RSP vs. RRSP
You may have heard friends, colleagues or others using the terms RSP and RRSP interchangeably, and wondered if these products are, indeed, the same thing. While they are connected, RSPs and RRSPs are not identical. Here’s how they differ and what role each can play in your financial plans.
RRSP vs. RSP: the Basics
As you may be aware, RRSP stands for Registered Retirement Savings Plan. It is a specific kind of tax-sheltered account designed to help you save for retirement.
In conversation, people often use “RSP” when referring to an RRSP because it’s shorter and easier to say. And it’s not inaccurate: an RRSP is a type of RSP, which is an umbrella term that refers to any Retirement Savings Plan.
But not all Retirement Savings Plans are RRSPs. Other RSPs in Canada include employer-sponsored pensions or Registered Pensions Plans (RPPs), Tax-Free Savings Accounts (TFSAs), and non-registered accounts.
Still confused? Below are brief explanations of each of these common Canadian Retirement Savings Plans (RSPs) and how they can help you achieve your retirement goals.
Canadian Retirement Savings Plans (RSPs)
Registered Retirement Savings Plan (RRSP)
Registered Retirement Savings Plans are probably the best-known RSP because they offer the following attractive tax advantages:
- Contributions can be deducted from your annual taxable income.
- Any earnings on savings or investments held within an RRSP are not taxable until you withdraw the funds.
You can hold many types of assets within an RRSP, including savings accounts, GICs, stocks, bonds, mutual funds and Exchange Traded Funds (ETFs). Generally, you’re allowed to contribute up to 18% of your previous year’s earnings to an RRSP. Unused contribution room is carried forward to subsequent years.
Because RRSPs are intended to provide a source of income in retirement, you are penalized with heavy withholding taxes if you withdraw the funds before you retire. There are a couple of exceptions—such as the Home Buyers Plan (HBP) and Lifelong Learning Plan (LLP)—which allow you to borrow a certain amount from your RRSP tax-free to help pay for your first home or full-time post-secondary education.
You must convert your RRSP into an RRIF (Registered Retirement Income Fund) the year you turn 71. Keep in mind that all RRSP/RRIF withdrawals, even in retirement, are subject to income tax. Since you get an income tax deduction when you contribute and pay income taxes on withdrawals, RRSPs are a tax-advantageous retirement savings vehicle for those who expect to be in a lower tax bracket during retirement than they are during their working years.
Registered Pension Plan (RPP)
As mentioned above, a Registered Pension Plan (RPP) is also often called an employer-sponsored or corporate pension. It is a retirement savings plan that your workplace sets up on your behalf.
There are two types of Registered Pension Plans:
- Defined Benefit (DB). A defined benefit RPP is a promise from your employer to pay you a specific monthly wage in retirement. The amount is usually determined using a calculation that considers your age, years of service, and level of income. Sometimes the employer bears the entire cost of the pension, making all the contributions and investing them on behalf of plan members, while other DB plans may split contributions between both the employee and employer.
- Defined Contribution (DC). A defined contribution RPP is more like an RRSP, in that you get to choose how to invest your contributions, and your pension income in retirement is based on how well those investments perform over the long term. You make monthly contributions to be invested in your DC plan (taken out of your pay cheque), and there is also usually some kind of “matching” program where your employer contributes a percentage as well.
If you contribute to an RPP, those contributions cut into your annual RRSP contribution room. This reduction is called a “pension adjustment” and is automatically included in the RRSP contribution room calculation on your annual tax assessment statement.
If you leave your employer prior to retirement, you can either remain a member of the RPP and collect your pension at retirement, or choose to receive a commuted value of the pension that can be reinvested in a Locked-In Retirement Account (LIRA) or, if applicable, another employer’s RPP.
Tax-Free Savings Account (TFSA)
Although it’s Canada’s newest RSP that was created in 2009, Tax-Free Savings Accounts are the most popular registered accounts in Canada, with more than 4 in 10 households contributing to one in 2015, according to the latest Census.
Strictly speaking, the TFSA is more than an RSP, as it can be used to save for any purpose, not just retirement. But because all savings/investment earnings growth within a TFSA is tax-free, and withdrawals are also tax-free, it can make a lot of sense to use TFSAs as a way to increase cash flow in retirement while minimizing taxes and potential claw-backs on income-tested benefits, such as Old Age Security (OAS).
Just like RRSPs, TFSAs can hold a variety of assets such as savings accounts, GICs, stocks, bonds, mutual funds and Exchange Traded Funds (ETFs). You can even open a TFSA investing account with an online brokerage or a robo advisor in Canada – a savvy strategy if you’re looking to cut fees to the bare bone while maximizing your earnings.
TFSA contribution room is a flat annual amount for everyone and is carried forward to the next year if unused. The limit for 2019 is $6,000, and the total cumulative limit for those who were 18 or older in 2009 is $63,500. You pay a penalty for overcontributions, but any withdrawals from a TFSA are added back to your contribution room in the following year.
Since you do not get a tax deduction when you contribute to a TFSA but pay no income tax on withdrawals, TFSAs can be a tax-advantageous retirement savings vehicle for those who expect to be in a higher tax bracket during retirement than they are during their working years.
Again, not strictly for retirement savings, Non-Registered Accounts include any kind of savings or investment vehicle that is not held within a registered account (eg. RRSP, TFSA, RESP, RDSP, etc.).
While they do not offer any tax-sheltering—meaning all the investment or interest earnings generated within non-registered accounts must be declared on your annual tax return as income—these types of accounts can still be a useful part of a retiree’s overall financial plan. Here’s why:
- Additional income. If you’ve maxed out contributions to all applicable registered accounts, non-registered accounts provide other ways for your money to grow and provide income in retirement. And although earnings generated within non-registered accounts are taxed annually, eligible Canadian dividends and capital gains are taxed at a more favourable rate than interest income.
- There are no contribution limits or rules on how much or when you must withdraw funds, so you can stay invested longer.
- Possible tax deductions. If you borrow to invest in a non-registered account, you can deduct the interest charges on the loan from your annual taxable income.
RSPs: Which to Choose?
Ultimately, there’s no one “best” retirement plan in Canada: they are all useful vehicles to fund your retirement and were designed to complement each other. Since no one plan will offer everything you need, your best bet is to spread out your savings – that way, you can be sure your nest egg will be ready to hatch in your golden years.