Taxes and your RRSP
The only tax matter that most people are concerned about when it comes to RRSPs is the value of the refund their contribution will produce.
But there are a number of other tax implications relating to RRSPs of which you should be aware. For the most part, they only apply to special situations—but if you happen to find yourself in one of those situations, you’ll need to know where you stand with Revenue Canada. Here they are:
Death of an annuitant.When you die, the tax impact on your RRSP can be serious for your heirs. In determining your final tax bill (unfortunately, they make you pay taxes even after you’re dead), Revenue Canada will treat your RRSP as if all the funds had been withdrawn in your final year. If your plan is a large one, the resulting taxes could be quite high.
There are a couple of ways to beat the tax people, however—at least for a while. One is to make your spouse the beneficiary of your RRSP. This should be done through the financial institution that holds your plan, and simply requires completing a form. If you do this, the money in the plan can be transferred to your spouse’s RRSP or RRIF, with no taxes payable.
If you have no spouse, ather way to reduce the tax burden on your heirs is to name a dependent child or grandchild as your RRSP beneficiary. An important change in the 1999 federal budget means that dependent children or grandchildren are now eligible for a tax-free transfer of assets on death, a strategy that was previously available only to the surviving spouse. The new rule gives rise to the possibility of tax savings for your estate, since children are more likely to be low-income earners.
Any income earned by an RRSP between the time you die and the time the assets are transferred to your spouse may be included in the tax-free transfer to your spouse until the end of the calendar year following your death.
Final RRSP contribution.A final contribution may be made to a regular or spousal RRSP by the estate of the deceased. This contribution may be made up to 60 days after the end of the calendar year of the death. Depending on the amount of RRSP contribution room available to the deceased, this could reduce taxes on the estate by several thousand dollars.
Foreign property.If the total value of foreign property in your RRSP exceeds the permitted limit, a special tax applies. This amounts to 1% a month of the excess or 1% of the cost of all foreign property in the plan at the end of each month, whichever is less.
Investment counsel fees.If you use an investment counselor to manage the assets in your RRSP or RRIF, the fees you pay are no longer tax deductible. We recommend you pay these fees outside a registered plan.
Loans.You cannot use your RRSP or any property held within a plan as security for a loan. If you do, you’re supposed to include the value of the property you’ve pledged as security in your taxable income for that year. However, you are not required to take the money out of your plan.
Maturity.You cannot hold an RRSP after the last day of the year in which you turn 69. When you reach the mandatory wind-up age, you must begin paying tax on the money in the plan, one way or another. If you choose, you can pay the whole shot at once by collapsing the plan and drawing out all the funds. In that case, the full amount will be treated as income in the year you receive it and taxed accordingly. Unless your plan is very small, this isn’t such a hot idea. You’d be much better off spreading the tax burden over a longer time frame, by converting to an RRIF and/or annuity
WARNING: If you fail to take steps to convert your RRSP to an RRIF or annuity before the age deadline, your plan may be automatically deregistered on January 1 of the following year. All the RRSP assets would be considered as having been taken into income, and you’d pay taxes accordingly. Some institutions will automatically convert your RRSP to an RRIF if you haven’t given instructions by a specific date, but others will not. So if anyone in your family is turning 69 this year, make sure they know about the need to act.
Moving abroad:Find out the rules governing your RRSP before you take any action. They’ll often be determined by the tax treaties between Canada and the country to which you’re moving; however, some rules apply no matter where you go. For example, if you move elsewhere but keep your RRSP in Canada, you’ll pay a 25% withholding tax on any lump sum withdrawals from the plan. But you can reduce that to 15% in the case of periodic withdrawals.
Special rules apply if you are moving to the United States, and you can use these regulations to decrease the taxes you’ll be assessed on money coming out of a plan.
Non-qualified investments.There are only a few types of investments that don’t qualify for an RRSP. But if you make a mistake and put one in a self-directed plan, the tax consequences are significant. Revenue Canada will require that the fair market value of the non-qualified investment be included in your taxable income in the year the asset was acquired. If you have any doubts, review the criteria carefully before going ahead. If your plan owns a qualified investment which, for some reason, becomes non-qualified later, a special tax of 1% per month of the fair market value when the asset was acquired must be paid as long as it stays in the RRSP.
Overcontributions.You may overcontribute up to $2,000 to your RRSPs over your lifetime (as long as you are age 19 or over). Any amount beyond that will attract a special tax, at the rate of 1% a month on the excess amount. However, if you overcontributed up to $8,000 between 1991 and 1996, different rules apply and you won’t be subject to penalty.
Spousal plan withdrawals.Early withdrawals from a spousal RRSP are subject to hefty tax penalties, so be careful about dipping into your mate’s plan. Under the rules, there has to be a gap of at least three years between the last contribution to any spousal RRSP and a withdrawal. Otherwise, the amount withdrawn is attributed back to the spouse who made the original contribution and is taxed as income at full rate.
For example, suppose you made a $2,000 contribution to your spouse’s RRSP in 1999. You or your spouse may not withdraw any money from that plan, or any other spousal RRSPs you own, until 2002 without creating a problem. Nor may you make any contribution to a spousal plan in 2002, even after a withdrawal has been made, without attracting a penalty.
If the spousal RRSP is converted to an RRIF in the same three-year period, any withdrawals in excess of the minimum required will also be subject to the attribution rule.
If you or your spouse make any premature withdrawals, the money is treated as income in the hands of the person who made the original contributions, up to the total amount claimed as tax deductions during the three-year period.
The result of this rule is to make income splitting more difficult, but it also ensures that taxes are not avoided altogether. Without it, a high-income spouse could claim a tax deduction for an RRSP contribution and then have the lower-income spouse withdraw the money immediately. If the withdrawing spouse had no other income, he/she might be able to escape paying taxes entirely on the withdrawal.
Transactions at other than fair market value.If your RRSP pays more than fair market value for an asset, the difference will be included in your taxable income for the year. A similar situation will arise if the plan sells an asset at below fair market value.
U.S. withholding tax.Dividend payments from foreign companies made to a self-directed RRSP are often subject to withholding tax at source. Canadians were most likely to run into this problem on dividends paid on U.S. stocks held in an RRSP, where 15% was withheld. However, this situation was rectified with the revised Canada-U.S. Tax Treaty which came into effect at the start of 1996.
Withdrawals.You can take money out of your personal RRSP at any time, as long as you’re prepared to pay tax on it. RRSP withdrawals are treated as income in the year they’re made; you don’t get any special tax concessions, such as a lower rate for any capital gains in your RRSP. You’ll pay tax on your RRSP withdrawals at your marginal rate—the rate that applies to the last dollar you earn in any given year. And, if you withdraw a large amount, you may find yourself in a higher bracket as a result.
The trustee of your RRSP is required by law to withhold tax at source on any withdrawals you make from a plan. The rate of withholding tax increases with the amount you take out, on the following basis:
|Up to $5,000||10%||18%|
|$5,001 – $15,000||20%||30%|
When you file your tax return, you can claim any tax withheld as a credit.
SPECIAL TIP: To minimize the impact of withholding taxes, consider making a series of small withdrawals from your RRSP rather than one large one. Four withdrawals of $5,000 each will be subject to only $2,000 in withholding taxes. One withdrawal of $20,000 will have $6,000 withheld. Unfortunately, some financial institutions discourage this practice because of the paperwork involved. This is done by putting a limit on the number of annual withdrawals or by charging a fee for each one. Check the policy of the company that holds your RRSP before proceeding.
Adapted from Gordon Pape’s 2000 Buyer’s Guide to RRSPs, by Gordon Pape and David Tafler, published by Prentice Hall Canada.