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Are RRSPs really worth it? The answer may surprise you

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February 19, 2020 , , ,


More and more people say to me that they don’t contribute to RRSPs. They don’t think it makes sense. If they ask my opinion, my response always depends on the specifics of the person who is asking. For the purposes of this article, I will address a few different scenarios.

For all of these examples, the key factors to consider are the following: In retirement, will the person likely be in a higher tax bracket than they are today, the same bracket, or a lower one? I call this the tax teeter-totter. Will their income likely be meaningfully higher or lower in the next five to ten years? How old are they? Are they married and, if so, how long will it likely be until both spouses have passed away?

Situation No. 1: Higher income, significant RRSP

This person has seen what happens when someone dies with a large RRSP or RRIF. When a single person (including widows and widowers) dies, their remaining RRSP or RRIF balance is fully taxable in the final year. For example, if their final balance is $500,000, nearly half of their account will disappear to taxes. Because of that concern, many people with a sizable RRSP and often high income decide that the RRSP isn’t a good use of their funds. To these people I say, “You are making a mistake.” If you are in a tax bracket where you can get at least a 45 per cent refund on an RRSP contribution, I say take the money today, get many years of tax-sheltered growth, and you can worry about a high tax rate on withdrawals at some point in the future. Depending on the province, this 45 per cent tax rate tends to be in place once your taxable income is above $150,000. While you could make a financial argument that it is possible to be worse off to do an (R)RSP contribution depending on what happens in the future in terms of taxes, given the certainty of tax savings at the front end, I would highly recommend making the contribution.

Situation No. 2: Lower income that could jump meaningfully in a few years, with TFSA room

RRSP Piggy BankIn Ontario, if your income is $35,000, your marginal tax rate is 20.1 per cent. If your income is $50,000, your marginal tax rate is 29.7 per cent. If you are making $35,000 today, but think you might be making $50,000+ in the next couple of years, it is better to put any savings into a TFSA now, and wait to do the RSP contribution until you are making $50,000. This is the situation for many people early in their careers. You will be making almost 10 per cent more guaranteed return (29.7 minus 20.1) by waiting, but will still have the same tax sheltering in the TFSA as you would in the RRSP. In general, if you think you will likely be in a much higher tax bracket in the near future, it is better to hold off RRSP contributions, and save up the room to use when you will get a much bigger refund. As a rule of thumb, I suggest people with a taxable income under $48,000 put any savings into a TFSA before putting it into an RRSP.

Situation No. 3: Income could fall meaningfully in a few years

This is the opposite situation and recommendation to No. 2. If you think that you will be in a much lower tax bracket in the near future (taking time off work for whatever reason), you may want to put money in the RRSP now, and actually take it out in a year when your income will otherwise be very low. Many people do not realize that you can take funds out of your regular RRSP at any time and at any age. While you will be taxed on these withdrawals as income, if the tax rate is very low because you have little other income, it usually makes sense to withdraw the money in those years and put it back when your income is much higher.

Situation No. 4: Couple in late 60s, not yet drawing from RRIF

Some people figure that there is no point to put money into an RRSP in their late 60s because they are just going to draw it out shortly anyways. It is true that one of the values of tax sheltering is the compounding benefit of time. Putting a dollar into an RRSP at age 30 will likely have more of an impact than at age 68. Having said that, often people forget that even if they start drawing funds out of a RRIF at 72 or earlier, they may very well still be drawing out funds 20 years later. There is still many years of tax sheltering benefit. The question goes back to the tax teeter-totter. If they are going to get a 25 per cent refund to put funds into their RRSP, but will be getting taxed at 30 per cent or more when they take it out, then it probably doesn’t make sense to contribute more to their RRSP. It all comes back to their likely income and tax rates once they start to draw funds down from their RRIF.

Situation No. 5: Husband is 72, wife is 58

The answer to the question of how to contribute to an RRSP for couples with a significant age difference depends on the taxable income of each person and the ability to most effectively split income over the next number of years. Larger age gaps can be quite valuable for RRSP investing. One reason is that if the younger spouse has a Spousal RSP, and the older spouse still has RSP room, the older spouse can contribute to the younger spouse’s Spousal RSP. This can be done by the older spouse, even if they are older than 71, as long as the younger spouse is below that age. In this example, if the 58-year-old isn’t working, she can actually draw income out from their Spousal RSP and claim the funds only as their income, even though the 72-year-old had benefitted from the tax advantages of contributing over the years. As a reminder, if the younger person had a large Spousal RSP and the older one had no RSP or RIF, they wouldn’t be forced to draw any income because the younger partner was not yet 71. The one area to be careful of is that for the income to be attributable to the 58 year old and not the 72-year-old, there can’t be any contributions to the Spousal RSP for three years. To take advantage of this scenario, maybe the older partner contributes for many years to the Spousal RSP, but stops three years before the younger spouse plans to draw the funds.

While the RSP is generally a positive wealth management tool for many Canadians, there is a time to contribute, there is a time not to contribute and there is a time to withdraw funds. Each situation may create opportunities to maximize your long-term wealth. Choose wisely.

Reproduced from the National Post newspaper article 19th February 2020.

Ted Rechtshaffen
Written By:
Ted Rechtshaffen, MBA, CFP
President and CEO
tedr@tridelta.ca
(416) 733-3292 x 221

These unfair tax policies are putting a burden on women and seniors and need to be changed now

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January 23, 2020 , ,

Here’s a scenario I’ve seen several times in my career as a wealth manager. A retired couple that receives two full CPP payments and two full Old Age Security (OAS) payments is able to fully split their income for tax purposes. Then one spouse dies. The survivor only receives one CPP payment, no OAS, and often has a higher tax rate on less family income because they now have one combined RRIF account that must withdraw more funds on a single tax return. It hardly seems fair, because it isn’t.

The scenario highlights just one of a number of thoroughly unjust tax policies that negatively affect hundreds of thousands of Canadians each year. Many of the policies are particularly harmful to older women because they hit those who are single/widowed and over the age of 65 — a group that contains a much higher percentage of women than men.

As we head into a new decade, and in the spirit of eternal optimism, I am providing a list of four main offending policies in the hope that some political titans vow to fix them.
Without further ado, here are the festering four:

1. Income splitting of a defined benefit pension, prior to age 65

THE SITUATION: If you receive a defined benefit pension at any age, you can split the income with your partner for tax purposes. However, if you convert some or all of your RRSP to a RRIF and withdraw money before age 65, you can’t split the income. You have to wait until age 65.

WHY IT MATTERS: Income splitting is another way of simply saying “pay less in taxes.” If you can income split you will most likely keep more of your pension money than if you can’t. As a simple example, if one person earns $120,000 in Ontario, their tax bill will be $32,895 (with no deductions). If instead, that person is able to fully split income and two people now show $60,000 in income, the total tax bill is $22,050. On the same amount of income, the tax bill is $10,845 lower.

WHO IT AFFECTS: Everyone who does not have a defined benefit pension. These days, most employees who have a defined benefit pension work for the government or a quasi-governmental organization. The private sector now has a very low percentage of employees in a defined benefit pension. To oversimplify, working for the government provides a sizable unfair tax advantage for those under 65 compared to those working in the private sector, without a defined benefit pension. It also benefits couples over singles.

HOW TO FIX IT: Apply the same income splitting age on RSP/RIF withdrawals as on defined benefit pension payments. If that is deemed too expensive for the government, do an income-splitting cap of something like $20,000, but apply it equally to all those of a specific age regardless of what type of retirement pension plan they have.

2. Couples tend to receive more dollars per person than singles in Old Age Security (OAS)

Older woman calculating her taxesTHE SITUATION: Current OAS is more than $7,300 per person per year. If you are collecting OAS starting at age 65, your income can be up to $79,000 before any of your OAS is clawed back. At an income of $128,000 it will be fully clawed back.

WHY IT MATTERS: This is significantly unfair to retired singles. If you are single and your income is $130,000, you will collect no OAS. If you are a couple with household income of $130,000, and you can fully split your income, you will collect about $14,700 of OAS every year indexed to inflation.

WHO IT AFFECTS: Single/widowed seniors get the short end of the stick, and they are more than twice as likely to be female. I have seen many cases where a couple receives two full OAS payments. When one passes away, the survivor suddenly receives $0 in OAS because all of the income (usually RIF income) now sticks to one person instead of being split. According to Statistics Canada roughly 70 per cent of those in long-term care and retirement residences are female. As far as private residences (houses, apartments, condos), 40.2 per cent of women aged 80 to 84 live alone, while only 18.6 per cent of men in the same age group live alone. However you slice it, it appears that at least twice as many single seniors are woman as opposed to men.

HOW TO FIX IT: Have the OAS clawback be based on a dual-person rate or a single-person rate, such that two-person families might see a little more clawback and single-person families see a little less. Given that the current clawback kicks in at $79,000 for one person, the two-person ‘family’ rate could be set at a little less than double that, say $145,000 (with full splitting, the current cutoff for two people is effectively $158,000). The new single-person clawback cutoff could then be raised to about $85,000. The idea is to massage the clawback criteria so that people are much less likely to go from double OAS payments to zero when one dies or gets divorced.

3. Effectively losing the CPP Survivor Pension

THE SITUATION: If two people in a couple are both collecting a full Canada Pension Plan benefit and one of them dies, the other will receive a one-time $2,500 death benefit, and then they will lose the entire CPP payment of the person who died. On the other hand, if the same couple has one person who is collecting a full Canada Pension Plan and their partner never paid into the plan and collects $0 of CPP, and either of them die, the net result is that they will continue to collect one full CPP amount. The reason is that no individual is able to collect more than 100 per cent of a CPP benefit. However, if one person is currently receiving less than 100 per cent, and let’s say her partner dies, that person is able to top up her CPP payment up to 100 per cent out of the amount that was being collected by her partner.

WHY THIS MATTERS: A full share of CPP in 2019 is over $13,800 a year. This is a significant amount of money. To go from receiving up to $27,600 a year and having it drop to $13,800 is a big impact when both people have contributed a lot to CPP over the years.

WHO IT AFFECTS: These rules almost provide an incentive to only have one working partner over the years. It hurts couples in which both partners worked full time. It especially affects couples who both work and in which the male is much older than the female, as this will lead to a longer period of one CPP payment as opposed to collecting two.

HOW TO FIX IT: Most defined benefit pensions have a survivor pension that pays out 60 per cent to 70 per cent of the pension to a surviving partner. You could change the CPP so that if a survivor is already receiving a full CPP payout based on her own contributions and her partner dies, she should receive 60 per cent of their partners’ CPP as well. Essentially make the maximum payout to an individual up to 160 per cent of a full CPP payout. In order to fund it, we could slightly lower a full CPP payout for everyone. In cases where only one person contributed to CPP, and one of the couple dies, then that person would be capped at receiving 100 per cent of the CPP. In this way, a lifetime of CPP contributions doesn’t go for naught if one spouse dies.

4. The Canadian dividend gross up costs OAS dollars

THE SITUATION: In simple terms, Canadian dividends from public corporations are more tax efficient than interest income and foreign dividends. For example, at $70,000 of income in Ontario, the marginal tax rate on income or foreign dividends is 29.65 per cent but the marginal tax rate on eligible Canadian dividends is just 7.56 per cent. This is a very big positive for investing in Canadian stocks that pay dividends. However, there is one nagging problem. The CRA likes to make things complicated, and in order to sort out something called tax integration for corporations, they have set up a complicated way to tax Canadian dividends. The tax formula is to ‘gross up’ a dollar of Canadian dividend income by 38 per cent and then apply a dividend tax credit to get to the right amount of taxation on the dividend. When the CRA determines your income for a variety of income tests, they take your net income — which includes the grossed up dividend income.

WHY IT MATTERS: We discussed the minimum OAS clawback at net income of $79,000. Let’s say you have $70,000 of taxable income from RRIFs, interest and global dividends. At this amount you would receive full OAS. Instead, if you had the same $70,000 of income but it was all Canadian dividend income (an unlikely scenario but good for making this point), it would be grossed up by 38 per cent, and your net income would be considered $96,600. Now your OAS would likely be clawed back by $2,640 a year.

WHO IT AFFECTS: This is an issue that exists for no good reason. At the end of the day, it isn’t the worst of the festering four, but does slightly punish seniors who invest in Canadian companies that pay dividends, especially those who check in around the $80,000 income bracket and are already having some OAS clawed back.

HOW TO FIX IT: I am sure that the strategies around corporate tax integration are complicated, but on a personal tax return, is it that hard to simply tax Canadian dividends using personal tax rates without any gross up? If there was no gross up calculation on a personal tax return, then there is no longer an OAS net income issue. Problem solved.

Reproduced from the National Post newspaper article 23rd January 2020.

Ted Rechtshaffen
Written By:
Ted Rechtshaffen, MBA, CFP
President and CEO
tedr@tridelta.ca
(416) 733-3292 x 221

Ever Considered Loaning your Spouse Money?

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March 21, 2013 , , ,

Here’s why you might.

We all look for ways to reduce the amount of tax we pay.  Sometimes I come across situations where one spouse has accumulated a larger non-registered investment account than the other.  This can happen over time when one spouse has a higher income than the other, or perhaps when one spouse receives an inheritance.

This often leads to higher taxes being paid by the household.  In an effort to reduce taxes, income splitting strategies can help shift income from a high tax bracket family member to a low tax bracket family member.

This is not as simple as making a non-registered account ‘joint’ with a lower income spouse or minor child.  CRA would consider this a gift to a non-arm’s-length person and attribution rules would apply, essentially attributing most if not all of the income back to the higher income individual and taxing it in their hands.

One income splitting strategy where attribution rules would not apply is to use a spousal loan.

A spousal loan works like this:

  •  The higher tax bracket spouse (lender) loans funds to the lower tax bracket spouse (borrower) at the prescribed rate.
  • The prescribed rate is set quarterly and is based on the 90-day Treasury bill rate.  Today that rate is at a historic low of only 1%!
  • The borrower must pay interest on the loan annually by January 30 of the following year ($1,000 for a $100,000 loan).
  • The investment income generated is taxed in the hands of the borrower, not the lender.
  • The interest paid on the loan can be deducted by the borrower and is taxed in the hands of the lender.
  • A written agreement should be put in place documenting the loan.  This also locks in the rate of 1% for the life of the loan, regardless if the prescribed rate increases in the future.

coupleTo illustrate the potential benefits of this strategy, let’s look at a hypothetical couple Tom & Mary Connor.

Tom recently inherited $500,000 from his mother.  Tom faces a marginal tax rate of 46.41% while his wife Mary’s marginal tax rate is 31.15%.  Tom plans on investing the money and can earn 5%.  For simplicity, let’s assume the 5% return is simple interest.

If Tom invests the funds himself, his after-tax return would be $13,397.

$500,000 x 5% x (1 – 46.41%) = $13,397.

Instead, Tom can lend Mary $500,000 at the prescribed rate of 1%, thereby shifting the growth on the money to Mary who is in a lower tax bracket while avoiding attribution rules.

Tom would include the $5,000 in interest on the loan as income, providing an after-tax return of $2,680.

Mary would include $20,000 in interest as income (5% return less 1% in interest costs), providing an after-tax return of $13,770

The total after-tax return for the household is $16,450.

The spousal loan strategy has provided an incremental family return of $3,053 after one year.  As the portfolio grows and the resulting income from the portfolio increases, the incremental improvement in family return also increases.

This tax-planning strategy does however have potential non-tax consequences that should be considered:

  • You may be more likely to be reassessed by CRA.
  • Tax returns become a bit more complicated.
  • If the marriage breaks down, the situation will become more complex and will be subject to family law provisions.

Your entire financial situation, goals & objectives should be considered before employing any strategy.  If you find yourself in a similar situation to Tom, a spousal loan may work very well, especially considering the historically low prescribed rate of 1% that can be locked in today.

Written by Brad Mol, Senior Wealth Advisor, TriDelta Financial

 

 

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