RRSPs, RRIFs, and TFISA – A Quick Overview

For all you Canadians out there who are reading PF blogs from the U.S. and reading all about Roth IRAs or 401ks, here’s my once-and-for-all RRSP mini primer.

I’ve been getting a lot of emails about RRSPs in general from readers and clients, and how the damn finagled thing works.

I’d rather just write one post and let y’all read it on your own time instead of repeating myself in emails.

Plus, I have cute pictures in a post that I can’t put in an email.

(Look at that cute little piggy bank! How can you not want to save money now?)

What does RRSP stand for?

Registered Retirement Savings Plan

Who can contribute to an RRSP?

Anyone who earns an ‘income’.

If you don’t earn an ‘income’ and you have a spouse, you can still save money, by contributing to a spousal RRSP.

Clarification from Money Minder:
To contribute to a spousal RRSP, you do have to have income as the contribution counts toward your RRSP contribution space.

FB Clarification:
Which means if you worked before, and carried forward your RRSP contributions, you can contribute to an RRSP.

But if you don’t have any income this year, and you have used up all your RRSP contribution room, you won’t have any RRSP room for next year.

However, if you earn $0 this year, you can still save money by having your spouse save it for you in a spousal RRSP since you won’t have any contribution room to save on your own.

What is an RRSP and how does it work?

It’s a tax-deferred retirement savings plan.

I really want to emphasis the word PLAN here. Because it’s not something you physically buy. There’s nothing out there called “The RRSP”, that you can buy a couple of pieces of.

An RRSP is just a PLAN that allows you to save money UNDER the plan. And how you decide to save that money and where you invest that money is up to you.

Let me try to explain it better:

Think of it like you signing up for a gift certificate membership plan at J.Crew, where for example they’ll give you 18% of what you spent last year to spend on anything you want in the store.

And every year, they’ll calculate how much you spent at their store, and give you a gift certificate worth 18% the next year.

So let’s say you spent $10,000 at J.Crew last year. You get $1800 as a gift certificate then.

But how you actually spend that $1800 gift certificate is totally up to you. J.Crew doesn’t have a section in the store that says: YOU MUST BUY SOMETHING FROM HERE.

That’s kind of how an RRSP works. It’s just a plan (gift certificate membership plan) that allows you to save up to 18% of your taxable income of this year (calculated from what you spent at J.Crew last year), tax-deferred.

And how you want to save that 18% of your income, in whatever places (whatever pieces of clothing or accessories) you want to save the 18% in, is totally cool with the Canadian Government (a.k.a. J.Crew).

Back up, what do you mean by Tax-Deferred?

I say tax-deferred because it saves your money for retirement tax free on the tax year that you save it in, and locks it in.

When you withdraw the money at the age of 65, the amount that you withdraw gets taxed.

You must withdraw your money from your RRSP by the age of 71, or convert it to an RRIF (Registered Retirement Income Fund)

Give me an example of how an RRSP works!

Let’s assume a simple example of just absolute numbers. No inflation or any other deductions factored in.

Imagine that I’m 25-years old, earning $50,000 a year.

My taxable income is $50,000 (the amount I’d normally pay taxes on).

I decide to save $9000 (18% maximum) in an RRSP.

This makes my taxable income drop by $9500 to $41,000 instead of $50,000.

I turn 65 and retire and I now have a taxable income of $0 each year because I’m not earning anything.

I decide to withdraw $37,500 (75% of what I originally earned – $50,000)

I finally get taxed on that $37,500, about 40 years later.

So if it’s tax-deferred why do I even bother?

Well, it saves you money in taxes, twice!

Using my example above, if I saved $9000 in an RRSP, I dropped my taxable income by that amount.

So instead of paying 19.68% in taxes on $50,000 I am now paying 17.17% in taxes on $41,000.

I am deferring those taxes for when I retire, so that I end up paying less taxes based on my income. This is a big deal for high income earners like myself because I may cut myself down to a lower tax bracket.

Clarification from Money Minder
Also, high income retirees don’t save money by withdrawing RRSP funds/RRIFs in retirement if they are in the higher tax brackets.

Savings comes from being in a lower tax bracket in retirement than you were during your working life. However everyone benefits from the years of tax deferred growth, regardless of income.

Contribution space can be carried forward indefinitely.

What do you mean you save on taxes twice?

If I earned $100,000 a year, I’d pay 28.74% in taxes.

Savings #1
But if I deferred those taxes by contributing $18,000 to my RRSP then I only get taxed on $82,000 instead of $100,000 which means I’d pay 25.52% in taxes and not 28.74%.

I’m saving on the percentage (%) of taxes I am paying, and I’m paying a lower amount overall, because even if I were paying the original 28.74% tax rate, it’s still a lot lower at $82,000 than if it were charged on $100,000, a savings of around $5173.

Savings #2
Then when I turn 65, and withdraw only $40,000 as income, I get taxed at 16.82%, which saves me money yet again because I would’ve originally be taxed on that amount at 28.74% or even 25.52%

…but since I’m pulling out an even lower amount ($40,000 instead of $82,000), I’m (again) paying a lower percentage of taxes.

Bonus!
Whatever you earn in there (interest, dividends, increase in stock value) from when you sell it is a bonus. Sure, you get taxed on it when you take it out, but your money sat there and collected interest tax free for about 40 years!

So what’s the maximum I can contribute to an RRSP?

You can contribute up to 18% every single year, with a total dollar ($) amount of $18,000.

So if you earn $50,000 in 2009 you can contribute up to $9000 (18%) in the next tax year, 2010.

But if you earn $150,000 in 2009, you’d normally be able to contribute $27,000 (18%), but Canada caps that total annual contribution to $18,000.

So anyone who earns above $100,000 doesn’t get any added RRSP tax deferment benefits.

And how do I save for an RRSP?

Well, first you need to save in something that is eligible for RRSPs. So that means you need to open an account somewhere that’s RRSP-eligible and save your money in there buying what you want to save your money in.

What you want to save your money in (like bonds, stocks or cash) is called an “RRSP Investment Vehicle”.

This is just fancy mumbo jumbo talk to mean: “saving it in a way that is eligible for RRSP deduction”.

The way I remember it, is that I imagine bonds, stocks and cash as little different coloured cars (get it? Cars? Vehicles… oh never mind.)

Why the hell do I have to do that? Why can’t I just save it in my bank? Or in a pair of shoes?

That’d be great and very easy, but see, you can’t just save $18,000 in a bank account and claim it’s for RRSPs.

(Nor for shoes. Buying something that doesn’t have a chance of increasing in value over time or pay out dividends is NOT an investment.)

How the hell does the Government know?

For all they know, you could claim you saved $18,000 in that account, and then you withdraw the money the next day for a wild party in Las Vegas.

The whole point of giving you a tax break down, and tax-deferment NOW is that you will NOT touch the money until you turn 65.

Hello? It’s a RETIREMENT plan.

You can’t save the money and then go out and spend it the next day on something shiny. Ooo… Etsy necklace.

And to track that, the government needs you to go with a reputable bank (PC Financial, ING Direct…even TD Bank *grumble*) who offers an RRSP-eligible account and allows you to save money in THAT account.

Then that bank gives you a little slip of paper at the end of the tax year (usually in January or February of the next year) and tells you that this is how much you’ve saved in your RRSP, and here’s proof to give to the Canadian Government so that you can save on your taxes and deduct that amount.

What can I buy to save in an RRSP?

TaxTips.CA can answer that.

Uh, what do YOU save in an RRSP?

I buy index funds (e-funds) from TD Bank under the Self-Directed RSP Plan.

It saves me on management fees (also known as Management Expense Ratios), which means that the manager of the fund can charge you a percentage each year for managing the fund.

Most fund managers take about 1% – 2%, and it seems like very little, but considering that you earn around 5% a year (conservatively), and inflation is at 3%, you are really only earning a profit of 2%… and if the fund manager takes 1% of that, well… you are SOL on profits.

Not only that, if you lose money that year and earn -5%, they STILL take a 1% cut! WTF is up with that? Read more about all of this starting here.

And a SELF-DIRECTED plan doesn’t charge me just to place an order for whatever fund I want to buy, which is what happens when you call a broker and ask him to buy or sell something.

Yeah, that’s another fee on top of that management one.

The guy takes a ‘small fee’ when he clicks a button to buy something for you!

I am NOT down with that BS. If I’m going to pay someone, it better be for something worthwhile.

What is an RRIF (Registered Retirement Income Fund) ….

And why do I care?

Well you don’t, right now. If you aren’t nearing retirement age, that is.

See, you can defer withdrawing from your RRSP until you turn 65. But once you turn 71 you MUST take out all the money.

Let’s assume you saved $1,000,000 in your RRSP. If you had to withdraw the entire amount at 71, you’d be taxed 44.57% on that.

That means you’d pay $445,700 in taxes alone!

So, you have to convert that RRSP into an RRIF (a.k.a. “rolling your RRSP over into an RRIF”), so that it pays out a set amount (calculated as a percentage of you total you own) each year until you die, and not all at once. That way, you pay less taxes.

And what’s this about a TFISA..something or another?

If you are starting out investing in Canada, you should definitely look into opening a TFISA (Tax-Free Investment Savings Account).

Clarification from Reader Emma: You’ve already paid the taxes on the $5000 as part of your taxable income that you’re saving, but you will save the taxes on the INTEREST that is earned on that $5000. So if that $5000 grows to $50,000 at retirement, you don’t get taxed on the $45,000

AND, AND AND!! You can take out the money any time you want.

You can contribute up to $5000 each year.

It’s kind of like the government’s way of saying: Please, for the love of the country, SAVE! SAVE at least $5000 a year!

So what’s $5000/year to you?

$5000 / 12 months = $416.67 that you have to save each month to max out the TFISA.

Reader Questions:

Karissa Dee: “I can’t remember if you discussed E*Trade.ca in your investment primer. Do you have experience with that?”

I may have touched on E*Trade.ca as a quick mention, but I don’t use them at all.

My siblings do and they swear by them, although I am not sure if they are RRSP eligible.

Dolly Iris: “Can I open RRSP savings at different banks if I don’t exceed the yearly limit?”

Yes.

You can open savings at as many banks as you want, but be careful when you do this because you may incur more fees (more banks = more fees), and if you stick with one bank like TD, if you keep a balance of $10,000 you don’t pay the yearly Self-Directed RSP Plan fee any longer.

You can contribute as much as you want in any bank, in any fund, in any way you want as long as you don’t go over the yearly limit.

However, you do have a $2000 over contribution lifetime limit. You can over contribute to your RRSP by a lifetime maximum of $2000. Once you use it up, it’s gone. So be judicious in using it because later on down the road you may over contribute by accident and get smacked with a huge fine.

Dolly Iris: “Also, can you move your RRSP to another bank? I’m just curious.”

Yes.

You must contact the bank you want to move your RRSPs to, and ask them for the proper procedures, and for the forms to fill out to verify that you’re authorizing them to pilfer the amounts from your other RRSP provider.

Every bank is different, and has different procedures, so check with the bank you want to move to before proceeding.

Rags2Riches: “Not that I am anywhere close to purchasing a house but what’s the deal on the first time home buyers plan w/ the rrsp?”

The basic idea is that whatever you’ve saved in your RRSP, you can use as a down payment towards your first home, and your first home only.

Normally, you’d get smacked hard by the government for even withdrawing $5000 (taxed hard) from your RRSPs, but if you’ve saved $20,000 in your RRSP and you only have $10,000 in savings but you need another $5000 for a down payment, you can take out the money from your RRSP of the $5000 amount without penalties.

The catch is that you have to pay back that $5000 amount within 5 years or something like that, so $1000 a year has to be re-contributed back to make up for what you took out.

You also lose the interest you’d earn on that $5000 and basically.. start from scratch, so to speak.

This methodology can also be used if you want to go back to school I think. I think the government has a plan or program for that.