“Many individuals fall in the category where their income tax rates in the accumulation phase are higher – that’s because they are in their peak earning years and are paying high income tax rates. Presumably, when they retire, they will be paying much lower income taxes. Since their contribution income tax rate is much higher than the withdrawal income tax rate, an RRSP contribution is probably the preferred option for this category of individuals,” says Lancaster.
“For the few Canadians who pay a higher rate in their withdrawal years than in their contribution years, a TFSA is probably the better choice.” If you choose to make RRSP contributions, remember that TFSAs still make sense for other savings purposes.
Brought to you be the Institute of Chartered Accountants of Ontario
RRSP Tip 2 of 16
Smaller house, bigger RRSP?
If you’re selling the family home to move to a less expensive one, consider all the options before you stash the extra cash in an RRSP.
“Money from the sale of a principal residence is tax-free,” says Vaughan Chartered Accountant Sidney Laufer.. “But that’s where the commonality ends. Everyone must examine his or her particular circumstances and decide how to use the proceeds in a way that’s best for them.
“If you’re purchasing a new, less expensive residence, any excess funds can be applied to an individual or spousal RRSP until the maximum contribution level is reached,” Laufer explains. “At age 65, each partner can transfer approximately $10,000 from the RRSP to a Registered Retirement Income Fund (RRIF). Then, each partner can withdraw $2,000 from the RRIF each year until age 71, at which point the remaining RRSP funds can be moved to the RRIF.”
It is important to note that each person’s situation is unique - there is no universal answer when it comes to RRSPs. A considerable contribution for those who have a large RRSP carry-forward may not make sense. If a person opts to take the money later it could well spike them into the next income bracket.
If you’re planning to rent rather than buy another home, Laufer suggests you first prepare a new financial budget that matches your new living arrangements. And, regardless of your situation, consult a Chartered Accountant first to be sure you understand all of the options and implications before purchasing any investments – RRSPs or otherwise.
Brought to you by the Institute of Chartered Accountants of Ontario
RRSP Tip 3 of 16
Mortgage payment vs. retirement saving
Should you focus on paying down your mortgage or contributing to an RRSP?
“Mathematically, you can calculate which alternative is better, given assumptions about mortgage rates and the rate of return in your RRSP. Most analysts conclude that it is better to pay off your mortgage first, assuming that the rate of return of the investment in your RRSP does not exceed your mortgage rate,” says Chartered Accountant Ann M. Donohue, a Partner with Campbell Lawless Professional Corporation in Toronto.
“There are many factors that you should also consider. Will you be able to catch up on your RRSP contributions once you’ve paid off your mortgage? Will you need the funds in your RRSP for emergencies? Do you want to diversify your investments rather than place all of your available cash in your home?
“Keep in mind that having the discipline to save money, either by paying down your mortgage or putting money in your RRSP, will mean that you will increase your net worth in the long run. Both paying off your mortgage and saving for retirement are important components of any good financial plan,” advises Donohue.
Brought to you by the Institute of Chartered Accountants of Ontario
RRSP Tip 4 of 16
How RRSP contribution room is calculated
How does the government calculate the amount that you are allowed to contribute to your RRSP?
“The Canada Revenue Agency (CRA) calculates your contribution limit for the upcoming year and highlights it in a box on the Notice of Assessment that you receive in the mail after you file your income tax return for the current year. You can also find your RRSP room for 2009 by way of My Account service or the Quick Access Service on the CRA website at [url=http://www.cra-arc.gc.ca]http://www.cra-arc.gc.ca[/url].
“You are entitled to contribute this amount to your RRSP without penalty, generally starting on January 1 of the upcoming year. Once you make a contribution to your RRSP, you can deduct it on your tax return in the current year or any future year,” says Chartered Accountant Bruce Ball, National Tax Partner with BDO in Toronto.
Any contribution made on or before March 1, 2010 can be deducted on your 2009 tax return if you have contribution room for 2009.
Brought to you by the Institute of Chartered Accountants of Ontario
RRSP Tip 5 of 16
Save for a house or invest in an RRSP?
It’s a big question, and the right answer depends on your goals and circumstances.
“If you have funds in an RRSP and you’re looking to buy a house, you must weigh the benefits of a smaller mortgage and less interest against the loss of tax-free compounding and earnings in an RRSP,” says Chartered Accountant Jennifer Wheeler, Tax Manager for KPMG Kingston.
While each case needs to be examined on an individual basis, the question to be asked is: what will you do with the additional cash flow? If you use the Home Buyers’ Plan, your monthly mortgage payments will be lower but will you use that additional cash flow towards your lifestyle?
For those who understand the risk, and use the additional cash flow to make higher than required mortgage principal payments, then it makes a lot of sense. You are essentially using RRSP money to earn “tax-free income” – reducing non-deductible mortgage interest.
“With the Home Buyers’ Plan, anyone who hasn’t owned a home in the last five years can use money in their RRSP to purchase or build a home,” Wheeler explains. “For couples, each partner who qualifies for the plan can withdraw up to $25,000. That’s as much as $50,000 toward the purchase of an existing home, or one that you build.
“The money must be repaid to your RRSP over the course of 15 years, beginning the second year after it’s withdrawn,” she says. At least one-fifteenth of the total amount borrowed must be repaid each year, or the shortfall will be added to your income and be subject to tax.
“The money used must have been contributed to your RRSP at least 90 days prior to being withdrawn for the Home Buyers’ Plan or you won’t be eligible to deduct it on your
tax return,” Wheeler cautions. “And, finally, for both partners to qualify for the plan, the property must be purchased jointly in both names.”
It should be noted that the Home Buyers’ Plan is subject to a number of intricate rules and individuals should ensure they have all of the appropriate information prior to making a decision.
RRSP Tip 6 of 16
“In-Kind” withdrawal for seniors – no charge
Are you faced with the unhappy prospect of withdrawing from your RRIF, even when it’s declined in value?
“Seniors can take advantage of what’s called an in-kind withdrawal,” explains Toronto Chartered Accountant John Mott.
“An in-kind withdrawal allows you to transfer stocks, mutual funds or other assets from a RRIF to a non-registered account at no cost. Just like a cash withdrawal, you will pay tax on the securities being transferred, but there is no sale involved and no extra charge.” But be aware, Mott cautions that withdrawals in excess of the minimum amount are subject to lump sum withholding tax rates.
Brought to you by the Institute of Chartered Accountants of Ontario
RRSP Tip 7 of 16
Sometimes, it just doesn’t pay you to work
If you’ve been conscientious about investing in RRSPs, there can be a point at which it doesn’t make sense to keep drawing a pay cheque.
“RRSPs should do more than simply allow us to defer taxes,” says Toronto Chartered Accountant David Aiken. “The idea is to make the contributions when your tax rate is higher than it will be when you withdraw them. As well, an adequately funded and properly managed RRSP will allow retirees to continue on with a secure, carefree lifestyle.
“For example, while you’re actively working, your marginal tax rate may be as much as 46.4 per cent in Ontario. If you cash out your RRSPs at age 71 and you are in a lower tax bracket, it provides a distinct tax advantage,” Aiken explains. “An added bonus is that while your money is invested in the plan, neither the principal nor the earnings it generates are taxed.
“But if you’re still working full-time past age 65, you could continue to be taxed at that higher rate. Then, your income will increase because you begin collecting Canada Pension and Old Age Security. Furthermore, if your income level is too high, Old Age Security benefits will be subject to clawback.
“By age 71, all your RRSPs must be converted to a Registered Retirement Income Fund (RRIF),” Aiken continues. “Those funds must then be withdrawn as taxable income, maybe gradually and for the rest of your life. But if you’re still getting a salary, your RRIF income could be taxed at a rate that’s even higher than when you invested in the RRSP in the first place.”
So if you’re blessed with the good health, joie-de-vivre and the desire to keep active after your 65th birthday, consider that golf, volunteer work and/or time with the grandchildren might be just as rewarding and easier on your bank account.
Brought to you by the Institute of Chartered Accountants of Ontario
RRSP Tip 8 of 16
File tax returns for children - build contribution room
No matter your age, filing tax returns as early as possible helps build RRSP contribution room and save taxes down the road.
“Many people know that a threshold income can be earned prior to the requirement to pay any tax,” says Chartered Accountant Carmelo Linardi, Carmelo Linardi Professional Corporation in Newmarket.
“Once that level is surpassed, the income in excess of that level is subject to tax at the various graduated rates in effect for that particular year. The threshold amount of income is based on the basic exemption for a given year – and in 2009 the federal level is $10,320.”
How does this tie into RRSPs?
Many kids earn income below the basic exemption level (from jobs including part-time work or babysitting), and their parents typically do not file tax returns for their children to report this income. RRSP room that could have been built up from these income sources has been lost.
According to Linardi, this RRSP room could be significant, given the potential increased exemption thresholds, and depending on the child's income and number of years he or she is below the threshold.
“Imagine a child who earns $5,000 per year doing summer work for a period of at least six years. While that's $30,000 of tax-free income; it’s also $5,400 of lost RRSP room. When that child is older and can make RRSP contributions to shelter tax at top personal marginal rates, the savings could be as high as $2,500 – well in excess of the trouble of preparing tax returns for six years.”
Brought to you by the Institute of Chartered Accountants of Ontario
RRSP Tip 9 of 16
Do spousal contributions still make sense?
Even though partners can now allocate half of their qualifying pension income to each other, spousal contributions may still be a good idea, according to Chartered Accountant Sam Zuk, Partner, Soberman LLP in Toronto. Qualifying pension income includes RRIF withdrawals for those 65 years of age or older.
“For many years, spouses have planned their RRSP contributions to equalize their RRSP accounts and minimize taxes paid on retirement. Through spousal RRSP contributions, one partner can contribute to the other’s RRSP and still deduct the contribution from his or her income for tax purposes.
“Pensioners may jointly elect, with a spouse or common law partner, to allocate up to one-half of their eligible pension income to their spouse or common-law partner.”
Zuk advises that, because only up to half of the pension income can be reallocated to a partner, people shouldn’t rule out a spousal contribution.
RRSP Tip 10 of 16
RRSP vs. Savings Account
What is the best way to save – with an RRSP or a non-registered savings account?
“RRSPs offer more benefits than just saving money in a non-registered account,” says Chartered Accountant Robin Cyna, Senior Manager, Tax Services, Grant Thornton LLP.
“Due to their tax-preferential treatment, an RRSP lets you save more, faster. It is like a savings plan with an added bonus, and you have the same access to your RRSP funds as a regular non-registered savings plan.
“An RRSP grows faster because of tax-deferred compounding. Consider a situation where a person invests $10,000 of salary directly into an RRSP and also invests $10,000 of salary ($5,350 after tax) into a non-registered account assuming a 46.5 per cent tax rate. After 20 years at 5.5 per cent, the capital in the RRSP before taxes would be $29,177 and the net after-tax capital would be $15,610. Conversely, the after-tax balance in the non-registered account at the end of the of the 20th year would be only $9,555,” explains Cyna.
Unlike regular savings plans, contributions to an RRSP offer tax-planning opportunities. For example, if your taxable income will be much higher in the next year, you might contribute to your RRSP this year, allow the contributions to begin to generate tax-deferred earnings, and only take the deduction in the coming year when it is of more value to you.
According to Cyna, an RRSP is also an effective method of setting up a savings plan, especially when employers permit direct contributions from salary. More importantly, you are contributing before-tax funds, meaning the money you would otherwise be paying in tax is deposited in your RRSP and earns tax-deferred income for you.
And don’t forget that we now have the Tax Free Savings Account as another tax-planning avenue to explore outside of RRSP contribution.
RRSP Tip 11 of 16
Fund your retirement while doing what you love
What if you have lost a significant amount of money through your investments? Is there another way to fund a comfortable retirement?
“Consider the ‘Starting Your Own Business Plan’,” advises Chartered Accountant David Trahair, author of Enough Bull: How to Retire Well Without the Stock Market, Mutual Funds or Even an Investment Advisor.
“This is something that anyone who can handle self-employment automatically has access to – the ability to do what you love doing during retirement and get paid for it. You’ll want to do something to keep yourself busy, so why not earn money for it?
“If you start honing your skills early enough, by retirement age you’ll probably have developed a niche you enjoy. You may even have clients, and you can get involved as much or as little as you like. At this stage you’ll have tremendous experience, which is worth good money to those who need it,” advises Trahair.
“Never been self-employed? Consider building your skills on a part-time basis. Learn how to find and keep clients, bill what you are worth, and run a business you enjoy. It has the potential to make up for what your investments took away.”
RRSP Tip 12 of 16
Borrow to save for retirement
Is obtaining a loan to purchase an RRSP a good idea?
“An RRSP loan can be advantageous if you have accumulated a significant amount of unused RRSP room because it allows you to maximize your contribution,” says Chartered Accountant Tina A. Di Vito, Director of Retirement Strategies, BMO Financial Group in Toronto.
“For example, say you have unused room of $18,500 and your marginal tax rate is 46 per cent – if you can come up with $10,000 yourself and borrow $8,500, for a total contribution of $18,500, the RRSP contribution will generate a tax refund of $8,500 – just enough for you to pay off the entire loan.”
RRSP Tip 13 of 16
RRSP contributions when working outside Canada
If you’re a Canadian expat or someone who commutes to work in the United States, you can still contribute a portion of your earnings to an RRSP.
“Many countries, including the United States, tax people on their citizenship. But in Canada, we’re taxed based on residency,” explains Chartered Accountant Walter Benzinger, from Deloitte & Touche LLP in Windsor.
Residency is a question of fact, Benzinger says, and the Canada Revenue Agency will consider things like the location of your home, your family members and your bank accounts in determining whether you are, in fact, a Canadian resident who is eligible to contribute to RRSPs and reap the associated tax savings.
“Commuters who live in Canada but cross the border to work in the U.S. must pay American federal, state and local taxes,” Benzinger continues. “You’ll receive a W2 form that states your earnings, and you must file a non-resident tax return called a 1040NR. You’ll need to file a Canadian T1 return as well, but don’t worry. There’s no double-taxing. Canada gives you full credit for any foreign taxes you pay, including things like the U.S. Federal Insurance Contribution Tax (FICA), Social Security and Medicare.
Any RRSP contributions you make can be used to offset taxes still owed in Canada, but Ontario residents must still pay the Ontario Health Premium, which is calculated at a graduated rate on income over $20,000. The Ontario Health Premium payable on incomes from $48,500 to $72,000 is $600 so you must decide if makes sense for you and your financial plan.”
RRSP Tip 14 of 16
New rules for RRSPs that lose value after death
Death and taxes are supposed to be two sure things. But when we defer taxes by investing in an RRSP, what happens if we die before age 71 with money still in the fund?
“Usually, RRSPs have a named beneficiary who inherits the contents of the plan in the event the owner dies,” says Chartered Accountant Jennifer Wheeler, Tax Manager with KPMG Kingston.
“On death, the holder of the plan is taxed on the entire amount, unless it’s left to a spouse or a financially dependent child or grandchild,” Wheeler explains. ”The RRSP can be transferred tax-free to a spouse’s RRSP. If it’s left to a financially dependent child or grandchild, then the value of the RRSP is taxed in the hands of that child or grandchild, and the tax can often be deferred for many years.
“If the beneficiary is not a spouse or dependent child, there is no tax-free rollover and the funds must be added to his or her income for tax purposes. Further, any changes in the value of the fund that occur between the date of death and the time distribution takes place must also be included in the beneficiary’s income.”
Wheeler says that historically no consideration was given to RRSPs that declined in value during the time the deceased’s estate was being settled. But with the poor economic climate of the last few years, the federal government has reassessed its rules.
“In the 2009 Federal Budget, a new relieving rule was introduced,” she continues.
“Now, if the value of the plan decreases between the time the RRSP holder dies and the fund’s contents are distributed to beneficiaries, the deceased taxpayer may be eligible to claim a deduction on their final income tax return. That difference can reduce the tax burden, leaving more money in the estate for beneficiaries.
Wheeler cautions, “This rule generally applies to RRSPs that were wound up after 2008. However, to claim the loss, the funds must have been distributed to beneficiaries, and the RRSP, which cannot hold any non-qualifying investments, must be wound up by the end of the year following the year of death.”
If you think these rules may apply to your situation, be sure to review all of the facts with your Chartered Accountant.
RRSP Tip 15 of 16
Tap into your RRSP savings
If you withdraw money from your RRSP, here’s how it will affect you financially.
“You’ll be subject to tax withheld at source of 10 per cent if the withdrawal is $5,000 or less; 20 per cent if the withdrawal is greater than $5,000 and less than or equal to $15,000; and 30 per cent for amounts greater than $15,000,” says Chartered Accountant Gary H. Kopstick, Senior Tax Partner, Soberman LLP in Toronto.
He suggests that you consider several smaller withdrawals rather than one large lump-sum payment to reduce the tax withheld at the time of the withdrawal. “The reduction is only a tax deferral, as the withdrawn amounts must be reported on your tax return where they will be subject to your regular tax rate.”
Keep in mind that in situations where a taxpayer makes a single request to withdraw an amount in installments, the withholding would be based on the total amount to be withdrawn.
RRSP Tip 16 of 16
Use your RRSP to help offset capital gains
Capital gains refer to increases in wealth that can result from a number of sources, in a number of different ways. At the personal level, for example, the sale of assets like stocks or bonds can trigger capital gains that the Canada Revenue Agency considers to be a form of income. Fifty per cent of a capital gain is subject to tax at whatever your personal rate of taxation might be.
Depending on your income level and the amount of capital gains incurred during a taxation year, those taxes can become substantial. But with proper planning, you can postpone and/or reduce the amount of taxes you have to pay.
“Stocks, bonds, mutual funds and other investments can be held in your RRSP, which can allow you to effectively defer capital gains,” Parkinson says. “There, they can continue to increase in value and not be subject to tax until they’re withdrawn. The strategy is that when you do withdraw them, it will be after you retire or at another time when your marginal tax rate is considerably lower than when you first purchased the investment. Remember, however, unlike a capital gain, gains on RRSP assets are 100 per cent taxable when that appreciation is received as an RRSP withdrawal. So, this planning may not be appropriate where your marginal tax rate in retirement won’t decline substantially.
“Another good reason to hold these assets in your RRSP is that upon death, they can be transferred to your spouse or common-law partner’s RRSP without diminishing his or her own contribution room,” Parkinson adds.
There are restrictions and conditions that apply, so it’s best to consult a Chartered Accountant or qualified financial planner to make sure you meet the eligibility requirements.
