Choosing the Right Registered Investments | FBC, Canada's Farm & Small Business Tax Specialist

Choosing the Right Registered Investments

These registered plans are designed to help you save with specific goals in mind, such as the retirement lifestyle you would like to enjoy

Your off-farm investments can be directed to either registered deferred income plans or to a non-registered portfolio. This article focuses on registered plans, all of which are subject to limitations set by the Income Tax Act.

The best investments for you depend on your unique situation. Many taxpayers are apt to find a registered retirement savings plan (RRSP) the most attractive deferred income plan due to the deductibility of their contribution. Registered education savings plans (RESP) also are attractive investment options for taxpayers with younger children because of the government bonuses and tax-free payout to students.

Most mid- to high-income earners probably should consider a new tax-free savings account (TFSA) as a strategic supplement to their RRSP, but not as a replacement. Finally, for low-income earners and families the TFSA could be their best way to set up a rainy-day fund.

Supplementing Your Investments with a Tax-Free Savings Account

The new Tax-Free Savings Account (TFSA) was passed into law in June 2008, and financial institutions are getting prepared to set up TFSAs starting January 1, 2009 for Canadians 18 or over. As with your RRSP, you can hold a variety of investments in your TFSA, ranging from guaranteed interest-bearing investments to bonds to equities.

The TFSA has several unique key features that make it different from other registered investments. While you cannot deduct your contributions like you can with your RRSP, the beauty of the TFSA is that any withdrawals will not be taxed regardless of how much income has been generated within the account. Your earnings (including capital gains) grow tax-free within the account and your withdrawals also are tax-free. If you wish to withdraw some or all of the funds to make a purchase, such as a home or a vacation, or invest in your business, you can do so with no tax consequences. You also can replace the funds at a later date without affecting your annual $5,000 contribution limit.

Payouts are not considered to be income and they do not affect your eligibility for federal income-tested benefits and credits such as the Guaranteed Income Supplement, Canada Child Tax Benefit, and GST credits.

You and your spouse can each deposit up to $5,500 for 2013 ($5,000 for each year from 2009 to 2012) in your separate TFSAs. Any shortfall in a year can be carried over indefinitely. You also can make deposits on behalf of your spouse without any income attribution.

Saving for a Comfortable Retirement

If you currently work off-farm or if you have in the past, you may be participating in employer-sponsored retirement plans such as a Registered Pension Plan (RPP) or Deferred Profit Sharing Plan (DPSP). All RPPs and DPSPs must be registered with the CRA and comply with the terms of the Income Tax Act. The payments within them accumulate tax-sheltered, in trust for the benefit of employees, and are not taxable until paid out to the employee.

There are two types of RPP: a defined benefit pension plan and a defined contribution (money purchase) plan. Employee contributions to an RPP are tax deductible.

In a defined benefit pension plan either the employer only or the employer and its employees must make monetary contributions towards providing employees with a retirement income. For a defined benefit RPP, the amount of pension an employee receives is set in advance according to a precise formula, usually based on annual earnings multiplied by years of service.

For a defined contribution RPP, the retirement pension is based on the amount of money an employee has accumulated in his or her individual account. This will vary according to the amount contributed, return on investment, and the cost of purchasing a monthly retirement income.

Through a Deferred Profit Sharing Plan an employer may share profits from the business with its employees. The amounts payable are tax-deductible to the employer. They are normally a portion or percentage of profits, but they can be a fixed dollar amount or a fixed percentage of payroll. The maximum an employer can contribute on an employee's behalf is 18 per cent of salary without exceeding the DPSP contributions limits set for each year.

A Registered Retirement Savings Plan (RRSP) allows you as an individual to accumulate retirement savings that will grow tax-free until you start to withdraw funds, provided you have “earned income”. You can have several different RRSPs and invest them in a variety of eligible vehicles such as Guaranteed Investment Certificates (GICs), mutual funds, etc. Eligible RRSP contributions reduce your taxable income and therefore save on your tax bill.

You can make RRSP contributions to either your own plan or a plan for your spouse or common-law partner, providing the aggregate of your contributions does not exceed the maximum allowable for a given year.

You can contribute to an RRSP until the end of the calendar year in which you turn 71, at which time you need to collapse your RRSP. There are several options for winding up your RRSP that will allow you to reduce its tax impact while providing retirement income, such as purchasing a Registered Retirement Income Fund (RRIF).

The annual RRSP contribution limit is 18 per cent of the previous year's earned income to the allowable dollar limit (see below), less the previous year's pension adjustment (PA) as reported on the T4, plus unused contribution room carried forward from previous years. (The PA measures the total value of all RPP or DPSP benefits earned for the year.) RPP past service pension adjustments (PSPA) and pension-adjustment reversals (PAR) also affect the contribution limit.

The RRSP dollar limit is $21,000 for 2009. This limit is reached with earned income of $116,666 for 2008.

Some small employers find it easier and less costly to contribute directly to an employee's RRSP or group RRSP rather than set up an RPP. When this is done, the contribution is a deduction to the employer, and it is salary to the employee and must be reported as such. However, it will be offset by the employee's RRSP deduction.

Investing in Your Children's Post-Secondary Education

It is never too early to start saving for their post-secondary education, regardless of how young your children or grandchildren are. The USC Family Education Savings Plan website projects the average cost of a four-year Canadian university program in 2015 to be about $50,000 for a student who lives at home and a little over $80,000 for a student who lives away from home. Those costs are expected to grow to about $70,000 and $110,000 by the year 2025.

Many financial planners believe that a registered education savings plan (RESP) is the best way to save for your children's education for several reasons. Although contributions are not tax-deductible, the income in the plan accumulates on a tax-free basis. The income, not the capital contributions, is taxed in the hands of the beneficiaries when withdrawn from the plan to pay for their education.

Since 2007, there has been no annual limit on contributions to an RESP although there is a lifetime contribution limit per student of $50,000. Beneficiaries under 18 qualify for the Canada Education Savings Grant (CESG) payable by the government. That grant is 20 per cent of the first $2,500 you contribute, up to a maximum annual CESG of $500. The CESG lifetime limit is $7,200. RESP contributions are permitted for the first 31 years of a plan, which must be wound up after 35 years. These time limits are extended to 35 and 40 years respectively for disabled beneficiaries.

Providing Long-Term Security for Disabled Children

If you are the parent of a child with special needs and are concerned about ensuring their financial security when you are no longer around, you should consider a Registered Disability Savings Plan (RDSP), which are new for 2008. Your contributions are not tax-deductible, but the investment income from funds contributed accrues tax-free. RDSP contributions are not taxable to your beneficiary when paid out. Only the income earned in the plan when withdrawn is taxable to the recipient.

There is no annual limit on contributions, and anyone can contribute to the plan. There is a lifetime contribution limit of $200,000 per child, and contributions can be made only until the child is 59. All contributions to a RDSP can earn both Canadian Disability Savings Grants and Canada Disability Savings Bonds.

"If all the economists were laid end to end, they’d never reach a conclusion." — George Bernard Shaw