The RRSP, or Registered Retirement Savings Plan, is a valuable financial tool that Canadians can use. Despite this, more than half of all young Canadians do not have this savings account. Much of this is due to misunderstanding the benefits of this fantastic account and how to use it to your advantage.
For example, opening an RRSP at the right time can ensure a healthy sum saved up for retirement as well as preventing the need for debt consolidation down the line.
This article will take an in-depth look into RRSPs and explore when it’s best to open them. Let’s get into it.
Who Should Open an RRSP
To better understand when to open an RRSP, it is essential to understand who can open it. Any individual earning a higher income than they are likely to make during retirement is suited to opening this account.
For example, an individual currently earning $75,000, but in retirement estimates earning $45,000, is a great candidate for an RRSP.
A student, or a recent graduate, on the other hand, will likely make less than in their retirement. For them, the best option is to contribute to a TFSA, or Tax-Free Savings Account. Thus, the best time to start contributing to your RRSP is when you’re in the right income bracket.
The main reason RRSPs are so advantageous is that they are tax-free until withdrawal.
Individuals can contribute up to 18% of their total income, with a maximum limit of $27,830 as of 2021.
If you don’t use up all your contribution room in a particular year, it carries to the following years. This money is then held until the age of 71 when the money is withdrawn from the account for your retirement.
By understanding the contribution limit and age of withdrawal, you can draw up an action plan to maximize the benefits of this account.
Contributing to an RRSP can be advantageous for many reasons. It can reduce claimable taxes within the year of filing, while capital gains, interest, and dividends remain tax-free until withdrawal.
The power of compound interest accelerates all the benefits of this account to provide for your retirement. The earlier you can open and contribute to your RRSP, the better. Remember, the money in the RRSP compounds, meaning that it can maximize higher the longer it sits in the account.
Consider the money you put in the RRSP as unable to be withdrawn. Let it be, let it accumulate interest, and then reap the benefits later.
If you open an RRSP later in life, you may find that you don’t have quite enough saved up. Withdrawing funds too early can make you susceptible to higher taxes, which nullifies the whole point of an RRSP.
RRSP Contribution Timing
When considering when to open your RRSP account, you may want to strategize your contributions.
The one basic rule is to contribute as soon as you have the money. There’s no requirement to invest the money when you’re contributing, so it can sit in the account until you decide. This way, it acts as a savings account, but with minimal interest.
Another strategy is to open your RRSP when you have the income and make smaller contributions throughout the year. This way, you’ll be able to adhere to your budget while putting away money for the long term.
Yet another strategy is to make a lump sum payment.
The annual deadline for contributing to an RRSP is typically the beginning of March. Many Canadians leave it until the deadline to decide how much to contribute and when.
To save yourself all the questions, you could very well make a lump sum payment and try to max out your contribution limit.
Consider Your Future Financial Goals
If you’re thinking of planning for retirement, you likely have other financial objectives you’re looking to fulfill.
Other than retirement financing, the RRSP can be used in a couple of different ways.
For example, you can use it for the Home Buyers Plan (HBP), where you can withdraw from the RRSP to buy your first home. The amount needs to be paid back within 15 years. Thus, individuals who wish to utilize the RRSP for the HBP should open their account when they can max out both the contribution and the withdrawals of $25,000.
This way, they won’t be subject to the 10%–30% penalty that can accompany the failure to pay back the loan amount within 15 years.
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