Retire Rich: Smart Strategies for Maximizing Your RRSP Investments
Nov 26, 2023
Written by: John McDowell
Registered Retirement Savings Plans are a great way for Canadian citizens to build a retirement by avoiding taxes. Having an effective retirement plan is an important consideration in any holistic investing strategy. If you haven't considered an RRSP, we hope this guide will help you make an informed decision regarding your long-term future.
This blog post explores smart strategies for maximizing your RRSP investments, focusing on RRSP benefits, contribution tactics, investment options, and tax-saving retirement planning.
What Is a Registered Retirement Savings Plan (RRSP)?
Registered Retirement Savings Plans allow Canadian workers an opportunity to save for retirement through tax-free investment savings accounts. The purpose of an RRSP is similar to a 401(k) plan in the US, offering workers a vehicle for savings without a tax burden so long as the funds are not withdrawn early.
According to RBC Royal Bank, eligibility for an RRSP depends on a few things:
Be a Canadian resident with a Social Insurance Number (SIN).
Have earned income.
File a tax return in Canada.
Contribute to your RRSP no later than December 31 of the year you turn 71.
Contribution Limits and Deadlines
There are several rules associated with RRSPs that Canadians must carefully consider before investing and saving. RRSPs are managed by the Canadian government and guided by the Canada Revenue Agency. This agency sets and adjusts the rules, limits, timing, and allowances for contributions, taxes, and withdrawals each year.
As of 2023, the maximum contribution toward your RRSP is limited to 18% of your previous year's income or the fixed contribution limit of $30,780.
Excess Contributions: By going over your limit by $2,000 or less, the Canadian Revenue Agency (CRA) will allow you to keep the money in your RRSP without penalty. However, go over that limit and you'll pay tax for the excess at a rate of 1%
Pension Plan Contributions: If you contributed to an employer-sponsored pension plan during the prior year, your contribution limit will automatically be lowered by the CRA.
Unused Contribution Rollover: If you haven't contributed the maximum amount to your RRSP in prior years, you'll be allowed to "rollover" the unused contribution in the current year. The amount will be calculated in your notice of assessment from the CRA. This carries forward to any future year, so long as you have not already turned 71.
Concerning deadlines, contributions can be made up to 60 days after the end of the year. For example, March 1st of 2023 was the deadline for contributions to 2022, and so on.
The Benefits of RRSPs
Tax Benefits of Contributing to an RRSP
While investing in an RRSP is no guarantee that your money will grow (this depends on the underlying investments and their performance) you can at least take comfort knowing your RRSP can compound without a tax burden -- so long as the funds are not withdrawn.
There are at least two advantages of having an RRSP. One is that you'll be able to deduct your contributions to the retirement account from your income up to your contribution limit. Secondly, the money grows tax-deferred until your retirement. By then, you'll likely be able to benefit from a lower tax bracket.
The idea behind the RRSP is to encourage self-planning for retirement to lessen the burden of the Canadian Pension Plan to fund retirement for its citizens.
Tax Sheltered Growth
Compound interest is a boon for any investor. As you contribute regularly to your RRSP, you'll benefit from compounding interest. As the initial investment grows, the rate of return grows faster over time because the balance in your account is growing from your contributions (and hopefully from the underlying investment performance).
The benefit is multiplied by the lack of taxes on the account as well. Keeping the account "sheltered" from taxes until your retirement withdrawals allows you to compound at a faster rate, while also enjoying the deductions from your current income. In fact, you can even claim RRSP contributions in different years than they are made. For example, if you expect to earn a higher income in a subsequent year, you may hold off on claiming the contribution until then, knowing you'll be paying a higher tax rate for the upcoming year.
Spousal Income Splitting Advantages
There are also advantages for couples looking to invest for retirement. In such cases where one partner earns more than the other, one advantage lies in the ability to "income split." For this advantage, the partner with the higher income can contribute in the name of the spouse with lower income and receive the tax deduction for themselves.
Tax advantages for married couples allow for the couple to balance their income together and effectively lessen their overall tax burden. After all, who wants to pay more taxes than they have to?
Home Buyers' Plan (HBP) and Lifelong Learning Plans (LLP)
Want to withdraw your RRSP early to buy a house or go back to school? There's an app for that. Just kidding, well maybe not. But you can definitely do this.
If you've saved and contributed to your RRSP but need to buy a home or go back to school, there are two programs that allow pre-retirement withdrawals without paying taxes for this.
The Home Buyers Plan empowers first-time home buyers to withdraw funds to put a down payment on a home. However, there is a limit of $35,000 that can be withdrawn without paying taxes. There is also a pay-back period of 15 years. That being said, it's a great way to "borrow" money tax-free from your own retirement account.
The Lifelong Learning Plan is the other program that allows you to borrow up to $20,000 of your RRSP tax-free (per year). However, like the HBP, you must pay this back, and you have 10 years to do it with the LLP.
Maximizing RRSP Contributions
Calculating your contribution room has been made easy by the Canadian Revenue Agency, which includes this information on your yearly notice of assessment. That being said, there are a few tips and tricks for maximizing your contributions. Let’s take a look at how to do this.
Strategies to Maximize Contributions
Contributing earlier in the year: While most wait to the last minute to make their contribution at year’s end, contributing early can actually maximize your compounding over time? How? Very simply, the earlier you contribute, the faster your money will grow.
Making regular contributions: The simplest way to maximize contributions is to by consistent. Keep the goal in mind if you plan to retire. Contribute even when it hurts — or better yet, exercise a little delayed gratification.
Catch-up contributions: When you fall behind on your regular contribution schedule, make sure you catch up. The great thing about an RRSP is that there is no limit to the amount of years you can catch up, until you turn 71.
Splitting with your spouse: No we don’t mean breaking up! We mean splitting your income contribution with the spouse who earns less income. It can help offset your tax burden by depositing your contribution into their RRSP, then claiming the tax benefits.
Set goals and targets: It’s wise to know how much you’ll need for retirement before you get there. Plan ahead each year for inflation. According to RBC Wealth Management, you should have at least $150,000 in assets by the time you retire for every $10,000 in pre-tax retirement income.
Common RRSP Contribution Mistakes to Avoid
While contributing to your RRSP seems pretty straightforward, there are a handful of mistakes you should consider avoiding. Take a look at these five investing faux pas, and consider your contributions more wisely.
Not investing your contribution: If you leave your contribution to cash, you’re essentially missing out on a myriad of investments that you could be making to accrue a greater percentage of compounding interest. For example, you can diversify your RRSP into stocks, bonds, mutual funds, and many other vehicles. Don’t leave all your savings in cash.
Withdrawing too early: The whole point of the RRSP is to defer the tax burden while your investments grow. If you must withdraw early without investing in the HBP or LLP programs, you’re going to get hit with a double tax burden anywhere from 10-30% on withholding tax, plus whatever tax bracket you fall into for income. (Imagine taking the withdrawal and it moves you to a new tax bracket. Yikes!)
Not investing the tax refund: Often you’ll receive a tax refund based on the deduction you can make from your contributions. Instead of spending it, why not invest it? This only compounds your savings by retirement. Like we’ve said before, a little delayed gratification can go a long way.
Misunderstanding beneficiary rules: Be careful when trying to assign your RRSP to an adult child, especially if you have a living spouse or common-law partner. They’ll get dinged with a big tax bill on your passing if they’re not a dependent below the age of 18.
Contributing too much: You can incur taxes if you contribute over the limit prescribed by the CRA in your notice of assessment. Be aware of any company pension plans you’ve already paid into before you make your contributions each year.
RRSP Investment Options
There are a wide array of options for investing within your Registered Retirement Savings Plan. While there are also a number of custodians and brokers who can help you diversify your RRSP portfolio, you also have the option of managing your own investments. Let’s take a look at several options for investing within the RRSP, and at least a few you might not have though about.
There are several options for making investments in your RRSP, but a lot will depend on whether or not you want to manage the account yourself. If using a bank or investment firm, your options will vary based on the funds they offer. Here are some examples of the type of funds you might find with an investment bank:
Money Market Funds
Short-term and Income Funds
Canadian Equity Funds
Global Equity Funds
Investing in any of the funds in this list would give you a varied risk exposure that includes equities, ETFs, debt-securities, T-bills, and more. The portfolio would be managed by a fund manager with a systematic diversification strategy to lower your risk.
In addition to this list, you may find Guaranteed Investment Certificates and cash solutions as viable options through your custodian. We’ll discuss GICs in more detail below.
Self Managed RRSPs
It is also possible to manage your own RRSP with some brokerages. This route is typically pursued by individuals with investing experience, or who want to manage their own risk appetite in the markets. Here are a list of items eligible for self-managed investments:
After looking at this list, you might be thinking, “But what about Bitcoin or gold?” Well, you do have options for both.
There are a handful of ways to expose your RRSP to gold. You can either do it through gold ETFs, gold mining equities, or holding physical gold through a custodian. There are exceptions and rules to owning physical gold bullion, however. The CRA requires you to buy from certain dealers and store with certain custodians. Nonetheless, it can be done!
Bitcoin is a little trickier in that no custodians are currently approved for holding Bitcoin in storage. However, there are some bank funds backed by Bitcoin that would give you exposure. You may also find a number of ETFs based on Bitcoin as well. Lastly, there are some Bitcoin mining stocks that could give you a diversified Bitcoin profile in your account.
Guaranteed Investment Certificates (GICs)
GICs are another way to invest your money inside an RRSP. GICs are basically loans that you make to the bank for a certain period of time that could be anywhere from 6 months to 10 years. By loaning your money to the bank, you earn a guaranteed interest on the money loaned.
Some disadvantages of GICs are that your money will be tied up for the length of the term. This may seem inconsequential depending on your age and the amount of time you have until retirement. Additionally, you should understand that if you withdraw your funds early, you could pay a penalty with the bank.
Beyond RRSPs: Other Retirement Savings Accounts
Other retirements savings options often get overlooked by the popularity of RRSPs, but you do have options. You can also combine your RRSP with other savings options. Many individuals do this with their employer’s pension plans, for example. Let’s take a look at a few of the options available outside of RRSPs.
Understanding Tax Free Savings Accounts (TFSAs)
TFSAs are another option for retirement savings, in addition to a myriad of other goals. Starting 2009, the Canadian government created the TFSA for Canadian citizens to save, no matter the reason. However, the contribution limit is much smaller than for RRSPs. For example, in 2021 the limit was $6000.
The main difference between a TFSA and an RRSP is that TFSA can be withdrawn at anytime and for any reason, while an RRSP is meant primarily for retirement with penalties for withdrawals sooner than that. TFSA, on the other hand, are not tax-deductible. That being said, you can continue to contribute to your TFSA beyond the age of 71, unlike an RRSP.
Employee Pension Plans
Employer-sponsored pensions plans are another great way to accrue compounding interest over time. According to the Canadian government, there are two main times of employee pension plans:
Defined contribution plans
Defined benefit plans
The difference between these two is that with the contribution plans, you know what you contribute each year, but you don’t know what to expect at retirement. Defined benefit plans, on the other hand, give you a expected retirement as your employer “promises to pay you a regular income after you retire.”
Depending your choice and the options with your employer, you may choose to also enroll in a TFSA or RRSP depending on your contribution room each year. The benefit of an employer-sponsored contribution plan is that your employer usually matches your contribution up to a certain percentage. Together with an RRSP, you can maximize your savings throughout your lifetime.
Creating a retirement plan is a core component of any long-term investment strategy. To that end, doing your research and planning for an RRSP can be a valuable part of your wealth strategy for retirement. And with a myriad of options for the type of investments you can make inside the RRSP portfolio, you’re sure to find something to satisfy your risk-appetite and retirement goals.
As with any investing strategy, we recommend speaking to a professional or financial advisor to help.