When working Canadians save for their retirement, they usually put money into a registered retirement savings plan, or RRSP. Like the IRAs used by Americans, they're an example of the government playing Santa Claus to investors. Not only are investments in an RRSP allowed to grow tax-free, the Canada Revenue Agency allows a tax deduction for contributions. However, there's a limit to any government's largesse – and RRSPs do have some notable limitations.
Evaluating Contribution Limits
One disadvantage of RRSPs for high-income Canadians, or anyone with a financial windfall to invest, is the limit on contributions. RRSPs were created to help Canadians of ordinary income build a comfortable retirement, not to help the affluent evade taxation. The contribution limit in any given year is a set dollar amount or a percentage of earned income, whichever is lower.
For the 2019 taxation year, for example, the maximum contribution was $26,500. Taxpayers with unused contributions from previous years can carry them over, and there's a lifetime $2,000 exemption for over-contributions. However, high earners can easily maximize their RRSP contributions and will need to find other investment options.
Restricted Range of Investments
Outside of an RRSP, your investment options are limitless. As long as you're confident you can buy it low and sell it high, anything from stuffed toys to vintage cars can be thought of as an investment. With RRSPs, many items of tangible but uncertain worth, such as jewelry, gold and artworks, are ineligible. So are mortgages and privately held companies, unless you're an "arm's length" investor.
That means it can't be your mortgage or a family member's, or in the case of a company, it can't be one you have a personal interest in or own more than 10 percent of.
Understanding Liquidity and Penalties
One key factor in any investment decision is how much liquidity you'll give up. Liquidity means the ability to move your money in and out of investments whenever you need to, without lengthy waiting periods or financial penalties. RRSPs withdrawals are considered taxable income in the year they're made, so they're going to cause you some pain at tax time – especially if they nudge you into a higher tax bracket.
The institution managing your RRSP will automatically withhold 10 to 30 percent of your withdrawal as a tax prepayment, depending on its size. You'll need to calculate and remit any further taxes as needed.
Exploring Retirement Complications
RRSPs can also have a few disadvantages at retirement time, when they're supposed to be making your life easier. By law, you'll have to convert your RRSP to a Registered Retirement Income Fund by the time you're 71 and start taking a minimum income from it. You might find that your income puts you in a higher tax bracket than you'd like, especially if you're still working or have other income.
Depending on your income and tax bracket, the government might also grab back part of your Old Age Security payments, which will offset some of the benefits of your RRSP investments.
Fred Decker is a trained chef and certified food-safety trainer. Decker wrote for the Saint John, New Brunswick Telegraph-Journal, and has been published in Canada's Hospitality and Foodservice magazine. He's held positions selling computers, insurance and mutual funds, and was educated at Memorial University of Newfoundland and the Northern Alberta Institute of Technology.