info@pyc.net
Newsletter Archive

The Future of Your RRSP
March 2003

Many Canadian taxpayers have been able to build substantial RRSPs that will one day supplement their pensions and other sources of retirement income. 

Since the inception of this strategic retirement savings program, the RRSP has become an attractive investment for many taxpayers. An RRSP offers the contributor both immediate and long-term benefits: 

•           a reduction of personal income tax for the year in which the contribution is made 

•           the security of knowing that these savings will help finance your future retirement but can also be accessed in the event of an emergency

•           the deferral of taxes on the income and capital gains on the RRSP investments that accrue within the plan, and 

•            substantial savings in taxes if your income (and marginal tax rate) is lower at the time you make withdrawals for your retirement.

Withdrawals from RRSPs

Generally, you can withdraw funds from an RRSP at any time and the tax consequences are very straightforward — the amount of your withdrawal is fully taxable in that taxation year. As these savings are for your retirement, withdrawals should only be made in the case of an emergency or in a year in which your income is particularly low. It is very important to get tax advice before you consider withdrawing RRSP funds prior to the maturing of your plan.

However, the lifespan of the RRSP does not continue beyond the year in which you turn age 69. In that year, the RRSP is said to have matured. That is, you must terminate your RRSP in the year in which you reach age 69.

You do have options for winding up the RRSP. Besides a lump sum withdrawal (which would be subject to tax in that year), you can purchase a life annuity or fixed term annuity and pay taxes as the payments are received. However, annuities lack flexibility and the rates of return may not be competitive with other investments. Your other alternative is to transfer the funds on a tax-free basis to a Registered Retirement Income Fund (RRIF).

Note that if you do not select one of these options by the end of the year in which you turn 69, the RRSP is automatically deregistered. For tax purposes, this deregistration is treated as if it is a lump sum withdrawal so a high portion of the funds would be taxed at the maximum tax rate.

Registered Retirement Income Fund (RRIF)

A RRIF is managed in much the same manner as an RRSP; however, deductible contributions cannot be made to a RRIF. For this reason, there is usually no advantage to establishing a RRIF prior to age 69.

Once inside the RRIF, the assets can be managed by the trustee of the plan according to the taxpayer’s directions. The wide range of qualifying investments that can be acquired in a RRIF may make it possible to achieve a better rate of return than those available through the purchase of annuities.

The RRIF offers some degree of flexibility as there is no maximum to the amount that you can withdraw in a year. However, it is important to note that you must withdraw a minimum from your RRIF each year. The Income Tax Act sets out the percentage of the fair market value of the RRIF assets that must be withdrawn (and are subject to tax) each year, beginning in the year following the year that the RRIF is established. If the RRIF is established at age 69, the percentage starts at  4.76% and increases until it reaches 20% at age 94. At age 94, it stays at the 20% level until such time that you die.

What Happens on Death?

Whether you currently have an RRSP or have transferred your funds to a RRIF, make sure you designate a beneficiary. Amounts received by your spouse or financially dependent children will be taxable in their hands; however, the tax on the receipt of these amounts may be eligible for deferral if they transfer the funds to an RRSP or annuity. If you do not designate a beneficiary, your estate will be taxable on the fair market value of your plan at the time of your death unless your legal representative jointly elects with the spouse/partner or financially dependent child to transfer the amount to him or her in which case it would be taxable in his or her hands.

You also need to revisit your assignment of beneficiaries periodically to reflect changes in your life such as separation or divorce, the birth of a child, or the death of a beneficiary.

An Example

Let’s look at an example. A taxpayer who was in the top tax bracket began making annual RRSP contributions of $10,000 on January 1, 1983.

 Throughout the years 1983 to 2002, he received a 6% return on his RRSP investments. By January 1, 2002, the RRSP vehicle had allowed him to defer almost $100,000 in income taxes while his RRSP portfolio grew to an aggregate principal and interest value of $367,855.

 In 2002, he reached age 69 and as the RRSP must be terminated before December 31st of the year in which you reach age 69, he transferred the funds to a RRIF. Unfortunately he met an early demise in 2003.

 Taking into account the additional interest of $22,071 that his investments would earn in 2002, the value of the RRIF at December 31, 2002 would be $389,926. The RRIF would have provided a minimum payment of $18,560 for 2003.  If this payment had been made, the remaining balance of the RRIF would be $371,366. The tax on this remaining amount, depending on the tax jurisdiction, would be approximately 45% of the RRIF face value, or $167,115. (The lowest tax rate is in Alberta and the highest in Newfoundland.)

How could he have protected his estate from this substantial tax liability on death?

 RRIF Transfers on Death

When a RRIF annuitant dies, the spouse or common-law partner can become the annuitant of the RRIF on a tax-free basis. There is also a rollover if the RRIF assets are left to a financially dependent child or grandchild. In essence, the beneficiary may defer taxes on the amount by transferring it to an issuer to buy an annuity that provides payments until the child reaches the age of 18. Of course, any payments received from the plan or annuity are subject to tax in the hands of the beneficiary. Also of note is that for children and grandchildren that are financially dependent by reason of a mental or physical infirmity, the amount can also be transferred to an RRSP or other eligible annuities regardless of their age. In this case, you should also consider the impact of the annuity on any social assistance that the dependant receives.

If the assets are left to any other beneficiary, the fair market value of the assets will have to be added to the deceased taxpayer’s income in the year of death. This could result in a very large tax liability. In some instances, the taxpayer will purchase a life insurance policy to provide the funds to pay this tax liability at death.

Consult Your Professional Advisors