You can start an RRSP once you have employment income.
But it may make sense to wait until you're in a higher tax bracket.
pay back debt OR CONTRIBUTE TO rrsp?
If you have the flexibility to delay debt repayment, think whether it makes sense to pay down your debt as soon as possible or pay some of it while you put some money into a registered account.
- Save first if you expect that the rate of return in the registered account will be higher than the interest rate on your debt.
- This is because paying down debt is like guaranteed after-tax savings (you know exactly the interest rate you’re paying), while the return on your investment is not certain (even the interest rate on your savings account will likely change in the future).
Once you've decided what kind of investment account you'll need...
what investments work best in a RRSP?
By the time you start your individual RRSP, you most likely already have a TFSA account.
- The rules of investing will be similar.
- But with both accounts in place, you should learn which investments are better suited for the TSFA and which for the RRSP.
The reason is taxation. Different forms of investment income are taxed differently. There is no tax on investment income in the TFSA at all. But the investment income in your RRSP will eventually be taxed - when you withdraw the money at retirement, at your marginal tax rate at the time.
Recapping the basic rules of investing, how you'll invest your RRSP money will depend on 2 things:
1. Your risk appetite, keeping in mind that RRSP is really long-term investing
2. How much investing work you want to do yourself.
You can learn about these things in the Saving & Investing section so that you can decide what kind of RRSP account you'll need.
CONTRIBUTE TO RRSP or TFSA - HOW TO DECIDE ?
You may not have a choice if your employer offers a mandatory defined contribution plan - it will be a portion of your RRSP.
Since such plans often come with employer contributions matching your own, they help you save faster.
In your personal accounts, the choice between contributing to your TFSA or your RRSP depends on 2 things:
1. What tax bracket you are in when you contribute – the tax deduction has more value when you pay more tax.
2. How much contribution room you have left in each plan.
- The general idea is to always use the TFSA contribution room first.
- If you're in the zero or the lowest tax bracket, it makes sense to defer your RRSP contributions if you expect to be in a higher tax bracket in the future.
- When you run out of the TFSA contribution room and still have some money to invest, open a taxable account instead of an RRSP.
- Once you move to a higher tax bracket, you can catch up with your RRSP contribution room by moving money from the taxable / TSFA accounts to the RRSP (and replenishing your TFSA as soon as you can).
- When you're in higher tax brackets, use up your RRSP contribution limit before putting money in taxable accounts.
how it works
When you report employment income when you file taxes, the CRA (Canada Revenue Agency) will calculate your RRSP contribution limit for the the following year. This is the maximum amount you can put in your RRSP account that year.
If your employer offers a defined contribution pension plan, it will likely use up some of your RRSP contribution limit because it's a group RRSP. If you have some room left, or you don't have an employer plan, you may start your individual RRSP.
In the year you decide to make a contribution, you will deduct the amount from your taxable income. This will reduce the amount of income tax you owe. In many cases this results in a tax refund.
Investment income in your RRSP is not taxed until you withdraw it in retirement. This makes your money grow faster.
Unlike with the TFSA, you shouldn't withdraw money from the RRSP before you retire - penalties would make it expensive and unproductive.
- However, there are two cases when you can use some of the money in your RRSP earlier - for education or to buy a house (but you have to put it back into the RRSP over time).
Why do you need to save for retirement?
- You will most likely be entitled to Canada Pension Plan when you retire, but even the Enhanced Canada Pension Plan may not be sufficient to cover your needs in retirement – some 45 years from now.
- Many companies do not offer a defined benefit pension plan. Statistics Canada says that that about 70% of employed Canadians aged 25-54 have no employer pension.
- Even if your current employer offers a defined benefit pension plan, you may change companies several times and work free lance at times, which makes it less likely that you’ll work for one company long enough to earn a full pension.
If you save up to your full RRSP limit each year, will this be sufficient to provide for your retirement?
- It’s a complicated question.
- Much depends on your lifestyle in retirement, how long you will live, and whether you'll have additional income in retirement, like a company / government pension plan.
- At some point, you’ll need to think this through and do the math, or discuss it with a financial planner.
Decide how you'll be investing and what kind of investment account you'll need...
WHICH INVESTMENTS WORK BEST IN A TFSA AND WHICH IN AN RRSP?
When you have both the TFSA and RRSP accounts, the rule of thumb is to place fixed income in the RRSP and equities in the TFSA.
- Equities are expected to grow more than fixed income and the TFSA will shelter your dividends and capital gains from tax.
- Interest will be sheltered in the RRSP account until you withdraw the money - your profit to be taxed will likely be lower than on equities, though it may be taxed at a higher rate than Canadian dividends and capital gains on your equities (this rate will depend on your overall income in the year when you withhold the money).
This will be even more important for you when you use up all your TFSA and RRSP contribution limits and are placing your additional savings in taxable accounts.
Click here to learn
which investments work best where
when you have a TFSA, an RRSP and a taxable account.
Click here for what you need to know about
Own your RRSP, step-by-step.
what's next?
Once you've opened an account...