Did you know? There was a time where the very idea of retiring was foreign to most Canadians. People would work their entire lives until they died or were too sick or disabled to continue any longer. Given the shortened life span of the average person prior to the institutionalization of retirement, there was simply no time for it.
As technology and healthcare advanced over the past hundred years, the average lifespan began increasing and retirement became what it is today.
Retirement was institutionalized with the ‘three-legged retirement stool’ during the 1900’s:
- Old Age Security (originally Old Age Pension), was the first retirement program offered by the government for its people in 1927. Technically the first pillar of the ‘three-legged retirement stool’, this program helped take care of the few who were retiring due to sickness and disablement and for their final few years. Now, OAS is available for most Canadian residents who have reached the retirement age of 65.
- In 1957 the government introduced the Registered Retirement Savings Plan as the second pillar of retirement and after that,
- the third pillar of the retirement stool, the Canada Pension Plan, was introduced in 1965 as a contributory plan and is available to those who have contributed to the plan and are of retirement age or who have become disabled.
A few important things to note when learning about RRSPs, is the economic environment in which it was created. The Income Tax Act, originally a temporary measure taken during the first world war, became a permanent fixture in our country. This act has affected the personal finances of every Canadian since then, making it more difficult to save money than it was before.
The Registered Retirement Savings Plan was created to help individuals save for their own retirement as it provided them with a tax deduction for the amount contributed every year. Though RRSPs are not an investment in and of itself, this vehicle also gave the average person greater access to investing in the stock market than was available previously and with tax-deferred growth.
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The Registered Retirement Savings Plan Today
Contribution and Deduction Limits
Because contributions are tax deductible, they are also limited. The contribution room a person may have in any given year is unique to the individual as it is limited to any unused contribution amounts in the previous year, plus the lesser of either 18% of your earned income made in the previous year or the set RRSP deduction limit for the year in which you are filing taxes (in 2020 this limit is $27,230). If you made any contributions to a registered pension plan, your RRSP contribution room will be reduced by that amount. The simplest way to know the contribution room you have available, is to view your most recent Notice of Assessment.
Not all types of investments qualify for the tax-deferred growth available within an RRSP. Qualifying investments include savings accounts, guaranteed investment certificates, mutual funds, bonds, and some securities.
It is possible in a self-directed RRSP to acquire non-qualified investments. Non-Qualified investments include real estate, life insurance, or any personal property inside an RRSP. If this were to happen just keep in mind there will be tax implications.
Withdrawals and Withholding Tax
Eventually, there will come a time when you begin withdrawing funds from your RRSP. This can be done before or during your retirement and is when the CRA will come calling to collect the tax that you owe them based on your income tax bracket at the time.
If you were to withdraw funds pre-retirement, your tax will become payable on the amount of funds withdrawn. Your financial institution will withhold a portion of the amount withdrawn automatically as a withholding tax to help pay the taxes due at the end of the tax year.
If you were to withdraw the money as income during retirement, this can be done by first transferring the funds directly to a Registered Retirement Income Fund, a registered annuity that you purchased, or as a lump sum payment. There will be no withholding tax applied when transferring these funds and your tax will be due when income is received from the RRIF or registered annuity. When the RRSP is taken out as a lump sum payment, withholding tax may apply if it is not transferred directly to another registered plan.
It is important to know your RRSP must be matured at the end of the year when you turn age 71, meaning you will need to have transferred the amount inside your RRSP to one of the above-mentioned options for income purposes by December 31st of that year.
A Spousal RRSP may come in especially handy when one spouse earns more income and is in a higher tax bracket than the other. This RRSP type has an annuitant (the owner and person withdrawing money) and separate contributor (the person contributing money who is the spouse or common law partner of the owner). The higher-earning spouse can pay into the lower-earning spouse’s RRSP and claim the tax deduction for that year. Then, during retirement, the lower-earning spouse can withdraw income from the RRSP, RRIF or annuity at a lower tax rate. Where the higher-income earner is paying into two RRSP accounts, they can only claim up to the set RRSP deduction limit for the year (for example, $27,230 in 2020). Contributions can continue to be made into the spousal RRSP up until December 31st of the year the owner turns 71.
It is important to know that any withdrawals made within two full calendar years of the last spousal contribution will be included in the higher-earning spouse’s income, not the lower-earning spouse, and will be taxed accordingly.
A Group Registered Retirement Savings Plan is a company administered RRSP where an employer will match all or a portion of employee contributions using pre-tax dollars.
Home Buyers Plan
If you are a first-time home buyer, you may be eligible to participate in the Home Buyers Plan (HBP). The Home Buyers Plan is an exception to the tax rules associated with the RRSP where the first-time homebuyer can withdraw up to $35,000 after March 19, 2019 from their RRSP tax-free and without withholding tax for the purchase of their new home. Prior to March 19, 2019, this limit was $25,000.
If you did not live in a home that you or your spouse or common law partner owned in the four-year period prior to buying a home, then you are a first-time home buyer. As a first-time home buyer, you must be a Canadian resident, have a written agreement to buy or build a qualifying home as your principal residence, and not have any outstanding requirements from any other HBP. When these conditions are met, you can withdraw up to $35,000 from your RRSP tax-free by filling out the appropriate forms with your financial advisor to help you with your home purchase.
Keep in mind, the HBP is a loan and like any other loan it must be repaid. The repayment period is 15 years starting the second year after you withdrew the funds from your RRSP. Your Home Buyers Plan account balance can be always be viewed through the Home Buyers Statement of Account issued with your Notice of Assessment or through the MyCRA mobile app. If you repay more than the minimum amount owed in a year, the following years minimum amount will be reduced. If you do not repay the annual minimum amount, the amount will be included as income for that year and will still need to be repaid. Any repayments made to the HBP account balance will need to be designated as a repayment using the appropriate forms with your financial advisor or it may be included as a contribution to your RRSP instead. Any repayments made to the HBP account balance also do not qualify for the tax deduction.
It is important to know that group RRSP and locked-in RRSPs do not allow withdraws for the Home Buyers Plan. You also must be the annuitant (or owner) of the RRSP to apply. Your RRSP deduction may be affected by your participation in the Home Buyers Plan.
Lifelong Learning Plan
The Lifelong Learning Plan (LLP) is another way to access your funds in the RRSP tax-free and is for a specific purpose: to further your and/or your spouses or common law partners fulltime education.
Along with the Home Buyers Plan, there is certain criteria that must be met before withdrawing funds. To be eligible for the Lifelong Learning Plan, you must own the RRSP as a Canadian resident and the student must be enrolled or intending to enroll with an offer already on the table on a full-time basis, in a qualified educational program, and with a designated educational institution all before March of the following year.
The good news is you can use this plan at the same time your spouse or common law partner is using it, and even if you are using the Home Buyers Plan with a balance that is still owing. The maximum amount you can withdraw in a year is $10,000 with a total limit of $20,000 per time you are using the LLP. To withdraw the funds, you will need to fill out the appropriate forms with your financial advisor. The funds can be withdrawn in full ($10,000 per year) or in smaller amounts every year or as needed until January of the fourth year after the year you made your first LLP withdrawal and as long as you meet the same criteria as before. If you need to go back for training or education after you have already used the LLP, you can qualify to use it again once you have made repayments to any previous plan and have zeroed out your balance.
Repayment of the Lifelong Learning Plan must be done within 10 years of starting your repayments. Repayments must begin in the fifth year after your first LLP withdrawal, if not before (if you are no long a full-time student). Your Lifelong Learning Plan account balance can be always be viewed through the Lifelong Learning Plan Statement of Account issued with your Notice of Assessment or through the MyCRA mobile app. If you repay more than the minimum amount owed in a year, the following years minimum amount will be reduced. If you do not repay the annual minimum amount, the amount will be included as income for that year and will still need to be repaid. Any repayments made to the LLP account balance will need to be designated as a repayment using the appropriate forms with your financial advisor or it may be included as a contribution to your RRSP instead. Any repayments made to the LLP account balance also do not qualify for the tax deduction.
It is important to know this plan is not available for your children’s education. Your RRSP deduction may also be affected by your participation in the Lifelong Learning Plan.
In case of bankruptcy, there are very few places where money is held that can help protect you from your creditors. Having a Registered Retirement Savings Plan can help you if this were to ever happen as it is one of the very few places that offers creditor protection.
It is important to know, however, that any attempt to contribute to your RRSP and avoid paying creditors in this situation will likely not hold up. Typically, any assets that have been in the account for over a year will be protected though there is a chance that any large deposits made, or assets purchased in the 5 years prior to bankruptcy may still be lost to your creditors.
Death of an RRSP Owner
If you name your spouse or dependent child as a beneficiary, the RRSP can be transferred on a tax-deferred basis to their own registered plan or annuity. When your surviving spouse dies, any amount in their registered plan will now be taxed. If a child that is not dependent is named the beneficiary, the proceeds can only be transferred to a term annuity.
If the RRSP owner were to die while there is an HBP or LLP loan outstanding, the remaining amount owing will be included as income to their estate. Alternatively, the spouse or common law partner of the deceased owner can elect to make repayments to the plan and to their own RRSP to avoid the income inclusion rule.
If no beneficiary has been named, the RRSP would flow to and be taxed in the hands of the estate.
My Thoughts on Registered Retirement Saving Plans
While the Registered Retirement Savings Plan has a role to play in many financial plans as part of the three-legged retirement stool outlined by our government and financial industry, it has largely been sold on the premise that you will be in a lower tax bracket in retirement. This idea makes sense. However, if we are planning to be in a lower tax bracket in our golden (age 51-75) and orator (age 76-100) years then only one thing is certain: we will be making less money.
According to the Franklin Templeton’s Retirement Income and Strategies survey done in 2019, 59% of retirees said that their expenses have either remained the same or increased since retiring. With less income and increased expenses in retirement, the numbers are not adding up. This leads me to believe that the type of planning or thought process currently being done (which is separate from the RRSP product itself) is not properly aligned with the realities we are facing in retirement.
I want to challenge you in your thinking and planning, especially when considering your role as financial stewards for the next generation. If we were to plan our finances in such a way that provides for not only ourselves, but also our kids and our grandkids, don’t you think there will be more than enough to provide for your retirement?
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