Want to save your investments and savings from high taxes and grow them consistently to secure your post-retirement life?
Here, we’re talking about a post-retirement life that lets you travel comfortably, go on vacations to exotic destinations, spend quality time with family and friends, and tick all your bucket list wishes.
If you’re a Canadian citizen, you can do that by opening RRSP and RRIF accounts. RRSP and RRIF are common ways to grow investment income tax-free.
In this article, we’ll discover what they are and how they work. Keep reading to find out!
What is RRSP?
Registered retirement saving plan (RRSP) enables Canadians to defer taxes and grow their investments. If you open an RRSP account, you may contribute a certain % of your annual income that will ultimately reduce the tax obligation.
Therefore, tax-free contributions provide you with tax relief in a specific year. Best of all, your savings in the RRSP account grow tax-free at a compounded rate in the long term.
What’s more interesting is that there will be no tax on the RRSP investment amount until you withdraw. Furthermore, the marginal tax rate is lower for Canadians during retirement than the contributing years, possibly because they shift to the low tax brackets by then due to low earnings.
As a result, the amount you withdraw during retirement will be subject to a lower tax rate. So, simply put, you not only defer your tax obligations, but you may also benefit from a low tax rate in the future. Isn’t that great?
Let’s now look at some crucial traits of RRSP accounts.
Key Characteristics of RRSP
Let’s start with eligibility. To open an RRSP account, you must file an income tax return and earn income to contribute.
Secondly, there’s a contribution limit in RRSP accounts. You can contribute the lower of either:
- 18% of your previous year’s taxable income, or
- Maximum contribution allowed in a tax year.
What’s more? An RRSP account can be opened in mutual funds, investment companies, banks, credit unions, and trust organizations. Plus, there’s a pool of investment vehicles, including gold, cash, ETFs, bonds, and saving deposits that you can hold in RRSP. However, there are some prohibited investments as well, including metals, future commodity contracts, and real estate.
Additionally, RRSPs can be of several types. Let’s take a look at them.
Types of RRSP
Following are the three types of RRSP:
Individual RRSP account is registered in your name, and all the investment belongs to you. You can either manage the investment through a self-directed RRSP option or go with an advisor. A self-directed RRSP lets you manage the investment decisions yourself.
Spousal RRSP is registered in the name of your spouse or common-law partner. They own all the investments, but you’re allowed to contribute to the account. Even though you get the tax deduction, your contribution limit for the year reduces as well. The best part about spousal RRSPs is that the combined income tax you pay as a couple will be lower than what you would have paid if it was for individual RRSPs.
An employer can also create group RRSPs to help employees save for retirement. You establish an individual Registered Retirement Savings Plan account, but the contributions to it are made through your employer. Moreover, all the employees’ RRSPs accounts are kept at the same financial institutions.
What is RRIF?
You’ll need to use the amount you’re contributing to RRSP someday or the other. Isn’t that right? This is where Registered Retirement Income Funds (RRIF) come in. By the time you turn 71, you must transfer your RRSP funds into special RRIF accounts.
These special accounts let you withdraw a specific minimum amount from the retirement fund you accumulated for years in your RRSP accounts. In simpler terms, RRIFs are precisely the reverse of RRSP. Ideally, an RRIF account is opened when you transfer the investment to RRSP.
You can open this account anytime, but not later than the end of the year you turn 71. Now, let’s find out how the withdrawal works.
How does RRIF withdrawal work?
Every RRIF account has a minimum withdrawal limit set by the federal government. This limit increases as you get older. For instance, the limit starts at 5.98%, but it’ll climb to 20% when you reach the age of 95. These limits are set to allow seniors to grow their investments in RRIF tax-free.
The limits are usually based on the account’s value. However, If your spouse is younger than you, you can use their age to calculate the minimum amount. The lower the age, the lower the minimum limit, as well as the income tax.
The best part is that you have complete flexibility in terms of withdrawal periods. For example, you can withdraw monthly, quarterly, semi-annually, or annually.
But here’s a catch: these withdrawal amounts are fully taxable. Plus, you can always withdraw over the minimum limit, but there will be tax complications. If you do go over the limit, you’ll have to pay the withholding tax on the excess amount.
Can I Convert RRIF back to RRSP?
Yes and no!
Once you create an RRIF, you can’t contribute, and the plan continues until you die. You can convert it to RRSP if your age is less than 71. After 71, if you still wish to save, you can contribute to your spouse’s account, provided they are younger than 71.
Additionally, you have got another option, i.e., Tax-free savings accounts (TFSAs). In case you didn’t touch the withdrawal limit of your RRIF income, you can contribute the difference in a TFSA. The notable benefits of TFSA are that your investments will not only grow tax-free, but you can also withdraw money without paying income tax. Isn’t that what you want?
Plan Your Retirement the Right Way
If you want to have an easy and enjoyable post-retirement life, you must start planning for it today. However, with so many saving options out there, it can get difficult to choose an appropriate one. If you’re looking to learn more tax planning tips, head over to the site “Get Smarter About Money,” which shares informative content.
Oh, and if you want to maximize your RRSP returns and gain exciting tax benefits, RealAlt® Investments – an RRSP and TFSA-eligible fund – helps you just do that.
Get in touch with us today!
Frequently Asked Questions
What happens to RRSP when you die?
The entire fund in the RRSP account is transferred to your spouse or common-law partner in case you pass away.
Can funds from RRSP be withdrawn?
Yes, you can, but it’ll be taxed.
However, you can withdraw a $35,000 down payment for your first home purchase. Similarly, you may withdraw $20,000 to pay for the education expenses. These amounts can be tax-free if you return them to the account within a specific timeframe.
How much RRSP should I contribute?
You can contribute the lower of:
- 18% of your previous year’s income, or
- Max contribution specified in the year.
What are the distribution rules in RRSP?
In case you pass away, your spouse or common-law partner is the main beneficiary. However, in the case of spousal RRSP, the income will be split more evenly during retirement.
What is RRIF withholding tax?
If you withdraw RRIF income exceeding the minimum limit, you’ll have to pay a withholding tax on the excess amount. This could vary according to the amount withdrawn.