RRSP 102: Opening Your First RRSP account, Step-by-Step Guide

Key Takeaways

• Your RRSP contribution room is the maximum amount you can contribute to it. So, it’s essential to be aware of your RRSP contribution room to avoid penalties for over-contributing.
• Remember, an RRSP is not an investment product but an account; the choice of financial products is entirely up to you. Within the government-prescribed limits, you can think about building a diversified investment portfolio.
• Getting a tax refund is the process of the government returning over-withheld taxes. You might want to consider reinvesting the tax refund back into your RRSP account, preparing in advance for future contributions.

In RRSP 101, we learned that the biggest advantage of an RRSP is its tax-deferral feature. Tax deferral means that you can use RRSP contributions to claim tax deductions, and the investment growth within the RRSP account remains tax-free. When you make withdrawals from your RRSP in the future, those withdrawals are considered income for that year and are taxed at the applicable rate for that year. If your tax rate at the time of contribution is higher than when you make withdrawals, the RRSP can help you save on taxes. Since an RRSP is a registered account, the process of opening one is a bit more complex than a regular account. However, by following the steps below, setting up a retirement savings account will no longer be a daunting task.

Step 1: Confirm your available contribution room

The contribution room for your RRSP is the maximum amount you can contribute to it. After all, the RRSP is a tax advantage account, and they don’t want you going on a limitless shopping spree. Buying too much means less tax revenue for the government. Hence, nearly all government tax incentive programs have a limit. If you exceed this limit, the government may impose penalties on the excess amount. Therefore, knowing how much RRSP contribution room you have is crucial.

The good news is, if you accidentally exceed the contribution limit by an amount less than $2,000, you won’t be penalized. However, once you surpass the $2,000 threshold, the Canada Revenue Agency (CRA) will start charging you a monthly penalty of 1% on the excess contribution.

How to calculate your available contribution room?

We can calculate the contribution room using the following formula:

1. Multiply 18% of your earned income you reported on your tax return in the previous year, but not exceeding $30,780 for 2023 and $31,560 for 2024.
2. Add any unused contribution room carried forward from previous years.
3. Add or subtract any pension adjustments, past service pension adjustments, or pension adjustment reversals.

Given the complexity of this formula, it’s far simpler to locate this information in your most recent Notice of Assessment. Alternatively, you can reach out to the Canada Revenue Agency (CRA) at 1-800-959-8281 or access your CRA My Account online to locate this information.

Figure 1: RRSP contribution limit

Step 2: Choose the Right Financial Products

Many people mistakenly view RRSP as an investment product, thinking they can simply invest it like any other investment. However, that’s a misconception. An RRSP is just an account. Within the government-prescribed limits, it’s entirely up to you to decide what assets to hold in the account. You can have cash, stocks, funds, or even gold bars in there. In RRSP 104, I’ll thoroughly compare the pros and cons of various investment assets to help you make informed choices.

A well-balanced investment portfolio can help you pursue higher returns within your risk tolerance. If you’re not familiar in investments, seeking the assistance of a financial advisor might be a wiser choice. They can design a portfolio tailored to your actual needs and risk tolerance. In most cases, this is more efficient than managing assets on your own, ensuring that your investments align with your financial goals.

Step 3: Verify the Accuracy of the RRSP Receipt

Once you’ve successfully made a contribution to your RRSP account, you’ll receive a receipt from the financial institution. This receipt is crucial for your tax filing, so it’s advisable to hand it over to your accountant for assistance. In case you spot any errors on the receipt, promptly notify the issuing institution to rectify them.

Pay particular attention to the contribution date mentioned on the receipt. If it indicates that your contribution was made within the first 60 days of the new year, you can use that receipt to offset taxes for the previous tax year. For instance, the receipt must show the contribution was completed before February 29, 2024, to qualify for a tax deduction in the 2023 tax year. Otherwise, you’ll need to wait until 2024 to utilize that receipt.

Friendly reminder: As mentioned in RRSP 101, you have the flexibility to make RRSP contributions for the previous tax year within 60 days after the year-end. In case this period falls on a weekend, the deadline extends to the next business day. Since 2024 is a leap year, the deadline is February 29, 2024, rather than March 1, 2024.

Tips: How to Smartly Utilize Your Tax Refund?

Upon making a contribution to an RRSP, it’s likely you’ll receive a tax refund. Many individuals view this refund as unexpected cash and promptly indulge in spending. However, this perception is significantly flawed. In reality, when you receive your salary, a portion is withheld by the government as pre-paid taxes. A tax refund merely returns the surplus amount the government collected in advance. It’s not a stroke of luck. After receiving a tax refund, if your RRSP contribution room permits, consider reinvesting it back into your RRSP account for the upcoming year’s contribution. This proactive approach ensures that when the next RRSP season rolls around, you won’t find yourself scrambling to gather funds for contributions.

With a clear understanding of RRSP contribution room, financial product choices, and the proper handling of tax refunds, we can make more informed financial decisions, laying a solid foundation for our future retirement. Through prudent asset allocation and smart use of tax refunds, we can maximize the advantages of RRSP and achieve better financial growth.

In RRSP 103, I will delve into how to choose the most suitable contribution amount within the limit to maximize returns.

For more RRSP-related articles, please visit our RRSP Registered Retirement Savings Plan Guide.

Last Updated: January 24, 2024
Published Date: February 16, 2020

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