RRSP Basics for Canadians

Part of Personal Finance For Canadians For Dummies Cheat Sheet

For almost all Canadians, a Registered Retirement Savings Plan (RRSP) is the single best, easiest, and most efficient way to save for retirement. An RRSP also offers one of the best ways to reduce the amount of tax you pay.

The benefits of RRSPs

When you open an RRSP, you’re making a deal with the government. By “registering” your retirement savings plan, you agree to put money away for your retirement and not spend it. In return, the government gives you two valuable benefits:

  • Money that you contribute to your RRSP is deductible from your taxable income. This means that any income you contribute to your savings plan is not taxed. Say you earn $50,000 a year, and contribute $5,000 to your RRSP. If you claimed that $5,000 as a deduction on your tax return, your income tax would be calculated as though you had made only $45,000 that year.
  • The government lets the savings in your RRSP grow tax free. Any profits you earn on investments inside your RRSP aren’t taxed until you close your plan and withdraw the funds. When interest and earnings on investments aren’t taxed, the full value of your gains is added to the original amount. This new, larger amount then earns further gains, which again are added to, or compounded with, your existing investments. This phenomenon is called compound growth, and over time it will lead to your retirement savings growing exponentially.

Maximizing your RRSP’s growth

You can maximize the growth of your RRSP in two simple steps:

  • Begin contributing as early as you can — and are eligible to — in life. The longer you have money in an RRSP, the more time your savings have to compound. Even if you’re just 25 and you have only $1,000 to spare, put it in an RRSP! If you earn an average of 10 percent a year, you’ll have an extra $45,000 in your plan when you retire at 65.
  • Try to maximize your RRSP’s returns. Choosing appropriate investments is critical to maximizing the growth of your RRSP. And the more years you have before you have to collapse your plan, the larger the impact of boosting your returns by even just 1 percent or 2 percent.