Working-age Canadians are not unfamiliar with the concept of Registered Retirement Savings Plan, or better known as RRSP. It was designed as a tax-deductible savings account where workers can save for their future.
People cannot rely on payments from Canada Pension Plan to keep their living standard in retirement. Old Age Security, Guaranteed Income Supplement and CPP are all meant to maintain a minimum living standard. A better choice will be to set money aside while one works and use that with any earnings during retirement.
RRSP serves that purpose well.
What is RRSP?
Any income earned in the RRSP is usually exempt from tax as long as the funds remain in the plan; generally, the taxpayer has to pay tax when he/she receives payments from the plan.
Read more about RRSP here. For more information on RRSP, please visit Canada Revenue Agency website, or engage the services of a professional in financial/retirement planning at your financial instituation.
Within a certain contribution limit, all contributions are tax-deductible, and any income (interests, dividends, capital gains, etc) in an RRSP account can be earned tax-free. When that money (both contributions and earnings) is withdrawn from that account, it will be included in one’s income and will be subject to taxes.
Advantages of RRSP Over Non-RRSP Savings Options
So what’s the point of an RRSP, if the money is going to be taxed anyway? There are a few advantages for having an RRSP over a non-RRSP account.
First, contributions are tax-deductible, which means no income taxes are payable on the amount of income that is contributed to an RRSP account. The higher the income, the bigger the tax savings, since the deduction saves taxes at the marginal tax rate. Money in an RRSP account only becomes taxable when withdrawn during retirement, when the taxable income is likely lower.
Second, investments within an RRSP grow tax-free, so long as the investments meet eligibility requirements. Tax-Free Savings Account, or TFSA, has the same feature. (For more on TFSA, visit the TFSA page. For a comparison between RRSP and TFSA, follow this link. )
Disadvantage of RRSP
It must be noted that all the withdrawals from an RRSP account will be taxable (other than withdrawals through a few programs, like Lifelong Learning Plan, or Home Buyers’ Plan). The income taxes owed at the time of withdrawal, if occurred during the retirement, would normally be lower, but individual circumstances should be taken into account while making financial and retirement planning decisions. For more information on this topic, please see my discussion on the choice between TFSA and RRSP.
Labour-Sponsored Funds Tax Credit
Labour-Sponsored Funds Tax Credit is less well-known, but it can be a very powerful tool to better prepare for retirement. The Labour_sponsored Funds Tax Credit is made available by the federal government and some provincial governments (some have cancelled the credit) to encourage Canadians to save for their retirement by contributing to Labour Sponsored Venture Capital Corporations (LSVCC), by providing extra tax credits on top of the regular tax savings on contributions into an RRSP account. The largest and most well-funded such Labour-Sponsored Venture Capital Corporation is the Fonds de Solidarite FTQ which had assets under management of over 11 billion dollars at their last year end of May 31, 2015.
The last Conservative government moved to phase out the credit, arguing that the funds had generally performed relatively poorly, and that those funds compete with private investment, potentially hurting the development of new companies in the areas where they operate.
The Liberals, as well the NDP, however, had vowed to fully restore the credit if they won the election. Now that the Federal liberals are governing, they have determined to include the reestablishment of the Labour-Sponsored Funds Tax Credit in their next budget.
The return of those funds tend to be lower as a big percentage (in the case of such funds in the province of Quebec) of the funds are required to be invested in no-guarantee venture business. But combining the moderate returns of those venture capital investments with the tax savings, the return on the contribution could be substantial over the short term. For someone a few years away from retirement, the investments into a Labour-Sponsored Venture Capital Corporation could be double digit returns over several years.