Managing Your RRSP


For most Canadians, RRSPs are an important part of their financial planning for retirement. The most attractive benefits are the tax deduction for the amounts contributed in that taxation year and the tax-free growth in the plan’s investments. Of course, when the funds are withdrawn, they are subject to income tax. However, this tax deferral can mean real savings if your income (and marginal tax rate) is lower at the time of retirement. If you currently have RRSPs, it is important to know the rules, and the tax implications, for contributions, the types of investments the RRSP can hold, and the ways in which withdrawals can be made. If you have not yet started an RRSP, now is the time to consider this important component of your financial planning.

RRSP Deduction Limit
The RRSP deduction limit, commonly referred to as the contribution limit, is based on a formula that considers your earned income of the prior taxation year. The limit for a taxation year is 18% of your previous year’s earned income up to a maximum amount for the current year, less the previous year’s pension adjustment. For taxation years up to and including 2003, the ceiling for the RRSP deduction continues to be $13,500. This amount increases to $14,500 in 2004 and to $15,500 in 2005. Earned income includes net employment income, royalties, taxable support payments, net income from carrying on a business, net income earned as an active partner, net rental income from real property, research grants, CPP and QPP disability pensions, and supplementary unemployment benefit plan payments. However, earned income does not include interest, dividends and capital gains.

Your contribution limit for the current year is reported on the Notice of Assessment that you receive after you file your income tax return. This limit also includes any amounts you can contribute because of undercontributions in prior years.

Excess Contributions
As there is a 1% penalty per month on overcontributions to the extent that amount exceeds $2,000, it is not advantageous to make an overcontribution exceeding this amount. The $2,000 cushion is intended to protect taxpayers from inadvertent overcontributions.

This does not mean, however, that the taxpayer should not consider taking advantage of the ability to over contribute the $2,000. Although the overcontribution will not result in an immediate tax savings as you do not receive the benefit of a current tax deduction, it will defer the taxes payable on the income earned on your $2,000 investment. Consider the tax-free compounding of this amount if the overcontribution of $2,000 earns a return of 7% every year until the individual is age 69 and the RRSP matures.

Contribution age Investment
years
until age 69		 Original
investment		 Future value* Tax-deferred
growth
20 49 $2,000 $61,140 $59,140
27 42 $2,000 $37,509 $35,509
34 35 $2,000 $23,012 $21,012
41 28 $2,000 $14,118 $12,118
48 21 $2,000 $ 8,661 $ 6,661
55 14 $2,000 $ 5,313 $ 3,313
62 7 $2,000 $ 3,259 $ 1,259
*Based on 7% return compounded monthly.

As the table illustrates, the earlier the overcontribution is made, the greater the amount of tax-deferred income. However, using your overcontribution does eliminate your $2,000 cushion so you must be cautious so as not to over contribute more than this amount and incur the 1% penalty per month on excess contributions in future years.

The table also underscores the earning power of just $2,000 when you maximize your contribution room each year. Of course, when the $2,000 is within your contribution room, you also gain the RRSP deduction for that taxation year. The overcontribution carries forward and can be deducted in a future year, to the extent of the RRSP deduction limit for that year. You should plan to eventually get a deduction for this amount. Remember the amount will be taxable when it is withdrawn in your retirement years.

RRSP Faux Pas
To ensure errors and dire tax consequences do not occur, taxpayers should pay close attention to their Notice of Assessments, RRSP statements, the contributions made, and ow and where the funds are being managed as well as seek professional advice.

Your RRSP holdings should be restricted to qualified investments, which fortunately include a wide range of investment vehicles. Although it rarely occurs, if your RRSP acquires a non-qualified investment, its value will be included in your taxable income and any income earned by this investment will also be taxable.

Foreign content rules currently allow 0% of the investments to be other than Canadian qualified investments. If your investments exceed that limit, you will incur a penalty of 1% per month on the excess amount.

Annual administration fees for trusteed RRSPs are not deductible for tax purposes. In addition, the interest paid on any funds that you borrow to purchase an RRSP is not deductible. Make sure you have indicated a designated beneficiary for your RRSPs. Amounts received by your spouse or financially dependent children will be taxable in their hands; however, the tax on the receipt of these amounts may be eligible for deferral if they transfer the funds to an RRSP or annuity. If you do not designate a beneficiary, your estate will be taxable on the fair market value of your plan at the time of your death. You should consult your financial advisor for the steps to be taken in your estate planning to reduce the income tax liability.

While you can withdraw money from your RRSP at any time, the amount of your withdrawal is fully taxable in that taxation year. As these savings are for your retirement, withdrawals should only be made in the case of an emergency or in a year in which your income is particularly low. It is very important to get tax advice on the tax implications before you consider withdrawing RRSP funds prior to the maturing of your plan.

There are two exceptions - the Home Buyers’ Plan and the Lifelong Learning Plan. These plans allow you to withdraw certain funds from your RRSP to purchase your home or to further your education and later repay them to your plan. As these plans have specific requirements, it is important to get professional advice before proceeding.

When transferring an asset to your RRSP, you should ensure the asset is transferred at its current value. Transactions that occur at other than the current value will result in adverse income tax consequences.

Get Professional Advice
These are just some of the issues you need to consider in effectively managing your RRSP. As there are many different RRSP investment alternatives available, be sure to discuss your tax planning strategies with your accountant to ensure you take full advantage of this opportunity to save for your retirement years.