Episode 7: The Best Retirement Savings Account?

[00:00:00] Scott Sather: Welcome to the Retire Ready Podcast. The podcast that helps Canadians prepare for all that retirement brings. I'm your host, Scott Sather, Founder, President, and Financial Planner at Awaken Wealth Management. And Portfolio Manager with Awaken Investments of Aligned Capital Partners in Regina, Saskatchewan.

[00:00:21] Thanks for joining me today. So in the next couple of episodes, we're going to review the different retirement accounts in Canada. Starting today with an often misunderstood account, but likely the best option available to save for retirement. We're talking about the RRSP. Or as many call it the RSP and its full name is the registered retirement savings plan. Now this account gets a lot of bad press and many retired investors.

[00:00:46] Talk about how they don't like it as much due to having to pay taxes on any money drawn from it. So we want to dig in as to why this account is a must for every Canadian wanting to retire. So I assume that's everyone. We'll discuss what the [00:01:00] account is, who can contribute, how much you can contribute, what investment options are available. Some of the strategies that can build up your retirement savings and a few of the options drawing out from the account. So what is an RSP? I registered retirement savings plan is a tax advantaged investment account designed to encourage Canadians to save for their retirement. It was established by the Canadian government, registered with CRA or a Canadian Revenue Agency. And it's regulated by the Canadian income tax act.

[00:01:30] The contributions made to an RSP are tax deductible. Providing an immediate incentive for individuals to save for their future. The earnings within the RSP grow tax deferred until withdrawal, allowing for compound growth over time. So let's stop right there. Despite what you might think or what the bank may have told you, an RRSP is not an investment. Okay.

[00:01:53] I repeat an RRSP is not an investment. That means you can't buy an RRSP and you [00:02:00] can't complain about the performance of your RSP. It's an account you can contribute or you can withdraw from an RSP. And you can invest within the RSP. And, uh, we'll talk more about that. You can definitely complain about those investments. But in and of itself, it is not an investment. One of the key advantages of the RSP is the contributions made are tax deductible.

[00:02:23] So let's dig into that a bit. That means. If I earn. $50,000 this year. And I contribute $50,000 to my RSP, assuming I have contribution room to do so. My taxable income is zero. Okay. It directly reduces my taxable income.

[00:02:41] That's a huge advantage as it allows you to reduce your taxes today. Now it's not tax-free but tax deferred, meaning when the time comes to dry out the RSP, you will pay taxes on the amount withdrawn. So if I withdraw out $10,000, the full amount gets added to my taxable income. And I'll pay taxes at my [00:03:00] marginal tax rate. But the whole idea is that in retirement, most likely for most Canadians. Their income is lower in retirement than it was in the working time. Okay. Let's talk about contributions. The RSP is open to any Canadian resident with RSP contribution room. You can contribute to your own RSP before December 31st in the year, you turn 71. There are ways to still possibly contribute to an RSP after you've turned 71, but we'll discuss those later on. Contribution room is set by CRA on an annual basis. Based on 18% of the previous years. Earned income. Up to the maximum limit set by CRA.

[00:03:40] So in 2024, that limit is 31,560. That also is.

[00:03:48] That also can change depending on pension adjustments. And other factors. But that means you would need to earn $175,333 [00:04:00] to max out on that contribution room. And your contribution room carries forward. So if you don't max out your RSP contribution, the remainder left will carry forward to following years. You're also given an extra 60 days after the end of the calendar year to contribute to the previous year. So if you miss out contributing to your RSP by December 31st, 2024, you'll still have until March 1st, 2025 to contribute for the 24 tax year. Some wait until this time to decide how much to contribute. They'll gather up all their tax slips to see what things look like and then enter them into a tax program or talk to their accountant to see how much they should contribute to reduce their tax bill or increase the tax refund. It's recommended instead to contribute when you have the funds, ideally on a bi-weekly weekly or monthly basis, however you get paid. Another idea would be to submit. Uh, T 1213, which is a request to reduce tax deductions at source, which would reduce the taxes withheld on your paycheck.

[00:04:58] So you'd pay less tax, [00:05:00] every pay period, instead of waiting until tax time and getting a big refund.

[00:05:04] So this contribution limit is one of the possible advantages in the retirement savings account in compared to other registered accounts. And what I mean here is the RSP allows you to put more away for retirement than say the T FSA. The contribution limit for the TFSA in 2024. Is $7,000. Okay. So that means if you just turned 18 this year, you had only started contributing this year. $7,000 is all you could put into it. Whereas, if you earned an income higher than $38,889, with that 18%, we talked about previously, you're able to contribute more to the RSP.

[00:05:41] If you made more than that amount.

[00:05:43] It's important to keep on top of your contribution limit. As you'll be charged a penalty tax. If you end up over contributing, you can find your contribution limit on your tax assessment. So that's the document that CRA sends you after they've assessed your tax return. Or by accessing your CRA account or by asking your [00:06:00] account. CRA allows you a lifetime over contribution limit of $2,000, which you can contribute without being penalized, but you also can't claim that against your taxes until you have that contribution room again. And then any over contributions beyond that amount are taxed at a 1% per month penalty.

[00:06:17] So not ideal. We'll have links in the show notes to get your, my CRA accounts set up. So be sure to visit retirereadypodcast.com. And check out episode seven. Okay. Now, what about if you decide to withdraw from an RSP? Well, if you're just straight up withdrawing, the amount will be added to your income tax for that year. And it'd be taxed at your marginal tax rate, but to make sure that CRA gets their taxes. Your RSP provider will have to withhold tax on the withdrawal. The amount you withdraw dictates how much they need to withhold.

[00:06:50] So from zero to 5010% is withheld 5,001 to 15,000, 20% is withheld. And any withdrawal over [00:07:00] 15,000 has 30% taxes withheld. What you would actually pay? In taxes, figure it out. That following tax year, when you do your income taxes and you'll have until April 30th to get that figured out. If you were drawing for the purposes of buying your first house. Or to further your education, you may qualify to withdraw through the home buyers plan or the lifelong learning plan. Which allow you to take money out from the RSP as sort of a loan, what you have to pay back over to period of time, or you'll be taxed on the amount.

[00:07:29] Okay. Again, I'll include information on these plans in the show notes. retirereadypodcast.com episode seven. Within an RSP investment earnings grow tax deferred. So that means that you don't pay taxes on the gains or the interest generated by your investments.

[00:07:43] As long as the funds remain within the RRSP, this tax deferral allows for compounded growth over time. Maximizing that potential for your retirement fund. In terms of investment options. It's pretty much everything under the sun cash, high interest savings accounts, guaranteed [00:08:00] investments certificates. Term deposits, mutual funds, stocks, bonds exchange, traded funds or ETFs, cryptocurrency through ETFs. Heck you could even hold your own mortgage in your RSP.

[00:08:11] Now having said that, I'm not saying you should hold those things in your RSP. I'm just saying you can, okay. There are some things that you can't hold in an RSP. Otherwise, no one has non-qualified investments. Those include investments such as real property, your land general partnership units and cryptocurrency held outright.

[00:08:30] These non-qualified investments are taxed equal to 50% of the fair market value at the time. That it was bought or that it became non-qualified. And the annuitant or plan holder is still also liable for the one hundred percent advantage tax on the non-qualified investment. If this income is not withdrawn promptly.

[00:08:48] Okay. So just be careful to do your research before you buy to ensure it can be held in an RSP. And of course, all good things must come to an end. And in the case of the RSP, the end is December 31st. If the year you [00:09:00] turn 71, That's when the government is determined, you need to collapse your RSP or it matures. Your options at that time, or to draw the full amount out and pay taxes on it, which hopefully will no one does, unless you have a very little saved.

[00:09:13] Otherwise you're paying a large amount of money to Ottawa, and no one likes doing that. option two. Is to move the funds to a riff or a registered retirement income fund. We'll cover this one in one of the next episodes. But the advantage here is that the funds from the RSP continue to be tax-deferred. Until withdrawal, but you do have to start making a minimum payment amount each year. based on your age, the riff allows you the flexibility to decide how much or how little you want to take out once you're over that minimum amount of withdrawal. The last option is to take the funds in the RSP and purchase an annuity. Think of it, an annuity has kind of like the pension plan.

[00:09:51] It's an insurance product that will guarantee you a monthly income for the rest of your life or over a set period of time. Now there's different bells and whistles. You can add to an annuity [00:10:00] such as ensuring it will pay out for a set period of time to you, your spouse, and any beneficiaries you can add on cost of living adjustments. But remember these bells and whistles, come with a price.

[00:10:10] Reducing your monthly income. With the annuity option, you can also move up to 25% of your RSP to a maximum here in 2024 of 170,000 to an advanced life deferred annuity. This is an annuity that won't start paying you until down the road. This can be ideal if maybe you want to defer receiving those funds further down the road, maybe to help offset potential healthcare. Long-term care costs. Each of these options have their pros and cons.

[00:10:37] And it really depends on your own individual situation and goals as to which is the best option for you. Remember though, with all of these options. As the money comes out into your hands, it's then taxed at your marginal tax rate. Okay. Another benefit of the RSP is that you can name a beneficiary to the account who upon your passing or receive the funds directly bypassing the [00:11:00] estate and probate fees. Hit that beneficiary as a spouse or common-law partner. They're financially dependent child or grandchild under the age of 18 or a financially dependent, mentally ill or physically, and from child or grandchild of any age, the plan will roll over with that continued tax deferral. Anyone else the taxes must be paid. As if having received the full amount in the year of passing.

[00:11:23] So there could be a potential large tax bail at that time. In many plans, you can also add a contingent beneficiary. So if something happened to the original beneficiary, say you and your spouse were in an accident and passed at the same time, the funds then would go to, these contingent beneficiaries. Now, before we end this episode, I thought I would share some strategies you may want to consider with the RSP. First strategy we'll talk about is how contributing now so that you can start getting the tax deferral growth, but waiting to claim it against your income down the road.

[00:11:53] So. This might make sense if you're currently at a lower income, but you expect higher income in the future, maybe a bonus or a severance that will be [00:12:00] paid out to you down the road, or expecting a job, change that may result in a higher income ongoing. Maybe you don't need to claim the full amount this year to significantly reduce your tax bill and can push claiming the rest of it to future years. Okay.

[00:12:14] Another thing you can do for kids under the age of 18.

[00:12:18] If they're earning income is make sure they're doing their taxes and submitting it so that they can start building up some of this RSP contribution room as it will continue to build. Another great tool to use as the spousal RSP. This is for those who have a spouse and you contribute your money with your contribution room, to your spouse's RSP.

[00:12:36] Now you, you might be asking why you'd want to do that. Well, It allows you to effectively income split. So if one spouse is in a higher income bracket or has a pension through work and the other doesn't have much of retirement savings. This strategy allows you to have their account built up and have the funds taxed in their hands upon withdrawal. Now the spousal RSP has a special rules for withdrawing that being in the year of contribution in the [00:13:00] following two years, any withdrawals made will be taxed in the contributors hands. But after that point, we'll be taxed in the account holders hands or the spouses. So for example, if I'm the larger income earner or my spouse isn't working at all, I can have them open a spousal RSP.

[00:13:15] So you can't just contribute to their RSP. It has to be. A spousal RSP in their name. I contribute to the plan. Assuming I have contribution room, I get the tax receipt, which reduces my taxable income and therefore results in less taxes paid my me, but they get the funds to go towards retirement. And once at retirement, assuming we're past the two year mark, after the year of contributing, the funds will be taxed in their hands, likely at a much lower tax rate than mine when they withdraw.

[00:13:44] We mentioned earlier 71 being that cut-off. Of contributing to the RSP. Those over the age of 71 can use the spousal RSP to continue to contribute. Assuming their spouse is younger than 72. In this case. If you have contribution room, you can [00:14:00] contribute to your spouse's spousal RSP, allowing you the tax deduction will adding to their investment. And one more stare at a GL suggest is a simple one. Instead of spending your tax refund. Take that money and contribute it back to the RSP. And therefore increase your investment and likely increase next year's tax refund. Now, the last thing I'll say on this is that you can have too much of a good thing.

[00:14:26] And the RSP is no different. There does come a point. Where it doesn't make sense to contribute or continue to contribute to the RSP as it could result in higher taxes or losing government benefits. But each person is different and you should look at your own plan and discuss with your own financial planner, whether that applies to you. Just because it doesn't make sense for one person doesn't mean that, that applies to everyone.

[00:14:49] So go get a financial plan. So in conclusion, the RSP is a great account to use, to save for retirement. Reduces your taxes today will allowing you to grow your investments for [00:15:00] retirement tomorrow and down the road. Okay. I think that covers everything for this episode. If you could do me a huge favor, click that follower, subscribe button, give a 5 star review. it, greatly helps get the podcast out to everyone.

[00:15:13] Also, if you have any questions or ideas for future topics, please email me at info@retirereadypodcast.com.

[00:15:20] You can view the resources listed in this episode, find any links to topics mentioned and find the show notes by visiting retire ready podcast.com, episode seven. You can also subscribe to The Wake-Up semi-monthly newsletter by visiting the Awaken Wealth site, which is awakenwealth.ca. Be sure to check back in two weeks for the next episode where we'll talk about the other big retirement planning account, the tax-free savings account. Thanks again for joining me today.

[00:15:44] And I look forward to seeing you back for the next episode.

[00:15:48] Julie Sather: Thank you for listening to the Retire Ready Podcast. Subscribe to this podcast or to learn more, please head on over to awakenwealth.ca/retirereadypodcast. Investment services [00:16:00] are provided through Awaken Investments of Aligned Capital Partners, Incorporated, an approved trade name of Aligned Capital Partners Inc slash ACPI.

[00:16:09] Only investment related products and services are offered through ACPI or awaken investments of ACPI and covered by the Canadian investor protection fund. Tax planning, financial planning, and insurance services are provided through Awaken Wealth Management Ltd. Awaken Wealth is an independent company separate and distinct from ACPI or Awaken Investments of ACPI.

[00:16:31] Awaken Wealth are not licensed tax professionals and you should consult with your tax advisor before acting on any recommendations. Investments and investing strategy should be evaluated based on your own objectives. Listeners of this podcast should use your best judgment and consult a financial expert prior to making any investment decisions based on the information found in this podcast.