Feb
2
By Fin MacDonald
As we approach the RRSP contribution deadline (March 2 this year) an examination of the benefits of RRSP and TFSA contributions will be the topic of this month’s article in The Beacon. First, let’s look at these acronyms: RRSP – Registered Retirement Savings Plan; RRIF – Registered Retirement Income Fund; and TFSA – Tax Free Savings Account.
An RRSP is a tax-deferred account that allows you to make contributions (up to your limit) each year from the age of 18 to the year you turn 71. A tax deduction is allowed on the contributions; over contributions totalling more than $2,000 attract a penalty of 1% per month. In the year you turn 71 there are three options for the RRSP: take it into income and pay tax on the whole amount; transfer it to a RRIF; or, use the proceeds to buy an annuity. If you do nothing, the Canada Revenue Agency (CRA) will deem you to have brought the proceeds of the RRSP in to your income and tax you accordingly.
With the low interest rates prevailing the last few years, very few people are buying annuities; most transfer the proceeds to an RRIF.
A RRIF requires a fixed percentage of the amount in it (as of Dec 31 of the previous year) to be taken into income each year. This percentage ranges from 7.48% at age 72, to 20% at age 94 and subsequently. This withdrawal is added to your income and tax is paid on it. If your income in retirement is higher than it was when you made your RRSP contribution, the amount of tax paid will be more than the amount of the tax deduction you received when you made the contributions.
TFSAs are the latest addition to the retirement savings option. Starting in 2009, you earned $5,000 per year in contribution room. In 2013 this was increased to $5,500 per year. These amounts are carried forward; if you have not made a contribution yet you now have $36,500 in contribution room. There is no tax deduction when TFSA contributions are made and they are not income when they are withdrawn. The income earned inside the TFSA is also not income. You can give your spouse or adult children money to contribute to their TFSAs, and since the withdrawals from the TFSA are not income they are not attributed back to you.
By the time you read this Federal Finance Minister Joe Oliver may have brought down his 2015 budget, so the following may be moot. There has been much speculation on 2 issues relating to TFSAs and RRIFs. During the last election the Conservatives promised to increase the contribution room for TFSAs to $10,000 per year. With an election scheduled for this October, time is running out to fulfill this promise. On the RRIF front there has been much agitation and advocacy in business circles to reduce or eliminate the minimum annual aged-based withdrawals from the individual accounts. The main reasons stated are twofold: that since RRIFs were first legislated life expectancy has increased; and that with interest rates so low many people would run the risk of outliving their RRIFs. It will be interesting to see what Mr. Oliver does.
Which is best for You? RRSP or TFSA
The biggest advantages of RRSP contributions are the tax deduction you receive when you make your contributions, and the tax-free growth inside the account until it is withdrawn. The biggest advantage of the TFSA is that it is not income when it is withdrawn. Depending on how much your income will be in retirement, how much RRSP contribution room you have and what your pre-retirement income is there are options.
If your current income is low and this is going to continue in retirement, RRSPs are probably not for you. In retirement the first $18,000 of taxable income in BC is not subject to tax. If your income before retirement is in this range, the deductions for RRSP contributions will be less than 20 cents on each dollar of contribution.
The other issue for low income retirees is the large number of income tested programs. The first is the Guaranteed Income Supplement (GIS). This is a tax free payment of up to $764.40 per month. Seniors with monthly income of less than $1,400 are entitled to some GIS payment – the amount is the maximum with a monthly Old Age Security payment of $563.74 and no other income. Every dollar of income reduces your GIS payments by fifty cents. For example: $10,000 in your TFSA earning 3% per year would yield $300. If this was outside your TFSA it would reduce your GIS by $150 per year. Receiving any GIS makes you eligible for the BC Bus Pass Program. This allows you to buy a yearly Bus Pass for only $45.
Another provincial program is Shelter Aid for Elderly Renters (SAFER). This provides rental subsidies for those 60 or older. This is available for singles with monthly income of less than $2,223 and for couples with monthly income of less than $2,423. We have all seen the relentless increase in Medical Services Plan (MSP) Premiums – now $72 per month for singles and $130.50 for a couple. Total relief from MSP premiums is available to singles over 65 with incomes of less than $25,000 – this gradually declines to no relief at an income of $33,000. For couples the numbers are $31,000 and $39,000.
For those who will have higher incomes in retirement, using TFSAs to avoid the OAS clawback (which starts at $71,592) or the Basic Personal Amount non-refundable tax credit clawback (which starts at $34,872) makes sense. Depositing unneeded compulsory RRIF withdrawals in your TFSA is another good use that eliminates any further income on those amounts.
To summarize, RRSPs have many good uses, especially for those who enjoy higher incomes both during their working lives and in retirement. Access to participation in the Home Buyers Plan or Life Long Learning Plan makes RRSPs very useful for younger people. For those with more modest income, TFSAs offer many benefits.
Next month: preparing to file your 2014 tax return.
I’d like to once again thank The Beacon for the opportunity to share these ideas with readers and clients as I look through my lens of Helping You to Keep More of YOUR Money!