If you want to secure your financial future, you need an RRSP account. Before jumping to open an RRSP account, keep reading to understand its role in your retirement.
How do you see yourself when you retire? Don’t you imagine yourself lounging on a beach, pina colada in hand, without any worry about work or finances? Sounds pretty dreamy, right? Or do you imagine yourself working 9 to 5, grinding your resting days instead of enjoying the time left with government benefits? Sounds unreasonable, right?
How you wish to see yourself in the future greatly depends on how you work and plan today. In Canada, if you want to secure your financial future, you will have to plan your retirement proactively. As mentioned, the standard age of retirement in Canada is 65, with a life expectancy stretching well into the 80s. That's potentially 20+ years where your pre tax income might decrease while expenses like healthcare often rise.
For young professionals or first-time investors in their 20s, retirement might seem distant to you. But let me break this to you: time has a way of accelerating, and there is no exaggeration that time literally flies.
Therefore, early planning is important to ensure that your retirement savings are enough to help you maintain a comfortable lifestyle when you are old and grey. Regarding the comfortable lifestyle, do you know Canada’s current inflation rate is 2.9%? This rate usually doubles, leading up to 7%, and we never know how much it will increase in the future.
The inflation rate defines purchasing power, and with your current spending habits, will you be able to maintain a comfortable lifestyle in the future? With the doubling inflation, you need a plan that keeps doubling with time.
Even the retirement savings plan in Canada provided by the government, like the Old Age Security (OAS), provides a bare minimum to survive your retirement. If you rely on these programs, you won’t be able to live the dream life you have imagined, and it will lead to a significant drop in your standard of living upon retirement.
On the other hand, many employers have stopped offering traditional pension plans, so it is totally on the individual to take charge of their retirement savings. That’s why direct investing for your future through the RRSPs helps you build a secure and fulfilling retirement. Registered Retirement Savings Plan (RRSP) leverages the concept of compound interest and allows your savings to match with the rising living costs.
What Are Registered Retirement Savings Plans (RRSPs)?
Simply put, it is a tool to secure your financial future, but its complex parts might overwhelm you. But don't worry, we are here to help, so let's begin with what it is and how it works.
Let’s say an RRSP is like your savings account, where you put money to use after retirement. Every year, you must contribute or invest in this investment income account, given your contribution limits. You have a Maximum Annual Contribution Limit based on your earned income. These contributions are tax-deductible, lowering your current Taxable Income.
The best part about your RRSP is that, unlike other accounts, this account is free from retirement account taxes. Your investment does not just sit there for nothing; it witnesses tax-sheltered growth. In other words, the funds within your RRSP grow tax free until you withdraw funds at the time of retirement. This means your savings compound over time.
When do you withdraw money or annual income? You can withdraw from your RRSP account after reaching retirement age (currently 71 in Canada), including the previous year's earned income and how many funds remain locked in your retirement account. However, these withdrawals are then considered taxable income and treated accordingly while you pay tax. The funds are converted to a Registered Retirement Income Fund (RRIF) at 72, from which you must make minimum annual withdrawals. Yes, there are a few hindrances, but in the end, you get a comfortable retirement with a good amount.
What RRSP Options Do You Have To Explore?
For your relief, there are two main types of RRSPs, providing you the ease to control your account according to your own preferences.
The Self Directed RRSP
In this type of RRSP, you fully control your investment portfolio (this is what an RRSP is an investment portfolio). You can choose from individual stocks, bonds, mutual funds, exchange traded funds, or other assets in compliance with Investment Industry Regulatory Organization (IIROC). But before you take any action, make sure you have done your homework by researching and due diligence. Don't worry. It offers flexibility and potentially higher returns.
The Managed RRSP
In this type of RRSP, a professional investment manager makes investment decisions on your behalf based on your risk tolerance and goals. This is the best if you don't want to go into the shenanigans of investment earnings, mutual funds management, and asset allocation. This is a more hands-off approach with a lower tax bracket but less control over your portfolio.
Additional Considerations Before You Invest In An RRSP Account
Remember that the rules for deductible RRSP contributions are different. For example, only contributions made to the Registered Investment Accounts qualify for income tax deductions. So, when you choose your financial institution to open an RRSP account, make sure it qualifies for it.
At the same time, you need to know that your investment earnings are taxable income that is taxed upon withdrawal. Your contributions will stay rent free or tax free in the account, doubling up with dividends and capital gains. But, at the time of withdrawal, this income will get taxed, which is usually much less than what you have gained throughout the years.
You can stay stress-free whether or not your chosen financial institution will fulfill its promise. The Canadian Investor Protection Fund (CIPF) is a government-backed program that protects qualified investments in case of a financial institution's failure.
How To Open RRSP Account? The Steps
Now that you know what RRSP is and how it works to benefit your retirement, it's time to put your efforts into creating an RRSP account. When you open this account, you get to enjoy the tax-advantaged retirement savings that help you secure your financial plan. But where do you start? This is where we help you through each step of opening an RRSP account. From choosing the right financial institution to funding your account and dealing with income tax implications, these steps will give you a headstart to for a financially secure retirement.
Step 1: Deciding to Open an RRSP
When you decide to open an RRSP account, there are certain things that you might need to consider. First of all, you must know what it brings to the table and what it takes to get the account, for example, the retirement account startup cost. With this account, you don’t have much to pay at the time of account opening. For now, focus on your contributions being free from any tax deduction that lowers your income tax bill.
Ready to Jump In? Not So Fast… Consider these factors!
Opening an RRSP might involve some initial fees and minimum contributions.
Do you have enough stable income and some leftovers after covering your essential expenses?
This contribution is for the future, not for now, so keep some money to live a life till you reach the future.
Again... How do you see yourself at retirement? The lifestyle you envision will help you determine how much you need to save and when to start. Keep it realistic!
Since this is an investment, how comfortable are you when it fluctuates? Are you able to take the loss? For your convenience, RRSP offers various investment options with its own risk-reward profile.
Step 2: Choosing a Financial Institution
This is a major decision in your life, so make it count. When you want to open an RRSP account, you have to select a financial institution where the account will be managed. But where do you even begin? There are several types of institutions offering RRSP options, so it can get confusing. The best way to pick one is to compare their strengths and weaknesses with one another.
The Options Include
The options include banks, credit unions, and investment firms. Here is how we state them:
● Banks usually have an extensive network of branches and familiar interfaces, but investment options might be limited.
● Credit Unions offer member-owned, community-focused services with potentially lower fees, but branch availability might be restricted.
● Investment Firms specialize in investments and offer diverse options like bonds, mutual funds, exchange traded funds, etc. but fees can be higher, and advice may not be included.
Now, how do we compare them? Besides their institution type, there are other features that you can compare. For example, compare their account fees, investment management fees, and transaction fees. On the other hand, how do credit scores matter for retirement plans, and how do these institutions help the customer with bad credit? To know about such RRSP FAQs or tax advice, utilize online comparison charts, institution websites, and independent reviews to thoroughly gather detailed information and compare options.
These are the general concerns, but other external factors also matter when it comes to your overall financial well-being. For example, maintaining a healthy credit score is also essential for you to figure out your institution type. Most institutions don’t take bad credits, so check your score now before applying. There are various free credit score checkers available online. These tools help you gauge your credit score and help maintain good credit.
Step 3: Gathering Documents and Information
You have successfully chosen the financial institution with whom you want to stick till the future. It is time for you to gather all the information and documents the institution might need in order to create your RRSP account. Knowing the details beforehand will help in a smooth application process.
In a general scenario, you might need your Social Insurance Number (SIN) as it works like your financial passport in Canada. Besides, you will need to provide the institute with proof of income, a government-issued photo ID, proof of address using a utility bill or bank statement, and even a credit report.
Building good credit can come in handy beyond RRSPs, and for this, we recommend you build your credit with KOHO, as their process is extremely easy. By keeping these essential documents organized and easily accessible, you'll be ready to start your retirement savings.
Step 4: Funding Your RRSP
We have mentioned what you will need to open an RRSP account, and we expect your account to be almost created. The institute you have chosen might have asked you to make an RRSP contribution or investment. So, it is time to fill your account with savings. Whether it is an individual RRSP or a spousal RRSP, you have options when it comes to funding your RRSP account.
For example, you can set up automatic contributions with a regular contributions option from your paycheck or bank account. It is like setting it and forgetting it; meanwhile, it grows over time.
The next option is the lump-sum contributions, where you enjoy the tax benefits with an income tax refund. This can be very fruitful for you, so consider integrating it directly with your RRSP for an immediate boost.
Every one of us who is earning well keeps on saving, so if you already have retirement savings in other registered accounts, transfer them into your RRSP. In other retirement plans and savings accounts, you are often withholding tax burden with high interest. But with RRSP, you will be saved from these deferring taxes unlike a non registered account. If you don't like the option of investing in a bond or mutual fund or don't want to pay taxes, consider a high-interest savings account where you get to save throughout the month while watching it grow.
Step 5: Completing the Application and Activation
You have your documents in one hand and your funding plan in the other; it’s time to apply for the RRSP account officially. Every institution has its own application process, but every process involves some steps that are necessary to comply.
Usually, it involves filling out online forms, providing your documents, and verifying your information. Once approved, activating your account might involve setting up online access or linking your funding source.
In fact, some institutes also provide a virtual credit card with their retirement account as a good gesture. At the same time, some provide overdraft protection coverage for a secure and convenient spending option. These features provide safety for unexpected expenses.
Final Thoughts
Having a plan for retirement is very important no matter at what stage of life you are. The best choice for your proactive retirement planning is the RRSP account. With your RRSP account up and running, you will be able to secure your financial future.