The most outstanding feature of the Registered Retirement Savings Plan (RRSP) is instant tax savings. Canadians are drawn to this celebrated retirement account because all contributions reduce taxable income or generate a tax refund in a given tax year.
While investments grow tax-free, the Canada Revenue Agency (CRA) will collect taxes when you withdraw funds down the road. This becomes a sore thumb if you’ll eventually pay higher taxes. Fortunately, it pays to know the strategies to avoid a big tax bill on your RRSP in retirement.
Source: Getty Images
RRSP taxes
Unlike the newer Tax-Free Savings Account (TFSA), the RRSP is not tax-free. It defers tax but does not eliminate it. You won’t be caught off guard if you remember that any income earned inside your RRSP is tax-exempt as long as it stays in the plan. The CRA treats withdrawals as regular income, taxed at your marginal rate.
RRSP drawdown strategy
You can open and contribute to an RRSP at any age, but you must be a Canadian resident with a valid Social Insurance Number (SIN). However, you must provide proof of employment or self-employment, including any rental income. You don’t earn contribution room if you have zero income. For the 2026 tax year, the RRSP contribution room is $33,810 or 18% of the prior year’s earned income, whichever is lower.
Some retirees have learned about the RRSP meltdown strategy. The approach is to withdraw money in the early sunset years, or between ages 60 and 70, when income and the tax rate are at their lowest. Because taxable income generally declines after full-time employment, this is the best time to make controlled withdrawals. Still, the objective is to minimize your overall RRSP tax bill later when mandatory payouts begin.
Important tip
You are required to convert your RRSP into a Registered Retirement Income Fund (RRIF) by December 31 of the year you turn 71. You don’t need to wait until 71 to initiate the process. Provide clear conversion instructions to your financial institution. Otherwise, you risk the automatic de-registration of your RRSP, and your entire balance becomes taxable income. This could potentially put you into the highest marginal tax bracket.
For the RRIF, the federal tax law requires mandatory withdrawal every calendar year. The amount is a government- prescribed minimum percentage of your account value based on your age.
Investment option
Large-cap dividend stocks are compelling investment options for RRSP users. All interest, capital gains, and dividends earned inside an RRSP are tax-sheltered until withdrawn. Meanwhile, you benefit from compounding during the tax-deferred phase.
Bank of Montreal (TSX: BMO) is a no-brainer choice for an RRSP portfolio. Canada’s oldest and third-largest bank by market capitalization today is also the TSX’s dividend pioneer. The $118.8 billion bank boasts a 197-year dividend track record. BMO currently trades at $165.28 per share and pays a 2.9% dividend yield.
For illustration purposes, a $33,810 investment via an RRSP today will compound to $60,259.70 in 20 years, including dividend reinvesting. Tax deferral helps build a sizeable nest egg for a future drawdown strategy.
Compounding power and reduced tax bill
Tax-deferred growth in an RRSP is welcome, but a well-planned, deliberate drawdown strategy is best to avoid a large tax bill in retirement.
