to have a lower income in retirement, you will hopefully pay closer to 20% tax on the money.

When is the last day I can contribute to my RRSP?

You have less than a month to contribute to your RRSP for the 2020 tax year.

The Deadline for RRSP contributions is March 1st. (This is the government giving you a little extra wiggle room to contribute before you do your 2020 taxes!).

What's the difference between an RRSP and a TFSA?

We’ll take a closer look at TFSAs in the coming weeks, for now here are some major differences:

A TFSA (Tax Free Savings Account) is another place where you can hold your investments, but it has different rules than an RRSP account.

As the name suggests, once your money has been put into a TFSA you will not be taxed on any money you pull out of it (it doesn’t count as income). The same is not true for your RRSP. Any money you pull out of your RRSP now, or in retirement, will count as if it’s income, and it will be taxed at your marginal tax rate.

If you earn less than $50,000 you will likely want to prioritize investing in a TFSA. This is because at that income level your marginal tax rate is similar or could be lower than what you’ll pay in retirement. If you invest in an RRSP first, this could mean you don’t obtain the full value of what an RRSP has to offer (but don’t worry, there are still tax-advantages that help your money grow inside an RRSP). RRSPs are the most advantageous when you are currently in a higher tax bracket and retire into a lower tax bracket as you scale back on your income. If you make less than $50,000, Untangle Money recommends filling up your TFSA first, then investing in your RRSP.

A TFSA could be a better place to save money that you may need in the medium term, because there is no penalty for taking money out of your account (you may have some administrative fees). One thing to note as life gets more expensive, and if you identify as a woman, it makes sense to keep the money you invested in your TFSA for your retirement if possible. Retirement is usually more expensive than anyone tells you, and as a woman, because of how our financial lives play out, it can be challenging to catch up later in life.

Who can open an RRSP?

There is no minimum age requirement to open an RRSP unlike a TFSA (minimum age is 18 years old). So long as you are a Canadian Resident for tax purposes, and you have employment income and a filed tax return, you can set up and contribute to an RRSP.

A rule of thumb is that you should also be earning over $50,000. If you make less than $50,000, Untangle Money recommends filling up your TFSA first, then investing in your RRSP.

Where can I open an RRSP?

There are a lot of different institutions where you can open an RRSP. These include, online (i.e. robo advisors like Wealthsimple or Questrade); Credit unions (i.e. Meridian); Life insurance companies, traditional banks (BMO, Scotiabank, TD, Royal, CIBC and National), and trust companies. Each of these have their own benefits - its best to do your research to figure out which one suits your needs best.

At Untangle Money we have a strong preference for robo-advisors, and credit unions.

I've opened an RRSP - now what?

Sometimes you need to fund your account after you open it. Make sure you don’t contribute more than you’re allowed to for the year. You can go to 'My Account' on the Canada Revenue Agency Website to find out how much contribution room you have.

Setting up ‘My Account’ can take some time to set up if you haven’t already, so start now if you don’t have access. It’s important to note that your contribution limit can change on a year-to-year basis.

CAUTION: If you contribute through your company’s employee plan, those numbers might not be reflected in your My Account yet, so you’ll need to ask your HR team how much has been contributed on your behalf this year.

What should I invest my RRSP in?

There are lots of options for you! One reason we like robo-advisors at Untangle Money, is that most of them have preselected diversified portfolios that can help you if you’re feeling stuck, and get you started with investing. There are literally thousands of financial products to choose from. With robo-advisors, you don’t pay much for the ability to have different types of financial products in your portfolio (which is good for risk and returns), and these portfolios have actually been shown to do better over the long run than most human advisors and most mutual funds.

You can hold many different types of assets, including:

• Cash (we don’t recommend leaving cash uninvested for long - get that money working for you),

• GICs (Guaranteed Investment Certificates),

• Treasury Bills (T-Bills),

• Bonds,

• ETFs,

• Mutual Funds (we would hesitate before investing in mutual funds at Untangle Money, they tend to have high fees and could be paying your advisor more than you are earning),

• Individual stocks (we also don’t recommend - unless you’ve educated yourself on the firm and can afford to lose that money),

• Other less common things you can hold within your RRSP are: gold and silver bars, mortgage-backed securities, Canadian mortgages and income trusts,

• And, Savings bonds (no longer sold).

You can’t hold any other precious metals, personal property or commodity futures contracts.

What's next?

Purchase our MINI for a better understanding of your retirement picture, and to see how RRSPs can make difference for your future!

At Untangle Money we help women understand their (real!) financial picture, and obtain financial guidance from people that actually, really, get it. We would love to help you, too. Join the community of hundreds of other women looking to strengthen their financial well-being. Get in touch here for a free consultation.

Stay tuned for more!