Chapter 10 – Retirement Savings and Other Special Income Arrangements The following topics are not covered in this course: RPP, RRIF, etc, - Slides after slide 26

Learning Objectives Explain how retirement savings plans provide tax deferral opportunities. Describe the basic operation of Registered Retirement Savings Plans (RRSP’s) Understand the terms: RRSP Deduction Limit, Unused RRSP Deduction Room and RRSP Dollar Limit. Calculate Earned Income for RRSP purposes Understand the concepts of: Pension Adjustments, Past Service Pension Adjustments and Pension Adjustment Reversals. Calculate the maximum RRSP deduction, contribution and Unused RRSP Deduction Room. Understand the issues involved with withdrawing funds from an RRSP. Understand the issues involved in terminating an RRSP. Apply the provisions related to spousal RRSP’s Describe the functioning of the Home Buyers’ Plan and the Lifelong Learning Plan

Planning for Retirement Minimal benefits are available to all taxpayers from Old Age Security Canada Pension is only paid to former employees and individuals reporting business income who contribute Above and beyond these two sources of income, there are some savings plans that will provide additional benefits –Registered Retirement Savings Plans (RRSP) –Registered Pension Plans (RPP) –Registered Retirement Income Funds (RRIF) –Deferred Profit Sharing Plans (DPSP) –Tax Free Savings Accounts (TFSA) Our focus will be on RRSP’s with some discussion of RPP’s

The Basic System for Retirement Savings Savings in RPP’s and RRSP’s are deductible for tax purposes when an amount is contributed to the plan by the taxpayer. Employer contributions to an RPP are not considered to be taxable benefits. In addition, the plans earn income tax free At retirement, funds are withdrawn from the plan gradually over a number of years, and taxed at the time of withdrawal (usually at this point in life the taxpayer is in a lower tax bracket) Retirement savings have an annual limit that is consistently applied

Example Contribute $5,000 per year to an RRSP for 30 years with an annual rate of return of 10%: –Funds accumulated = $822,470 Contribute $5,000 per year to a non - registered (taxable ) savings plan with an annual rate of return of 10% (tax rate = 45%) –Funds accumulated = $199,198

Benefits of RRSP contributions Tax deductibility Tax free compounding Contribute as early as possible in the year to maximize the benefits –Contributions for 2012 can be made anytime from January 1, 2012 to 60 days after December 31, –It has been demonstrated that if contributions are consistently made at the beginning of the year, funds accumulated can be 10% higher than if contributions are made at the end of the year. Taxpayers may have lower tax rates after retirement Taxpayer will be eligible for pension tax credit of $2,000 when retired and receiving RRSP money from their plan.

Two Types of RPP’s Defined Benefit –Plan sponsor agrees to provide a specific benefit on retirement, usually a % of income based on years of service. –The employer makes the necessary contributions, and often the employee contributes some as well Money Purchase – Defined Contribution –Employer agrees to make specific contributions, and employee may make contributions as well, but no guarantee is given as to the amount of the retirement benefit that will be paid.

Two types of plans Although the term is not applied to RRSP’s, DPSP’s and RRIF’s, they are all: –MONEY PURCHASE PLANS Some of the complexity in this area results from trying to keep a level playing field between Defined Benefit and Money Purchase plans.

RRSP’s A trust with the individual as the beneficiary, and a financial institution acting as the administrator. If the plan is registered, contributions to the plan are tax deductible, subject to the limits set in the Act. Funds can be borrowed to make a contribution, but interest on the debt will not be tax deductible.

RRSP - Withdrawals Most amounts withdrawn must be included in income, as regular income (even if dividend or capital gain income is withdrawn from the RRSP) Some withdrawals can be made tax free –Home Buyers’ Plan –Lifelong Learning Plan Withdrawals are subject to withholding tax, and this should be kept in mind by someone needing a certain amount of cash after tax from their RRSP

Investment Options Managed RRSP –Financial institution manages the investment of the funds Self administered RRSP –Investment of the funds is managed by the taxpayer –Can transfer securities already owned into the plan (may result in TCG’s as this is a deemed disposition) An individual can have multiple RRSP’s Potential investments are broad – main limitations are investments in shares of private companies and direct investments in real estate.

Some Taxation Problems Capital Gains –Will be treated as ordinary income when withdrawn from the plan –If an investment is held for a long time, the capital gain is essentially earned tax free until the time the investment is disposed of Eligible Dividends –Dividends also lose their favourable tax treatment inside a registered plan –This has become a larger issue with the introduction of eligible dividends, which reduces the effective tax rate on this source of income Non-deductible financing costs –Interest paid on borrowing to finance an RRSP contribution is not tax deductible, but if borrowing to finance a non-registered investment, the interest is deductible Complete Exercise Ten-1 on Pg. 469

RRSP Deduction Limit =unused RRSP deduction room at end of preceding taxation year + the amount if any, by which a)The lesser of i) the RRSP dollar limit for the year and ii) 18% of earned income for the preceding taxation year, Exceeds b)The Pension adjustment for the preceding year, and c)A prescribed amount in respect of the taxpayer for the year, + the taxpayer’s total Pension Adjustment reversal for the year -the net past service pension adjustment for the year = RRSP Deduction Limit

RRSP Deduction Limit and Contributions RRSP deduction limit -Amount deducted for year = unused RRSP deduction room at end of taxation year (carry forward to next year) Contributions cannot exceed the RRSP deduction limit + $2,000 (margin of safety) – any undeducted contributions The amount a taxpayer deducts is a choice. It cannot exceed either of the following amounts: i) the total undeducted contributions ii) the RRSP deduction limit for the year

Definitions Unused RRSP deduction room: –The cumulative total of all prior year RRSP deduction limits, less all prior year contributions, since 1991 –Carry over of deduction room is not time limited RRSP dollar limit –This is a constantly changing number, that is currently $22,970 for It is indexed for future years, and the 2013 amount is $23,820.

Definitions, continued Earned income –Additions: Net employment income, computed without RPP deductions Royalties, taxable support payments, Supplementary unemployment benefit plan payments (not regular EI benefits), business income, net rental income from real property, research grants, CPP and QPP disability benefits –Deductions: Deductible support payments, business losses, real property rental losses Complete Exercise Ten-2 and Ten-3 on Pg. 472

Definitions, continued Pension Adjustment –A reduction to reflect retirement savings taking place in RPP’s or DPSP’s. –Prevents taxpayers with these plans (RPP, DPSP) from benefiting from additional contributions. –You do not need to know how to calculate this number, just how to use it if it is given to you. –Are reported on the employee’s T4 slip Prescribed amount –A deduction that may arise as the result of an individual transferring benefits from one RPP to another RPP (which can happen when a taxpayer changes employers) Complete Exercise Ten-4 on Pg. 473

Definitions, continued Past Service Pension Adjustments (PSPA’s) –Happen rarely, when there is a past service contribution under a defined benefit RPP –You do not need to know how to calculate this number, just how to use it if it is given to you. Complete Exercise Ten-5 on Pg. 474 Complete Self Study Problem Ten-1 on Pg. 501

Definitions, continued Pension Adjustment Reversal –Will occur when an employee leaves an employer, and he/she receives less from the plan at the time of departure, than the total of all PA’s and PSPA’s reported over the term of employment. –This amount is added to the RRSP deduction room in the year the employee terminates their employment. Complete Exercise Ten-6 on page 477 and Ten-7 on Pg. 478

Undeducted RRSP contributions There is no requirement to deduct your contributions immediately. As long as there is deduction room, and funds to invest, the investment can be made. If you are currently in a low tax bracket, and expect that to change in the near future, make your contributions, but wait until later to deduct them to get the maximum refund. You cannot invest more than the deduction room available to you (plus a $2,000 cushion, for taxpayers over the age of 18). There is a penalty for doing so, currently 1% of the over contribution per month. Complete Exercise Ten-8 on Pg. 479 and Self-Study Problem Ten-2 and Ten-3 on Pg

RRSP withdrawals Lump sum withdrawal –Possible at any point in time –Tax consequences: Amount withdrawn must be added to income Amount is not added back to the taxpayers contribution room Subject to withholding taxes

Conversion of RRSP on Retirement Most taxpayers will want to convert their RRSP into a stream of income for retirement This can be done by: –Purchasing a life annuity Taxation occurs as annuity payments are received. –Purchasing a fixed term annuity Taxation occurs as annuity payments are received. –Transferring funds to a Registered Retirement Income Fund (RRIF) Taxation occurs as payments are made from the RRIF RRSP’s must be terminated in the year in which the taxpayer reaches age 71.

Spousal Plan A taxpayer can make contributions to a plan that will pay benefits to a spouse, called a spousal RRSP This is one of the few income splitting devices available to all couples –Allows higher income spouse to boost retirement income of lower income spouse –May allow spouse to use $2,000 pension tax credit that they would otherwise lose. –Contributions are deductible to contributor, usually the higher income spouse.

Spousal Plan Income attribution provision –Prevents an immediate transfer of funds to the lower income spouse through the use of a spousal RRSP –Withdrawals are normally taxed in the hands of the beneficiary spouse –If a withdrawal is made from a spousal plan, and the spouse has made a contribution in the current or two preceding calendar years, the withdrawal will be attributed to the contributor. Caution –Funds contributed to a spousal RRSP become the property of the spouse. Complete Exercise Ten-9 on Pg. 482

Home Buyer’s Plan Permits a withdrawal of up to $25,000 without the usual tax consequences under the following conditions: –All prior HBP loans have been repaid by Jan 1 of year of withdrawal –All amounts must be received during the year, or by Jan 31 of following year –Use of funds is for a “qualifying home”, which is a principal residence for the taxpayer within 1 year of its acquisition (no minimum holding period) –Must not have owned a home occupied (taxpayer or spouse) during 4 calendar years prior to the withdrawal. Both a taxpayer and spouse could utilize this loan for access to up to $50,000 Borrowings must be repaid over 15 years (maximum, can repay faster if desired) Complete Exercise Ten-10 on Pg. 485

Lifelong Learning Plan (LLP) Similar to HBP, except use of funds is to finance own or spouses education (but does not have to be used specifically for tuition) Must be enrolled as a FT student in a qualifying educational program at a post secondary institution Limits On Withdrawals $10,000 In Any One Calendar Year $20,000 Maximum Over Four Calendar Years Repayment must begin within 6 years Repay over 10 years straight line. Complete Exercise Ten-11 on Pg. 486

RRSP - Other plan terminations Departure from Canada –Does not immediately result in the collapse of the plan. –Withdrawals are subject to tax under Part XIII of the Act. –Amounts must be repaid by the earlier of: Filing date for year of departure 60 days after becoming non-resident Death of annuitant –If there is a surviving spouse, RRSP can be rolled over to spouse on a tax free basis. Note that in order to be eligible to do this, the spouse must be named as the beneficiary of the plan, not named in the will. Complete Self Study Problem Ten-4 on page

Registered Pension Plans (RPP) These plans are established by a contract between employer and employee They are becoming less popular than they have been historically. Employer contributes, and may deduct the contributions made in year days. –Contributions to a money purchase plan are deductible when made in accordance with plan as registered (cash basis)

Registered Pension Plans (RPP) Excess contributions –There are provisions to limit the amount that can be contributed, so that people with RPP’s don’t have access to more retirement savings than people without RPP’s –The plan will become revocable (cancellable) when the PA of any plan member exceeds the lesser of: The money purchase limit for the year ($22,000 for 2010) 18% x employee compensation from employer

Registered Pension Plans (RPP) Employee contributions –Are deductible to employee –Will be included in the PA

Registered Retirement Income Funds (RRIF’s) Taxpayers can transfer their RRSP funds to an RRIF tax free, and they commonly do this when the taxpayer turns 71 and is no longer eligible for an RRSP. Can have multiple accounts, and can set up at any age. Withdrawals from the plan are calculated based on a formula, and a minimum amount must be withdrawn beginning in the year after it is established. –For individuals <79 at beginning of year, minimum withdrawl = FMV/(90- age at beginning of year) –For individuals >79 the minimum withdrawal = a specific percentage x FMV. Percentage changes annually, for example, it is 8.53% at % at 80, 13,62% at 90, and maximizes at 20% per year starting at age 94. Complete Exercise Ten-12 on Pg. 493

Remaining topics in Chapter 10 These topics are not being covered, however, if you are interested, the book is always available for you to read! –Death of RRIF registrant –Deferred Profit Sharing Plans –Profit Sharing Plans –Transfers Between Plans –Retirement Compensation Arrangements –Salary Deferral Arrangements (actually discussed in Chapter 3) –Individual pension plans.

Final Steps Do the assigned problems on the course outline Review the key terms on pages of the text. The glossary (at the back of your study guide, and on the CD-ROM) can be used for terms you do not understand. Review the learning objectives at the beginning of these slides – for any that you don’t feel you have learned, review the related material in these slides, and the text. Do the practice exam that is on the CD-ROM that came with the textbook.