A registered retirement savings plan or RRSP is a personal savings plan registered with Revenue Canada in which contributions and investment earnings accumulate on a tax-deferred basis. Withdrawals from an RRSP account are taxed as income. By the end of the year in which the RRSP holder reaches age 71, the RRSP must be closed, converted to a registered retirement income fund, or used to purchase an annuity from a life insurance company. An RRSP holder may make contributions during the taxation year, or 60 days after the end of that year. Contributors who become age 71 during the year may contribute until December 31 of that year, but not beyond. More information can also be found here.
Have you ever thought about the lifestyle you would like to live when you retire? A lot of it will depend on how much money you have set aside. Would you like to travel, buy yourself new things, visit your relatives that live far away, or would you rather live just to pay your basic sundries and possible healthcare costs? By starting a RRSP early, you’re investing money when you can most afford it – during your peak earning years – to build up a comfortable retirement fund. Not only do you invest some money that would otherwise be paid in taxes, but the earnings of your plan are not taxed until you withdraw them. Since 100% of these earnings can be reinvested and compounded, the growth of your RRSP could be substantial over the years.
The first stage of an RRSP is to accumulate retirement savings. The second is to provide retirement income. Your accumulated savings may be invested in a variety of asset classes (ie. Bonds, T-bills, Equities) to provide a retirement income. The retirement income withdrawals are taxed each year as you receive them, thus spreading the taxation of your accumulated savings over your retirement years.
Your Notice of Assessment from CRA, received after filing you tax return, will state you RRSP deduction limit for the following year. At certain times of the year, you can also phone the CRA TIPS line to confirm your deduction limit. The calculation of the amount will depend on whether you are a member of a pension plan, and if you are, the type of pension plan. The RRSP deduction limit is the maximum amount that a taxpayer can deduct in the tax return of a given year for contributions made to an RRSP after 1990 and before the first 60 days of the following year. This deduction limit applies to RRSP contributions to the taxpayer’s RRSP, or to a spousal RRSP, for which the taxpayer did not previously obtain a deduction. The unused RRSP deduction limit for the current year is equal to:
The unused RRSP deduction limit at the end of the previous year
Plus: 18% of previous year’s earned income up to the annual RRSP dollar;
Minus: previous year’s pension adjustment, if any;
Plus: pension adjustment reversal, if any;
Minus: net past service pension adjustment, if any.
A taxpayer may contribute an amount up to the RRSP deduction limit. Each year, the RRSP deduction limit is set to 18% of the previous year’s earned income, up to a dollar limit. The dollar limit, called the annual RRSP dollar maximum, has a series of scheduled changes: Each year, Revenue Canada provides a statement of this amount in the Notice of Assessment.
Retiring Allowances are a lump sum (or sums) paid to you by your employer, at your termination, in recognition of loss of employment. Accumulated sick leave credits paid qualify under this definition but holiday pay, death benefits and pension benefits do not. The portion of a retiring allowance eligible for sheltering in your own RRSP can either be transferred directly (no income tax deducted), or up to 100% can be contributed in the year of receipt or within 60 days thereafter. No portion of a retirement allowance can go to an RRSP in your spouse’s or common-law partner’s name. The maximum retirement allowance which can be sheltered is:
$2000 for each full or partial calendar year of service with your current employer prior to 1996, plus
an additional $1500 each full or partial calendar year or service prior to 1989 with your current employer, in which you were not a member of a pension plan or DPSP, or years for which your employer’s contributions to such plans have not vested with you.
The transfer of a retiring allowance to an RRSP does not affect your RRSP deduction limit for that year.
A Spousal RRSP is an RRSP in which one spouse makes contributions to the other spouse’s RRSP. Spousal RRSPs are used to reduce the amount of taxes that a couple pays. With a spousal RRSP, the higher income spouse makes contributions to the Spousal RRSP account during the working years and then the lower income spouse draws retirement income from the proceeds of the RRSP during retirement.
In this way, a Spousal RRSP allows the higher income spouse to re-direct retirement income to the lower income spouse to reduce the overall amount of taxes a couple pays during retirement. In 2006/2007, a major tax rule change was introduced so that qualified pension income (from RRSPs, RRIFs, registered pension plans and life annuities) can be divided between the two spouses. Up to 50% of one spouse’s qualified pension income can be redirected to the other spouse without making use of a Spousal RRSP. One important limitation of the 2006/2007 rule is that income derived from RRSPs and RRIFs cannot be split between spouses until age 65.
Although the 2006/2007 rule makes retirement income splitting easier, spousal RRSPs may still be beneficial in limited circumstances. Mainly, Spousal RRSPs will be of interest to couples who plan to retire early and who want to split RRSP/RRIF income before they turn age 65.
A spouse is defined as a person who lives with and is engaged in a conjugal relationship for 12 or more months, or is the parent of natural or jointly adopted children.
If you have the cash to contribute now, but expect your income to be taxed at a higher rate in the future, you can contribute now and claim the deduction in a future year or years. This strategy is not penalized as an over-contribution as long as your contributions are within your deduction room. And it has the advantage of tax-sheltering the earnings on your contribution.
The official tax receipt should be filed with your tax return in the year of contribution, even if not deducted, and the amount reported on Schedule 7 of your tax return.
You may contribute any time during the year. Contributions made during the first 60 days of any year may be deducted for the current of the immediately preceding taxation year. If you are contributing by mail, your application and/or deposit must be received by the plan issuer on or before the contribution deadline.
Over-contributions are contributions that exceed your deduction room. Over-contribution can be made by an individual who was 18 years of age or over in the prior year, and can be carried forward indefinitely.
You can exceed your RSP contribution limit by up to $2,000. If you make contributions which increase your over-contribution above $2,000 you will pay a 1% penalty tax per month on the amount in excess of $2,000. Non-voluntary (normally employer) contributions to group RRSPs based on current earnings are not taken into account until after the end of the year in which they are made.
Under the Life Long Learning Plan you can withdraw up to a total of $20,000 from you RRSPs.
Annual limit: $10, 000
Total plan limit: $ 20, 000
You can participate in the LLP for yourself while your spouse or common-law partner participates in the LLP for themselves. Alternatively, you can both participate in the LLP for the benefit of one of you, or you can participate in the LLP for each other as well. Each of you can withdraw up to the annual LLP limit of $10,000 in a year, and up to the total LLP limit of $20,000 over the period you are participating in the LLP. The amount you withdraw is not limited to the amount of your tuition or other education expenses. You can keep withdrawing amounts from your RRSPs until January of the fourth year after the year you made your first withdrawal, as long as you meet the qualifying LLP conditions every year.
You cannot withdraw more than $20,000 each time you participate in the LLP. This is your total plan limit. You can participate in the plan again, starting the year after you repay your RRSP withdrawals, so that the balance you owe is zero. If you withdraw more than the annual limit of $10,000, you must include the excess in your income for the year of the withdrawal. The excess does not reduce your total plan limit of $20,000. If you withdraw more than the total plan limit of $20,000, you must include the excess in your income for the year you exceed the total limit. Your RRSP issuer will send you a T4RSP, Statement of RRSP Income, showing the amount you withdrew under the LLP.
Each eligible RRSP holder can withdraw, without immediate taxation, up to $35,000 to be used as part of a down-payment for a qualifying residence. Income tax will not be paid on any portion of the withdrawal repaid to an RRSP before or during the 15-year repayment period. The repayments will not be tax deductible. You are requested to repay ( to any RRSP) the amount withdrawn, without interest, in equal payments over a 15 year period commencing in the second calendar year following the year of your withdrawal. Repayments made in the first 60 days following a calendar year can be treated as if they were made within the calendar year. On your income tax return, you will designate what portion of your total RRSP contributions are repayments under the Plan, and therefore not deductible from income.
If you repay less than the specified amount in a year, you will be taxed in that year on the portion you did not repay. If you repay more than the amount specified in a year, but not the whole balance of the withdrawal, your required repayments in subsequent year will be reduced.
The amount of tax withheld depends on the amount of money being withdrawn. The breakdown is:
10% – on a withdrawal under $5,000
20% – on withdrawals between $5,001 to $15,000
30% – on a withdrawal $15,001 an over
The amount of tax withheld will be reported to you on a T4RSP and should be claimed on your tax return. You should remember that RRSP withdrawals are included in you taxable income, so that tax withheld will not necessarily cover the taxes payable due to the withdrawal.
Robin Muir, CFP®, CLU®, CH.F.C.