What Is an RSP Account and How Does It Work?

A Registered Retirement Savings Plan (RSP) serves as a retirement savings vehicle, designed to help individuals accumulate funds for their future. This type of plan provides a structured approach to saving, often incorporating tax advantages to encourage long-term financial security.

Fundamentals of an RSP

An RSP (Registered Retirement Savings Plan) is a retirement savings account registered with the Canadian government. Its primary purpose is to help individuals save for retirement by offering tax-deferred growth on investments. This means that money held within the plan grows without being subject to annual taxation, allowing the investments to compound more effectively over time.

Individuals with earned income are generally eligible to open an RSP. US citizens or residents who hold these plans must be aware of specific US tax implications and reporting requirements, as outlined by the US-Canada Income Tax Treaty. The US-Canada Income Tax Treaty provides provisions that affect how these accounts are treated for US tax purposes.

Making RSP Contributions

Contributions are based on available “contribution room,” calculated as a percentage of previous year’s earned income up to a maximum. Unused room can be carried forward, allowing for larger future contributions. Contributions can be made in cash or through in-kind transfers of eligible investments.

For Canadian taxpayers, contributions are tax-deductible, reducing taxable income and potentially leading to a refund. However, for US citizens or residents, contributions to an RSP are generally not tax-deductible in the United States. Despite this, the US-Canada Income Tax Treaty typically allows for the deferral of US taxation on the income earned within the RSP until funds are withdrawn.

US persons holding RSPs are subject to US reporting obligations, which may include filing FinCEN Form 114 (FBAR) and IRS Form 8938, depending on the total value of their foreign financial assets.

Investment Growth and Management within an RSP

Funds within an RSP benefit from tax-deferred growth. Interest, dividends, or capital gains are not taxed annually while in the account, allowing for rapid compounding. This deferral allows investments to grow more rapidly over the long term through compounding.

RSPs typically permit a wide range of investments, including stocks, bonds, mutual funds, and Guaranteed Investment Certificates (GICs). While the framework allows for various investments, selecting those that align with personal retirement goals is important.

For US persons, the tax deferral on investment growth within an RSP generally extends to US taxation as well, thanks to the US-Canada Income Tax Treaty. This deferral is often automatic, and a specific IRS election form, Form 8891, is no longer required for most individuals. However, it is worth noting that some US states may have different tax treatment for RSP income.

RSP Withdrawals and Maturity Options

RSP withdrawals are generally fully taxable as income in Canada. Canadian withholding tax may apply. For US citizens or residents, these withdrawals are also taxable in the United States.

To prevent double taxation, US taxpayers can often claim a foreign tax credit on their US tax return for the Canadian taxes paid on the withdrawal.

At age 71, an RSP must convert to a Registered Retirement Income Fund (RRIF) or be used to purchase an annuity. A RRIF requires annual minimum taxable withdrawals.

While converting to a RRIF or purchasing an annuity are standard maturity options, cashing out the RSP entirely is generally not advised due to the immediate full taxation of the entire amount. For US persons, RRIFs typically maintain tax-deferred growth under the US-Canada Income Tax Treaty.