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What are the major differences between the two?

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I've worked on software to model both kinds of retirement accounts – the RRSP in Canada and the 401(k) in the U.S. – and here's what I've learned about their major similarities and differences:

How the 401(k) and RRSP are similar:

  • Both are official investment account types created by government and conferring tax advantages designed to encourage you to save for retirement:

    • Both permit pre-tax contributions; i.e. you can claim an income tax deduction for contributions made to the account during the year.

    • Both enable tax-deferred investment growth. That is, any returns generated in the account are not taxed in the year returns are generated – rather, they are taxed later upon withdrawal – hence the "deferred". This helps compound growth work to your advantage.

  • Both have annual contribution limits designed to prevent you from contributing all of your income into the account.

  • Both generally permit you to invest in a variety of investment products (e.g. mutual funds, stocks, bonds, CDs / GICS) – though what options exactly depends on your plan or broker.

  • Both have ages beyond which withdrawals or conversion to an account type requiring withdrawals is mandatory. (Required Minimum Distribution rule in the U.S., and RRIF accounts in Canada.)

How the 401(k) and RRSP are different:

  • 401(k) accounts are offered only in conjunction with an employer via payroll deduction. Whereas, in Canada it is possible to have an individual RRSP, as well as a group RRSP from an employer, and payroll deductions are just one way to put money in. In Canada, there are also distinct employer-sponsored Defined Contribution (DC) pension plans which are not considered RRSPs; I understand in the U.S., most DC plans are 401(k)-type plans. On the other hand, while there are no individual 401(k) in the U.S., there are Individual Retirement Account (IRA) plans, but contribution limits are less generous.

  • 401(k) accounts can optionally offer two additional contribution types: traditional post-tax contributions, and Roth post-tax contributions. Such types of contribution do not exist for RRSPs, where the only contribution type is pre-tax. However, Canada recently introduced the TFSA (Tax Free Savings Account), which behaves similar to U.S. Roth-type accounts.

  • 401(k) contribution allowances are use-it-or-lose-it for the year, but in Canada the RRSP contribution allowances cumulatively carry forward. That is, if you don't put in your allowed contribution this year, you can put in that amount next year, plus next year's amount, etc. Many Canadians have built up lots of unused contribution room, to a point where they could conceivably shelter very large sums in an RRSP – a symptom of past under-saving.

  • 401(k) accounts have early withdrawal penalties where generally speaking any withdrawal before age 59 1/2 is penalized with an additional 10% tax, on top of the regular tax due. However, in Canada, early withdrawals from an RRSP are treated no different than withdrawals made in retirement.

  • 401(k) accounts have "catch-up" contributions permitting individuals age 50+ to contribute additional funds. Canada's RRSP has no such provision; perhaps owing to the cumulative contribution allowance I mentioned above.

  • 401(k) accounts are subject to rules for Highly Compensated Employees (HCE), which prevent some top-earners in a company from contributing the maximum if other employees don't contribute enough. RRSPs don't have such a requirement.

There are many more differences; e.g. inheritance rules, loans, etc. and I'm sure they could be uncovered if you look at legislation for each in detail (and manage not to fall asleep doing so!) However, I think I've covered the most common differences above.

Official reference sources:

  • Wow. What a comprehensive look. Thanks, most useful! – ChrisInEdmonton Aug 16 '11 at 20:57

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