What is a Registered Retirement Savings Plan (RRSP) deduction?
A registered retirement savings plan deduction is the maximum amount that a Canadian taxpayer can contribute annually to a savings plan and deduct from taxable income for that year.
Generally, the amount is 18% of the taxpayer’s earned income for the previous year, up to an annual limit. For fiscal year 2020, the RRSP limit was $ 27,230. By 2021 it went up to $ 27,830 and by 2022, to $ 29,210.
An individual’s contribution limit can be determined by completing Form T1028, which is available online.
- An RRSP deduction is the maximum amount a taxpayer can invest in a retirement account and deduct from income tax for that year.
- Generally, the maximum is 18% of previous year’s earned income, with a limit that is reviewed annually.
- Taxpayers can contribute less than the maximum, but it is in their best interest to take advantage of the higher tax break.
Understanding the RRSP Deduction
Anyone can, of course, contribute less than the maximum allowed. As this is a deduction from taxable income, it is best for the taxpayer to save as much as possible to minimize the amount of income subject to personal income tax.
How an RRSP works
A Canadian taxpayer can establish a registered retirement savings plan through a financial institution such as a bank, credit union, trust, or insurance company. The financial institution advises its clients on the types of RRSPs and available investments.
Married people, in particular, have decisions to make. A Canadian government site notes that couples can establish a spousal or de facto RRSP to ensure that their retirement income is divided evenly between both partners.
A self-directed RRSP allows the investor to make their own investment decisions, buying and selling at will.
The greatest benefit is achieved if the higher-income partner contributes for the lower-income partner. In that case, the taxpayer will obtain the immediate benefit of the tax deduction for the contributions of that year. But the beneficiary, who will likely be in a lower tax bracket during retirement, will receive the income and report it.
If you prefer to take care of your own investments, you may want to set up a self-directed RRSP. This type of plan allows you to create and manage your own investment portfolio by buying and selling any of a variety of investments.
Generally, the money you invest in your RRSP account and the returns on that investment are tax deferred until you cash it out, make a withdrawal, or receive a payment from the plan. In most cases, it should be after your retirement.
Locked or unlocked
RRSP plans can be blocked or not blocked.
The locked retirement account, or LIRA, is similar to a company or government pension plan. Only the employer can contribute money to the account. Pre-retirement withdrawals are not allowed and post-retirement withdrawals are paid in regular installments, like an annuity. (Some provinces allow some hardship withdrawals).
An unlocked plan allows withdrawals at any time, except that you will owe income taxes for that tax year.
In any case, RRSP contributions are made directly to the RRSP issuer.