Saving for retirement is a big job best done slowly and steadily over many years. But like every long journey, it must begin with a first step: Setting up the right retirement savings accounts to guide you toward financial security.
The two most popular options are Registered Pension Plans and Registered Retirement Savings Plans, which have distinct differences and come with various pros and cons.
What is a Registered Pension Plan (RPP)?
An RPP is an employer-based retirement savings plan, which means that the employer establishes the plan with a financial institution so that employees can contribute to it with pre-tax income. The employer has control of which institution hosts the plan and the investment options it includes.
Many employers match employees’ contributions to these plans so that the employees’ savings grow even faster. The employee gets periodic payments from the plan after retiring and pays tax on the money at that time.
RPPs come in two types: defined benefit RPPs and money purchase RPPs. Defined benefit plans set out a specific pension that the retiree will receive and adjusts contributions to match, with no limit on how much can be invested per year. Money purchase RPPs allow employees and employers to contribute without specifying a pension amount and are subject to contribution limits.
What is a Registered Retirement Savings Plan (RRSP)?
An RRSP is an individual retirement savings plan that is not related to your employer. You establish the plan on your own with a financial institution approved by the Canada Revenue Agency (CRA). Then you and your spouse (or common-law partner) can contribute to it until age 71, when you have to roll the plan over to another type of retirement savings account in order to make withdrawals.
There are also GRSPs—Group Retirement Savings Plans—which are employer-sponsored plans and therefore closer in kind to RPPs.
You can take tax deductions for your contributions, so you are not paying tax on the money when you put it in the account, just like with the RPP. But also like the RPP, you do pay tax on the money when you take it out.
Similarities and differences between RPPs and RRSPs
Tax-deferred savings: Both RPPs and RRSPs allow you to put away money tax-deferred. In the case of an RPP, your employer will put the money in the account prior to deducting taxes from your paycheck. With an RRSP, you can deduct your contributions on your tax filing. Both of these types of accounts allow your investments to grow tax-free until retirement age. Both require that you pay tax at the point that you withdraw the funds.
Contribution limits: Money purchase RPPs and RRSPs come with a maximum annual limit on contributions. This limit is determined as a percentage of your previous year’s income and must fall below the universal maximum that limits all taxpayers. Defined benefit RPPs typically don’t have contribution limits. Contributions to RRSPs above the limit can be applied to retirement savings in future years.
Age limits: You are required to stop contributing to an RRSP at age 71, at which time you must either close the account and pay all the taxes owed or convert it to a Registered Retirement Investment Fund. The latter is another type of tax-deferred retirement savings instrument that allows for only a partial deferral of income. An RPP plan comes with guidance on appropriate retirement age when disbursements can be made.
Employer-based vs. individual: The largest difference between RPP and RRSP accounts is that an RPP is an employer-based account and the RRSP is an individual account. An RPP is managed by a financial service provider chosen by the employer, while investors in an RRSP choose their own provider and plans. Those with RPPs may receive matching contributions in their account from their employers.
Pros and cons of RPPs and RRSPs
Each of these plans has its pros and cons. Here’s a look at what makes each of them appealing and potentially undesirable.
Registered Pension Plan (RPP)
RPPs are attractive because they often come with an employer match, but a big disadvantage is that your money is likely not accessible until retirement age. Here are some other pros and cons:
Pros:
Your employer may match your contributions.
Your contributions are deducted pre-tax from your paycheck by your employer.
Funds grow tax-free as long as they are in the account.
Some RPPs guarantee you a set pension amount in retirement.
Cons:
You have no say in the choice of financial institution or plan.
You must be a full-time employee with a certain amount of work time to qualify.
There’s a contribution limit based on percentage of income for some RPPs.
Your funds are likely to be “locked in” the fund until you retire.
Registered Retirement Savings Plan (RRSP)
RRSP plans have the advantage of allowing withdrawals even before retirement, but you face contribution limits. Here are some other pros and cons:
Pros:
You are able to choose the financial institution and plan to save with.
You can make taxable withdrawals at any time with no penalty.
You can contribute to your spouse’s RRSP and vice versa.
Above-limit contributions can be rolled over to the next year.
Cons:
You get no employer match.
There’s a contribution limit based on percentage of income.
Your contribution limit may be reduced if you also contribute to an RPP.
You can only contribute until you are 71.
How to Decide Which Account Is Right for You
Depending on your employment situation, the decision about which type of plan to save with—an RPP or an RRSP—may be made for you. Those without full-time employment will need to opt for an RRSP or some other non-employer-based savings option. Those with full-time jobs who qualify for matching funds from their employers will be wise to take advantage of that “free money” by enrolling in an RPP.
Those who want more control over their savings, think they might like to make withdrawals before retirement age, or would like their spouse to be able to contribute to their plan, will find an RRSP attractive. Those with spouses who don’t work outside the home, for instance, may decide to open an RRSP to take advantage of extra savings options for the family.
You may want to have both an RPP account and an RRSP account, especially if you have a defined benefit pension plan that will provide you a set amount of income in retirement. You can calculate how much income that is likely to be and decide whether you need to save more in an RRSP to make sure you have sufficient funds. One complicating factor in this scenario is that the accumulation of money in your RPP may reduce your annual RRSP contribution limit.
Whichever account you choose, figuring retirement savings out is the first step to ensuring financial stability and independence in your later years.
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