Jan. 30, 2013

What are RRSPs and How do They Work?

RRSPs are becoming more and more popular these days, and rightfully so. As fewer companies offer pensions for employees to rely on, an increasing number of Canadians are using RRSPs to help fund their retirement. Moreover, many employers now offer RRSP contribution plans where they will match your RRSP contributions (usually around 3-6% of your paycheque). Are you not sure what Registered Retirement Savings Plans (RRSP) are?

Here are a few pointers for you to help clear the air:

I won't get too in-depth here considering there are so many little quirks, but here are the basics. Before I continue, first things first: If you ever hear people referring to RSPs instead of RRSPs, stop confusing yourself - it's the same thing.

1. Overview: RRSPs are a way to shelter your investments for the longterm to help you save for retirement. Just like a TFSA, you do not pay tax on any money earned from your RRSP investment.

2. Type: Just like TFSAs, you can have an RRSP as a typical savings account, GICs, Mutual Funds, Stocks, etc. Think of RRSPs as an umbrella, and you're simply sheltering your money underneath it from tax. What type of investment you shelter it in is up to you.

3. Tax Benefits: As stated earlier, any money earned from your RRSP investment isn't claimed as income until you withdrawal the funds from your RRSP. This is a big deal, especially if you're building up your RRSP over a long period of time.

4. Tax Benefits Continued: Any money you contribute to your RRSP comes off your income earned for that tax year. In other words, you are lowering your taxable income. This is huge.

For example: If you earned $20,000 in 2012, but contributed $2000 to your RRSP, it is as if you only earned $18,000.

As a result, you save a lot of money when it comes to filing your taxes. Over the longterm, the money you save in your RRSP from not paying taxes will reap rewards in the future.

5. Limits: You can contribute up to 18% of your overall income to your RRSP. Make sure you watch what your employer is matching to ensure you don't go over the limit. However, if you earn more than $125,000 per year, you are capped at contributing $22,970 for the 2012 tax year.

6. Withdrawal of your RRSP: You can withdrawal your RRSPs at any time, however when you do, the money you take out is actually considered income for that year. So be careful, and try to avoid doing this until retirement (or buying your first home - see number 8).

7. Timeframe: You can contribute to your RRSP at any time, however the timeframe is extended for an additional two months each calendar year. In other words, you can contribute to your RRSP for the 2012 tax year in January and February of 2013. This may be beneficial to you if you know you're going to have to pay significant taxes for the 2012 tax year.

8. Buying a home: If you are buying your first home, there is an exemption where you can actually withdrawal your RRSPs tax free. This is called the Home Buyers' Plan (HBP). You then have to recontribute the funds you withdrew over a 15 year time period. 

Hope that helps! If this didn't answer your questions, just leave a comment or head on over to the official Government RRSP page.

1 comment:

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