Q: What's an RRSP?

A: It's an account designed to help Canadians save for retirement.

So, what is it exactly? A registered retirement savings plan (RRSP) is an account designed to help Canadians save for retirement. The money in an RRSP can be used to buy a whole host of investments—mutual funds, ETFs, stocks, bonds, and the like. While the investments are held in your RRSP, you won’t have to pay tax on any interest, dividends, or capital gains you earn. This makes the decison to open a RRSP a wise one.

Because RRSPs are registered accounts, they’re subject to certain rules. One of the rules is that you’re limited in the amount of money you can contribute to the account in any given year. The amount changes, but for 2018, the maximum contribution amount is 18% of your income or $26,230, whichever is smaller. You can also catch up if you didn’t max out your investments in earlier years; to find out how much you can contribute, check out the Notice of Assessment that you got after filing your taxes last year.

What are the pros? When you open a RRSP, the money you contribute is what’s called “pre-tax.” That means that you can subtract the amount you contribute from your income and pay less in income taxes. If you made $60,000 and you contributed $5,000 to your RRSP, you will pay tax on only $55,000 of income. You will eventually have to pay taxes when you withdraw your money, but the idea is that when you do so, you’ll be retired and your tax rate will be lower.

While the government charges a hefty tax penalty to withdraw funds early (10% to 30% immediately but possibly adjusted when you file your taxes), they do make exceptions if you’re using it to buy a house or go back to school, as long as you put the money back within 10 years for education loans and 15 years for home purchases.

Is there anything to be careful about? The biggest pitfall is forgetting, when doing your retirement planning, that you will have to pay taxes on your withdrawals. Also, the government requires you to close your RRSP by the end of the year you turn 71 and use the money to buy a registered retirement income fund (RRIF) or an annuity.