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Kevin Greenard: Many factors to consider with RRSP contributions

Last week we took a mathematical approach to looking at Registered Retirement Savings Plan (RRSP) contributions.
Kevin Greenard

Last week we took a mathematical approach to looking at Registered Retirement Savings Plan (RRSP) contributions. Although this quantitative analysis provides a useful starting point, we feel that there are many qualitative factors that should be considered, beyond solely your current income.

Every couple of years, we update and republish the main factors to consider prior to making a RRSP contribution. A RRSP could be an important vehicle in reducing the amount of tax you pay in your lifetime. A RRSP is typically the key retirement account for those without a company pension plan. A RRSP is beneficial for some, but it may not be for everyone. For those where a RRSP may make sense, it must be executed correctly. By executed correctly, we mean the dollar amount and timing of contributions and withdrawals must be done methodically.

Below are 50 questions to help those who are still considering making a RRSP contribution.

1) How old are you?

Typically, the younger you are the longer you have tax deferral. Tax deferral is the number one benefit of a RRSP, not the immediate tax deduction for the contribution. A 40-year-old could have over 30 years of deferral. A 65-year-old has six years.

2) What is your income level?

If your income is very low, then it may not make any sense to contribute. If you are in higher marginal income tax brackets, then the income tax savings can be significant. Last week we outlined the math for those with regular forms of income.

3) Does your income level fluctuate year to year?

Certain professions have income levels that fluctuate year to year. With some years being so low that dipping into savings is necessary. The greater the fluctuations in income, the more important it is to have some emergency funds outside of a RRSP.

4) Do you have future large income tax years?

In cases where clients have moderate levels of income today, but intend on selling an asset such as a rental property for a significant capital gain in the future, building up and saving the contribution room or building an “unused” component, to offset the large income tax years can often be a good strategy.

5) Are you looking to purchase a principal residence?

If one of your goals is to purchase a principal residence, then the majority of your savings should be done in either a non-registered account or a Tax Free Savings Account (TFSA) for easier access. The one exception could be the RRSP Home Buyers’ Plan (see below).

6) Are you eligible for the RRSP Home Buyers’ Plan?

First time home buyers can participate in the RRSP Home Buyers’ Plan (HBP). This program allows you to withdraw up to $35,000 in a year from your RRSP towards a qualifying home. If your income is higher and you do not yet have $35,000 in a RRSP, then contributing to a RRSP up to this level and then withdrawing the funds under the HBP can be a good strategy for new homeowners. A RRSP can not only help you save for retirement – it can also help you save for your first home.

If you and your spouse both borrow the same amount from your RRSP accounts, you can put up to $70,000 combined towards a down payment. The HBP enables you to get access to the money you saved, the investment growth, and receive the tax savings.

With the HBP you are essentially borrowing from yourself. You must pay the amount you borrowed back within 15 years. If you took out $35,000, you must pay back into your RRSP $2,333.33 annually. If you miss these repayment amounts, then you will be taxed on the missed payment.

One item to note is that when making RRSP contributions that are intended to be used in the HBP, the RRSP contributions must be in the RRSP for at least 90 days before they are withdrawn, otherwise the deduction for the contribution may be declined.

7) Have you contributed to a RESP for any minor children?

Often we see parents not taking advantage of the Canada Education Savings Grant (CESG) linked to Registered Education Savings Plan (RESP) contributions. The government matches 20 per cent on the first $2,500 contributed annually per child, up to age 18.

8) How old are your children?

If cash is limited, a RESP contribution may be a better use of funds, especially if the children are approaching 18 and have not yet obtained the lifetime maximum of $7,200 CESG.

9) Have you set up a Registered Disability Savings Plan for a minor or adult child with a disability?

The Registered Disability Savings Plan (RDSP) has benefits even for those who do not contribute. The government also gives funds under a matching program which is dependent on the beneficiary’s family income. If funds are limited, then contributing to a RDSP often is a better option.

10) Do you have a TFSA?

Individuals with lower income today are generally better off to contribute to a TFSA. If income levels rise, then you can always move the funds out of the TFSA and contribute to a RRSP in the future.

11) Have you maximized contributions to your TFSA?

A RRSP contribution can assist you in reducing the current year income but will eventually be taxed when the funds are pulled out. On the other hand, the TFSA grows tax-free but does not assist you in deferring any of your earned income in the current year. If you have a lower income, and amounts to save, you should first consider a TFSA over a RRSP.

12) Are you, or dependents, attending post-secondary education?

These costs can often help with lowering your taxes payable. Obtain an estimate of all potential deductions and factor this in when determining what amount, if any, to contribute to a RRSP.

13) Are you claiming any disability deductions and credits?

The disability tax claimed either for self, or others, can significantly lower your income tax liability. It is important to factor these credits in when making RRSP contribution decisions.

14) Did you know that your RRSP can help you get an education?

There is a RRSP program called the Lifetime Learning Plan (LLP). Through the LLP, your RRSP can help pay for the education and training you may need to either change or build a new career.

The LLP enables you to take out up to $10,000 per year ($20,000 maximum over four years) from your RRSP to pay for tuition for you or your spouse.

With the LLP, you are essentially borrowing from yourself, and you must pay back the amount you borrowed within 15 years. If you took out $10,000 you must pay back into your RRSP $666.67 annually. Much like with the HBP, if you miss LLP repayments, then you will be taxed on the missed payment.

15) Do you have family, childcare, and caregiver expenses?

If you have these types of expenditures, then you may be eligible for deductions and/or credits on your income tax return. These deductions and credits should be factored in when looking at the amount of RRSP contributions to make. It is important to know that some credits are non-refundable and contributing to a RRSP in some situations may not be as worthwhile from a deduction standpoint.

16) Do you have significant medical expenses in the current year?

If you had an unusually high level of medical expenses in the current year, you should advise your Portfolio Manager and accountant. It may be that these medical expenses have already helped reduce your projected taxes payable to an acceptable level and making a RRSP contribution is not necessary in the current period.

17) Do you have excess cash in the bank?

If you have excess cash that would otherwise be invested in a non-registered account and generating T3 and T5 income, then a RRSP can help reduce two forms of income. By investing these funds in a RRSP, you will not be receiving a T3 or T5, or have to report the capital gains on dispositions. These savings, along with the deduction, can make sense if the cash in the bank can be committed to retirement.

18) How did you intend to fund the RRSP contribution?

If you do not have money to fund the RRSP then that sometimes helps with the decision making. Clients have asked me whether it makes sense to borrow money to put into a RRSP. Interest on RRSP loans is not deductible. Historically, there have been a lot of articles that discuss how to use a short-term RRSP loan in February that can be partially paid back (provided you get a refund) once your tax return is filed and assessed. If the funds can be paid back quickly, with minimal interest costs, then it can make sense.

19) Do you have a spouse to name as the beneficiary?

If your spouse is named as the beneficiary of your RRSP then you have less risk of an adverse tax consequence if you were to pass away (see question 50). Contributing to a RRSP, with your spouse named as the beneficiary, has two benefits in our opinion. The first obvious benefit is that it assists both of you in retirement should you live a normal life expectancy. The second benefit is that it provides financial assistance to your spouse in retirement in the event that you were to pass away before retirement.

20) Where can you find out how much you can contribute?

The most common approach is to look at last year’s Income Tax Notice of Assessment (NOA). The RRSP deduction limit table will provide these numbers. If you are unable to find the NOA, then you can log into CRA My Account.

21) Are you aware of the different types of investments to put into your RRSP?

A RRSP is a type of an account and not a type of investment. The options for what you can put into a RRSP can vary significantly. Making the initial cash deposit into the RRSP is only the beginning. The most important part is ensuring the capital is protected and invested appropriately to grow for the decades ahead. We encourage you to do some research.

22) If you make a RRSP contribution, have you estimated how much tax you will have deferred in the current year?

Many online RRSP calculators can compute the tax savings for a contribution. This works great if you have regular forms of income, such as T4 employment income. If you have certain other types of income, such as dividend income from a corporation, then it is best you have your accountant do the projections for you.

In our article last week, “Mathematical approach to RRSP contributions”, we illustrated an example of the potential tax savings at different income levels for a $10,000 RRSP contribution. For further information, refer to the article here.

23) Are you aware that you can contribute to a RRSP and save the deduction (considered “unused”) for future years?

One might ask, “why would I contribute money into my RRSP and not immediately claim all of it as a deduction in that year?” Perhaps the best way to answer this is by looking at a real scenario where a couple may have worked hard for over 20 years to pay off their mortgage and become debt free. During all those years of focusing on paying down debt, they accumulated a significant RRSP deduction limit. Unexpectedly, this same couple receives a significant inheritance. They decide to move $50,000 into a RRSP account. By moving some of these funds into a RRSP they have immediately tax sheltered and obtained deferral of the income and growth. They have a goal of retiring in five years and have mapped out a plan of deducting $10,000 of the unused each year for five years.

24) Are you a member of any Registered Pension Plans?

If you are a member of a Registered Pension Plan (RPP), then you will see a Pension Adjustment (PA) calculation on your annual Income Tax Notice of Assessment. Depending on your income level, and the quality of your RPP, some, or nearly all, of your RRSP deduction limit will be reduced by the PA. A RRSP was primarily designed for individuals without a RPP. Those without a RPP should consider a RRSP more closely. If you have a RPP, a RRSP is still definitely worth considering if you have both the deduction limit and cash flow.

25) Do you have non-deductible debt?

A mortgage on your principal residence is normally non-deductible unless you have a business component operating from your home. Credit card charges and personal lines of credit are also normally non-deductible. The more non-deductible debt you have, the less attractive committing your savings to RRSP contributions becomes. Any high interest credit card or other debt expense should be a top priority to tackle before making RRSP contributions. This is especially true if the debt is non-deductible.

26) Do you have any deductible debt?

If your interest costs are deductible, then these costs also help lower your taxable income. If with your excess savings you choose to pay off deductible debt, then this would result in lower interest costs for you (which is good) but also results in a lower interest expense deduction. If funds are dedicated to a RRSP then you have the benefit of both the interest expense deduction and the RRSP deduction.

27) What are the balances of all lines of credit, loans, and mortgages?

Looking at your pre-payment options and the interest rates on each form of debt is important. Also important is to focus on paying down the non-deductible debt before the deductible debt. If all the debt levels and interest rates are reasonable, then considering a RRSP contribution can provide you the balance of both real estate and financial assets.

28) Have you made any significant donations?

If you have made, or are planning to make, a significant charitable donation, then you should factor this into the amount to contribute to a RRSP. Both federal and provincial charitable tax credits are available which would reduce income taxes payable.

29) Were you intending to borrow funds to contribute to a RRSP?

Interest on a loan for a RRSP is not tax deductible. If the RRSP loan is at a good rate and you feel you can pay the loan off within a reasonable time period (i.e. with tax refund) then it may make sense in higher income earning years.

30) What are the rates on your non-deductible and deductible debt?

When we meet with clients and they have questions about where to put the excess cash (TFSA, RRSP, or paying down debt), one of the first items we’ll ask for is the terms of any existing debt (i.e. interest rates, prepayment privileges, and whether or not the debt is deductible). Sometimes we can propose a series of transactions to make more of your interest costs tax deductible.

31) Should I set up a spousal RRSP?

A spousal RRSP contribution may make sense if there is a disparity between taxable incomes in the long term. We like to look at longer term projections and try to equalize taxable income throughout retirement to lower taxes as a household. Care must be taken to ensure attribution rules do not kick in with withdrawals.

32) Do you and your spouse work?

One of the pitfalls to a RRSP for single people is the loss of employment or if a financial emergency comes up. Two income families can often weather this without having to dip into RRSP funds to pay the bills. If you are in a single income household, consider maintaining a safety net of non-registered funds in case of a rainy day.

33) Are you intending to become non-resident of Canada in the future?

The strategy with respect to a RRSP can be impacted if the long-term intention is to retire in a foreign country. Any withdrawals out of a RRSP if you are non-resident will be subject to a flat 25 per cent withholding tax, or at a reduced rate pursuant to the tax treaty with the foreign country. If you are normally in the highest tax bracket, becoming non-resident before making any withdrawals can work to your advantage. If you had planned to have retirement income within the lowest federal income tax bracket, then you are likely to pay close to twice the normal tax if you’re non-resident.

34) When are you planning to retire?

Providing details on your retirement to your Portfolio Manager will also help with determining if a RRSP contribution makes sense. In some cases, your RRSP deduction limit can be used to roll in retirement allowances and offset a high-income final employment year.

35) What is your ratio of non-registered funds to registered funds?

Prior to entering retirement, it is advisable to also have investments in a non-registered account and funds in the bank. If all your investments are currently in a RRSP then you should talk with your Portfolio Manager about TFSA and non-registered accounts. Ideally, you should have the ability to adjust your cash flow needs without having adverse tax consequences in retirement. The non-registered account is often the solution to deal with these fluctuations.

36) Do you have a corporation where income can be tax sheltered?

The ability to tax shelter funds within a corporation has historically come with many benefits. In past years, many accountants have advised small business owners to keep excess cash within the corporation and avoid RRSP contributions. Cash flow to the shareholder was often done in tax efficient dividends. Recent changes in tax rules has resulted in many business owners meeting with accountants to determine the best strategy going forward, including RRSP contributions.

37) Have you spent the time to invest the funds appropriately?

Investment options within a RRSP vary considerably. The choice of investments should reflect your risk tolerance, investment objectives, and time horizon. It goes without saying that if RRSP funds are invested appropriately you will achieve your retirement goal sooner.

38) Do you have the discipline to keep the funds invested through to retirement?

One of the biggest mistakes young investors make is pulling funds out of a RRSP early. RRSP withdrawals become taxable income when they are withdrawn. The RRSP room is lost indefinitely and cannot be replenished (apart from withdrawals made under the HBP or LLP). Prior to contributing, you should determine if you can commit the funds for its intended purpose. If in doubt, you should consider a TFSA or non-registered account.

39) Are you aware of the pre-authorized contribution (PAC) approach to RRSP savings?

One approach to saving for a RRSP is to do forced savings every month. For clients who don’t have large excess cash flows and still wish to save within RRSP, coming up with a lump sum amount of cash can be difficult. If that client were to pay themselves $500 into their RRSP every month, then slowly over time, they would build up a RRSP nest egg. It is important with pre-authorized contributions (PACs) that you always keep an eye on your contribution limit and adjust the PAC accordingly. The benefit of a once a year lump sum is that you can always ensure that the amount contributed is equal to, or below, your deduction limit.

40) Do you know the consequences for putting too much into a RRSP?

All over-contributions of more than $2,000 above your deduction limit will incur a penalty of one per cent per month. To avoid receiving brown envelopes from CRA, take extra care to not exceed your allowable contribution limits.

41) Does it make sense to have more than one RRSP account?

The Income Tax Act does not put a limit on the number of RRSP accounts you may have. For all intents and purposes, we recommend having only one or two RRSP accounts. Having one RRSP account with a Portfolio Manager will help them manage your asset mix, sector exposure, geographic exposure, and position size on each investment. If you have the option of a group RRSP with matching contributions, then having two RRSP accounts makes sense.

42) How do I combine my RRSP accounts?

Unfortunately, combining RRSP accounts comes at a cost most times. Nearly all financial institutions will charge a transfer out fee. An example of the fee may be $125, plus tax. Let’s say Jack rushes to make a last-minute RRSP contribution for $10,000. He is so rushed that he also agrees to put the funds into a two-year GIC at 0.55 per cent. The year before that, Jack had done the same thing but at a different financial institution. When we met Jack, the first thing, he said to us was he was not making a lot of money on his RRSP accounts. Jack showed us four different RRSP accounts at four different financial institutions. Jack had intended on doing the right thing each year but had slowly created a bit of a mess that was not performing above inflation levels. We explained to Jack that we could diarize to consolidate the GICs once they mature. We also explained to Jack that this will come at a cost. The relinquishing institutions will each charge him $125, plus tax, wiping away more than the amount of interest he will make on that two-year GIC. In our opinion, having one well managed RRSP, with all investment options available is the best approach.

43) When do I have to convert my RRSP to a RRIF?

The Income Tax Act states that your RRSP must be collapsed by the end of the year you turn 71. Most clients choose to convert their RRSP to a Registered Retirement Income Fund (RRIF). Other options are to de-register the full account. This option may be okay for small accounts when your other income is low. Normally, this is not advisable as the entire value of the RRSP becomes taxable in one year. Another option is to purchase an annuity. We also do not feel that an annuity is the best option for most clients.

44) How long can I have a RRSP?

In British Columbia, the age of majority is 19. A RRSP must be collapsed no later than age 71. Mathematically, one could have deferral for 52 years within a RRSP and continue most of that deferral even further within a RRIF. The reality is that many do not start contributing as early as age 19 and many have collapsed their RRSP accounts before age 71.

45) Is it possible to contribute to a RRSP after the age of 71?

You may contribute to your own RRSP until December 31 of the year you turn 71. You can also contribute to a spousal RRSP until December 31 of the year your spouse or common-law partner turns 71. If your spouse is younger than you, and you still have RRSP contribution room, then you may contribute.

46) Should I participate in a Group RRSP plan?

The primary purpose of a Group RRSP plan is to encourage you to save some of your hard-earned dollars. Your employer may offer this option by enabling you to contribute through payroll deductions. Often the investment options are limited to those offered by the group provider. In some situations, your employer may offer a matching program where you put in a set percentage of your pay, and they will match up to a maximum level. In nearly all cases when an employer is willing to match your contributions it is worth participating in the Group RRSP.

47) Do I have to wait until I retire to transfer part or all my Group RRSP plan to a self-directed RRSP?

Not all Group RRSP plans are the same. In most Group RRSPs you are permitted to transfer the investments to another RRSP account provided the plan does not have any provisions preventing the transfer. In most cases we recommend that when a sufficient amount has accumulated in the Group RRSP that the amount is transferred to your other RRSP account.

48) What is one of the most common errors you see with RRSP accounts?

All too often individuals are so focused on wanting to save as much tax in the current year that they forget to look at the big picture of minimizing tax during their lifetime. This can be an issue on both the contribution and withdrawal side of a RRSP.

49) What happens if I need cash out of my RRSP before retirement?

The standard withholding rates are 10 per cent for amounts up to $5,000, 20 per cent for amounts over $5,000 and below $15,000, and 30 per cent for all amounts over $15,000. The actual level of tax that you pay will be dependent on your other forms of income and if you have any deductions or credits.

50) What happens if I passed away with money in a RRSP?

We left this question for last for a reason. If your spouse is listed as a beneficiary, then your RRSP would be combined with the surviving spouse’s RRSP and you would have complete deferral of immediate tax on the first passing. For all others, single people, and widows, the tax deferral ceases on the second passing. Canada Revenue Agency is likely to collect over half of the amount you have remaining in your RRSP.

The above is just a sample of the potential questions that could be asked as the RRSP conversation unfolds. Understanding the reasons for the above questions can help both you and your Portfolio Manager make informed decisions.

Kevin Greenard CPA CA FMA CFP CIM is a Portfolio Manager and Director, Wealth Management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week at timescolonist.com. Call 250-389-2138, email kevin.greenard@scotiawealth.com, or visit www.greenardgroup.com.