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The turning over of the calendar means it will soon be time to start doing your income taxes. That also means the deadline, March 1, 2022, to contribute to your RRSPs is coming up for the 2021 tax year. You may start to see ads online and on TV reminding you that the time to invest in your RRSPs for the 2021 tax year is running out. Lots of Canadians have RRSP accounts, but that doesn’t mean they know how they work. Full disclosure, when I opened my first RRSP account 20 years ago I had no idea how they worked and the education I received from my financial adviser at the time wasn’t the best.
During this time of year many of the ads you’ll see promoting RRSPs will say something like, “be sure to get some RRSPs before the deadline!” This way of marketing has led to some confusion around what RRSPs are and how they work. You can’t buy an RRSP because it’s not a tangible investment product. RRSP, which stands for Registered Retirement Savings Plan, is a trust account that you can purchase investments through. You place your money inside an RRSP and then buy the investment. When an ad tells you it’s time to buy some RRSPs, what they really mean is that it’s time to buy investments inside your RRSP. This could be one of many different types of investments including mutual funds, exchange-traded funds, stocks, and bonds.
It’s important what you’re purchasing investments to hold in your RRSP that you know what types of investment you are actually purchasing. More full disclosure- when I first opened my RRSP account 20 years ago my adviser sold me mutual funds. At the time I did not know I was purchasing mutual funds, nor did I understand what I was investing in with these funds. I thought I was purchasing RRSPs.
Now that you have a better understanding of what exactly an RRSP is, what are the benefits of using one? As the name suggests, you purchase investments in an RRSP to save for retirement. How much you can contribute to an RRSP annually is determined by your income. This amount can be found on your annual income tax assessment. Any unused amount can be carried over to future years.
By using an RRSP you receive two tax benefits – a tax deduction for the amount deposited into an RRSP and tax deferred growth on investments made in an RRSP.
Investments held in an RRSP grow tax deferred. This means any profits made on these investments are not immediately taxable as income. Since this tax is deferred it will need to be paid when funds are withdrawn at retirement. Since most people have a lower income during retirement, this tax burden may be less.
The other benefit is a tax deduction. Your annual taxable income is reduced by the amount you contribute up to a certain amount. For example, let’s say your taxable income for 2021 was $50,000 and you made $5,000 in RRSP contributions. This would reduce your taxable income to $45,000 and could potentially set you up for an income tax refund. Although you get a tax deduction when you contribute to an RRSP, it is treated as income when you withdraw the contribution upon retirement.