RRSPs for 20-somethings

Don’t get scared away from RRSPs by numbers and financial jargon. Here’s some of the easy-to-understand basics of RRSPs.

You’ve heard it a million times, you need to start saving for the future. And the answer is usually a list of excuses: When I get my next raise, after I pay down my school debt, after I get my new iPhone etc. But as the life expectancy for Canadians grows and the retirement age lowers, you may need to have enough money to live up to 30 years after retirement!

Short term RRSP advantage – you get money!

Contributing to your RRSP means you get money back when you do your taxes. When you do your taxes, the government takes every dollar you’ve put into your RRSP and “reduces” your income by that amount. Then they give you the tax you paid on the amount you’ve contributed to your RRSPs back. For example, you made $10,000 in a year. You put $2000 into an RRSP. Now you’ve only “made” $8,000 according to the government. So, they give you the taxes you paid on that $2,000 back.

Not everyone pays the same amount of income taxes. How much you pay is based on your yearly income and where you live. This link takes you to the Government of Canada website which shows the income per “tax bracket”, per province.

When can I take the money out of my RRSP?

The government wants people to save. That’s why they encourage you to put money into your RRSPs by giving you a tax rebate, and once it’s there, they try to get you to keep it there. So taking money out can happen in three circumstances with three very different results.

Retirement

At age 71, the government forces you to start taking an income (you can choose to take an income sooner). You open a new account called a Retirement Income Fund (commonly referred to as a RIF) and roll your RRSP into the RIF and start monthly income payments. You are then taxed on that money as you would if it was regular income from a paying job.

First Home Buyers Plan

You can take up to $25,000 out of your RRSP for your first home. But you have to pay it back. The good news is that you’ve got 15 years to pay it back and the repayments don’t start until two years after you took it out. So, if you took out $25,000 in two years, you’d pay it back over 15 years and that’s just $1666.67/year.

You just plain need it

You need the money, its not for retirement or buying a house. You can have the money, the catch is that you’re taxed on it. And not once, but twice. When you initially request your money (called a redemption) the fund company or bank will take what is called a withholding tax. The tax charged depends on how much you want to take out. This is the government’s way of making sure they’re getting at least some of the taxes right away. The money you take out is considered additional income on top of what you make at your job and is therefore subject to income taxes (that’s the second time). So you’ll have to pay the rest of what was owed when you do your taxes. They do it this way because the fund company or bank has no way of knowing what your income is, therefore they can’t tax you right away based on your income tax bracket.

Types of investments

We’ve all heard in the news over the last year about the spectacular nose dive the market took which was caused by the US Credit Crunch. So you may understandably be worried about losing all your hard earned money. Relax, there are plenty of safe investments. Many financial advisors would suggest investing a bit higher risk at a younger age, since we have time to recover any losses over the next forty or so years. However, if you plan on possibly using that money for a downpayment on a house, or youre just downright uncomfortable being in the market, there are lots of secure investments. Talk to a financial advisor about what suits you best.

Time is money

Even conservatively invested money is making interest, and that’s free money! And then that free money earns interest — more free money!

Take baby steps

Find a number that works for you and make a commitment to yourself. If you make it automatically come out as soon as you get paid, you’ll probably never even notice it’s gone. Try for $25 or $50 bi-weekly and notice how little it disrupts your lifestyle. If you really want a wake-up call, for two to four weeks record every penny you spend and you’ll be surprised how much money you could potentially be investing in an RRSP.

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