Are Canadian RRSPs the equivalent of 401ks in the States?
What are the major differences? I was reading a thread in GD and the two seemed very similiar.
Based on a cursory glance at Wikipedia, they appear pretty similar.
Both plans are tax-deferred (your contributions are deductible from your taxable income in the year you make them). Both allows investments to grow without capital gains or dividend taxes. Both allow you to withdraw the funds are retirement, when you’re probably in a lower tax bracket, at which point you pay the taxes on them.
I’m not quite certain how the income is taxed on an RRSP when one retires. In a 401(k), all dividends and capital gains are taxed as regular income upon withdrawal, which is yet another advantage of that plan.
RRSPs are converted at retirement into an income-generating instrument, the Registered Retired Income Fund, and withdrawals above a certain minimum amount are taxes as income; interest generated by the RRIF, however (it’s still an investment, just registered differently) are NOT taxed. Canadian seniors, however, get tax breaks others do not, so up to a point they would pay less tax than someone generating a working income.
RRSP income is also considered as normal income when it is withdrawn. You must withdraw the balance in the RRSP or roll it over into an annuity or RRIF (Registered Retirement Income Fund) by age 71. (The RRIF makes regular annuity-type payments but otherwise operates much the same way as an RRSP tax-wise, and I am not tax-savvy enough to know why there needs be two such programs.)
Obligatory link to the Arrogant Worms’ Sex, Drugs, and RRSPs. 
canadian here:
Can someone please eleaborate on this for me please: If I make capital gains inside an RRSP then I’m taxed upon them as regular income when I withdraw them? However, If I make capital gains outside of an RRSP, I’m only taxed on 50% of the capital gain. my back of the envelope calcs suggest that this discrepancy in tax rates more than offsets the tax deferal you receive on the principal investment:
for example: lets say you invest $1000 in an RSP, with a 100% return, at a current tax rate of say 40%, a future tax rate of 35%, and a capital gains tax rate of 50%. you also reinvest your tax rebate from the RSP contribution (in this case $400).
so: in RSP:
principal invested: $1000+$400=$1400. x100%return = $2800-tax@35%=$1820
outside RSP:
principal invested: $1000 x 100%return=$2000 -tax@35%x50% = $1825
This doesn’t add up to me: it would seem that I’d be better off to avoid using an RRSP. What am I missing here?
I’m sure it has something to do with the fact that capital gains are taxed at different percentages during different years.
thanx
Not sure I follow you. How are you generating capital gains inside your RRSP? The accumulated interest is not capital gains.
DancinPete has hit upon one reason why registered investments might not be a good idea. As you can see, if your marginal tax rate at the time of withdraw is the same as the marginal tax rate at the time of contribution, your benefit is going to greatly diminished, as there is no capital gains exemption for RRSP withdraw. The underlying assumption here is that most people are going to be earning at a much lower tax bracket when they retire than when they are at the peak earning years, and thus, it would make sense.
RRSPs are different from the American 401k’s in one respect (I think, I’m not an expert on the US system) is that a Canadian can carry forward indefinitely his allowable RRSP contribution “space”. What this means is that for young people, RRSPs could be a bad idea - it’s better to save one’s RRSP contribution room for later in life when you are in the 40% tax bracket, than using it up when you’re in the 17% tax bracket. This could be especially true if, say, one wished to liquidate a number of investments at a point close to retirement, as they can be rolled into registered status using the accumulated “space” and a large one time tax hit could be avoided.
Surely the interest you’d earn would dwarf potential one-time tax savings?
if you have stocks in an RRSP and these stocks increase in value, then isn’t this called a capital gain? However, since they’re in an RRSP, they don’t qualify for the captial gains exemption and are taxed at the same rate as income when withdrawn from the RRSP.