As a student who hasn’t even started a career, you probably haven’t thought about what’ll you do once you stop working.
And to some degree, that’s fine. If you spend all your time counting down to when you can finally stop working, you might never enjoy the work you can do in your lifetime. However, even if you can’t imagine what retirement will look like yet, the one thing that’ll always be true is that you’ll need money when you get there.
It’s never too soon to start saving for retirement or to consider the different options for it. One of your options is to open a registered retirement savings plan (RRSP), which is a type of account specifically created to encourage Canadians to save for their retirement. Even though you’re probably on a tight budget while you’re in school, saving even a small amount of money each month is a great start. If you’re thinking of putting your money in an RRSP, here’s what you need to know.
How to Set Up an RRSP
First of all, in order to open an RRSP, you need to have worked a job and filed at least one tax return in your life. RRSPs have contribution limits, which are calculated based on how much money you’ve earned. So if you haven’t had a job yet, you can either keep reading to learn how things work or skip to the TFSA section below.
To set up an RRSP, you can usually open an account online or in person at any bank, credit union, or investment brokerage. You can put your money in a registered high-interest savings account, in GICs, mutual funds, stocks, or bonds.
While we’re not in the business of giving investment advice, remember that you won’t need this money for many, many years. Therefore, you can afford to take risks and ride out the waves of the market. But educate yourself, ask a lot of questions, and invest only in what you feel comfortable with.
When to Contribute to Your RRSP
What’s great about RRSPs is that you can contribute to them anytime you want. You can setup an automatic savings plan, so you invest the same amount to it every month (for example, start with $50 a month). You could also contribute whenever you have some extra money (like your tax refund). Or you can do both!
Something to be aware of, however, is that one of the benefits of putting money in an RRSP is that it helps you at tax time. Specifically, the amount of money you contribute to your RRSP is subtracted from the total amount of income you’ve earned, so you’re taxed on less money. The calendar year for RRSP contributions is kind of strange in that it runs from March 1 to the end of February. So when you file your 2016 taxes next year, you can claim any RRSP contributions you made from March 2016 to February 2017.
When to Make Withdrawals
Since RRSPs were designed to be a retirement savings plan, you likely won’t touch the money in your account until you retire. However, you’re technically still able to access your money anytime. But withdrawing money before you retire isn’t cheap. When you make an early withdrawal from your RRSP, you have to pay income tax (called withholding tax). Here are the rates at which you’ll be taxed right away:
- Withdraw up to $5,000: 10% (5% in Quebec)
- $5,001 to $15,000: 20% (10% in Quebec)
- $15,001 or more: 30% (15% in Quebec)
Depending on how much you earn that year, this tax rate might be too high or too low, which means maybe they took too much off the top (and you’ll get some back after you file your taxes) or not enough (and you’ll owe more).
How to make Tax-Free Withdrawals
The only way you can avoid being taxed on your RRSP withdrawal is if you use the money to buy a home or go back to school later in your career. If you’re using it to go back to school, the Lifelong Learning Plan allows you to borrow up to $20,000 tax-free (up to $10,000/year), but you have to put the money back into your RRSP over 10 years. And if you’re using it to buy a home, the Home Buyers’ Plan lets you withdraw up to $25,000 tax-free, but you have to put the money back in your RRSP over 15 years.
Why a TFSA Might be Better
While it might sound like RRSPs are the best option to help you save for your retirement, Canadians have had to change the way they think about investing for the future, since tax-free savings accounts (TFSA) were introduced in 2009. While putting money in a TFSA doesn’t help you at tax time (it doesn’t reduce the amount you’re taxed on, like an RRSP does), it does allow you to withdraw the money anytime and for any reason, tax-free. And you don’t even have to pay it back. Like RRSPs, TFSAs also have the same investment options.
The only restriction is you’re limited to contributing $5,500 a year and you must be the age of majority in your province or territory before you can open a TFSA. The age of majority is 18 in Alberta, Manitoba, Ontario, Prince Edward Island, Quebec, and Saskatchewan. And it’s 19 in all other provinces and all territories.
The Bottom Line
At the end of the day, you have to do your research and figure out which account is best for you. Maybe you only save in a TFSA, in an RRSP, or maybe you do both. Every account exists for a reason and you’re allowed to use them however you think is best for you and your future. Our only advice is to start saving as early as possible. Time is on your side and compounding will help you retire with more money in the bank.