(This is for Canadian Taxpayers)
NOTE: I retired from the Tax Preparation business in late 2001 so these pages are not up-to-date.
This is written for those who are confused about all they have heard and read about RRSPs. Hopefully, this will clarify the muddy waters. We'll explain it by answering the questions most people have.
This web-page goes "hand-in-hand" with my page of Income Tax Tips. If you are serious about reducing your income tax to the very lowest amount legally possible, you should study both pages.
NOTE: when you are done learning how to take maximum advantage of RRSPs, don't forget to check out my Diamond Willow Walking Sticks and Hiking Staffs page by clicking HERE.
An RRSP is like a savings account at your bank. You deposit into it how much you want, when you want. Strictly up to you. You can also take it back out anytime you want, including whatever it has earned since you put it in.
An RRSP is better than a savings account because of two reasons:
1a. on your income tax return, you may deduct the amount of your RRSP contribution from your income; thereby
reducing your taxable income and reducing your tax for that year.
b. the money in your RRSP will earn income (but see below) and that income is added to the value of your RRSP. You DO NOT PAY TAX on those earnings. Money in your savings account earn interest and you pay tax on every cent of that.
Almost everyone benefits from an RRSP. Even if you have a pension plan at work, it may not be enough to provide you
with a comfortable income after retirement. Some feel that the Canada Pension Plan is not secure and we all know that
the Old Age Pension is hardly enough to get by on, at about $400 per month. As for the proposed new Seniors' Benefit,
apparently it has been put "on hold" early 1998. Let's see what happens. Many people feel that this plan will
discourage taxpayers from contributing to their RRSP, feeling that if their income is low after retirement, the
government will look after them quite well with that plan.
Also, if you have a period of time without any income due to illness, strike, work shortage or whatever reason, you can cash in your RRSPs and use that money to get by.
Yes and no. When you make the contribution and take the tax deduction, you save tax. When you take money out of your RRSP, you must pay tax on whatever amount you take out. This is reasonable because you have never paid tax on that money yet. In this sense, it is more a deferral of paying tax; pay it later instead of now. BUT, you immediately get the tax break when you claim the tax deduction on your tax return, and when you are in your "earning years", you may well be in a higher tax bracket than you will be after you retire. Thus, you may well pay tax at a low rate, while you had the tax break at a high rate. Further, due to inflation, you may pay back the tax in "smaller", future dollars. Lastly, you get the tax break now, which means you can invest that extra refund now for many years of growth.
A spousal RRSP is one which one spouse (married or common-law) buys for his/her spouse. The benefit of this is that
after retirement, the overall tax each year may be lower than it would otherwise be. To explain with an example: Bob
and Mary have a family. Mary keeps the home while Bob has a high income. Bob has a pension plan at work. Because he is
paying into the CPP, he will also be entitled to that upon retirement. Bob invests heavily into his RRSPs. This means
that after retirement,
Mary will get the OAP and Bob will get the OAP, CPP, Company Pension and RRSP pension. Mary will be in the lowest tax
bracket and Bob in the middle or top bracket. If some of Bob's income could be reported by Mary, her income would go up
and Bob's would go down. As long as Mary's taxable income stays below about $30,000, she would pay tax at the lowest
rate. This could be a significant tax saving.
The way to do this, Bob tells the agent (financial advisor or bank etc) that he is buying a SPOUSAL RRSP. The receipt which he gets for his tax return shows his name as the "contributor" and Mary's name as the "annuitant." Bob can claim the tax deduction, but the RRSP belongs to Mary. The amount Bob may deduct on his income tax return is not affected by whether or not he buys a spousal RRSP. His RRSP deduction limit, as shown on his "Notice of Assessment" for the previous tax year, is his limit. Buying an RRSP for his spouse does not affect that limit. But read #6, below, also. Note this simplified illustration:
And as the Provincial Tax is a percentage of the Federal Tax, it follows that if you reduce the Federal Tax, you are
also reducing the Provincial Tax. So, the savings are greater than shown in the above chart.
We assume, here, that the 17% Federal tax rate applies to the first (prox) $30,000 of taxable income and the 26% rate applies to the next (prox) $30,000.
If their marriage breaks down, this is Mary's asset. (but a legal advisor should be consulted in such a case)
(Incidentally, Bob's CPP could be split also; contact Health & Welfare Canada at 1-800-661-3921)
Yes, you can. If you get a spousal RRSP, you get the tax deduction. If your spouse cashes in that RRSP after three years, and during those three years, you have not put any more RRSPs into your spouse's name, then, if the spouse cashes in the RRSP, your spouse will report it as income. If, during those three years you have put more into the spousal RRSP, you will have to report the cashed-in RRSP as income on your tax return. If you are making a spousal contribution, and there is a possibility that your spouse may cash it in, it might be better to make the contribution *before* Dec. 31 rather than during the first 60 days of the next year. This way, the 3-year period will end sooner.
Yes; if you are married you should probably name your spouse as your beneficiary. If you should meet with an unfortunate death, the RRSP could be rolled over tax-free into the spouse's RRSP.
One of the key ingredients in the true benefits of an RRSP is time. An RRSP needs time to grow, and compound, tax free. Many of us make the serious mistake of starting too late in life. There is an example to show you the absolute necessity of starting early in my book at http://www.sticksite.com/money/index.html; you will find the chart at Chapter 7: "The Magic of Compound Interest."
This depends on where the money is. As with any other investment, if you want to try for extra fast growth, you must
sacrifice security. If you want high security, you must sacrifice high growth. There is a vast number of funds
available. The difficulty is choosing the one which suits your needs.
Generally, if you are young, your RRSP will have time to recover from "bad times" so younger people may be well advised to get into an "equity fund" which means their money will be pooled with that of others and the money will be invested in shares or corporations. If you are older and do not have time to recover from "bad times", you may feel more comfortable with slow, steady growth, provided by an RRSP which is very similar to a "guaranteed investment certificate."
This is like asking "should I buy some bread and veggies or should I buy some food?" See the previous question. You can invest in a Mutual Fund either "in" your RRSP or "outside" of your RRSP. Any income earned by your investments outside your RRSP will, of course, be "taxable income." Interest earned outside the RRSP will be taxed at your "marginal rate" which means that if your income is in the $30,000 - $60,000 range, the government will take close to $40.00 on every $100.00 you earn in interest income. Dividend income is taxed at a lower rate. Capital Gains are also taxed lower because you report only of a Capital Gain as income.
Yes and no. If your RRSP is similar to a GIC (see above) it may qualify. The fund may be insured by the CDIC (Canada Deposit Insurance Corporation). If the term of the deposit exceeds five years, it can not be so insured. Funds which invest in "equity funds" can, of course not be covered, because stock markets always go up and down. You can call the CDIC at 1-800-461-2342 to ask for their brochures and visit them at http://www.cdic.ca. Note that this website is not "secure" so that third parties may be able to access the information you put in. You may prefer to put in a fake name and fake data.
Generally, you can not do so. It is legal but can have very detrimental, unexpected disadvantages. It probably means that RevCan would consider your entire RRSP to have been "deregistered" and the entire amount might have to be included in your income, possibly pushing much of it into a higher tax bracket. Mr. Tracy LeMay (firstname.lastname@example.org) wrote a very interesting article "Collateral consequences" in the July 3, 1999 issue of The National Post. It is too long to include here. If you are thinking of using your RRSP as collateral, please read all the fine print and ask all the right questions. Talk to your banker, your tax-person and Revenue Canada before you do. Study Mr. LeMay's article.
Yes. A retired pensioner would not likely get any benefit, as his/her income will not likely take a drop into a lower tax bracket. NOTE: While we are commonly told by the "financial experts" that *everyone* must have an RRSP, this is not true. They are trying to sell a product and conveniently forget to tell you the downside. For many, many LOW income Canadians, an RRSP may NOT be a good idea at all. For a technical but very relevant explanation you might go to http://www.cdhowe.org/pdf/backgrounder_65.pdf and download that PDF file. It was referred to in the "50Plus" magazine by CARP News, August 2003 edition, page 46 ( http://www.50Plus.com )
For the 1999 tax year, you should buy your RRSP on January 2 of 1999. Most of us get our RRSP within the first 60 days of the next year. Big mistake. If you always get it at the start of that year, for that year, the difference at retirement will amaze you. Truly amaze you. Don't take my word for it; check it out; ask your bank or financial advisor.
Maybe. A great many of us make the mistake of planning for a big annual income tax refund. If you have already got your RRSP for the current year (see previous question) then you know for sure that you will get the tax deduction for the year when you do your next tax return. So why not take advantage now of that refund; why let the government use your money as an "interest-free loan?" Your payroll department can help you take this deduction (and other deductions to which you may be entitled) into account when your (monthly) pay is calculated. Your tax can be reduced, you will have your money much sooner and pay off bills or invest in your next RRSP sooner and save more. Your tax refund next spring should be next to zero. And you'll have been laughing all the way to the bank!
The amount you may deduct on your income tax return is indicated on the Assessment Notice which you get back from Revenue Canada after you file a tax return. When you filed your tax return for 1997, you got back an Assessment Notice for that return. On it, you will find a notice to you indicating the maximum amount you are able to deduct on your tax return for 1998. The amount is determined by the figures on your return for 1997. You may contribute more than that amount, but the limit as shown is all you may deduct. If your contributions exceed that limit by more than $2,000 you may be hit with penalties. Children under 18 may not take advantage of this overcontribution.
A detailed worksheet for calculating the amount you may deduct on your tax return is printed in the guide "RRSP and Other Registered Plans for Retirement." In summary, to determine the amount you may deduct on, say, your 1998 tax return, you need to use the numbers on your 1997 return. Add your Employment Earnings, Self-Employed earnings, Rental Income, Taxable Alimony or Maintenance Payments received, Profit Sharing Plan allocations, CPP Disability Payments, and from all these, deduct your (deductible) Alimony or Maintenance Payments Paid, Union/Professional Dues paid and Employment Expenses. Multiply the result by 18%. Take the lessor of this result or $13,500 and deduct the Pension Adjustment (if any) on your 1998 T4 slip. If you had "Unused Deduction Room" left from 1997, add this amount. The worksheet has a more detailed calculation.
You have 60 days after the end of a year to get your RRSP for the year just passed. The bank does not know when you will want deduct contributions of the first 60 days; for which year. So, they give you two receipts. One is for "the first 60 days" and the other is for the "remainder of the year." You can then use the two-month receipt for either year. If your (bank) gives you more than 2 receipts each year, or gives you one for every contribution, you might ask them to quit wasting your money and give you only 2 per year.
At the end of the year in which you turn 69, you must convert your RRSPs into a pension of some sort. If your spouse is not yet 69, you may get spousal RRSPs until that spouse reaches 69 years of age. See also point 26.
Some charge fees; some take the fees right out of the pool of funds provided by all investors. Ask the agent with whom you are dealing. Ask about fees to get into the plan, to get out of it and annual/period fees. If there are annual fees, you can pay those fees by cheque rather than have your plan charged. If you do, those fees will be a tax deduction; almost like a small, extra RRSP contribution!
A recent financial publication stated: "The RRSP Home Buyers' Plan allows a first-time home buyer to take an interest-free loan of up to $20,000 from his or her RRSP. The cost is the current tax-sheltered growth plus all future compound interest. It's very likely that an HBP loan would turn out to be the most expensive mortgage you'd ever have." Clearly, the writer is referring to your TRUE cost of using an HBP loan.
If you cannot do both, possibly the RRSP is the best way to go. Keep in mind that it gives you an immediate cash benefit now (tax refund) and it starts compounding tax free now, and, as stated earlier, time is the key ingredient. Also, if tough times come, and income drops, you can cash in an RRSP and use it to make mortgage (and other) payments. The RRSP which you cash in will be taxable but if your income is down, your tax rate will probably be down also.
That depends on your tax rate. In Alberta, if your taxable income (after deducting your Northern Residents' Deduction, Child Care Expenses, Alimony paid, etc.) is below $29,590, you are in the "bottom" tax bracket. The basic federal rate is 17%, plus 3% of that as a surtax, PLUS the Alberta tax which is 45% of the basic federal tax, plus of 1% of your taxable income. IN OTHER WORDS, up to about $30,000 of taxable income, you pay about 26%. If your taxable income is more than $29,590 the excess over that amount falls into the "middle" tax bracket where the basic federal tax goes up from 17% to 26%, making your "marginal" rate about 40%. So, if you are in the "middle" bracket, every $1,000 you put into your RRSP will reduce your tax by close to $400!!
This is the tax rate you are paying on your last dollar of income for the year. Suppose you had completed your tax return for 1998, and then discovered that you had forgotten about $1,000 of income you earned "on the side." If you then corrected your return, you might find that this additional $1,000 of income increased your tax for the year by $420. This means that your "marginal tax rate" is 42%.
No; this is referred to as your "unused deduction room." From 1991 on you may now accumulate this "room" indefinitely. BUT, notice how you lose if you don't contribute early. You lose the tax-free compounding, and chances are you will never catch up.
No; you cannot contribute to your own RRSP after the end of the year in which you turn 69. You may not contribute to your spouse's RRSP after the end of the year in which that spouse turns 69. There is no minimum age limit. Thus, young persons who are not taxable, should, if they have earned income, file tax returns in order to establish RRSP "deduction room." See also point 19. There is a way to make the rules work to your advantage, though. Suppose you are single and turned 69 this year. You worked this year so have built up some "contribution room" for next year. Since you must convert your RRSPs to retirement income by the end of *this* year, you can NOT make a contribution early in next year. But you can make that contribution in December of the current year. This is an overcontribution because it was not supposed to be made until *next* year. RevCan will charge you a penalty. By the time January of next year comes, it will no longer be considered as an "overcontribution" and you will be able to deduct it on your tax return for next year. The penalty charged will be far less, no doubt, than the amount of tax you will save.
Yes. Suppose you are earning $40,000 per year now and you expect to lose your job next year. Now you are in the "middle" tax bracket, around 40%. If your income will drop (say to under $30,000) next year, you will drop into the "bottom" tax bracket, around 26%. You could put a "huge" amount into the RRSP this year, dropping you into the bottom bracket (and getting a huge tax refund) and then take out (only what you need) next year, while trying to keep your Taxable Income below $30,000.
Likewise, if you are now in the "bottom" tax bracket, but expect your income to rise drastically next year, you might make your contribution now but not claim it until next year when the tax deduction will be a higher percentage. You would of course, not get as big a refund this year.
Probably not. The amount of tax deducted upon withdrawal may be 10% or higher, depe nding on how much you withdraw. The amount you actually have to pay on it depends on your marginal tax rate for that year.
No. If you put your money into an RRSP which pays interest, like a Savings Account, you will have a choice as to how long you want it locked in. If rates are good, and, in your opinion, rates are likely to drop, you may want to lock it in as long as possible. (remember, if the term exceeds 5 years, you cannot benefit from CDIC coverage) If rates are low, you may prefer to pick a short period. At the end of that period, you will have to give the trustee who holds the RRSP instructions as to what to do with it; lock it in for another year, two years or whatever feels good to you. You decide. When it is about to mature you normally receive a reminder to tell you the term is about over and asking for your instructions. If your RRSP is in some kind of mutual fund which invests in shares of corporations etc., there will be no maturity dates and it rolls along, year after year. If you want, you can roll it over at any time to a different plan or a different company/bank if you want. If you do, there may be fees for you to pay. Ask your agent about a "self-directed" plan where you pay an annual fee which allows you to make some adjustments without additional fees.
Probably. On your tax return, you first add all your income amounts to arrive at your "Total Income." From this, you deduct some amounts, such as your Union/Professional Dues, Child Care expenses AND your RRSP contribution. When you deduct these amounts, you arrive at a very important sub-total called "Net Income." This figure is used in calculating such things as Child Tax Benefits (monthly payments), the quarterly GST payments, and also any possible clawbacks of Old Age Pension and E.I. benefits. The lower the Net Income, the Better. It can even affect your claim for Medical expenses, your Charitable Donations AND your "Refundable Medical Expense Supplement" at line 452. For the 1998 tax year, a new "Personal Amount Supplement" was introduced and it is based on "Net Income" as well. So, a greater RRSP deduction means lower Net Income which may mean several other benefits.
Probably. Financial advisors generally agree that if you can pay back the loan within a year, you will probably be far ahead to borrow for your RRSP. And the resulting increase in your tax refund may go a long way to paying back the loan.
Possibly our political representatives realize that each one of us must take a greater responsibility for our own welfare after retirement, since the safety of the Old Age Pension is not secure nor is the Canada Pension Plan. Already, some pensioners are paying back part of their Old Age Pension if their income reaches a certain level.
Nope; your understanding of the situation is not clear. You pay tax on your income. True. When you put your money into an RRSP, though, you take the amount of that RRSP contribution off your income, on your tax return, and get back the tax paid on that income! So the money going into your RRSP has never had any tax paid on it. Thus, when you take it out, it is "taxable income." By then, hopefully, it will have grown (tax-free) many years and be worth much more. Probably also, you will be retired and in a lower income tax bracket so you will pay less tax on it.
There is no lower age limit. If a child has earned income in a given year, (s)he will have "deduction room" in the following tax year, as indicated on the child's "Notice of Assessment" which RevCan will send after processing the return. NOTE: this is a good reason for a child to file a tax return , even if (s)he will not receive any refund of tax or CPP/EI overpayment. Of course, if the child is 19 at the end of the year, or is a parent, then that child should file in any event, simply to get the quarterly GST payments. Another question spoke about "how much" you may contribute. It mentioned that children under 18 may not take advantage of the "overcontribution." See also the question about the overcontribution. If you are a parent of children under ager 18, you can give such children money. If the child invests that money and earns interest or dividends, such earnings are "attributed" back to you and you, as the donor, must report that income and pay tax on it. If the child earns capital gains on it, such gains are not attributed back to you. If the child puts the gift into his/her RRSP, the earnings are not attributed back to you either.
If your Notice of Assessment for your1997 tax return states that you may deduct a maximum RRSP of, say, $3,000 on your 1998 tax return, you may actually buy an RRSP of no more than $5,000. (We assume that you do not have undeducted contributions from previous years.) This is a good idea if you have money in the bank earning interest. Such bank interest is taxable, so by putting $2,000 of that into your RRSP, you protect that interest from tax. But, please note: you cannot do this every year. You can *keep* your overcontribution at $2,000, and you may let this amount go down, by claiming some or all of it on your tax return, but your overcontribution may not exceed $2,000. If you decide to keep an overcontribution going, make sure that you will have deduction room to take advantage of it, and deduct it. If your earned income will drop, e.g. at retirement, best to use it. If you do not, you will pay tax on it when you withdraw it - paying tax twice on that amount.
No, only for yourself or your spouse, including "common-law" spouse.
One person asked me:
"I'd be interested to know what happens with RRSPs when you retire early Is there a penalty if you retire before age 65? In other words, if you want to retire at age 58, for example, do you just transfer the funds to an RRIF or something, or is there a minimum age limit for that? Thanks." (RRIF = Registered Retirement Income Fund)
I put this question to Mary-Jo Mather, financial planner, and she replied:
"Ken, If you retire early you can set up a RRIF. You don't have to wait until you are 65."
Debbie J asked me "Why are people not told that if they cash in their RRSP just before they retire they are penalized by the Old Age Security. My parents cashed in their RRSP's and because of this they are losing $600 a month from their Old Age Pension cheques for the next 2 years?"
All I can say, Debbie, is that all money coming out of an RRSP is taxable income. If you cash in a lot of RRSPs, you could be hit with the "clawback" of OAP (which means paying back OAP benefits already received!) and your OAP monthly payments for the next year could go down, but not for 2 years as you stated. You can confirm this with Health & Welfare Canada at 1-800-277-9914.
At one time, apparently, once you converted your RRSP into a RRIF you could not convert back to an RRSP. That is not the case now. You can start a RRIF and then later transfer it back to an RRSP up to the age of 69 years. Revenue Canada provides a form for that purpose: T2030(E) "Direct Transfer under Subparagraph 60(I)(v)." Thanks to Mike Murray for pointing this out to me!
Yes, you can put your Canada Savings Bonds as well as most stocks, mutual fund investments and some mortgages into your RRSP. There may be a disadvantage though; if stocks have gone up in value since you acquired them, you may have a taxable Capital Gain if you put them into your RRSP. As to how to put them in, see your RRSP dealer/banker.
As mentioned earlier, some tax will be taken off when you cash in part of your RRSP, but the tax withheld will probably not be enough, depending on your other income for that year. Another reason to think twice (maybe 3 or 4 times?) before you make that fateful step, is because this will increase your "NET INCOME" (line 236 on your tax return) and this figure is used for all kinds of other things. The higher your "Net Income", the lower your other benefits. Raising the Net Income may have such unfortunate effects as: lowering your claim for Medical Expenses, lower quarterly GST payments, lower "Refundable Medical Expense Supplement", lower monthly Child Tax Benefits, Reduced Old Age Security Guaranteed Income Supplement benefits, and it could reduce the "Age Amount.'
Starting in 1999, you may be able to withdraw funds tax free from your RRSPs if you or your spouse participates in a continuing education program. For more information, get the guide called Lifelong Learning Plan (LLP).
Maybe not. There was a *very* important/informative article in The Financial Post of Oct. 6, 1999, by Mr. Tracy LeMay, entitled "Taxman punishes seniors who save." This is too long a subject to be included here but if your income is low and you are age, say, 50 or better, you really *must* read that article and any others which discuss this problem.
I put this question to a large, national firm of Financial Planners and this is their answer:
"At the end of the day there is no simple solution. We always recommend that clients personal financial situations/goals are reviewed prior to initiating any type of investment strategy. I have been hearing from several clients of late that they lament having ever invested in RSP's as they are now in the kind of situation that is mentioned in the article. Unfortunately, it is always easier to look backwards rather than to the future. We don't know what the future holds for tax rates and or clawbacks and deductions. I know as a salaried employee I have virtually no other allowable deductions and thus feel I have no other option than to contribute to an RSP. I may be sorry down the road but as I say, who knows what the tax/clawback implications will be 20 years(wish I had a crystal ball) I haven't really answered your question but I guess it does reinforce the direction that we are heading towards here at Royal Trust. As an accredited Financial Planner we are able to help our clients by completing a financial plan (centered around clients goals) which looks at ways to achieve financial goals, while taking in to account cash flow, net worth, and tax implications."
In the year during which you turn 69 years of age, you must, by December 31, convert your RRSPs to some kind of retirement income, such as a Registered Retirement Income Fund or an annuity. If you do not, the institution which holds your funds must close your RRSPs, deduct income tax and send you a cheque for the balance. The gross amount closed out will have to be reported as income by you on your income tax return for the year in which the RRSP is closed out. This could result in a very great, unexpected tax bill. BE CAREFUL not to miss this deadline!
See my page by clicking HERE.
Any contributions which you make by the end of the year, MUST be attached to the tax return for that year, and reported on Schedule 7 for that year, whether you claim them or not. Contributions which you make in the first 60 days of the following year may be claimed, but SHOULD be attached and reported on Schedule 7 whether you claim them or not; by doing so there will be no danger of losing them and there will be an immediate, permanent record of them. Your Assessment Notice will show that you have "unclaimed contributions." It might be a good idea to keep an extra copy of Schedule 7 with your RRSP files to keep track.
This is for CANADIAN taxpayers. It has no value to anyone who does not pay Income Tax to the Government of Canada.