The Registered Retirement Savings Plan, commonly called the RRSP, is the most tax efficient way for Canadians to save for retirement. It is the only way for you to invest your savings and potentially save a significant amount of money in income taxes over the course of your lifetime.
Unfortunately with the onset of a newer registered account, the Tax Free Savings Account, a growing number of Canadians are completely disregarding the power of the RRSP.
Make no mistake. While the TFSA is also a great way to invest and save money on taxes with very little complexity, nothing beats a RRSP that is properly structured with an appropriate exit strategy.
Contents of RRSP Guide
- What is a RRSP Exactly?
- Basic Tax Structure
- When Should I Contribute to a RRSP?
- RRSP Contribution Limits
- When Should I Withdraw from a RRSP?
- When to Avoid Using a RRSP
- Spousal RRSP
- Holding Your Own Mortgage
- "Tax-Free" RRSP Withdrawals
- Non-residents and RRSPs
- Dying with a RRSP
What is a RRSP Exactly?
A RRSP is an investment account that defers your income taxes to a later date and protects your investment returns within your RRSP from taxation.
This means, once you adjust for the tax savings on contributions, you can contribute more to an RRSP than any other account; you can invest the RRSP in many different types of investments without any impact on your income taxes; and you need to carefully consider how you withdraw money from your RRSP in the future as you will need to pay taxes on those withdrawals.
It is important to understand that a RRSP is not something you buy from a bank. It is a flexible investment account with special tax privileges. You can manage your own RRSP via a self-directed brokerage account like Questrade, you can hire an advisor to manage your RRSP investments on your behalf, or you can engage a trustee to secure certain RRSP investments.
You can use your RRSP to invest in a wide variety of qualified investments. Your RRSP can hold publicly traded stocks, bonds, listed options, GICs, ETFs, REITs, mutual funds, mortgages packaged within a mortgage investment corporation, a mortgage on your own house using a mortgage trustee, precious metals, certain foreign currency exchange investments, and small business shares in limited cases.
A RRSP account is flexible and extremely powerful. You should aim to make good investment returns at your appropriate risk level.
Basic Tax Structure
The tax structure that makes the RRSP unique from other investment accounts can be a little complex to understand. This might be one reason why many Canadians are no longer using it. With this explanation I hope you understand how RRSPs work and how they can save you a substantial amount of money over the course of your life.
- You contribute to an RRSP account with pre-tax income.
- At tax time, you can deduct the dollar amount you contribute to your RRSP account from your top line income. This can save you up to 54% income tax on that contribution depending on your province and income level.
- For example, if you contribute $10,000 to your RRSP and you are in the 54% income tax bracket, you will receive a tax refund of $5,400 when you file your taxes.
- You do not pay taxes on investment income earned within your RRSP account.
- When you invest, you will likely be generating investment income such as dividends or interest payments. You may also realize capital gains when selling your investments at a profit. Any income or profit earned within your RRSP account is not reported and is not taxed.
- For example, if you earn $100,000 a year at work, your RRSP investments earned interest income of $5,000, and you sold an investment in your RRSP for a profit of $25,000, you only need to report and pay taxes on the $100,000 you earned at work. You do not report or pay tax on any investment income earned within your RRSP account.
- Money you withdraw from your RRSP account is taxed as regular income.
- Only when you pull money out of your RRSP do you need to report it and add it to any other income you earned that year.
- RRSP withdrawals are taxed at the same tax rates as regular income. Try to withdraw smaller amounts of money in years where you are in a low tax bracket.
- For example, if you withdraw $10,000 from your RRSP and you are in the 25% tax bracket, you will pay $2,500 in income taxes. This translates to a net withdrawal of $7,500.
You can think of your RRSP as an investment vehicle where you defer your taxes to later years and you pay no taxes on any investment income you receive in your RRSP as long as it remains in the vehicle.
Understanding the tax structure is very important and can help you decide when you should contribute to your RRSP and when you should withdraw money from your RRSP account.
When Should I Contribute to a RRSP?
Every Canadian should open and contribute to their RRSP account if they are earning moderate to higher levels income and are investing money for good returns.
You should contribute to a RRSP if you are earning an income that places you in the 30% tax bracket or higher. The higher your tax bracket is while you contribute to your RRSP, the more you financially benefit from contributing to a RRSP.
You should also contribute to your RRSP if you prefer investments that are oriented to higher taxed investment income. For example, interest income is normally taxed at your marginal tax rate. Every dollar of interest income you earn can be taxed at up to 54% depending on your other income and your province of residence. This means your real after-tax returns are significantly lower than your listed returns.
If you invest in interest bearing investments within your RRSP account, such as bonds or mortgages, you will pay absolutely no taxes on that income while it is in your RRSP account. This means you can compound your returns at much higher rates, growing your wealth substantially faster than you would be able to outside of a RRSP account.
You should only contribute to your RRSP account if you have a plan to withdraw that money at low tax rates. This will ensure you can benefit financially from the spread in tax rates as well as the deferment of taxes on your investment returns.
If you are contributing to your RRSP account, do not forget to gross-up your contributions. This means you are taking the money you save in tax by contributing to your RRSP and adding those tax savings back into your RRSP account. To make investing in your RRSP worthwhile and better than investing in a TFSA, you must also invest the money you save on taxes.
To make this process easier, complete a Form T1213 with Canada Revenue Agency every year. Once approved, your employer is authorized to reduce tax withholding on your paycheque immediately; your paycheques will be larger and can put those savings straight into your RRSP account.
RRSP Contribution Limits
If you decide that contributing to a RRSP account is right for you, make sure your contribution stays within the contribution limits.
Every Canadian who is eligible to open a RRSP account can contribute as much as 18% of their earned income in the preceding year to a maximum annual increase of $26,500 in 2019. This amount is reduced by any contributions to pension plans and deferred profit sharing plans.
You can find out your RRSP contribution limit for the current year by registering and logging into My Account online with Canada Revenue Agency, by referring to your latest Notice of Assessment, or by calling Canada Revenue Agency.
Any contribution room you do not use is rolled forward to the next year. If you have not contributed to a RRSP or pension plan in a long time, your current contribution room may be substantial.
In addition to your contribution limit, you may contribute an extra $2,000 to your RRSP without any penalties. This is running total amount, you cannot contribute an extra $2,000 each year.
Overcontributions to your RRSP are penalized at a rate of 1% per month. It is important to monitor your contributions and make sure you do not run over your contribution limit.
It is particularly important to monitor your RRSP contributions if you are contributing to your personal RRSP and to a Spousal RRSP. As the contributor, your combined contributions to each account cannot exceed your contribution limit. If you contribute to a Spousal RRSP benefiting your spouse, your contribution has no impact on your spouse's contribution limit.
When Should I Withdraw from a RRSP?
If you have a RRSP account, you should have a plan to withdraw money from your RRSP when paying as little tax as legally possible. Investing through a RRSP only makes sense if you are contributing money to the account at a higher tax than when you withdraw money from the account.
The RRSP was primarily designed as an account where Canadians can save for retirement. This is still a great use case for the RRSP. Most Canadians earn more money when they are in their working years than they spend in their retirement years.
If you have contributed to a RRSP during your working years, it is generally best to convert part, or all, of your RRSP to a Registered Retirement Income Fund (RRIF) before taking out income in retirement. In any event your entire RRSP must be converted to a RRIF in the year you turn 71, or it must be withdrawn and will be taxed as regular income.
An RRSP can also be very useful if you are employed in an industry with very cyclical environments. These tend to be concentrated around resource sector employment and certain areas of construction work.
Cyclical sector jobs tend to pay very well when you are working. It is not unusual to find yourself in very high tax brackets for several years in a row when your skills are in high demand. This is a fantastic time to contribute as much as you can to your RRSP.
However, these sectors also go through busts where you might earn very little for a year or two. A well-funded RRSP will help you get though the lean years, withdrawing money at lower tax rates.
If you are employed in cyclical industries, you can strategically use your RRSP to fund your lifestyle through the down cycles and save yourself a significant amount of money overall in taxes.
Another great use case for RRSPs is when you are planning on staying home and raising children while they are young. If you contribute to a RRSP when you are working, you can later withdraw from a RRSP when you are a stay at home mom.
This is particularly advantageous if you are a higher income family that will see reduced government child benefits. These benefits are paid as non-taxable income and do not affect your tax rates on RRSP withdrawals.
Not many people have the luxury of taking sabbaticals, also called mini-retirements in some circles. However, a planned sabbatical can be a great benefit for your personal and professional life. You can develop yourself, work on new skills, train for new types of employment, look after your kids, and so on.
Withdrawing money from your RRSP when you are not working is almost always a good idea. If you have a well-funded RRSP account, you might be able to take a sabbatical that otherwise is only a luxury for few people in academic careers.
Home Buyers' Plan
The RRSP Home Buyers' Plan is a popular way to help fund a downpayment on a house if you have never owned a home before, or haven't owned a home for the past four years.
You can quickly boost your downpayment amount by contributing to your RRSP account, collecting the tax deduction, and borrow the money back under the Home Buyers' Plan 90 days later.
The Home Buyers' Plan technically is not a withdrawal from your RRSP. Instead, it is an interest-free personal loan made to you from your RRSP account for the specific purpose of buying or building a house. You must pay back your RRSP within 15 years according to a defined payment schedule. If you don't make the payments, the outstanding Home Buyers' Plan required payment will be treated as a RRSP withdrawal and taxed as regular income.
Currently the Home Buyers' Plan allows you to withdraw up to $35,000 per person with a RRSP. This means a couple can withdraw up to $70,000 to buy a house together.
Lifelong Learning Plan
If you are studying full-time in Canada the government allows you to borrow money from your funded RRSP free of interest under a program called the Lifelong Learning Plan. You can even contribute to your RRSP, collect the tax deduction, and borrow it back under the Lifelong Learning Plan 90 days later.
Under the Lifelong Learning Plan you can loan yourself up to $20,000 total for education reasons. You do not need to justify where the money goes, you only need to meet the qualifications of taking full-time education at a qualifying education institution in Canada while you are a Canadian resident. You may even use your RRSP to fund a spouse's education under the Lifelong Learning Plan.
The maximum loaned withdrawal you can make in a single year under the Lifelong Learning Plan is $10,000. So it is most efficient to complete your education in two years—about the right time for a Master's degree or upgrading to a Bachelor's degree.
After you complete your education, you must repay the borrowed money in ten equal payments over ten years. If you don't make the required annual repayments, the outstanding payment amount is added to your income and taxed as a withdrawal from your RRSP.
If you are taking full-time education as an adult you are in a sabbatical situation. This is another great opportunity to withdraw from your RRSP account. Chances are you will be earning a lot less income while you are studying, so you are typically able to withdraw money at low tax rates.
When to Avoid Using a RRSP
There are a few common situations when one should avoid using a RRSP account. This means you should either not open and contribute to a RRSP account at all, or you should be extremely cautious about how much you will be contributing to your RRSP account and how large you will allow it to grow.
Instead, consider using a Tax Free Savings Account (TFSA) and/or Non-registered Investment Account to save and invest.
Low Income Earners
You might be one of a number of Canadians who earn a low level of income, meaning you are in the first federal tax bracket, but spend less than what you earn so you can still save and invest money regularly.
If this sounds like you, you should avoid contributing to a RRSP since there is little to no tax benefits in doing so. Even worse, you may be penalized when making withdrawals from your RRSP as it will likely reduce your eligibility for low income benefits and subsidies. These can range from the Guaranteed Income Supplement (GIS) to pharmacy and dental care subsidies to low income housing subsidies.
It may sound strange since you are a low income person, but in certain low income situations you can find yourself facing effective tax rates of 70% or higher on RRSP withdrawals.
Remember, you should only contribute to a RRSP if you are making those contributions in a 30% or higher tax bracket and you have a plan to withdraw money from your RRSP at low tax rates.
High Pension Income Earners
You could be one of the many Canadians who will be earning a large income in retirement. Often, it will be forms of income where you have little control over your tax situation. By this I generally mean people with large anticipated pensions, but the same could also apply to certain owners of small business corporations.
If you have the kind of job where you are planning to work for the government or a regulated utility for 35 or 40 years, and are contributing to a well-funded pension plan all the way through, you should be very careful contributing to and growing a large RRSP account. This is true even if you are contributing while you are in a high tax bracket.
The most lucrative pensions will pay 70% or more of your base salary for life in retirement. There are often higher top-ups if you are, or you will be, in a management position. You have little to no control over these payments. They simply come in every month and are fully taxed as regular income. If you earn a high salary, the pension income alone can lead to recovery clawbacks in Old Age Security (OAS) benefits.
If, in addition to your pension, you have a large RRSP, you will be forced to make withdrawals from your RRSP account at extremely high tax rates. With the OAS clawbacks factored in, effective tax rates can easily exceed 60% on your RRSP withdrawals.
Saving for High Cost Purchases
It is unfortunately common to hear people who are very critical of RRSP accounts, often complaining about taxes they had to pay on withdrawals from their RRSP account. This is generally because they did not understand how RRSP accounts work in the first place. They did not have a low tax withdrawal plan in place before contributing to a RRSP account.
You should never contribute to your RRSP just so you can collect the tax refund. The tax refund you receive now, or at least a portion of it, must be paid later when you withdraw from your RRSP account. Ideally you should use your RRSP tax refund to increase your RRSP contributions, or contribute to your TFSA or non-registered investment account.
Never use your RRSP to make withdrawals, particularly large withdrawals, in years where you are earning a large amount of other income. This includes withdrawals to start a business, buy a house (outside of the Home Buyers' Plan), buy a boat or RV, pay off an outstanding loan, or anything else. Withdrawing from your RRSP while you are also earning other income can lead you to pay tax rates up to 54% on those withdrawals.
Contributing to your RRSP is part of a strategy to save tax, defer tax, and shelter your investments from tax so your wealth can can grow at higher rates. Have a low tax RRSP withdrawal plan!
If you are married or have a common-law partner, you may also open and contribute to a Spousal RRSP account in addition to your personal RRSP account.
A Spousal RRSP account is a special RRSP that allows the contributor to deduct the Spousal RRSP contribution from their income, but only the beneficiary (the spouse or common-law partner) can later withdraw from the account and claim the withdrawal as their income.
The only catch is that the withdrawal must be made at least two tax years following the last contribution to the Spousal RRSP account. This means if you make a contribution to a Spousal RRSP in 2016, your spouse should not withdraw money from the account until 2019 or later.
Based on this design, Spousal RRSP accounts allow for unique opportunities to split income between two spouses. They are particularly useful if you and your spouse have very uneven levels of income, or if you plan to have uneven levels of income in the future.
If you use a Spousal RRSP setup for your finances, it does generally require some foresight and planning. This is particularly true if you are planning to use a Spousal RRSP before retirement.
One of the best ways to use a Spousal RRSP is to smooth income and significantly reduce overall family taxes when one spouse decides to stay home and raise the family children for several years. Before children, the higher income spouse can contribute to a Spousal RRSP and lower income spouse to their personal RRSP (while they are still working). Once the children come, the higher income spouse stops contributing to the Spousal RRSP and the stay-at-home spouse can withdraw money from their personal RRSP for several years. After three years has passed, the stay-at-home spouse can begin withdrawing from the Spousal RRSP.
Holding Your Own Mortgage Within Your RRSP
One of the more interesting use cases for your RRSP is to hold your own mortgage. You can legally use your RRSP to fund your house purchase or refinancing and become your own bank. However, there are a large number of rules surrounding the structure and safeguards in place to ensure it is all done correctly.
Holding your own mortgage is called a self-directed RRSP non-arms length mortgage. This is a fancy term that means your RRSP has a close relationship with you, as the account holder, so you need to abide by special rules to ensure you are not abusing your RRSP account.
This may sound complex, but it isn't. All you have to do is hire an approved trustee service to manage the paperwork for you and administer the mortgage terms. Some common trustees who offer this service include Canadian Western Trust, TD Bank (Canada Trust), and B2B Trustco. Contact them for all the information you need, and don't be surprised if you need to push a little beyond the sales pitches; after all, they make their real money selling you mortgages.
Your trustee makes sure you follow the standard rules that apply for all commercially available mortgages. You will probably need to get a professional house appraisal, you must maintain a loan-to-value ratio of 90% or less, you must obtain mortgage insurance from CMHC or Genworth Financial to protect your RRSP against default losses, you must choose mortgage terms that are in line with publicly available mortgages, and you have to demonstrate your credit worthiness through credit checks, income verification, and so on.
The fees to establish a self-directed RRSP non-arms length mortgage are not cheap, but also not that extravagant considering the money you will save on interest expenses. The trustee will charge around $500 to do the initial setup and paperwork. The property appraisal will cost about the same amount. Your mortgage insurance costs depend on your loan-to-value ratio, but can cost several thousand dollars. Finally, the ongoing fees charged by your trustee will run around $200 per year. There are also fees for rolling over your mortgage to a new term, requesting certain paperwork, and so on.
If you have sufficient equity in your home and your RRSP balance is large enough to make holding your own mortgage worthwhile, you may be able to deduct the setup costs, interest costs, and administrative fees from your taxes. To do this, you will need to establish a non-arms length mortgage against your equity. Your RRSP, via your trustee, will essentially write you a cheque for the mortgage amount. You will need to deposit this money into a non-registered investment account and use the money to buy stocks which pay a dividend. This will ensure your RRSP non-arms length mortgage is also an investment loan.
Once it is all established, you will make bi-weekly or monthly payments to your RRSP as per your chosen mortgage terms. Your RRSP collects the interest and over time your principal balance is reduced, just like a standard mortgage. Don't forget to regularly invest the money in your RRSP as you make your mortgage payments!
Over the course of a standard 25 year mortgage amortization, you can save yourself hundreds of thousands of dollars in interest costs by funding your own mortgage through your RRSP. This is money otherwise lost to the banks.
Some Interesting Notes
Holding your own mortgage within your RRSP is not a creative way to begin financial shenanigans. Your trustee is legally obliged to ensure you make your payments on time as required. If you don't make your payments, your trustee is required to initiate a foreclosure process on behalf of your RRSP. Your RRSP will take possession of your house and your trustee will sell it on their terms within one year. As you might expect, the fees your trustee charges for this process are very substantial!
Try choose common mortgage term lengths, such as five years. This will save you money in fees as the trustee charges you for rolling over your mortgage and setting a new term.
Except in very special situations (see down below) do not charge yourself high interest rates by selecting a longer term mortgage. It is not ideal to grow your RRSP significantly in this manner because you will pay taxes on RRSP withdrawals eventually. It is generally best to choose the lowest five year discount mortgage rate you can find and would qualify for.
You can use a RRSP non-arms length mortgage to purchase certain multi-family income properties. You must reside in one of the units, the property cannot have more than four units in total, and you must meet the other standard terms for this kind of loan. This could be a great way to fund a duplex or tri-plex property where you are your own onsite property manager.
"Tax Free" RRSP Withdrawals
There are a few ways you can withdraw money from your RRSP account and pay effectively no taxes on those withdrawals. If you understand the RRSP account structure, this is an ideal situation. It means you contributed to your RRSP with pre-tax income and are withdrawing from your RRSP paying no tax. In addition, you did not declare or pay taxes on any of the gains within your RRSP account.
Basic Deductions & Dividends
If you have no other income, you can withdraw as small amount of money from your RRSP account completely tax free once you adjust for the basic personal deductions. The federal basic deduction amount is $12,069 in 2019. A couple, each with their own RRSP account can withdraw over $24,000 tax free.
In addition, if you meet the age amount requirements, you can withdraw an additional $7,494 per person tax free. This now adds up to $19,563 per person or $39,126 as a couple.
Within pension qualifications, you get an additional $2,000 per person. Effectively, as couple in retirement with the adequate RRSP structure you can withdraw over $40,000 completely tax free from your RRSP accounts provided you have no other taxable or declared income.
Several Canadian provinces have a negative tax rate on dividends paid by eligible Canadian corporations when these investments are held in a non-registered account and you are in the lowest tax bracket. You can use these negative tax rates to offset any taxes owed on RRSP withdrawals.
This effectively means a retired person with $21,563 in RRSP withdrawals and no other income can also receive approximately $15,000 in eligible dividend income and pay no tax. In an ideal situation with the ideal structure, a couple could have a tax free income exceeding $73,000.
These scenarios are rare because they would require incredible planning, foresight, and absolutely zero changes to tax rules over the course of your lifetime, but it does demonstrate that it is theoretically possible to withdraw a substantial amount of money from your RRSP and pay no tax on that income using the most basic deductions everyone uses when filing their tax returns.
Offsetting with Interest Expenses
The next easy way for you to withdraw money from your RRSP and pay no taxes on those withdrawals is to offset the withdrawal amount with deductible interest expenses.
The government allows you to deduct the interest costs on loans you take out for the sole purpose of investing and generating some income. For this purpose, income includes dividends, interest payments, business income, and so on. However, to be eligible for the deduction, the borrowed money must be invested outside of a registered account such as an RRSP or TFSA.
There are two common ways one might take advantage of this rule. First, you can take out a loan against your personal residence with a HELOC. You would move the money to your non-registered investment account and use the money to buy dividend paying stocks or ETFs.
Second, you could take a margin loan in your non-registered account and use that money to buy dividend paying stocks or ETFs.
All of the interest costs and other administrative fees that arise directly from this loaned money can be deducted straight from your income on your tax return. This effectively reduces your taxable income by the interest expenses of the loan.
If you take out an investment loan for $100,000 at a 4% annual interest rate, you will be able to deduct $4,000 every year from your taxable income. This would allow you to withdraw an extra $4,000 every year from your RRSP and you would pay no taxes on that RRSP withdrawal.
RRSP Mortgage Withdrawal Strategy
This strategy is a lot more complex than the prior two methods of getting money out of your RRSP account tax free. However, it is also much more lucrative and can allow you to withdraw a substantial amount of money from your RRSP completely tax free. The correct setup is important, so it may be worth consulting with a professional who has experience executing this strategy.
You need to have a relatively substantial RRSP balance and a paid off residence to make this structure worthwhile.
- Sell your current RRSP investments so your RRSP account is in cash.
- Find a trustee to set up the RRSP non-arms length mortgage. This time you will choose a high interest rate mortgage that is posted and commercially available. It will normally be a 10-year fixed mortgage.
- Open a non-registered investment account and put the entire loan proceeds from your RRSP non-arms length mortgage into your investment account. Invest this money in dividend paying stocks.
- You now have the correct basic setup.
Every month you will need to make mortgage payments to your RRSP as per the mortgage terms. To make these payments, withdraw money from your RRSP that is at least equal to the interest portion of your monthly mortgage payment. If you need to, top up your mortgage payment by using money you earn from dividends in your non-registered investment account or TFSA.
Every year you will be able to deduct the full interest, administration costs charged by your trustee, and setup costs from your taxable income. Your RRSP will slowly deplete since you are legally withdrawing all the returns that your RRSP generates (the interest on the mortgage) tax free. You can also withdraw additional money from your RRSP tax free using the other deductions, dividend offsets, and any other interest or carrying costs.
It is important to remember that your overall financial situation will not change. All you are doing is shifting assets around and completing some paperwork. You still have a RRSP account, you still have a house. Normally you would invest inside your RRSP and withdraw money each year to pay your living expenses, paying taxes on those withdrawals. Now you invest your RRSP money in a non-registered account and that money generates lower taxed dividends and capital gains which you use to pay your living expenses.
RRSP & TFSA Mortgage Withdrawal Strategy
This strategy uses all of your investment accounts and is slightly more complex than the strategy used above. It can be extremely lucrative if you are in the right financial situation. With this strategy you will be shifting money from your RRSP to your TFSA in a completely legal and tax free manner.
To set up this structure, you will need to have a substantial RRSP balance, a moderate TFSA balance, and a paid off residence.
- Sell your current RRSP and TFSA investments so your accounts are in cash.
- Find a trustee to set up two non-arms length mortgages—one for your RRSP and one for your TFSA.
- Create a primary (first) mortgage against your residence with your RRSP account at a low, commercially available interest rate. This will usually be a discount 5-year variable rate mortgage.
- Create a second place mortgage against your residence with your TFSA at a high interest rate. Since it is a second mortgage, you can find interest rates well over 10%. You want this interest rate to be as high as legally possible.
- Place the loan proceeds from both accounts into a non-registered investment account and purchase dividend paying stocks.
- You now have the correct basic setup.
With this setup in place, you will be making mortgage payments to your RRSP and TFSA as per the mortgage terms. To make these payments, you will withdraw money from your RRSP that is at least equal to the interest expenses on both mortgages, plus any other deductions you can take advantage of. You will repay the remaining principal amount of the mortgage payments with dividends earned from your non-registered investment account or tax free withdrawals from your TFSA (if absolutely necessary). Every year you will be able to deduct the interest you paid on your RRSP mortgage and TFSA mortgage, as well as setup and administration costs charged by the trustee.
Since your TFSA is charging a much higher interest rate, your TFSA account will grow rapidly. Meanwhile your RRSP account will rapidly decline as you pull money out each year to pay those hefty interest expenses. It is possible to complete shifted your wealth from your RRSP to your TFSA in just ten years while paying little to no tax in the process.
Non-residents and RRSPs
If you have a RRSP account and you become a non-resident of Canada for tax purposes, you can legally retain your RRSP account and continue investing within that account. The RRSP is generally recognized as a pension account in Canada's tax treaties with other countries, so any gains within the account would not be subject to taxation. However, it is important to always check the tax treaty that applies to your new country of residence and ensure this is the case.
Keeping your RRSP and maintaining your investing within the account is a great option if you are planning on returning to Canada to live sometime in the future. While you are gone you can grow your account in a tax sheltered format and when you return you can eventually withdraw money at low tax rates.
While you are a non-resident, you generally would not gain any advantage from continuing contributions to your RRSP account. You wouldn't have any taxable income in Canada to deduct your contributions against, so you are not contributing while in the 30% or higher tax bracket in Canada.
If you are not planning on returning to Canada in the foreseeable future, and you are living in a country with favorable taxes on investment income, you may want to take advantage of your residency status and withdraw money from your RRSP. With most countries, you can take full lump-sum withdrawals from your RRSP and pay a flat 25% withholding tax on those withdrawals. For reference, 25% is the average marginal tax rate charged for income below $47,000 in 2019.
Not all brokerages will allow customers to maintain their RRSP accounts after they become non-residents. If this is the case for you, find a brokerage that accepts non-resident accounts. As of 2019, Questrade is one of the brokerages that does.
Dying with a RRSP
When an individual with RRSP dies, the value of their RRSP is considered to be withdrawn and the entire value is taxed as regular income on the deceased person's final tax return. If the RRSP account value was substantial, the taxes owing on the estate be very substantial as well. Tax rates on RRSP withdrawals can go up to 54% in some provinces.
Make sure the estate has enough funds set aside to pay for the taxes owing when the final tax return is done. Generally brokerages will not withhold a sufficient amount to cover these taxes.
The RRSP can be transferred tax free to the beneficiary in certain cases:
- If the beneficiary is the deceased person's spouse or common-law partner;
- If the beneficiary is a dependent child or grandchild under the age of 18; or
- If the beneficiary is a dependent disabled child or grandchild of any age.
The RRSP value must be transferred to the beneficiary's RRIF or RRSP. The beneficiary will then pay taxes on withdrawals they make from their registered account.
There are some other requirements to be eligible for this type of transfer, so be sure to speak with an accountant or estate lawyer to ensure a smooth tax-efficient transfer.