Today I want to talk about something that confuses a lot of people: the registered retirement savings plan or RRSP.  The RRSP is a quintessentially Canadian retirement-savings tool that was introduced by the Liberal government in 1957.  Some of you may be asking why I am talking about RRSPs literally days before the end of the RRSP “season”.  There are two reasons.  The first is that it’s bad practice to pay attention to RRSP seasons because you’ll get better return for your dollar, save money and have less stress in your life if you’re contributing year-round because of dollar-cost averaging.  Secondly, I want to make sure you take the time to understand the RRSP instead of quickly skimming this and then making hasty decisions.

Ok, on to the good stuff.  RRSPs are accounts that are registered with the Canadian federal government.  That means the Canada Revenue Agency knows how much you’ve put in and how much you’ve taken out before you even tell them.  You can store all sorts of things in these accounts including cash, stocks in public companies, bonds, mutual funds, your mortgage (yes!), really there are piles of options.  Notice that RRSPs are not mutual funds, they can hold mutual funds.  A lot of people miss this distinction and it’s sad because they’re missing the point of an RRSP: tax deferral.  The basic thing that makes an RRSP so special is that you don’t pay income tax on the money you put into it or the interest you earn until you take it out.  This means an RRSP will lower your taxes NOW!  Here’s a quick example:

Alice and Bob both make $45,000 one year. Alice leaves$2000 in her bank account at the end of the year for savings.  Bob puts the $2000 in cash within an RRSP. Both of them will earn almost no interest because cash accounts pay almost nothing. Alice pays$7471 in income tax at the end of the year.  Bob pays $6848. How did Bob save$623 in taxes?  Well, to the Canada Revenue Agency, Bob only made $43,000 this year because he dumped$2000 into an RRSP. That’s the tax deferral part.  Bob didn’t have to pay any tax on the money he put into the RRSP.  It won’t grow much, mind you, because he left it in cash.

### Then your money grows tax-free

Alice and Bob both decide they will buy a GIC that has a rare-as-a-unicorn interest rate of 5% (what a great find!).  After 10 years, Bob’s money is worth $3258 because it grew without any income tax. Alice’s money is only worth$2806. What the heck, Alice?  Oh… she had to pay income tax every single year on her 5%, making her interest rate actually 3.44%.  If this doesn’t make sense to you, check out my post on net worth. So far Bob’s paid no tax on his savings, and Alice is left crying in the corner.

### Spousal RRSPs

If you’re married and you make more money than your spouse, you can contribute to their RRSP.  The idea here is that you get the immediate tax deduction but they are the ones taxed when the money gets withdrawn down the road.  This facilitates a form of income splitting.

### Wrap-up

As you’re probably guessing, someone who knows what they’re talking about could pretty much talk about RRSPs forever.  There are endless permutations and combinations of possibilities that the RRSP allows to minimize your income taxes.  That’s why you should familiarize yourself with them early on in life.  Plan to pay less tax!  Let’s wrap up with some bullet-point characteristics of the RRSP:

1. RRSPs are a container for an investment, they are not themselves an investment
2. RRSPs do not have an inherent interest rate
3. It’s difficult to predict how someone’s RRSP affects their net worth or future income since the investments are taxable when withdrawn
4. Money you put in an RRSP is money you haven’t yet paid tax on
5. You can only put so much into an RRSP in a given year.  What you can contribute is tied to your income and is inflation-capped.
6. If you don’t contribute the maximum to your RRSP in a given year, you can carry forward that contribution room into the future.

Like I said earlier, I hope to write about the TFSA (Tax-Free Savings Account) in the future.  For now, start saving!