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The following is an Excerpt from my first book Invest Now. Invest Now is jam-packed with timely information and timeless advice for the beginning Canadian investor. Invest Now covers a broad range of topics including RRSP. To purchase a copy, visit Chapters Indigo or click here to buy online - Invest Now: A Canadian's Guide to Investing
What Is An RRSP?
Friday, April 18, 2008. Toronto. An RRSP (registered retirement savings plan), or registered account, is not something you actually buy. This is just an account type, and you buy qualified investments to hold inside that registered plan. Think of the RRSP as an umbrella sheltering you from the sun. Think of the sun as the Canada Revenue Agency. As long as you are under the umbrella, you are protected from the heat. As long as you are inside your registered plan, you are protected from taxes.
Advantages of a Registered Account
- Deposits generate tax receipts to provide tax breaks.
- If the account generates income, no taxes have to be paid, because income is sheltered.
- If you sell your holdings and achieve profits, you pay no taxes on capital gains, but you pay withholding taxes on withdrawals.
- You pay no taxes on growth and switches made inside your account, as long as you are not going outside the registered plan.
Disadvantages of a Registered Account
- The account is registered with Canada revenue Agency (CRA). That’s where the term registered comes from.
- You are only allowed to deposit so much money.
- Withdrawals are restricted.
- You are taxed on the amount you withdraw. The more money you withdraw, the more taxes you pay. See withholding tax rates listed at the end of this chapter.
- You can’t keep this account forever. The account has to be terminated once you are 71, and you have to convert this account to a Registered Income Fund (RIF), from which you have to receive annual income by law. Also, you can take out all your money once you are 71, but this is not a good idea, as you have to pay hefty taxes.
RRSP Annual Limit
You can only invest so much money into your RRSP. The formula goes as follows:
A + B – C, where
A = Any unused portion of prior year’s contribution
B = 18% of prior year’s earned income (up to a maximum for that tax year as below)
C = Pension adjustment for the current year (RPP contributions, etc.)
Contribution Limit
2006 $18,000
2007 $19,000
2008 $20, 000
2009 $21, 000
2010 $22, 000
2011 indexed*
*Starting in 2011, the limits will be indexed for inflation.
Miscellaneous
- Income can be earned in many forms. When your savings accounts pay interest, that is income. When your mutual funds pay distributions, that is income. When your stocks pay you more stocks, that is income.
- The amount you save by putting money in an RRSP depends on your marginal tax rate. The minimum tax savings will be 22% of your contribution—e.g., a $5,000 contribution would save you $5,000 × 22% = $1, 100. But the same $5,000 would save you
$1,400, if your marginal tax rate is 28%
$2,150, if your marginal tax rate is 43%
$2,500, if your marginal tax rate is 50%
- The amount of withholding taxes you pay by taking out money from an RRSP depends on the amount you are withdrawing. Follow the rate below:
Default rates in Quebec
$0–$5, 000: 21%
$5, 000.01–$15, 000: 26%
$15, 000.01 and up: 31%
All other provinces
$0–$5,000: 10%
$5,000.01–$15, 000: 20%
$15, 000.01 and up: 30%
- Although the registered account type looks very cool, many personal-finance columnists would argue that it is only tax deferred, not tax sheltered, because eventually, you pay taxes at a later date. There is no escape from paying taxes.
- If you are not sure what type of account to choose, just start with an open account for now. You will be able to change the account type later on.
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