Tag: RRSP/RRIF

What to do with your tax refund

Saving is the way to pay yourself back, over and over

At the risk of taking the fun out of tax season – stop laughing, keep reading – I suggest that you devote your tax refund toward savings.  Okay, spend some, but allow me to make my case for making saving your first priority.

A tax refund is a kind of forced savings already.  In essence, the taxes that were withheld over the course of last year were more than necessary to fulfill your annual income tax obligation.  Once the full calculation has hit the books with the filing of your tax return, the government sends back that overage.

Commonly for those whose income is mainly employment-related, the refund arises due to RRSP contributions.  Your employer would have reduced its withholding where it knew about contributions to workplace pensions and RRSPs, but it would not have known to do that for RRSP contributions you made outside of work.  For example, at a 40% tax bracket, a $1,000 contribution to your own RRSP reduces your reportable income by that amount, so you have $400 coming to you.

As well, you likely made RRSP contributions in January and February, and are allowed to apply those contributions against last year’s income.  Assuming so, that gets you your tax break as early as possible, but let’s pause and think about the mechanics involved in that.

For those workplace RRSPs, you are using some of your 2018 income to reduce 2017 income, in effect paying last year’s taxes with this year’s income.  That can put growing pressure on your cash flow from year to year, and put you in an especially difficult bind if you lose your job.

At a minimum, save the refund related to those first 60 days, whether it’s simply set aside in a tax-free savings account or it goes as a further RRSP contribution.  If it is the latter, your larger refund next year can help reverse you out of catch-up mode with your taxes.  Supplement that with the refund from your other RRSP deposits and you’ll be ahead on both your taxes and your savings.

Three tips to jump-start your savings as your career gets going

You’ve spent a long time, a lot of effort and a fair bit of money to get going in your career. Now here you are launching into it, and likely the last thing you’re thinking about is … retirement.

Fair enough, let’s not stretch too many decades down the road, and just look a few years ahead for now. Why is it so important to get a savings habit going now? And how can taxes – yes, taxes – act as a strategic guide on where and when to invest those savings?

Save early, save often … and save smartly

In terms of what is saving smartly, ideally your savings will be flexible to be applied to your financial needs as they arise, and will take best advantage of tax-sheltering where possible.

Choices: RRSP and TFSA

While not the only place to put your savings, registered retirement savings plans (RRSPs) and tax-free savings accounts (TFSAs) are common choices:

RRSP – You get a tax deduction for the amount you put in, there is no tax on earnings while in the plan, and then withdrawals are taxable.

TFSA – There is no tax deduction when money goes in, but similar to RRSPs there is no tax on earnings, and all withdrawals are tax-free.

In a sense, the RRSP and TFSA mirror one another in that the big tax break comes at the beginning with the RRSP and at the end with the TFSA. Apart from the tax-sheltering (which both plans get), an RRSP makes sense for retirees because they expect to be in a lower bracket in retirement when withdrawals are taxed. If you used a TFSA for this purpose, it would cost you more tax than with the RRSP.

So if that’s the case, is there any situation when a TFSA would be preferred because someone goes up in tax bracket over time?

A tax strategy for young earners

Yes, and you’re it as a new entrant into the workforce. You’ve negotiated a fair wage to begin, but you expect that to rise as your career progresses. The value of the tax break on an RRSP contribution is more modest at this level than it will be when you fully hit your stride later on.

It may not sound appealing to allow yourself to be taxed now, but that’s what happens if you first contribute to a TFSA. Then when you get into that higher income (and tax) bracket, you can take your tax-free TFSA withdrawal to make your tax-deductible RRSP contribution. What you do with your eventual tax refund … well that’s a topic for another day.

What’s more, you are allowed to re-contribute to your TFSA in future years what you took out of it this year. With a little planning you can strategically use the TFSA over and again throughout your life. Of course there’s much more to consider than this little tax hook, not the least of which is the choice of investments within the accounts. That’s where a conversation with your financial advisor can help you decide if and how to apply this strategy in your situation.

RRIF rollover allowed via joint election between deceased’s estate and grandson

At issue

On death, a person’s property is deemed disposed, including funds held in registered retirement savings plans and registered retirement income funds. The RRSP or RRIF value is brought into income in the deceased’s terminal year. In addition to triggering taxation sooner than the family may wish, this can contribute to a higher tax bill than anticipated due to the lump sum being taxed in a single year.

Relief is available by certain tax-free rollovers to qualified beneficiaries: a spouse, a dependent minor child, or a disabled dependent minor or adult child. Commonly this can be achieved through direct beneficiary designation on the plan, or alternatively if the funds have fallen into the estate then by joint election between the deceased’s personal representative (executor) and a qualified beneficiary who has a sufficient entitlement as an estate beneficiary. The procedure for spouse beneficiaries is typically straightforward, but could be more complicated with a minor or mentally infirm individual.

Putting the focus on minors, even if there is a remaining surviving parent, that parent is generally the automatic guardian of the child’s person but not of property. Approval of the provincial public trustee or other court order will be necessary to make the election and execute a legal contract for the required annuity to age 18 – and having those funds in such a young person’s hands without oversight is likely not a desirable result. These hurdles were addressed in a unique fact situation in a recent advance income tax ruling from the Canada Revenue Agency (CRA).

Income Tax Act (ITA) Canada

Paragraph 56(1)(t) and parts of section146.3 – These provisions work together to allow the value of a RRIF to be a designated benefit (income inclusion) of a beneficiary rather than the deceased/estate.

Section 60.011 – A lifetime benefit trust may be established for a minor child or grandchild who was dependent on a deceased by reason of mental infirmity. A qualifying trust annuity may be purchased with the trust funds.

Paragraph 56(1)(d.2) and section 75.2 – These provisions cause income paid to a qualifying trust annuity to be included in the income of the trust beneficiary.

CRA 2016-0627341R3 (E) – Rollover of RRIF proceeds after death

The exact date of this advance income tax ruling is redacted, but it was issued some time in 2016.

The minor child was adopted by his grandmother because his parents were incapable of caring for him. A court issued a parenting order providing that the grandmother had “all powers, responsibilities, entitlements of guardianship and decision-making regarding the grandson.” Furthermore, it was clear that he was financially dependent on her and no-one else.

Unfortunately a difficult situation got worse when it was determined that the grandmother had a terminal medical condition. As part of arranging her affairs, she named her son as executor under her will, and executed an authorization for that son and his wife to apply to adopt the grandson (presumably their nephew). Two RRIFs came into the grandmother’s estate upon her death, the combined value of which was less than the grandson’s share of the estate.

The proposal to CRA goes into a number of steps, including reference to the above ITA sections, essentially having the RRIF go by tax-free rollover to an annuity that will pay out over the years until the grandson reaches 18. The payments will be received by the trust, but will be taxable to the grandson whose basic personal tax credit will negate much or all of any tax.

In approving the proposal, the CRA acknowledges the dual-purpose to reduce taxes otherwise arising on the grandmother’s death and to allow the executor to maintain control over the funds. Though not stated in the ruling, take note that the minor child must have had a mental infirmity in order for ITA s.60.011 to have applied. This also skirts the issue of having the minor enter into the contract for the annuity, as it is the executor/trustee of the lifetime benefit trust who carries out that purchase.

Practice points

  1. Directly naming minors or mentally infirm individuals as RRSP/RRIF beneficiaries may enable tax deferral, but it does not resolve all complications and hurdles.
  2. Though there is only brief mention of the grandmother’s parenting court order and the presumed/forthcoming adoption order in the ruling, those seem to have facilitated the process. Together with the child’s apparent mental infirmity, an acceptable result is obtained.
  3. More generally, all parents and guardians of minors should be conscious of the need to coordinate beneficiary designations with will provisions to satisfy their estate planning needs.