RSP vs. RRSP: What’s the Difference Between the Two Retirement Plans?

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rsp vs rrspI hear it all the time: “What’s an RRSP?” and “I have to buy RSPs before the deadline!” I once thought these terms could be used interchangeably, but there is a difference between an RSP vs. RRSP. This article will explain what makes these two terms unique, and how they overlap.

What is an RSP Account?

An RSP stands for Retirement Savings Plan. It can signify a number of different accounts that you can use to save for retirement. An RRSP – or Registered Retirement Savings Plan – is just one of several accounts that fall under the RSP umbrella.

So, an RRSP is an RSP; but an RSP doesn’t necessarily refer to an RRSP. Got it? How meta.

Other registered savings plans include accounts such as the TFSA (tax-free savings account), a registered pension plan (RPP), which include defined benefit pension plans and defined contribution pension plans, and non-registered (or taxable) accounts.

Can You Claim RSP on Income Tax?

It depends on where you put your money. When you contribute to an RRSP, you receive a tax deduction that lowers your net income by the amount of your contribution. Not all RSP contributions, however, allow you to claim a tax break.

The easiest example is a contribution to your TFSA. These are made with after-tax dollars, so the contributor does not receive an immediate tax benefit. The advantage comes later when it’s time to withdraw the funds. Any growth inside your TFSA is tax-free, and it is tax-free upon withdrawal as well.

Contributions to non-registered investments don’t receive any tax benefits either. For that reason, most investors tend to max-out their available RRSP and TFSA room before opening a non-registered account for investing purposes.

While you cannot claim a tax deduction for contributing to a non-registered RSP, there are other tax breaks, such as capital gains only being taxed at 50% of the investor's marginal tax rate. On the other hand, capital losses can be used to offset capital gains – carried back three years and forward up to 10 years.

Registered Pension Plans (RPP) contributions do impact your RRSP contribution room through something called the pension adjustment (PA). Each year, your pension contributions and pension adjustment are reported on your T4 slip to Canada Revenue Agency, who will advise you of the maximum RRSP contribution you can make each year.

So, can you claim an RSP contribution on your income tax? Here's the break down to help you remember:

RSPTax Deduction?

RRSP: All You Should Know

Any Canadian who has earned income can and should file a tax return to start building RRSP contribution room. You can contribute to an RRSP until December 31st of the year you turn 71.

Contribution room is based on 18% of your earned income from the previous year, up to a maximum contribution limit of $26,500 for the 2019 tax year. If you cannot use up your entire RRSP contribution room in a given year, fear not – unused contribution room can be carried forward indefinitely.

However, watch out for over-contributions, as the taxman levies a stiff 1% penalty per month for contributions that exceed your deduction limit. The good news is that the government built in a safeguard against possible errors and so you can over-contribute a cumulative lifetime total of $2,000 to your RRSP without a tax penalty.

Find your RRSP deduction limit on your latest notice of assessment or view it online using CRA’s My Account service.

Claim a tax deduction for the amount you contribute to your RRSP each year to reduce your taxable income. Note that just because you made an RRSP contribution doesn’t necessarily mean you have to claim the deduction in that tax year. It might make sense to wait until you are in a higher tax bracket to claim the deduction.

When the time comes to open an RRSP, our top choice for a robo advisor is Wealthsimple. With their low fees, excellent customer service, and easy-to-use platform, Wealthsimple makes investing and retirement planning a cinch. You can also take advantage of our exclusive promotion and get $10,000 managed for free for a year when you start investing with Wealthsimple.

Why Contribute to Your RRSP

There are two no-brainer reasons to contribute to an RRSP. One, when your employer offers a matching program of any kind – such as with a group RRSP. Check if your employer offers an RRSP match and aim to take full advantage. For instance, some companies match up to 3% of salary for employee contributions. Say you make $60,000 per year? That means your employer will match RRSP contributions up to $1,800. Don’t turn down free money.

The second reason it makes sense to contribute to an RRSP is when it’s obvious you’re in a higher tax bracket now than you’ll be in retirement. RRSPs work best as a tax-deferral strategy, meaning you get a tax deduction on your contributions today and your investments grow tax-free until it’s time to withdraw the funds in retirement, a time when you’ll hopefully be taxed at a lower rate. So contributing to your RRSP makes more sense during your high-income working years rather than when you’re just starting out in an entry-level position.

RRSPs work best when you consider how contributions and withdrawals will benefit you the most from a tax perspective. A great option for getting started is opening an RRSP account with Nest Wealth, one of the best robo advisors in Canada. There's no minimum investment amount and they offer sophisticated, personalized portfolio management for as little as $20/month. Plus, you can try Nest Wealth FREE for the first 3 months when you open an RRSP.

The Difference Between RSP vs. RRSP

We’ve touched on how RSP is an umbrella term for retirement savings plans that include RRSPs, but also many other kinds of accounts. Here’s a quick overview of those accounts and how to use them to save for retirement:

RRSPs For Retirement Savings

The cornerstone of retirement planning for Canadians, RRSPs have been around now for more than 60 years. Your goal as an investor with a decent (and hopefully rising) income is to max out your RRSP contribution limit each year. While it’s tough to get there in your early working years, all that unused contribution room carries forward and can be used in your higher salary years.

I caught up my unused RRSP contribution room with a couple of year-end bonuses, plus a few years of forced automatic contributions designed to max-out all that available room. The contributions were key to lowering my net income in those higher income years, thanks to the RRSP tax deduction.

Once your savings rate is higher, it should be much easier to max-out the deduction limit of 18% of your salary. Where do you park any extra savings? Let’s move on down the list.

TFSAs for Retirement Savings

Every Canadian 18 years or older should open a TFSA and try to save the annual contribution limit (currently $6,000 in 2019, but it varies year-to-year). Like RRSPs, any unused TFSA contribution room carries forward into future years. So, if you haven’t been able to max out your room each year, there is still time to catch up in future years.

Many people use their TFSA for safe investments and short term, emergency fund-like savings. That’s perfectly fine, but know that you can use your TFSA as a retirement savings plan as well. Inside you can hold a myriad of investments, including stocks, mutual funds, and ETF investing.

Remember, no tax deduction for a TFSA contribution, but you won’t be taxed on any gains inside your TFSA or pay taxes when you withdraw the money later.

Non-Registered Accounts for Retirement Savings

Once you’ve maxed-out both your RRSP and TFSA accounts, it’s time to look at opening a non-registered investment account and using it to save for retirement. You can open a non-registered account at any discount brokerage (our favourite for the DIY investor is Questrade), fund it from your chequing account, and start trading stocks or ETFs.

Note that you will not receive a tax deduction for a contribution to a non-registered RSP, so plan accordingly. There can be favourable tax treatment inside, such as capital gains, capital losses, and the dividend tax credit.

Yes, many Canadians invest in blue-chip dividend paying stocks inside their non-registered investment account, specifically to take advantage of the dividend tax credit, which taxes dividends more favourably.

RPPs for Retirement Savings

While defined benefit pensions are declining, defined contribution plans are on the rise. Like RRSPs, both plans offer tax breaks for contributions and they will affect your RRSP deduction limit.

I work in the public sector and pay into a defined benefit plan. My contributions lower my net income for tax purposes but also reduce my available RRSP contribution room to around $3,600 per year rather than 18% of my salary.

If you and your employer contribute to a defined contribution pension plan, then know that your employer’s contributions also count as your own for tax purposes and will impact your available contribution room.

Final Thoughts

So now you know that an RRSP is a type of RSP, but the two terms shouldn’t be used interchangeably. Falling under the umbrella of RSPs are RRSPs, but also other accounts such as TFSAs, non-registered accounts, and RPPs – which include pension plans. An RRSP is only one type of retirement account – one in which you can only contribute the lesser of 18% of your salary or $26,500 (in 2019), but also the one that offers a tasty tax deduction.

The lesson here? All RSPs can serve a purpose in your retirement planning, and your best bet is to spread out the savings as much possible. That way, you can rest easy knowing that all your bases are covered for your golden years.

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Robb Engen
Robb Engen is a leading personal finance expert in Canada and the co-founder of Boomer & Echo, an award-winning personal finance blog. He writes a monthly column in the Toronto Star’s Smart Money section and is a fee-only advisor who helps Canadians at different ages and stages get their finances on track and prepare for retirement. He's also regularly quoted or featured in top financial media, such as the Globe & Mail, MoneySense, the Financial Post, CBC, and Global News. Robb lives in Lethbridge, Alberta and is the married father of two young girls who keep him very busy.
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