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Ontario|Investments & SecuritiesRRSPs and RRIFs 266 RRSPs: What benefits do they offer? The Government of Canada has established special tax rules for retirement investments. These rules were created to encourage people to save for their retirement. Investments made under these special rules are called Registered Retirement Savings Plans, or RRSPs for short.
RRSPs are tax deferral plans that allow you to put a percentage of your income into an investment account. RRSPs are registered with Canada Revenue Agency. You will not have to pay tax on the income you contribute to your RRSP until you withdraw the money. The Income Tax Act describes eligible investments for an RRSP. The money that you put into an RRSP can be invested in mutual funds, GICs, term deposits, stocks, bonds, or mortgages. The RRSP planholder is responsible for ensuring that the investments held in the RRSP are eligible investments.
- Benefits of RRSPs
There are many benefits to investing in an RRSP.
First, your RRSP contribution for a particular year is included on your income tax return as a deduction. This reduces the amount of tax you have to pay in the year that you make the contribution, because it reduces your annual taxable income for that year.
The second advantage of RRSPs is that they defer some income taxes. You will not have to pay tax on the money you invest until you withdraw it. If you withdraw the money during your retirement or at a time when you have very little income, you will be in a lower tax bracket and you will pay less income tax than if you had paid tax on the money when you earned it.
The third advantage is that RRSP investments are tax-sheltered. This means that any increase in the value of your investment will not be taxed while the money is in the RRSP. Because your RRSP is tax-sheltered, it grows faster than it would if you had to pay tax on it. Any gain in your investment will be added to the principal amount you contributed. The entire investment is tax-sheltered, and you will not have to pay tax on it until you start making withdrawals.
Fourth, RRSPs are a good way to save for your retirement or for some other time when you need to supplement your income. For example, if you decide to take time off to raise your children, or if you quit your job to start your own business, you can use your RRSP as a source of income. You should understand the terms and conditions of your RRSP and any restrictions that may apply, such as the ability to withdraw money immediately. Some RRSP plans, such as GIC investments, lock in your investment for a certain period of time.
Canada Revenue Agency also allows you to contribute to an RRSP on behalf of your spouse. The contributing spouse may deduct the contribution amount from his or her taxable income. A withdrawal from the plan is taxed in the hands of the planholder. However, if a withdrawal is made from a spousal plan within 3 years of a contribution being made, the amount withdrawn may be taxed in the hands of the contributing spouse.
The advantage of contributing to a spousal plan is the ability to split income at retirement to minimize the tax liability when money is withdrawn from each spouse's plan. This results in two smaller incomes that will be taxed at a lower rate than the rate that would be applied to a single larger income. The overall result is that you will pay less tax.
- Locked-in RRSP
A locked-in RRSP holds funds transferred directly from a pension plan. If you change jobs, the pension plan which your former employer offered may allow the value of your pension benefit to be transferred directly to a locked-in RRSP. The funds held in the locked-in RRSP are administered under the same federal or provincial pension legislation under which the pension plan is administered. You may not withdraw from or contribute to a locked-in RRSP.
Upon reaching a certain age, which will be defined in the pension legislation, you may convert your locked-in RRSP to a Life Income Fund (LIF), Locked-in Retirement Income Fund (LRIF) or to an annuity. Again pension legislation will determine whether an LIF or an LRIF is an eligible option. It becomes compulsory to convert to an LIF or an LRIF at age 69.
You can obtain more information about RRSPs and the tax advantages they offer by contacting Canada Revenue Agency, a financial advisor, an accountant or a tax lawyer.
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