I really struggle with RRSPs. I understand they are retirement saving funds but what makes them different then just regular savings?
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RRSPs are a registered savings plan, meaning they are registered with the Government.
RRSPs are excluded from taxes, meaning that you don’t pay income tax on money put into your RRSPs. You get this back as a tax return.
The catch is when you retire you have to pull that money out, and you pay taxes on it at that time counting it as part of your income. But since you’re theoretically making less money as a retiree you get charged taxes based on a lower income bracket.
That money in the meanwhile sits in an investment account usually managed by your bank so it collects interest.
You can pull money out of your RRSPs if you badly need it, but you will have to pay taxes on it.
You can also borrow against your own RRSPs for your first home but you have to pay that back over 15 years or face a tax penalty
Saving for retirement without an RRSP:
* Invest $100 now
* Watch it grow.
* Get back $500 in the future
**You have $500.**
Saving for retirement with an RRSP:
* Invest $100 now. Government loans you $30. Invest $130 now.
* Watch it grow.
* Get back $650 in the future
* Government says, “You owe us $20, but just pay $8, s’all good.”
**You have $642.**
Why does this happen?
When you invest in an RRSP the government says, “Let’s pretend this $100 is tax-deductible, except you’ll have to reverse the tax deduction when you’re old”. So you have income today and pay 30% income tax.
One day you’re old. The government says, “Okay, we’re undoing $100 tax deduction, so you have to pay income tax on it now.” But now you have a low tax rate — you’re retired with almost no income! Say you pay just 8% income tax, or $8 back.
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