Tax-sheltered investment growth
Investments in an RSP grow on a tax-deferred basis until money is withdrawn. The fact that your plan is â€śregisteredâ€ť with the Canada Revenue Agency allows you to benefit from this tax-deferred growth.
Outside an RSP, most investments are taxed. Interest is fully taxable, half of capital gains are taxable and dividends are taxable but eligible for the dividend tax credit. Inside an RSP, none of these taxes apply.
Because you pay no tax on investment growth while your money remains inside an RSP, your investments compound far more quickly. At the end of the road, that makes a huge difference.
RSP vs. Non-RSP Calculator
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Even though youâ€™ll be taxed on amounts you withdraw from RSP savings in retirement, your tax rate is likely to be lower than during your working years. So the tax bite will be considerably less. And the money left in a retirement plan continues to grow sheltered from tax.
Reduce yearly income tax
Contributions to an RSP are tax deductible. So they lower your annual taxable income and your yearly income tax bill. The tax savings will depend on your marginal tax rate and how much you contribute to your RSP. In 2016, youâ€™re allowed to contribute the lesser of $25,370 or 18% of the earned income reported on your previous yearâ€™s tax return. If you make less than your maximum allowable contribution in any year, the shortfall can be carried forward to future years.
The dollar maximum is revised annually, so contribution limits regularly increase. Since 2011, increases have been linked to average Canadian wage growth.
You have until March 1 of the following calendar year to make contributions for the current tax year (subject to change if March 1 falls on a weekend or holiday or if itâ€™s a leap year).
Range of investment possibilities
You can hold a wide range of investments in an RSP. These include cash, mutual funds, GICs, stocks and bonds. If you want to hold a mix of different investment types or a variety of individual investments such as stocks, consider a self-directed RSP. A self-directed plan allows a number of investments under the umbrella of a single RSP.
Easy transition to retirement income
When itâ€™s time to use the money youâ€™ve accumulated in your RSP to generate retirement income, itâ€™s easily done. Most Canadians choose to convert their RSP to a Retirement Income Fund (RIF). A RIF provides steady retirement income (subject to government-mandated minimum annual withdrawals), while the money that remains in the plan continues to grow sheltered from tax.
Annuities are another popular income choice. You use funds in your RSP to purchase an annuity, which provides regular fixed income for life or a specified term. Payments are taxable when received.
RSP funds can be easily transferred to a RIF at BMO Bank of Montreal. Annuities are available through life insurance companies and their agents.
The right strategies can make your RSP an even better tax-saving tool. For example, spouses can â€śsplitâ€ť income to reduce their combined tax bill. This can be done while saving for retirement through a spousal RSP, or in retirement by taking advantage of pension income-splitting opportunities.