Tax sheltering income for retirement is an option available to all Canadians, usually through the Registered Retirement Savings Plan (RRSP).
While this is not the only investment vehicle used for retirement savings, RRSP contribution maximums are used to set a fair level of sheltered benefits for everyone.
For this reason, Registered Pension Plan (RPP) contributions outside of your RRSP will very likely reduce your RRSP deduction limit – the space that you have to contribute to your RRSP.
Registered Retirement Savings Plans
For direct shelter of income tax in a given year plus tax avoidance on investment income, the RRSP is the core of retirement financial planning for many Canadians.
- The Canada Revenue Agency (CRA) sets annual deduction limits for taxpayers based on previous income and communicates this information with the taxpayer by way of notices of assessment or reassessment.
- There is a maximum deduction limit beyond which taxpayers may not contribute, but unused contributions from previous years can carry forward. The deduction limit for RRSPs also factors contributions to RRPs.
Existing registered pension plans are, in some cases, eligible for transfer into your RRSP, and qualifying transfers do not affect your RRSP deduction limit as long as they are transferred directly between RPP and RRSP.
Registered pension plans provide employees or union members with a group investment vehicle for retirement savings in which the employer will sometimes matches employee contributions and the administrative costs of running the plan are spread between plan members and the employer. That makes an RPP a low-cost augmentation to your retirement plan.
- Like RRSPs, contributions and investment earnings through an RRP are exempt from taxes until the benefits payout upon retirement.
- While RRP proceeds are taxable when withdrawn, your retirement income is likely lower than employment earnings, so your lower tax level during retirement provides additional savings.
Pensions come in two main types:
- Defined benefit plans guarantee a specific payout of income when the pension matures.
- Defined contribution plans guarantee how funds enter the pension, such as employer contributions and matching funds, but no provision for retirement income is made until the pension pays out, at which time you can manage the funds to meet your needs.
Pensions Affect RRSP Limits
RRPs and deferred profit-sharing plans affect your RRSP contribution limit in the same way.
As both types of programs are pensionable benefits earned through an employment arrangement, your annual T4 information slip from your employer includes a pension adjustment (PA) amount. This is required under the registration rules for the pension or profit-sharing plan.
- The PA reduces your RRSP contribution room, allowing you to contribute less for the current tax year.
- If your pension benefits increase for an adjustment for the period after 1989, you also may be subject to a past-service pension amount (PSPA) if it is authorized by the minister, under terms of the Income Tax Act. This is only in cases where an event or award affects your pension retroactively.
- The PSPA also reduces current year RRSP contributions. Pension adjustment reversals (PAR) increase your contribution room and may occur if you leave your pension plan prior to retirement.
- The PAR compensates for past PA amounts that exceed the termination benefit of the abandoned pension.
Your RRSP deduction limit for a tax year starts with contribution room carried forward plus your current year’s contribution room, minus any PA or PSPA and plus any PAR.
Reasons to Join a Pension Plan
Joining an RPP through your employer has plenty of benefits to offset the reduction in your RRSP contribution room.
- Employers often match your contributions and, in the case deferred profit sharing, you may need to join to receive the benefits.
- Fees tend to be lower on group plans and over time even a one percent savings in fees becomes substantial. For people who find a challenge staying on a savings budget, RPP contributions deduct at payroll, so you’re not tempted to spend prematurely.
- Likewise, funds in RPPs are, for the most part, locked in, relieving you from the temptation of withdrawing from your retirement fund.
- Some pensions allow you to transfer RRSP money into the RPP, though this may be an advantage or disadvantage, depending on your retirement investment strategies.