This week was my birthday week, which got me to thinking about aging, retirement, and savings. It also happens to be RRSP season, so I answered your questions about registered retirement savings plans and tax-free savings accounts!
WHAT IS AN RRSP?
Registered Retirement Savings Plans – otherwise known as RRSP’s are government-controlled savings plans, meaning there are specific rules surrounding them, but they also offer some tax advantages.
WHAT IS THE BENEFIT OF AN RRSP?
The idea behind an RRSP account is to give taxpayers the benefit of getting a tax deduction in the year you make your contribution to the account. Every dollar that you put into an RRSP decreases your taxable income by a dollar. The RRSP year is from March 1-February 28 (usually, it can change based on leap years or the way a weekend falls, but that’s general guideline). The reason for this is to allow people to do tax planning at the end of the regular tax year (which is January-December). For example, if you know you got a huge bonus at work in 2018 and you want to bring yourself down an income tax bracket, you could make an RRSP contribution as late as March 1, 2019 in order to keep yourself in that lower bracket.
You can choose from a bevy of different investments within your RRSP plan, it’s not necessarily just an interest-bearing savings account – you can have stocks, bonds, mutual funds, index funds, exchange-traded funds, shares, even gold & silver within an RRSP. Any investment income you make within that RRSP is not taxable for the entire time it’s in there.
Some of you may also get the opportunity to contribute and even be matched by an employer to an RRSP. This usually means that the employer will deduct the RRSP contribution right off your paycheck, so you don’t even see it in the first place, and put it into your RRSP account. Sometimes, if you’re really lucky, your employer will even match your contribution – if you have this chance, take it – it’s free money!
HOW MUCH CAN I CONTRIBUTE TO AN RRSP?
The amount that CRA lets you put in is based on your previous year’s income – right now it is 18% of your 2017 income, or $26,010, whichever is less. Now, if you don’t put the entire 18% or $26K in this year, you will get to carry that amount forward, which is why a lot of you listening probably have a way higher contribution limit than that. If you don’t know what your contribution limit is, take a look on your 2017 tax return, notice of assessment, or you can check your online My CRA account.
If you over-contribute to your RRSP fund in any given year, there is a penalty, which needs to be calculated using a very complicated form called a T1-OVP. The penalty is based on how much you over-contributed and how long that over-contribution stayed in the RRSP account.
WHEN CAN I TAKE OUT MY RRSP?
Technically, you can take a draw from your RRSP at any time, but as soon as you do, it becomes taxable income to you. The amount of tax you will pay depends on what income tax bracket you are in in the year that you take it.
The point of RRSP’s is to take the funds out when you’re retired, so presumably, you no longer have employment income, you’re likely living on your pension or CPP and you’re in a lower tax bracket than you would have been when you were working. In this way, it’s an ideal savings program because you did end up saving tax on it – you just have to be careful when planning to take out your RRSP’s that the bank or your investment firm is taking off an appropriate amount of tax when they release the funds to you so that you are not stuck owing tax at tax time.
There are also 2 other life events that may occur in which you can “borrow’ your RRSP funds and not have a tax penalty.
1. If you are a first-time homebuyer, you are allowed to take up to $25,000 out of your RRSP to make a down payment on your home. If you are purchasing with somebody else who is also a first-time homebuyer, they could also take $25,000 out of their RRSP. It is considered a loan, so you must repay your RRSP those funds within 15 years. If, during any of those 15 years, you do not make your minimum repayment contribution, that repayment becomes taxable income to you in that year. You do not need to start making repayments until 2 years after your purchase, but you can if you want, so you technically have 17 years to pay it off, but the clock doesn’t start ticking until 2 years later.
2. If you or your spouse is enrolling in a full-time post secondary program (or part-time if you meet certain disability requirements), you can borrow the money from your RRSP through the Life-Long Learning Plan. You can take out up to $10,000 per year, and up to $20,000 total. This amount doubles if your spouse also has an RRSP that they are willing to take money out of for schooling. The money does not have to go toward tuition or books, you can technically use it for whatever you like, as long as you meet the conditions of being a full-time student Again, this program is a LOAN, so repayment is necessary to not be taxed on the income. With this program, you have up to 10 years to repay your loan. The repayment period starts when you are not a student for at least 3 months of the year for 2 years in a row. If after the 5th year, you are still in school for at least 3 months of the year, you will then have to start repaying the loan regardless. If you have money in an RRSP and you are considering taking a student loan, please consider the LLP program instead – it’s a great, interest-free way to fund your schooling with your own money.
If you take any RRSP funds out for any other reason other than the 2 caveats above while you are still working, and presumably in a higher tax bracket, you will end up paying the same amount of tax you do on all your other income (save capital gains), and usually you wouldn’t have saved any tax at all, or worse yet, if you take out your RRSP in a year that you have higher income than the year you contributed it, you will end up paying MORE tax than you should’ve to begin with. For this reason, I do not recommend RRSP’s to be used as a savings vehicle unless it is specifically for retirement, a down payment for a house, or life-long learning.
The other issue when taking out RRSP funds and having to report as income is that it may affect any government benefits that you receive that are contingent on income. Some examples would include:
OAS or Guaranteed Income Supplement
Alberta Senior Benefit
AISH, Alberta works
Child Tax Benefit
GST Credit
Alberta Carbon Tax Levy
It will be taken into consideration if you’re applying student loans, child care subsidy, or rental subsidy
On the other hand, RRSP contributions can be used to lower your taxable income for these very same benefits!
The year you turn 71, you must cash out or transfer your RRSP. Now, you have a few options on what to do here:
1. Cash out in full: If you’ve been diligently saving for most of your working life, hopefully you have quite a bit in your RRSP account, and of course cashing it all at once would lead to a high tax rate since your income would be all of the RRSP fund + any other taxable pension that you may have. So, unless your RRSP is quite small, I would not recommend this option.
2. Convert your RRSP into a RRIF: A very popular option is to convert your RRSP into a different government-controlled account called a Registered Retirement Income Fund (or RRIF). For all intents and purposes, it’s basically the same account, but now you have minimum required annual withdrawals. Your RRIF service company (your bank or investment firm) will determine a percentage of the total fund based on your age and pay that minimum amount to you – that payout is taxable income, and can be taxed at source if you like. You will also have the ability to take out more than the minimum if you need to as well.
3. Purchase an annuity: You can purchase an annuity from an insurance company with your RRSP funds and receive pre-determined payments for the rest of your life, which again are taxable. In my experience, this isn’t really a popular option, and I know there are different annuity options that have different features, so it’s not something that I know a ton about, but I do have a Sunlife agent in my back pocket you can ask!
WHAT IS A TFSA?
Tax-Free Savings Accounts – otherwise known as TFSA’s are also government-controlled savings plans, meaning there are specific rules surrounding them. If you are a resident of Canada, have a valid Canadian SIN, and you’re over 18, you can open a TFSA. They don’t have quite the same tax-deferral benefits as an RRSP does, but they are far more flexible when it comes to cashing them out.
WHAT IS THE BENEFIT OF A TFSA?
Like the name implies, any investment income that you make within a TFSA is tax-free. What the name doesn’t imply is that it’s not just a savings account – just like an RRSP, you can have all kinds of different qualified investments within a TFSA - you can have stocks, GIC’s, bonds, mutual funds, and exchange-traded funds. You can also just set it up as a simple interest-bearing savings account. What you CANNOT do in a TFSA is day-trade, which isn’t exactly defined by CRA, but essentially if you are buying and selling stocks more than biweekly, CRA considers this business activity and it is not allowed within a TFSA, so be careful there.
HOW MUCH CAN I CONTRIBUTE TO A TFSA?
The amount that CRA lets you put in is not based on income, it is a flat amount – for 2019, it is $6,000, but that amount has changed several times since 2009 when this program started. Just like the RRSP program, if you don’t put in the full $6,000 this year, that amount will carry forward. If you’ve never contributed to a TFSA, your contribution limit will be $63,500, all carried from 2009-2018. If you don’t know what your contribution limit is you can check your online My CRA account.
Unlike RRSP’s, TFSA’s follow the calendar year, so there is no extra January/February time to contribute for the previous year. If you over-contribute to your TFSA fund in any given year, there is a penalty, which needs to be calculated using a complicated form called an RC243. The penalty is based on how much you over-contributed and how long that over-contribution stayed in the TFSA account.
WHEN CAN I TAKE OUT MY TFSA?
Unlike RRSP’s, when you make a contribution to the TFSA, you do not get a tax deduction for that year. However, you can take money out of a TFSA, anytime, for any reason, with no additional tax burden to be concerned about. For this reason, I would always recommend a TFSA over an RRSP for short-term savings or anything other than retirement, home buyer plan, or life-long learning plan that we already talked about.
WHAT HAPPENS TO MY SAVINGS WHEN I DIE?
With both plans, you can name your spouse as a beneficiary. This means that when you die, the money will roll over to their registered account with no immediate tax burden to them.
However, with an RRSP, after your spouse dies, taxes will be due on any money left in the account. So if your children inherit the money, they will receive what is left after the tax is paid.
With a TFSA, only the increase in the value of the TFSA since the date of death would be taxed in the year the children receive it. If the amount they receive is not greater than the value of the TFSA at death, no tax is paid.
Now that you have a better idea on the key differences between an RRSP and a TFSA (all the acronyms!), I hope you have a good idea of where you want to direct your savings. If you have any questions on if you should make an RRSP contribution before the March 1/19 deadline, please feel free to contact me and we can chat!
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