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A Registered Retirement Savings Plan or RRSP is a type of Canadian account for holding savings and investment assets. Introduced in 1957, the RRSP’s purpose is to promote savings for retirement by employees. It must comply with a variety of restrictions stipulated in the Canadian Income Tax Act. Rules determine the maximum contributions, the timing of contributions, the claiming of the contribution tax credit, the assets allowed, and the eventual conversion to an RRIF (Registered Retirement Income Fund) in retirement.
An Individual RRSP is associated with only a single individual, termed an account holder. With Individual RRSPs, the account holder is also called a contributor, as only they contribute money to their RRSP.
A Spousal RRSP allows a higher earner, termed a spousal contributor, to contribute to an RRSP in the spouse’s name. In this case, it is the spouse who is the account holder. The spouse can withdraw the funds, subject to tax, after a holding period. A spousal RRSP is a means of splitting income in retirement: By dividing investment properties between both spouses each spouse will receive half the income, and thus the marginal tax rate will be lower than if one spouse earned all of the income.
Year Contribution Limit
A RRSP deduction limit is the maximum amount of RRSP contributions that can be claimed on a tax return for a given tax year.
A deduction limit is calculated as the unused deduction limit from the prior year (which includes all unused deductions going back 10 years, plus 18% of a person’s earned income from the previous calendar year up to a specified maximum, minus any pension adjustment (PA) and past service pension adjustment (PSPA), plus pension adjustment reversals (PAR). The CRA calculates the RRSP deduction limit for the next year and prints it on every Notice of Assessment or Reassessment, provided the taxpayer is 71 year or younger. It is also recalculated and a copy mailed in certain cases such as when a PSPA or PAR is issued.
The specified maximum has been rising as shown in the table to the left.
The Tax-Free Savings Account (TFSA) is an account that provides tax benefits for saving in Canada. Contributions to a TFSA are not deductible for income tax purposes. Investment income, including capital gains and dividends, earned in a TFSA is not taxed, even when withdrawn.
The TFSA is an investment option for Canadian residents 18 years and older wanting to save for the future. The TFSA’s flexible structure allows the holder to be able to withdraw money from the account at any time, free of taxes. The allocations into the account are non-deductible; however this represents a lucrative opportunity for individuals with left-over income to invest in a savings vehicle, without the pressure of time constraints. The account also alleviates the burden of the capital gains tax. The interest-income will be able to compound tax-free. In essence, the account-holder can withdraw any amount out of the account, free from capital gains and/or withdrawal taxes.
One mechanism in the design of the TFSA is the carry-over aspect. Any unused space under the $5,000 cap can be carried forward to subsequent years, without any upward limit. The TFSA also allows income splitting to an extent, because a higher-earning spouse can contribute to the TFSA of a lower-earning spouse.
The $5,000 annual contribution limit will be indexed to the Consumer Price Index (CPI), in $500 increments, in order to account for inflation.
In a sense the tax treatment of a TFSA is the opposite of a Registered Retirement Savings Plan (RRSP). For RRSPs, there is a tax deduction for contributions to a RRSP, and withdrawals of contributions and investment income are all taxable. In contrast, there is no tax deduction for contributions to TFSA, and there is no tax on withdrawals of investment income or contributions from the account. Up to $5,000 per year can be placed into a TFSA. This money can then be withdrawn at any point of time, without penalty. Unlike RRSP’s, which must be withdrawn before the holder turns 71, the TFSA does not expire. The contribution room for funds withdrawn from a TFSA is reallocated in the tax year after the withdrawal, unlike an RRSP, where the contribution room is permanently reduced once a contribution is made.
The Canada Revenue Agency (CRA) describes the difference between a TFSA and an RRSP as follows: “An RRSP is primarily intended for retirement. The TFSA is like an RRSP for everything else in your life.”