Written by Steve Nyvik, BBA, MBA ,CIM, CFP, R.F.P.
Financial Planner and Portfolio Manager, Lycos Asset Management Inc.
WHAT’S AN RRSP?
A Registered Retirement Savings Plan, or RRSP, is a government approved savings or investment account designed to encourage you to save for your retirement.
When you contribute to an RRSP you may receive a tax deduction equal to the amount of your contribution (to a certain limit). The deduction reduces your taxable income, so the higher your marginal tax rate, the greater your tax savings.
Income and gains earned within an RRSP grow tax-free until withdrawn. When you take withdrawals from your RRSP, the withdrawal amount is taxed as ordinary income (like interest income).
By investing in an RRSP, you’re likely to have higher growth than investing outside of an RRSP as:
- You have more money working for you as you’re investing untaxed income as opposed to a lesser amount of after-tax income outside of an RRSP;
- Your money within the RRSP grows without tax compared to investing outside an RRSP where income and realized gains are subject to tax.
Over a long enough period of time, the compounded growth of untaxed income can be worth substantially more than investing outside of an RRSP.
Other benefits to making RRSP contributions include interest free loans from your RRSP under:
- the Home Buyers Plan (up to $25,000 for each person, who is considered a “first time home buyer”, may be borrowed from their RRSP towards the purchase of a home; note that your RRSP contributions must remain in the RRSP for at least 90 days before you can withdraw them under the Home Buyer’s Plan, or the contributions may not be deductible for any year); or
- the Life Long Learning Plan (The Lifelong Learning Plan allows you to withdraw up to $10,000 in a calendar year from your registered retirement savings plans (RRSPs) to finance full-time training or education for you, your spouse or common-law partner. As long as you meet the LLP conditions every year, you can withdraw amounts from your RRSPs until January of the fourth year after the year you make your first LLP withdrawal. You cannot withdraw more than $20,000 in total).
These plans provide interest free loans from your RRSP to help first time home buyers or funding of post secondary education.
WHEN CAN YOU CONTRIBUTE?
If you have “Contribution Room”, you may contribute:
- To your RRSP at any time up to December 31st of the year in which you turn age 71;
- To a Spousal RRSP at any time up to December 31st of the year in which your Spouse or Common Law Partner (in this article we’ll refer to either of these as spouse) turns age 71. Contributing to a Spousal RRSP is a technique to shift more retirement income into a lower income spouse’s hands beyond the pension income splitting rules.
RRSP CONTRIBUTION LIMIT
The amount you may contribute to an RRSP is equal to the Lesser of:
- 18% of your Prior Year’s Earned Income, and
- Maximum Dollar Limit
- Pension Adjustment (PA) from Prior Year
- Past Service Pension Adjustment (PSPA)
- Pension Adjustment Reversal (PAR)
- Unused Contribution Room
Note that the Maximum Dollar Limit equals:
|Year||Maximum Dollar Limit||Prior Year Earned Income Required|
Your Notice of Assessment will provide you with your RRSP Contribution Limit. But here’s how Canada Revenue calculates that amount.
Earned Income generally equals the sum of:
- income from office or employment
- less annual union, professional or like dues
- less employment expenses
- plus income / (less loss) from self-employment or a business carried on by you, either alone or as a partner actively engaged in the business
- plus royalty income from work or an invention of which you were the author or inventor
- plus income / (less loss) from rental of real property
- plus taxable support payments received
- plus net research grants received
- plus employee profit sharing plan allocations
- plus CPP or provincial disability pension income
- plus amounts received under a supplementary unemployment benefit plan (not federal Employment Insurance)
- less deductible support payments made
If you contribute more than your limit, you may be subject to the Overcontribution penalty tax of 1% per month of the excess contribution (excluding the allowable $2,000 over-contribution).
RRSP CONTRIBUTION DEADLINE
For an RRSP contribution to generate deductions for a particular year, it must be made before 60 days after the end of the calendar year. So for the 2015 tax year, to generate a deduction for 2015, the RRSP contribution must be made on or before Feb 29, 2016.
The amount you may deduct in your tax return will equal your RRSP Contributions (excluding excess contributions) plus any prior year undeducted contributions.
Although you may make RRSP contributions up to your RRSP Contribution Limit, you need not claim the maximum RRSP deduction.
It may be worthwhile to consider forgoing all or part of your current deduction claim if you anticipate moving into a substantially higher tax bracket in the near future. The decision to delay claiming the deduction should consider the lost income that could have been generated on your tax savings.
A Spousal RRSP is merely an RRSP which names your spouse rather than yourself as the owner (also called the “annuitant”) but to which you may make contributions.
Contributions made by you to a Spousal RRSP are subject to your contribution limit (which is reduced by contributions you have made to your own RRSP). Your spousal contributions will generate deductions that you may claim against your income.
Withdrawals from the Spousal RRSP will be taxable to your spouse if you have not contributed to any Spousal RRSP in the year of withdrawal or in either of the two preceding calendar years. If you have made a Spousal Contribution during that time, the lesser of the funds withdrawn and the amount you contributed over that period will be taxable to you and not to your spouse.
To avoid Income Attribution you may wish to have your Spousal Contributions kept separate from your spouse’s contributions as it will be presumed that Spousal Contributions are the first to be withdrawn if contributions are co-mingled.
Locked-in RRSPs arise when you terminate membership in an employer-sponsored pension plan and elect to transfer pension funds out of the plan and into an RRSP where you can control the investment.
The locked-in restriction means that you cannot withdraw funds at will, as is the case with a regular RRSP. Withdrawals from a Locked-in RRSP are restricted and normally can only be done through conversion to a Life Income Fund (LIF), Locked-in RRIF (LRIF) or Life Annuity.
Conversion rules vary by province and locked-in funds that originated from federally regulated pension plans have their own set of rules.
When it comes to withdrawing funds from RRSPs for meeting your living needs, it generally makes sense to utilize locked-in monies before using your non-locked-in funds. Two possible exceptions to this are if a marriage is unstable (pension money which is treated differently than family assets in determining a split) or if you have creditor concerns (as pension money may be creditor protected).
Funds withdrawn from an RRSP will subject to withholding tax. Withholding tax is an amount that your RRSP administrator is required to withhold from your gross RRSP withdrawal and remit to the government on account of your income tax. The withholding tax rate depends on the amount of your total withdrawal request (not on how you choose to receive the payment – i.e. single lump sum, monthly, quarterly, etc.).
The table below summarizes the amount of withholding tax to be applied:
|Amount of RRSP Withdrawal||All Provinces
|Up to and including $5,000||10%||5%|
|$5,001 to $15,000||20%||10%|
|More than $15,000||30%||15%|
- For funds held in the province of Québec, there will also be provincial income tax withheld.
- For non-residents of Canada, the withholding tax rate is 25%, but can be reduced by a tax treaty.
The above withholding tax amounts will show on your tax return as taxes already remitted. The gross withdrawal amount will be included in your taxable income. Your total taxable income will determine the total taxes payable on your withdrawal.
No tax is withheld when the minimum amount is withdrawn from a RRIF. When withdrawals in excess of the minimum amount are made, the above RRSP lump sum withholding tax rates apply.
You will receive a T4 RRSP receipt for any funds withdrawn during the year showing the amount to be included in your taxable income and the credit for the incomes taxes that were withheld. So you end up paying tax on the withdrawal at your marginal personal rate.
Note that for a RRIF, there’s no withholding tax required to be withheld on minimum RRIF payments. Also, withholding tax is not required for withdrawals under the Home Buyer’s Plan or the Lifelong Learning Plan.
Funds can remain in an RRSP until December 31st of the year that you turn 71, at which time the RRSP must be matured.
If you fail to mature your RRSP, it will be cancelled at the beginning of the following year and the full fair market value of all of the assets are included in your income for that year of cancellation – this can be costly.
To mature your RRSP means to “roll over” your RRSP into some form of retirement income payment stream, of either:
- a Registered Retirement Income Fund (RRIF), or
- an annuity:
- that will pay income for as long as you live, or as long as you and your spouse lives, or
- that pays income for any fixed term up to age 90.
No tax results from the conversion of your RRSP to a RRIF or annuity. In both cases, you will receive periodic payments (at least annually) and such receipts will be taxable to you as ordinary income.
WHAT’S A RRIF?
A Registered Retirement Income Fund is exactly like an RRSP except for two differences:
- You cannot make contributions to a RRIF;
- Each year you must withdraw a minimum amount from your RRIF.
The minimum RRIF withdrawal is calculated each year and is equal to a prescribed percentage (see table; age is a one time election of your age or your spouse’s) multiplied by the value of the RRIF on January 1. The RRIF owner may elect to withdraw an amount greater than the minimum RRIF amount for that year, though withholding tax will apply to this supplementary amount.
|Minimum RRIF Withdrawal Schedule|
Note: For age less than 71, the prescribed factor is 1/(90-age).
PENSION INCOME SPLITTING
Canadian residents may be able to allocate up to one-half of their income that qualifies for the existing pension income tax credit to their resident spouse (or common-law partner) for income tax purposes.
The amount allocated is:
- added to the net income of the spouse or common-law partner, and
- deducted from the net income of the person who actually received the pension income.
“Eligible pension income” is generally the total of the following amounts:
- For individuals who are 65 or older at the end of the year:
- life annuity payments from a pension plan,
- annuity payments under a registered retirement savings plan (RRSP) or deferred profit sharing plan,
- minimum RRIF payments out of a registered retirement income fund (RRIF), and
- other taxable annuity payments.
- For individuals who are under 65 at the end of the year:
- life annuity payments from a pension plan, and
- certain payments received due to the death of a spouse or common-law partner.
- Canada or Quebec Pension Plan and Old Age Security payments do not qualify as eligible pension income);
- Foreign source pension income that is tax-free in Canada because of a tax treaty (that entitles you to claim a deduction at line 256) is not eligible pension income;
- Income from a United States individual retirement account (IRA) is not eligible pension income;
- Variable pension benefits paid from a money purchase provision of a registered pension plan or payments out of a pooled pension plan are not considered life annuity payments and do not qualify unless the pensioner is age 65 or older at the end of the year or the variable benefit or payments are received as a result of the death of a spouse or common-law partner;
- For Canada or Quebec Pension Plan payments it is possible to request from the ministry to “Assign” your CPP/QPP pension income which will be averaged with your spouse for the years you live together and split.
WHAT HAPPENS ON DEATH
On your death, your RRSPs and RRIFs are collapsed and included in the income of your final tax return.
Income tax can be deferred if the beneficiary of your RRSP / RRIF is a “qualified beneficiary” being your spouse or an eligible dependent.
The designation of a qualified beneficiary can be made directly through the RRSP/RRIF plan document or through your Will. These options are discussed in greater detail below:
1. Designating Your Spouse
(i) RSP/RRIF Beneficiary
Where you’ve designated your spouse as beneficiary of your RRSP/RRIF, on your death, the RRSP/RRIF is paid to your spouse / common law partner, this amount is taxable to him/her and not in your final return.
If your spouse / common law partner transfers these proceeds to their RRSP/RRIF before December 31st of the year following your death the transferred amount may be deducted in full.
Where you have named your spouse / common law partner as beneficiary in the RRSP/RRIF plan documents, you avoid probate.
(ii) RRIF Successor Annuitant
If you designate your spouse as the “Successor Annuitant” of your RRIF in the plan document, he or she simply becomes the annuitant of your RRIF and starts receiving RRIF payments on your death. Where this happens, the RRIF remains tax deferred. Probate under this option is also avoided.
2. Designating an Eligible Dependent
Where a financially dependent child or grandchild is the beneficiary of your RRSP/RRIF, the following tax-deferred transfers are available to this dependent child:
(i) Financially Dependent Child who is Physical or Mentally Infirm
- Rollover to an RRSP, RRIF or qualifying annuity
Where the financially dependent child, regardless if an adult or a minor (under 18 years of age), is physically or mentally infirm, the RRSP/RRIF proceeds can be rolled over tax-deferred to an RRSP, RRIF or qualifying annuity (for example: a life annuity) for the child.
- Rollover to a Registered Disability Savings Plan (RDSP)
Where the financially dependent infirm child or grandchild is the beneficiary of your RRSP/RRIF or pension plan and receives, as a consequence of your death, proceeds from these plans, these amounts may be rolled over (up to a certain limit) to a Registered Disability Savings Plan (RDSP) of the financially dependent infirm child.
The maximum transfer amount is $200,000 which is reduced by the amount of all contributions and rollover transfers that have previously been made to any RDSP. The amount of money transferred into an RDSP will form part of the $200,000 lifetime contribution limit. The Government will not pay matching Canada Disability Savings Grants on the money you transfer.
For example, if there is already $50,000 in private contributions in an RDSP, the amount rolled over from an RRSP, RRIF and RPP cannot exceed $150,000.
A rollover to an RDSP can only occur if the child is eligible for the Disability Tax Credit and the deposit into the RDSP occurs prior to December 31st of the child’s 59th year.
(ii) Minor Child – NOT physically or mentally infirm
- Rollover to a fixed-term annuity to age 18
If the child or grandchild is not physically or mentally infirm and is under 18, your RRSP/RRIF proceeds can rollover tax-deferred where the proceeds are used to purchase a fixed-term annuity that does not extend beyond the year in which the child turns 18. The annuity payments will be taxable as ordinary income to the child in the years they are received.
3. Designating a non-Dependent child over age 18 or any other person
If the beneficiary of your RRSP/RRIF is not a qualified beneficiary, the fair market value of your RRSP/RRIF as at the date of death is fully taxable as ordinary income in your final return. By naming a non-qualified beneficiary (such as your adult children) directly in the RRSP/RRIF plan document, you may avoid probate and legal fees on your RRSP/RRIF assets as these amounts pass outside your estate.
Care must be taken with non-qualfied beneficiary designations where:
(a) your chosen RRSP/RRIF beneficiaries are not identical to the beneficiaries of the remainder of your estate.
The danger is that you might unintentionally benefit one beneficiary more than another. This could happen because RRSP/RRIF assets are taxed in the estate, but the gross amount flows to the designated beneficiaries. For example, if you are a widower and you name one child the beneficiary of your $300,000 RRIF and a different child the beneficiary of your personal chequing account with $300,000, the RRIF beneficiary gets the $300,000, but your estate must first pay tax on the RRSP/RRIF proceeds from the other assets of the estate. If taxes averages out at 40%, then the other child’s entitlement (before factoring in probate, legal and tax costs) would be only $180,000 (= $300,000 x (1 – 40% tax rate)).
(b) where you name all of your children as equal beneficiaries RRSP/RRIF
Should one of your children predecease you, on your death, the RRSP/RRIF proceeds may then pass only to your surviving children. As such, the family of your deceased child might then receive nothing.
So in naming your children as beneficiaries of your RRSP/RRIF, it is important to review and update your beneficiary designation as family circumstances change.
4. Naming a Trustee of a Trust as beneficiary
Rather than name your adult children as beneficiaries of your RRSP/RRIF, you might instead name a Trustee of a Trust as your RRSP/RRIF beneficiary. The benefits of this alternative include:
- avoiding probate and legal fees associated with the proceeds and funds end up in a Testamentary Trust which has tax advantages and creditor protection features compared to direct gifts;
- avoiding the loss of a child’s government disability benefits by having their inheritance go to their RDSP up the allowable limit with the remainder to a Henson Trust or the $100,000 Disability Expense Trust
- ensuring that a deceased child’s family is not disinherited;
- ensuring that a spendthrift child won’t eat through their inheritance prematurely which you prefer to last for his or her lifetime;
- to achieve an unequal distribution of your estate – say to ensure that more monies go to a mentally or physically infirm child – and avoid a disgruntled child in making a successful Wills Variation Act Claim;
- building marriage/creditor protection provisions into the Trust to help keep the inheritance in the family.
The disadvantage of naming a Trustee is that you likely need to incur legal costs to have the Trust document created. The Trust could be in your Will, but it is preferable to be a separate document so that your beneficiary designation is not invalidated if you should later update your Will.
5. Estate as Beneficiary
In the event that your estate is the beneficiary of your RRSP/RRIF, the Executor of your Will might elect to have some of your RRSP/RRIF assets taxed in your hands to use up personal tax credits, losses or other deductions available in the year of death.
The Executor can then elect jointly with qualified beneficiaries to have the remaining RRSP/RRIF assets taxed in their hands or transferred tax deferred.
Leaving blank your RRSP/RRIF Beneficiary Designation or designating the estate may make sense if there is no spouse, your qualified beneficiary has little or no income, and where your RRSP/RRIF is small (example less than $50,000).
Although you would subject the RRSP/RRIF proceeds to probate fees, your estate with qualifying beneficiaries gain flexibility in better managing taxes through allocating income to the estate, to the qualified beneficiary, or to an RRSP/RRIF or qualified annuity for the benefit of a qualified beneficiary.
6. Naming one or more charities as beneficiary of your RRSP/RRIF
When a charity is designated as the beneficiary of your RRSP/RRIF (which should be done direct in the RRSP/RRIF plan document to avoid probate), the gift is eligible for the charitable donation tax credit and is deemed to have been made immediately before your death, as long as the RRSP/RRIF assets are transferred to the charity within 36 months of your death. Since the balance in an RRSP/RRIF is treated as income in the year of death, the charitable credit should eliminate the entire tax on the RRSP/RRIF.
For many people, the option of designating a charity as the beneficiary is attractive for two reasons:
- Flexibility – You don’t commit to giving monies that are needed for your living needs until after you’ve passed away. So, if you live longer than expected or you happen to have higher expenses, the RRSP/RRIF monies are still there to take care of you. The charity simply gets any residual.
- Supporting your charity rather than the taxman – your donation helps your favourite charity while reducing or eliminating the tax otherwise applicable to the RRSP/RRIF proceeds.
- Start saving early in life and make the maximum contributions, if possible.
- Make your RRSP contributions early in the year to gain an extra year of tax-free compounded growth.
- Spousal RRSPs still make sense where it is anticipated that one spouse will have substantially more retirement income than the other. That’s because only up to one-half of eligible pension income can be split with your spouse.
- If you and your spouse will become age 65 or older and don’t have at least $2,000 of pension income, consider converting an RRSP to a RRIF to qualify for the $2,000 Pension Income Tax Credit. Note that through the Pension Income Splitting Rules, you might elect up to $2,000 of Minimum RRIF Income to be taxed in your spouse’s hands if she does not have any eligible pension income.
- If you have Earned Income in the year in which the younger of you and your spouse turns age 71:
- estimate your Contribution Room that would be generated this year;
- consider making your maximum RRSP contribution plus next year’s contribution (taking into consideration any excess contributions) before Dec 31st – the date when the RRSP must be matured.
- If you cannot manage to make your maximum RRSP contribution, you might consider obtaining an RRSP Loan. As the interest expense is not deductible, you should repay the loan as soon as possible.
- If you’re retiring from your employment (which began prior to 1996) and you anticipate receiving a retiring allowance, consider taking advantage of the rollover of a portion of this severance amount to your RRSP.
- If you have a Locked-in RRSP, review the provisions of the province of jurisdiction rules to determine whether part or all of it might be unlocked.
THE NEXT STEP
To help develop your estate plan including beneficiary designations for your RRSPs and RRIFs, please contact our financial planner, Steve Nyvik. He will work together with your estate planning lawyer to help custom design and implement your estate plan. Estate Planning is included as part of the service for Steve’s clients of Lycos Asset Management Inc. Steve can be contacted by calling: (604) 288-2083 or by email: Steve@lycosasset.com