An RRSP (Registered Retirement Savings Plan) is an investment option that helps you save for retirement by growing your money and sheltering it from taxes.
RRSPs come with four great tax benefits that make them well-suited for retirement savings.
1. RRSP contributions are tax-deductible
For every dollar that you place in an RRSP, you can take a deduction against that year’s income. This means that if you make $65,000 this year but add $10,000 to your RRSP throughout the year, you'll be taxed as if your income was $55,000.
Your RRSP contribution limit is also determined by your income – that’s why it varies from person to person.
Check the federal government’s RRSP contribution guidelines for details.
2. RRSP earnings and growth are sheltered from taxes
When you invest money in an RRSP all earnings are tax-sheltered. You don’t pay tax on them, just as you don’t pay tax on the money you contribute. As you add investments to your RRSP and grow your savings, you can take comfort in knowing that you won’t have to claim it as income on your taxes.
However, sheltering your RRSP from taxes doesn’t last forever, because you will pay tax on your RRSP funds when you withdraw the funds (we’ll explore that below). That’s why some people prefer the term “tax-deferred” to tax-sheltered.
3. RRSPs allow for tax-efficient reinvestment and compounding
Let’s review: You don’t pay taxes on the funds you contribute to your RRSP and you don’t pay tax on the income generated by your RRSP. So when you reinvest the income you’ve earned from your RRSP, you’ll earn income on your initial investment + the income you’ve previously earned. This is called compound interest.
For example, if you invested $10,000 at a 5% interest rate, your earnings at the end of the year would be $500. Then, when you reinvest that $500 you’ll be earning 5% on $10,500, giving you higher earnings the next year ($525). And so on, and so on. Bonus: All this will stay sheltered from taxes in your RRSP.
4. RRSPs allow you to defer tax until withdrawal
When you eventually withdraw funds from your RRSP, you will have to pay tax on them – but there’s a hidden benefit to this. Since most people wait until retirement to withdraw from their RRSP, their income (and therefore their tax rate) will be lower.
The ideal situation is to contribute to your RRSP when you’re earning more income and withdraw from it when you’re earning less. This is why it can make sense to opt for a TFSA when you’re young and just starting your career and then shift to RRSP contributions later.
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Learn more about investing
- Choosing between an RRSP and TFSA
- Minimize your taxes with a spousal RRSP
- What is an RRIF and how do you use it?
A version of this article was originally published on January 4, 2022.
