The Canadian federal government established the Registered Retirement Savings Plan (RRSP). It is a type of account created for Canadians so that they can save money for their retirement years. The main advantage of having an RRSP is that it allows tax deferral for investments and provides a tax credit each year that is based on an individual’s contribution amount.
When individuals discuss their RRSP, they may refer to it as their actual investment. In reality an RRSP only acts as an account, which is similar to a regular brokerage account.
While a person can’t buy an RRSP, they can use qualified investment vehicles such as savings bonds, ETFs, RRSP-eligible mutual funds, Treasury bills, income trusts and mortgage-backed securities. It is vital for an investor to make sure that their investment vehicle is eligible for the plan before making a purchase.
Tax Advantages Associated With An RRSP
There are three tax advantages enjoyed by an investor when they utilize an RRSP:
– Taxes are deferred: The taxes paid on savings that are in an RRSP are deferred until funds are withdrawn from the plan. This includes both the contributions and earnings. Capital gains, dividends and interest are allowed to accumulate, which helps grow the total amount invested in the plan even faster.
– Contributions act like tax credits: RRSP contributions (up to a certain amount) can be deducted from income each year. This serves as a tax credit, which provides immediate tax relief.
For example, if a person made $34,000 during the fiscal year and their allowed contribution is equal to $6120, the $6120 would act as a tax credit and be deducted from the $34,000. A person would only have to pay taxes on an income figure of $27,880 (34,000 – 6,120 = 27,880).
– Provides incentive to save: By not being taxed on the funds held in their RRSP, Canadians are rewarded by the Canadian federal government and encouraged to save even further. By allowing this, it will enable a person to store away more funds for the future continuously. Typically, income is lower in later life when a person is retired, and this arrangement should help provide a retiree with the extra income that they’ll need when they aren’t earning as much as they used to.