Firstly, what does RRSP stand for?
It stands for a registered retirement savings plan. It is some of the most common types of tax-deferred accounts, which means the tax payments can be postponed and paid until the deadline reaches for to pay the taxes. RRSPs were introduced by the government to aid and benefit the retirement plans of the citizens. RRSPs were introduced to encourage people save money for their retirement, which many of us aren’t very much concerned till now, but we should be independent and financially secure at any point of our life.
So how is this beneficial and how does it really work?
For example, if you have an annual income of a $100,000 and you decide to contribute $20,000 in your RRSP account, you will be Taxed as if your income was $80,000 for the year, so you are likely to have a lower tax bracket for the year and lower calculated tax deduction. But tax deferral doesn’t really mean tax-free. The individual will have to pay the buildup taxes for the past years down the line after he/she finally retires and has to withdraw the money. So, when the time comes and the money will be withdrawn, the individual mostly will have a lower annual income and so he/she will be charged with a lower tax bracket. So eventually it means you are paying less tax money in present time and also in the long run and you are using your income tax efficiently.
Opening an RRSP account is a wise man’s job, but there are some rules to follow!
RRSP investments have a maximum investment limit each year so that people do not contribute excessive amounts of income to run away from paying tax. The amount may vary from year to year. Over contribution can result in penalties as well.
RRSPs can also be beneficial while buying a new house. It is the only exception when it is allowed to withdraw a substantial amount of money for the down payment of the house “tax-free”. The amount can be up to $35,000. The funds can be used tax-free towards buying a new house, which is a huge advantage to be taken of. You are basically avoiding paying the taxes for those funds. But in other cases, if the person tries to withdraw the taxes early on in the plan, it might backfire and the person may have to pay huge amounts of taxes all at once and also a penalty!