RRSP’s and Annuities
One of the most popular and significant tax planning options available to the public is
registered retirement savings plans (RRSPs). The RRSP program was created, by the
government, to allow people to save for their retirement. With the ever increasing
pressures on the Canada pension plan (CPP) and Old age security (OAS) programs, it is
no secret that our generation will likely benefit insignificantly from these programs.
RRSP’s help us offset the shortfalls of the CPP and OAS programs – at least to some
degree. The program works fairly simply. You purchase investments through an RRSP,
get a deduction on your tax return in the year you contribute and take the tax savings.
The investments grow inside your RRSP program without paying any tax on the income
you earn within the plan. In future, only when you take money out of the plan is it taxed
in your hands. The program assumes that people, in their working years, would have a
higher tax rate then in their retirement years. As such, the tax savings on the deduction
they get when they contribute should be greater then the tax they pay when they take the
money out. Theoretically, you save taxes and grow your investments at a greater rate
within the plan.
There are limits as to what you can contribute. Basically, you can contribute up to 20%
of your prior years income (there are certain adjustments to calculate what the
government calls “earned income”) to a maximum of $13,500 each year to 2003. After
that, it is suppose to increase to $14,500 for 2004 and $15,500 in 2005.
There is, however, a lot of confusion with respect to these plans. In my experience, the
following are the most common misunderstandings:
1. First, an RRSP is not an investment unto itself. It is a plan that you can put
investments into. You can have many types of investments including GIC’s,
mutual funds and a number of other investments allowed by the income tax
2. Secondly, people, especially our parents’ generation, tend to forget that when
they contributed to the RRSP they received a deduction on their tax return in
the year they contributed to the plan. When they draw money out of the plan
the money will be added to their income that year and taxed.
3. .When you go to the financial institution to draw money from your RRSP, the
institution is required by law to withhold a certain amount of tax. This
amount is typically around 5% or 10% depending on how much you
withdraw. Many people think that is the only tax on the RRSP money. In
fact, that is just a “down-payment” of tax. You must include the amount you
withdrew from your RRSP account on your tax return for that year. Based on
what your total income and thus resulting income tax is, you may get a refund
or have to pay more tax. I have had many older people quite upset with the
bank and government for believing they have been taxed on their RRSP draw
“twice” – once by the bank and once by the government.
Everyone is allowed deductible contributions on their return even though they
contributed to their spouse’s plan. For example, if dad contributed $2,000 to a “spousal”
RRSP, he gets the deduction in the year of contribution. The money, however, sits in
mom’s account for her to draw on in the future. When she draws on it, she pays the tax
on it. This is a nice way for our parents to split income and reduce taxes since it is
normal for the income earning spouse to be taxed higher then the non or lower income
earning spouse. If mom never worked, then it also allows her to claim the annual $1,000
pension deduction, thereby doubling this amount between mom and dad. There are some
rules governing the spousal plans that are designed to prevent abuse. Simply talk to your
investment advisor about those rules. They are fairly straightforward.
If your parents separate, then the RRSP accounts can also be split without any tax
If one of your parents, say mom, is already older then 69 and thus her RRSP had
“matured” and thus has been transferred to an annuity like a RRIF, she can still get a
RRSP deduction on a spousal contribution. This assumes that the dad is less then 69
years and as such is allowed to still have RRSP’s and that mom has earned income in the
prior year that qualifies for RRSP contributions. Nice trick.
Extra contributions to your RRSP
There are rules that allow for certain windfall income gains to be transferred tax free to
your RRSP program in order to allow the investments to grow tax-free. Retirement
allowances termination pay, foreign pensions, foreign superannuations and lump-sum
payments from a company registered pension plan or deferred profit sharing plan qualify
for this transfer. There are rules to limit some of the transfers. Again, I desperately do
not want to bore you by listing a whole series of tax rules so if your parents’ have any of
the above coming, contact an accountant.
You can contact Louis Sapi for consultation at 905-678-2740
Over or under-contributions
If your parent contributed less then the maximum allowed, that difference can be added
to a future years deduction.
I had a new client come visit me last year. She was worried because she had just made a
very large commission on a once-in-a-lifetime deal. She was worried that she was about
to loose 50% of this commission to tax. Upon reviewing her tax returns, we discovered
that she had not contributed anywhere near her yearly maximum to her RRSPs for the
last number of years. In fact, she had accumulated around $40,000 of room where she
could put that amount into an RRSP and get the full deduction that year. Needless to say
she was very happy.
On the other hand, you are allowed to contribute up to $2,000 more then your deductible
limits. Unfortunately, this is not an annual benefit and it is not deducted from your
income. This $2,000 is the sum total over-contribution for your lifetime. It’s not a bad
idea to over-contribute this amount since it will earn tax-free money within the plan. The
danger lies, particularly for our parents, that at some point they should claim this excess
contribution as part of your yearly deduction – preferably in the year you turn 68. For
example, if dad, who is now 68, can deduct $5,000 in RRSP’s this year, then he should
only contribute $3,000 and claim that $2,000 over-contribution he made years ago. If he
does not make this claim, then he will be paying the tax whenever he withdraws it from
his RRSP account but have never had the tax deduction in the first place. So be careful
with this one.
If you over-contribute more then the lifetime limit of $2,000, then there are penalties that
are rather unattractive. Consult your tax advisor on this one. There are specials forms to
pull out an excessive over-contribution without paying the tax on a withdrawal from an
RRSP. The forms are quite a bother, but are required.
The financial institutions (i.e. Banks) and investment managers manage most RRSP
accounts. However, the government allows for self-administered plans that allows us and
our parents’ much greater say and control over the type of investments they choose to be
in. In fact, the investments you choose are your sole responsibility. There are several
advantages to a self-administered plan.
1. Your parents can transfer investments you own outside an RRSP into the
self-administered one as your contribution or in exchange for cash. There
will be a tax on any gain existing on the investment you transfer to the
RRSP account but any future growth in value is free of tax until you draw
on the RRSP account.
2. These self-administered plans also allow you to invest in foreign equities
which typically out-perform Canadian investments. As most smart
investment advisors would say, diversification is an excellent strategy for
any investment portfolio. You are limited to 20% of your total portfolio
for foreign investments but that silly limitation may be changed in the
future. There is a lot of pressure on the government from the investment
community to change this outdated limitation.
Maturing of your RRSP’s at age 69
When your parent(s) turn 69, the government has a very special birthday gift for them.
They no longer are allowed to have an RRSP account with no set time frame for
removing the funds and thus paying tax on them. The RRSP account is collapsed and the
entire amount is taxed in the hands of your parents that year. For most people, they will
likely loose as much as one-half of their entire RRSP savings to taxes because that much
income claimed in one year will push your parents’ tax rate up to the 50%. Fortunately,
your parents have some options on how to deal with this problem:
1. Purchase a registered retirement income fund (RRIF).
2. Purchase a “life annuity contract” from an insurance company.
3. Purchase a “term certain annuity” from a financial institution.
4. Do nothing and pay the tax.
5. Any combination or all of the above.
Before you choose an option, please recall something I wrote in this book. Never let the
tax decision outweigh the investment or practical needs. So, before your parents choose
an option, they must first decide what kind of income they will need to live on – after tax.
Convert to a RRIF
RIFF’s is similar to a self-administered RRSP program in that you can hold investments
that grow tax free until you take them out. However, unlike an RRSP, this annuity plan
forces your parent, after the age of 69, to take a minimum amount out each year from
which your parent will have to pay tax on. Your parents are not limited to taking the
minimum amount but you want to ensure they do not deplete their investments too
quickly. After all, they hopefully will live a long life and everyone wants to see them
financially stable. As I mentioned in the taxation chapter, your parent can also create a
RRIF program well before his or her 69th birthday. Adjustments will be made to the
minimum they can withdraw. Depending on their lifestyle needs as well as their
investment and tax planning, it may be a good strategy.
The think I like about RRIFs is that they are similar to the self-administered RRSPs in
that you can decide on the investments within the plan. I am a control freak, so my
partners, family and friends say (which just about counts everyone), and as such I like to
think I have control of what I will invest in. Upon a person’s death, the RRIF is
transferred to the surviving spouse has three options.
1. First, they can take the RRIF proceeds into cash and pay the tax.
2. They can continue the RRIF program and collect the monthly annuity.
3. If the spouse in less then 69 years of age, they can roll the RRIF into their RRSP
Purchase a life annuity contract
A life annuity contract offers your parent a fixed amount of income for the rest of their
life. This can be monthly or yearly depending on your parent’s desires. As with the
RRIF, the payments are taxed only as they are received. This is not bad since your parent
will never have to worry about running out of money.
However, I don’t like these plans for the simple reason I am about to explain. Lets say
your father turned 69 and transferred his $75,000 RRSP into a life annuity contract. This
contract promises to pay out a certain amount of money each month for the rest of his
life. But, and this is a huge “but”, if your father dies anytime after signing the contract,
like a week later for example, then the insurance company keeps the entire $75,000 and
nothing goes to the estate or the surviving spouse or dependents. Effectively it is like
gambling. I don’t like it and I don’t recommend it. However, there are people who like
the fact that they never have to think about investments ever again and can rely on the
payments. I would like to speak to some of those people who purchased these contracts
from some of the insurance companies who went bankrupt in the early 1990’s. I am a
believer in controlling your own destiny not letting someone you don’t even know do so.
Purchase a Term-Certain annuities
This type of contract provides for a fixed monthly payment until your parent turns 90. It
invests only in interest bearing instruments and pays out a blend of interest and principle.
If the one parent dies before 90, the payments continue to the surviving spouse until the
date at which the deceased spouse would have turned 90. If there is no spouse, then the
entire balance left is paid to the estate. Again I am not a fan of this or any product which
Do nothing and pay the tax
Unless you need the money badly, I truly distaste any option that not only pays tax before
you absolutely have to but also pays more of it because of the increased tax rate. That
type of planning offends me. Enough said.
Again, any financial planning should be done with competent professionals. Your
parents’ future lifestyle depends on this. In fact, you depend on this since you may have
to financially assist your parents as a result of poor planning. It is not smart to be too
conservative and thus see your parents live a life of poverty because they fear to run out
of money. At the same time, it is not too smart to plan foolishly and do run out of money
later on. There are many complicated decisions that need professional help. Don’t let
your parents be “penny-wise and pound-foolish” on this point.
You can contact Louis Sapi for consultation at 905-678-2740