Registered retirement savings plan (RRSP)
Just as registered pension plans that are transferred into locked-in accounts have a savings phase and income phase, registered savings plans are similarly structured. Registered retirement savings plans (RRSPs) are the savings phase. Registered retirement income funds (RRIFs) are the income phase.
RRSPs are a voluntary savings program that were introduced to encourage saving for retirement through tax incentives. They are offered by many financial institutions and may hold segregated funds when offered by life insurance companies.
An RRSP account owner has responsibility for decisions about how his contributions are invested. There are three types of accounts available:
A managed account
The investor decides between investments that are typically restricted to Guaranteed Investment Certificates (GICs), Canada Premium Bonds, mutual funds and segregated funds.
A self-directed account
The investor has a wide choice of investments including all those available through a managed account plus many others such as stocks, bonds and exchange-traded funds (ETFs).
A fully managed account
A professional money manager creates and manages a customized investment portfolio.
There are three kinds of fees that can be charged against an RRSP. Administrative or trustee fees cover the financial institution’s cost of looking after the account. Investment fees can be charged, depending on the investment, for buying, selling and switching. Account change fees may be charged for closing the account, changing the withdrawal schedule and/or making a lump sum withdrawal.
A person can own as many RRSP accounts as he wishes. However, each account may charge an administration fee that is reduced to a single fee if accounts are consolidated. Regardless of the number of accounts, the maximum contribution limit for the year across all accounts cannot be exceeded.
An RRSP can reveal many characteristics of its owner:
Investments in the account reveal his risk tolerance;
The form of account (managed or self-directed) can show investment experience or lack of investment knowledge;
Contributions indicate dedication to savings and concern for retirement income;
Contributions post-retirement indicate a continuing stream of earned income.
RRSPs provide the following tax advantages:
The contribution made to the RRSP account can be deducted from federal and provincial income tax and may move the taxpayer to a lower tax bracket, thus lowering his marginal tax rate;
The investment income earned in the account is not taxed until it is withdrawn.
Those with RRSP accounts may use the value in their accounts for the HBP and LLP. Both plans allow the plan owner to make a tax-free withdrawal from the RRSP account. The HBP requires the withdrawal to be used when buying or building a qualifying home for the individual or a related person with a disability. The LLP withdrawal is used for the purpose of financing full-time education or training for an adult or his spouse.
Both plans limit the amount that can be withdrawn and specify the conditions for use of the funds and repayment. If repayment does not occur according to the terms of the plan, it can be added to taxable income as a penalty.
RRSP eligibility and contributions
In order to contribute to a personal RRSP, one must:
Contribute before reaching the age limit, which is December 31 of the year one turns 71 years of age;
Have earned income for the previous year;
Have filed an income tax return for the previous year in which business or employment income was declared, or have available contribution room.
Available contribution room arises because the account owner has not made the maximum RRSP contribution in a previous year. This is called the “carry-forward provision.”
Contributions can be made to an RRSP throughout the year. The CRA establishes a date, usually 60 days after December 31, as the cut-off date for contributions for the previous year.
The annual contribution limit is the lesser of:
18% of earned income for the previous year;
Maximum dollar limit established for the year.
Earned income is income received from salaries and wages, employment bonuses, alimony, rental income and business income. It does not include income received from investments or pension benefits.
An individual’s annual contribution limit is reduced by:
Pension adjustment: the amount contributed to an RPP or DPSP in the previous year;
Spousal plan contribution.
In addition to the sum that can be contributed to an RRSP annually, the plan owner could use carry-forward contribution room that was created by not making the maximum contribution in previous years. A one-time over-contribution of $2,000 is also permitted. The over-contribution is not tax-deductible and grows on a tax-deferred basis. If a plan owner over-contributes more than the permitted $2,000, a 1% penalty tax is applied against the excess contribution.
When funds are transferred into an RRSP from a DPSP, GRRSP or another RRSP, the transfer is not considered a contribution.
RRSP spousal plan
An RRSP spousal or common-law partner plan is funded by a spouse (husband, wife or common-law partner), who has earned income and contribution room, for the benefit of his spouse. This plan is a way to split income for a couple during retirement between one spouse who earns more and the other who earns less. Splitting income reduces total income tax for the couple.
Contributions to a spousal plan are based on the contribution room of the contributor and reduce his RRSP contribution room.
If the spouse who has received funds into his RRSP from the other makes a withdrawal from the plan in the year the deposit is made or the two calendar years following that year, the amount of withdrawal (up to the amount contributed) will be added to the contributing spouse’s taxable income in the year of the withdrawal. In other words, if the withdrawal is a combination of contributed money and growth on that money, only the contributed portion of the withdrawal is attributed back to the donor spouse, not the growth portion.
Having a spousal RRSP can extend the tax benefit of contributions past age 71 if the recipient spouse is younger. Contributions can be made until the younger spouse reaches the end of the year in which he turns 71, at which time his RRSP matures.
Withdrawals can be made from an RRSP at any time. The financial institution holding the account is obligated to hold back a portion of the withdrawal in a withholding tax. This represents an advance payment and not the full amount of tax that will be owed on the withdrawal. There may be more tax owed in addition to the withholding tax, the balance will be calculated when the income tax return is field.
There are separate withholding tax rates for Québec and the rest of Canada. The withholding rate increases in proportion to the withdrawal, as illustrated by following table.
WITHDRAWAL FEDERAL WITHHOLDING TAX
OUTSIDE QUÉBEC IN QUÉBEC
0 – up to $5,000 10% 5%
$5,001 – up to and including $15,000 20% 10%
$15,001 or more 30% 15%
Moreover, Québec residents making a withdrawal from their RRSP (no matter the amount) must pay an additional 16% provincial withholding tax for Québec.
At the end of the year in which an RRSP account owner turns 71, he must transfer the funds in the account to continue tax deferral. Otherwise, he can cash out the RRSP and pay tax on the proceeds.
Transfer options, also called “maturity options,” include a registered retirement income fund (RRIF) account. Investments in the RRSP can be transferred in kind, in which case they are simply switched from the RRSP to RRIF without having to be sold. The investments in the RRSP can also be sold and the cash transferred over to the RRIF.
The other transfer options at maturity are a term annuity to age 90 and a life annuity. Either option requires the investments in the RRSP to be sold so the cash can be used to pay for the annuity.
It is not necessary to pick one option exclusively. Funds in the RRSP can be split across the options. The plan owner may want some future flexibility in regard to income and apply some of the RRSP account towards a RRIF. He uses the annuity to provide a guaranteed income stream.
Death of RRSP owner
A beneficiary should be named for the RRSP account. If a beneficiary is not named, the value of the account is included on the final income tax return, and it will be included in the calculation of probate fees in the provinces where they apply. (They not apply in Québec.)
Naming a beneficiary eliminates probate fees on the value of the account. If the beneficiary is the spouse, a financially dependent child or grandchild younger than 18, or any financially dependent child or grandchild who is infirm, then the RRSP can roll over tax-deferred to a registered plan in the name of the beneficiary.
If certain conditions are met, the RRSP may be rolled over on death of the account owner to a Registered disability savings plan (RDSP).