Registered Retirement Savings Plan (RRSP) or simply Retirement savings Plan, is an account for keeping savings and investment assets, introduced in 1957 in Canada to promote savings for retirement. It is different from other regular accounts because of the tax benefits.
Sometimes RRSP is perceived as an investment, but it is not. Simply put it is an account that holds other investments, it is just like a regular brokerage account, you contribute to the RRSP account when you buy investments in it. Obviously, it is registered with the federal government in Canada; can hold many investment types; tax benefits for regular investment accounts; and it is recognized as a trust.
HOW IT WORKS
First you have to be eligible to be able to participate, this means any working age Canadian qualifies, or if you are currently working in Canada under the age of 69, you have room for contribution, and have your income tax filed to the Canadian government.
The tax benefits an RRSP gives is the key motivation for contributing to the account. The Canadian government is trying to ensure Canadians make provisions for themselves for life after working, which is partly because of federal government incorporated cost in financing poorly planned retirement. There are two forms in which participators receive tax benefits which are tax deferred growth and tax credits.
Tax Deferred Growth
Profits made within the RRSP account in any form whether it is interest, capital gains or dividends are not going to be taxed immediately as income. RRSP account holders would still pay tax on the profits earned but not until the funds are withdrawn.
This is the second tax benefit you get from this plan. It simply stating that you are taxed on what is left after contributing. Though contributions have limits.
How to Contribute
The government in Canada limits the amount of contribution due to the tax benefits this account gets. The Canadian government allows people contribute 18% of their annual salary or $22,000 whichever is less, to their RRSPs.
RRSP contributions can also be used to reduce the amount of combine tax a couple pays to the government. This is when you make RRSP contributions for yourself and your spouse, it is more effective when both spouses are in different tax brackets (large income margin). These contributions cannot exceed each person’s personal limit, although the government has granted everyone a $2000 room for over-contribution during their life time without penalty.
Registered Retirement Savings Plan changes with different government policy. Of recent these changes have increased the amount people can contribute annually. You can take money out of RRSP at any time but it of your best interest that you shouldn’t because the penalties are harsh, and expensive due to withholding tax. Unused contributions are normally carried into the next years which increases future deduction limits. Unlike Tax Free Savings Account (TFSA) you cannot recontribute any money taken out of the account prior to your retirement.