RRSP Basics: Contributions and Withdrawals

The first 60 days of every year is known as RRSP season.  March 1, 2011 is the RRSP deadline when Canadians can make contributions to an RRSP and have it eligible for a tax deduction for the previous year (2010).  Before you make a RRSP contribution, here are some basics you need to know.

What is an RRSP?

The RRSP is a well-known account that has been around since 1957.  RRSP is short for Registered Retirement Savings Plan.  The plan is designed to help individuals save for retirement by giving them two tax benefits.  The first is a tax deduction and the second is tax deferred growth.  With these two benefits, RRSPs remain one of the best ways to save for retirement.

How much can you put into a RRSP?

There are two ways to figure out how much you can contribute to a RRSP.  Let’s start with the harder way. Basically, there is a formula to determining your RRSP contribution limit, which goes like this:

18% of your previous year’s earned income less your previous year’s pension adjustment to an annual maximum.

The easier way to know how much you can contribute to your RRSPs is to look at your Notice of Assessment (NOA).  This is the form you get back from the government once you have filed your return.  It will include any unused RRSP contribution room from the past.  Here’s an article I wrote for more details on determining your RRSP limit.

Are RRSPs a good thing?

There are some situations when you should not buy an RRSP but for the most part, RRSPs do make sense.  The ideal situation for RRSPs is when you can put the money into the RRSP when you are in a higher tax bracket than when you take the money out of the RRSP.  I call this the one formula approach to RRSPs.

What’s the best way to buy RRSPs?

The best way to buy RRSPs is to make it automatic.  Studies have shown that those that contribute to RRSPs regularly whether it is off their paycheques through employer sponsored Group RRSPs or through preauthorized debits from the bank account tend to save more and have more money in RRSPs.  It’s the habit of saving that makes all the difference.

What should you invest in?

This is probably the hardest decision for most people.  There is no shortage of choices.  You can invest in savings accounts, money markets, GICs, mutual funds, stocks, bonds, Exchange Traded Funds (ETFs) and so much more.

How you invest your RRSPs will depend on what stage of investing you are at. When you are first starting out with your first RRSP contribution, you will likely keep it simple.  The more money you have in your RRSPs, the more sophisticated you can get.   Not matter how much you have you might want to know my 5 timeless tips for investing your RRSPs

When should I take money out of the RRSPs?

RRSP stands for Registered Retirement Savings Plan.  Therefore, the ideal situation is to make an RRSP withdrawal when you retire.  When you take the money out of the RRSP, you have to pay tax at your current marginal tax rate.  Taking money out of RRSPs while you are still working full time is not ideal because you are typically in a high tax bracket and you lose that contribution room forever.

How does withholding tax work?

Essentially, the government says that any withdrawals less than $5,000 will be subject to a withholding tax rate of 10 per cent. For example, if you take out $4,000 from your RRSP, you will only get $3,600 because $400 (or 10 per cent) will be sent to the Canada Revenue Agency for taxes withheld at source. If you take out a lump sum between $5,000 and $15,000, you will be subject to 20-per-cent withholding and any withdrawals greater than $15,000 will be subject to 30-per-cent withholding.

The most important point to stress is that the withholding tax rate is not your marginal tax rate. Often people try to minimize withholding tax, thinking that that will be their total tax bill but they get surprised at the end of the year with additional taxes owing.

2011 RRSP Kit

I have just released my special report, 2011 Annual RRSP Kit available to my monthly newsletter subscribers.  If you want a copy, just subscribe to my monthly Bright Ideas Newsletter.

Written by Jim Yih

Jim Yih is a Fee Only Advisor, Best Selling Author, and Financial Speaker on wealth, retirement and personal finance. Currently, Jim specializes in putting Financial Education programs into the workplace. For more information you can follow him on Twitter @JimYih or visit his other websites Retire Happy Blog, Group Benefits Online and Advisor Think Box.

16 Responses to RRSP Basics: Contributions and Withdrawals

  1. Open source portfolio says:

    RRSP are great for people with inconsistent income. If you work contract and you have a year with no income it would be a great time to withdraw from RRSPs since your tax obligations would be minimal.

  2. Gisele says:

    Do you know what the consequences are for overcontributing to an RRSP? I put a lump sum in towards the end of last year but checked my contribution allowance and see that I am way over it. Would it be better to remove the overage and put it into a different account prior to filing/assessment date?

    Thanks!

    • The Ghost says:

      Hi Gisele,

      Overcontributions to an RRSP are generally penalized at a rate of 1% per month on the amount of the overcontribution; however, you are given a $2000 “buffer” by the CRA. Essentially, if you over-contribute by $2000 or less over the course of your lifetime, you will not face any penalties, though you do not get the tax deduction on any over-contribution. If your over-contribution is over $2000, it would be best to take out that amount asap to minimize penalties. Here is a useful CRA link: http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/rrsp-reer/cntrbtng/xcss-eng.html.

  3. This is a really informative post Jim! Investor Education Fund has a RRSP Savings Calculator that is useful in estimating how much your RRSP savings will provide in income once you retire.

  4. Terri Sterner says:

    RRSPs are just about always good. You want to save for retirement and this is a great way. The smaller tax burden means a guaranteed win from that perspective. Furthermore, by not paying the tax right away, you’re letting that money grow and, in essence, have those returns pay the tax burden on the other moneys. It’s a shame that the RRSP limits are so low, though more people don’t hit them anyway.

  5. Virata Gamany says:

    Did you know that you can also use RRSP’s to purchase investment properties either by loaning it to yourself as a 2nd mortgage or investing with a property investment company that has a RRSP eligible program.

  6. Virata Gamany says:

    I don’t think they are always good though. There is no such financial instrument that fits all. At VSM we believe strongly in real estate investments but we certainly don’t think it’s for everyone. Virata Gamany

  7. I was just thinking about learning more on RRSP accounts. Can you tell me if there are penalties for withdrawing early? For US account, you will get a 10% penalty for early withdrawal (unless you meet certain provisions). Do RRSPs have similar penalties?

    Tim

    • The Ghost says:

      Hi Tim,

      Any time you withdraw from RRSP accounts, other than as a result of some very specific circumstances such as those around a marriage dissolution, the amount of the withdrawal is included as part of your taxable income for the year in which the withdrawal is made. In years in which your taxable income is already high, this will obviously be costly. In years in which your taxable income is low, it might be worthwhile.

  8. Virata Gamany says:

    There are definitely penalties though you can find institutions that will lend you the money for a low rate if you place the money with them

  9. artur says:

    I have some credit card debit and was thinking of using my RRSP to pay it off ! would this be a good idea? I make around 58,000 a year credit card is at 9,000 and my rrsps are at 13,000
    thank you

  10. IVY says:

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  11. erkek says:

    I have some credit card debit and was thinking of using my RRSP to pay it off !I make around 88,000 a year credit card is at 19,000 and my rrsps are at 23,000
    thank you

    Reply

  12. james smith says:

    It so nice one.Thanks for sharing.

  13. Paul says:

    If I did not earn any income this year, 2011, and I withdraw $25,000 (lump sum) from my rsp, my witholding tax will be $7,500, but my tax payable on reported taxable income of $25,000 (ontario resident) is approximately $3000. Will I get a refund cheque for the difference from CRA when I file my return? In other words, is it worth while to do this?

  14. Michael Czan says:

    For most first time home buyers, using RRSP’s to buy a home is a great option.

    visit Mississauga Real Estate Professionals for more home ownership incentives
    http://www.mississaugarealestate.pro/home-ownership-incentives

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