Tag: RRSP/RRIF

Repay your HBP … or pay dearly for that delay

The first 60 days of the year is commonly referred to as “RRSP season.” That’s because deposits made to your RRSP in this period may be claimed as a deduction against a person’s prior year’s income. 

For those who have participated in the RRSP Home Buyers’ Plan (HBP), it might be a higher priority to regard it as “repayment season,” since failure to pay an instalment will result in the amount due being included in taxable income for that prior year.

For HBP loans commencing prior to 2009, a repayment will be due in the 2010 tax year, for which the last allowable repayment date is March 1, 2011.

HBP in brief

The HBP allows individuals to withdraw some of their RRSP funds to buy or build a qualifying home. As long as the individual and the property meet the qualification criteria, the amount withdrawn is not included in the individual’s income.

The individual must buy or build the qualifying home before October 1 of the year after the year of the withdrawal. RRSP repayments must commence the second year following the year of withdrawal, continuing for no more than 15 years. A minimum of 1/15 of the original withdrawal amount is due each year until the full amount is repaid.

What is it really costing you?

An RRSP can certainly be a useful vehicle to accumulate funds for a home purchase, with access to those funds facilitated by the availability of the HBP. Still, participants should consider carefully their ability to repay HBP before making an RRSP withdrawal.

As already mentioned, unpaid instalments are taxable in the year the instalment is due.  As the original funds will have already been applied to the home purchase, cash will have to be found to pay the tax on the income inclusion, likely from current income sources.  

To illustrate, assume that a homeowner with a 40% marginal tax rate fails to repay $1,000. In order to make the subsequent $400 tax payment, $667 of gross income will be required. Arguably, this could be viewed (at least in part), as a beneficial deferral of the tax payment. However, if the individual is in a higher bracket at that later time, it will cost relatively more in pre-tax income to make that payment. 

Of course, it is even more costly to actually fulfill the $1,000 instalment, requiring $1,667 out of gross income. Mind you, if you don’t make the instalment then you don’t regain any RRSP room. This brings to mind the newly available Tax-Free Savings Account (TFSA), which may be a good alternative or complement when saving for a home.

By the way, if a person misses the first 60 days deadline, all is not lost. Any RRSP contributions made during 2010 may be designated as HBP repayments at tax filing time, but keep in mind that these amounts will then not be deductible against 2010 income.

The first 60 days – Coordinating TFSA and RRSP

Whether or not you subscribe to the notion of “RRSP season,” the first 60 days of the year is a good time for a fresh review of your clients’ savings practices.  

And with the TFSA now becoming more familiar to both advisors and investors, it may also be a good time to consider how the two plan types may be coordinated to make them mutually more effective.

Relative accumulation

Generally we expect to move from a higher marginal tax bracket in our income-earning years to a lower bracket in our retirement years. With that dynamic, an investment dollar will yield a better after-tax return through the familiar RRSP over the newcomer TFSA (refer to my piece in the May 2009 issue of Fundamentals). 

That certainly is the key point of distinction for investors between the two plan types when investment dollars are scarce. It does not necessarily mean, however, that an immediate direct deposit to an RRSP is the only route that will take us to our goal of a more secure retirement.  

If we can resist the allure of the early tax refund connected to an RRSP deposit, there may be other benefits to reap by taking a more strategic path. 

TFSA fundamentals

TFSA room may be carried forward indefinitely, but it remains at its nominal amount denominated  in the year it was granted. To illustrate, if a person did not use the $5,000 of room from 2009, that particular entitlement remains as $5,000, whether used the next year (2010) or in any year in future. [NOTE – This should not be confused with the indexing of the annual TFSA dollar limit, which grows by $500 increments about every three to four years.]

Consider also the novel feature of the TFSA that allows each dollar withdrawn in a particular year to give rise to a re-contribution credit the following January 1.  

Is there a way that the TFSA re-contribution rule can assist the TFSA carryforward rule?

TFSA first, RRSP second?

Though counter to common practice, what if a person decided to forego the RRSP deposit in the first 60 days and instead place those funds into a TFSA?  

Assuming for illustration a fixed interest investment option, the TFSA would be at a higher value by year-end, at which time a withdrawal would be made to contribute to the RRSP. The credit to the TFSA room the following year would be larger than if the TFSA had been untouched, and the RRSP contribution would lead to a larger refund, albeit one year delayed. 

Alternatively, if you want to keep closer to the traditional route, go ahead and make the RRSP contribution as usual and direct the tax refund into the TFSA – but remember to withdraw before year-end to make that RRSP contribution.

There may be a cost of not receiving the refund in the first year, but in my calculations that initial cost is not dire. After that first year, you are back on track with rolling annual RRSP contributions, though routed through the TFSA, and it’s for you to decide whether any initial cost is worth the additional TFSA room gained.

Personally, I continue to contribute the bulk of my RRSP money directly, but in 2010 I isolated a small part of my TFSA and RRSP assets to test this strategy. While it worked fine, I’m cognizant that a drop in TFSA value (I’m principally in equities) will leave me with an interesting decision at a future year-end – which will be good fodder for a future article.

Homebuyer triumphs in the face of conflicting HBP acquisition rules

The Home Buyers’ Plan (HBP) enables would-be homeowners to access their RRSP holdings to assist in the acquisition of a new home.  

In simplified terms, a person may withdraw up to $25,000 in a year and not have it included in taxable income, so long as the funds are devoted (a purposely soft term I have chosen for now) to the purchase of a new home by October 1 of the following year.  The person then has about 15 years to re-deposit the money to the RRSP without incurring penalties.

The set of HBP rules is not the most complicated drafting one may come across, but is nonetheless tax legislation, and earns its stripes fairly in that regard.  The cross-referencing of terms makes it a bit of a challenge to navigate, particularly for first-time homebuyers who by definition are likely to consult the rules but once in a lifetime.

And in a case heard near the end of 2009, a judge was presented with a set of facts that highlighted a conflict in those rules.

Undisputed facts

In June 2005, taxpayer AL withdrew $20,000 from her RRSP (the maximum allowed by the rules at that time), and used it as part of a series of initial payments to a builder for construction and eventual occupation of a condominium unit, with the last payment made in April, 2006.  The agreement required AL to take possession by May, 2008.

Following her 2005 tax filing, AL was assessed by the Canada Revenue Agency (CRA) for a $20,000 income inclusion on the basis that she had not taken possession of an eligible housing unit prior to October 1, 2006 in compliance with the HBP rules.

AL initiated an appeal from the assessment to the Tax Court of Canada under the informal procedure.  She represented herself opposite Crown counsel on behalf of the CRA.  

Daisy-chaining definitions 

For a taxpayer not to be immediately taxed on withdrawn RRSP funds, all parts of the definition of “regular eligible amount” (REA) must be satisfied, including the requirement that the individual must acquire the property by the completion date.  

One part of the REA definition addresses possession, whereby an individual must intend to use the property as a principal place of residence not later than one year after its acquisition.  In the case of a condominium unit, acquisition is the day the individual is entitled to immediate vacant possession of it.  In the present case, the written agreement entitles AL to vacant possession at May 1, 2008, so that is the deemed completion date.  

Another part of the REA definition addresses the issue of payments, which must be equal to or exceed the RRSP withdrawal and have been made between the withdrawal date and the completion date.  Pursuant to this rule, the deemed completion date is before October 1, 2006.

The world be deemed

According to Crown counsel, the date of acquisition cannot be considered to occur after the completion date for purposes of habitability and vacant possession, and before the completion date with respect to the commitment of building payments.  It must be one or the other; else, a person could engage a builder with an agreement for a very distant possession date, which in Crown’s opinion would be against the purpose of the HBP program.

The Crown goes on to suggest that the extension of the completion date was only available in circumstances when unforeseen delays occur, not if it is known in advance that the date of acquisition will be after the completion date.  Indeed, the written agreement has a possession date of May, 2008 which, according to the Crown, implies that AL knew at time of RRSP withdrawal she would not be acquiring the housing unit before the completion date. 

The judge acknowledged that the two deeming provisions were inherently in conflict, but declined to accept the further Crown submissions as to precedence of those rules.

In the end, the judge held that as long as the amounts withdrawn from the RRSP were used for the construction of the qualifying home before the completion date, that is October 1, 2006, it does not matter after that when the housing unit was ready to be occupied.  In fact, the property was still not ready by the time of hearing in 2009.

Overall, it is a practical determination that comports with the reality of building timelines in many cases.  Otherwise the rules would discriminate against buyers acquiring a property as part of a large scale building project, and that certainly could not be what the HBP was ever intended to do.