What You Need to Know About RRSPs with a Wealth Advisor

Have you ever wondered what exactly an RRSP is and how you can use one to your advantage? Maybe you already have one but just how the tax treatment of it works is beyond you, or maybe you're wondering how a spousal RRSP could work to your advantage. We have your answers as Luke MacLennan, CPA, CA, QAFP joins us to chat all things RRSP.

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Transcript

00;00;08;18 - 00;00;32;18
Speaker 1
Hello and welcome to Integrating for Success a Ward and Uptigrove podcast. My name is Amy Noonan and I will be your host. It will soon be RRSP season. And for those who don't know, that's registered retirement savings plan season. And honestly, it probably is by the time this episode is released. So we have Luke MacLennan, president of Ward and Uptigrove Wealth Management, back with us today.

00;00;33;07 - 00;00;47;20
Speaker 1
He's done a couple great episodes with us already on integrated financial planning and the age old question of saving versus paying down debt. I highly suggest you go take a listen if you haven't already. Welcome back. Glad to have you with us again.

00;00;48;10 - 00;00;49;28
Speaker 2
It's great to be back. Thanks for having me.

00;00;50;15 - 00;01;06;04
Speaker 1
So before we talk about our RSP accounts specifically, maybe we can like take a quick step back and talk about why there are different types of accounts. Like RSP is within a person's or a family's investment portfolio.

00;01;07;14 - 00;01;31;03
Speaker 2
Great idea. That's a great time to to start. And as I said in a previous podcast, everything seems to come down to tax. And the reason for all these different investment accounts is no different as the main difference between the different types of investment accounts is the tax treatment on various activities related to the account. Specifically, the act of moving money into the investment account.

00;01;31;19 - 00;01;51;28
Speaker 2
The function of earning income through investments. Whether that be dividends, interest or realizing gains on the sale of investments. And the act of moving money out of the investment account. Right now I will note that there are some other accounts that, in addition to having specific tax attributes, there are also linked to government programs as a result in the account.

00;01;52;25 - 00;02;13;29
Speaker 2
They can receive bonds or grant money from a government agency when deposits are made. Specifically, those investment accounts are registered education savings plans or RSP accounts or a registered disability savings plan account or our RDSP account. We can probably have a separate podcast to chat about those at some.

00;02;13;29 - 00;02;29;16
Speaker 1
Definitely. No, that's super helpful because I think we all think of our space, but we forget sometimes that there's other options. So with that in mind, maybe you can talk about and you've already mentioned tax, but the specific tax attributes of an RRSP account.

00;02;30;08 - 00;03;01;02
Speaker 2
Yeah, for sure. And it's important to keep in mind that these these these tax rules are in place to, to encourage certain behaviors of the investor and with your RSP account. Let's keep in mind that the purpose of the RRSP account is to aid and encourage Canadians to save for their eventual retirement. So when addressing your previous question, I comment about the different investment accounts, about the tax of the different treatment for the different types of activities, putting money in earning investment income, taking money out.

00;03;01;27 - 00;03;20;04
Speaker 2
And that's the RSP account has tax implications for all those different activities. So we'll walk through those one by one. Keep it in mind that the treatment is to help and encourage individuals to save for their retirement. Right. Starting with putting money into the RRSP account. And this is the main reason why people put money into the RSP account in the first place.

00;03;20;12 - 00;03;43;16
Speaker 2
During their working years, the amount that is put into the RSP account can be deducted from your income when filing your taxes and thereby lower your taxes for the year. As an example, if someone living in Ontario is making $75,000 in employment income per year, their marginal tax rate, which is the highest tax bracket there, is going to be roughly 30%.

00;03;44;20 - 00;04;26;03
Speaker 2
If that person makes a $10,000 RRSP contribution, they will be reducing their taxable income by that same amount and therefore will improve their tax position by $3,000 for the year, which typically leads to receiving the tax refund. The next step is the tax treatment of the income that is being earned on money invested in our speaker. So using that $10,000 example, from what I just previously chatted about, that money gets invested and starts earning interest and dividend income along with realizing gains by selling the securities for a higher price than what it was purchased for and starts to grow year after year as more contributions are being made and it continues to grow and grow

00;04;26;21 - 00;04;35;16
Speaker 2
as long as that money continues to be invested inside the RSP account. Taxes do not have to be paid on that investment income. It grows tax deferred.

00;04;35;22 - 00;04;36;09
Speaker 1
Right.

00;04;36;28 - 00;04;42;02
Speaker 2
Make note of the fact that I said tax deferred and right there.

00;04;42;04 - 00;04;42;14
Speaker 1
Okay.

00;04;43;06 - 00;04;53;24
Speaker 2
Because now we are going to talk about what happens when money is withdrawn from the RSP account and a third act is in as a rosier picture for investors compared to the previous two acts where it was tax advantages.

00;04;53;24 - 00;04;54;09
Speaker 1
Right.

00;04;55;27 - 00;05;16;04
Speaker 2
So I should say that although you can withdraw money from an RSP account at any time, you can do that. Typically money that is invested in an RSP account is held there until you start needing to draw money out of the account to fund your retirement. At which time the investments held in RRSPs are converted to what is called a registered retirement income fund, or Rrif account.

00;05;17;10 - 00;05;38;12
Speaker 2
And just a couple of quick points about the mechanics of this. The act of transferring money from an RSP account to a ref account does not trigger any tax. The earliest you can convert money from an RSP account to a ref account is age 55 and all money in an RSP account must be converted to a ref account by December 31st of the year that you turn 71.

00;05;38;22 - 00;05;39;02
Speaker 1
Okay.

00;05;40;13 - 00;06;11;20
Speaker 2
When the money is drawn out of a refreshed account, it is treated as taxable income. The opposite treatment of the contribution where the amount is subtracted from your taxable income withdrawal amount is added right. As I noted before, the investment income grew taxe deferred, and that deferral ends when you start drawing money out of that account. So paying tax on a returned RSP redraw can sometimes be a bit of a tough pill to swallow as people can start paying tax on their own money.

00;06;12;11 - 00;06;38;10
Speaker 2
Some things to keep in mind that will maybe help soften the blow a little is remember the tax refund you got when making the contribution? Not only that, but chances are your income is lower in retirement than it was when you were working. So you're likely likely paying tax at a lower tax rate on the withdrawal than you're getting there for permanent tax savings as a tax you paid on the withdrawal is less than what you got for it for the refund.

00;06;38;15 - 00;07;07;26
Speaker 2
Right. With not having to pay tax on the income, the investment income that was earned while it was in the RSP account, you got to hold on to more of your money to have that reinvested. And furthermore, if you're over age 65, there's an opportunity to split income with a spouse to lower your tax rate even further. So to quickly summarize the tax treatment for RSP accounts reduction of tax on contribution, tax deferral on on investment income pay, taxes on withdrawal, the.

00;07;08;19 - 00;07;31;29
Speaker 2
And because I often get asked the difference between making an RSP and a TFSA, what the difference are between the two accounts. Maybe just I'll make a quick note of what how they do differ just in this context. But again, we can probably have a separate podcast to talk about, but a TFSA. So those three actions just talking about the GFA TFSA, sorry, no reduction of taxes on deposit.

00;07;32;17 - 00;07;50;16
Speaker 2
So this could be considered a con compared to. But you don't get that that tax reduction. No tax on the investment income inside the account. This is similar to an RSP account, but remember it's a tax deferral with the TFSA. It is truly tax havens and no taxes on withdrawals. So you take money out of that TFSA account.

00;07;50;17 - 00;07;58;28
Speaker 2
Unlike an RSP account, there's no tax. So that's considered a pro. Yeah. That's that's mainly the tax mechanics of an RSP account.

00;07;59;21 - 00;08;19;07
Speaker 1
Okay. No, that's so great. And I, you know, I think a lot of people are are probably familiar with the idea of the tax deferral. You know, you get that bonus at the time. But I, I personally have actually never thought about the shield that sort of the tax shield it provides for the income that's being produced within that RRSP.

00;08;19;07 - 00;08;49;22
Speaker 1
So I think that's a great point to bring up. So I think you already mentioned it or at least I, I think we've already sorted touched on it. But there's a lot of buzz phrases when people are talking about RRSP accounts, you know, like the RRSP deadline or the RSP limit. And I guess deadline and limit are kind of self-explanatory terms, but maybe you can shed some, some light on more details and what those mean in the context of our RRSPs.

00;08;50;13 - 00;09;13;12
Speaker 2
For sure. Okay. So let's start with the RSP deadline. As most people, I'm sure they're aware, Canadians are required to file a tax return every year by by April 30th and for the following year. RSP rules are such that we can make contributions up to 60 days following the end of the year. We can then apply against our previous year's income when filing our taxes in the spring.

00;09;13;23 - 00;09;39;27
Speaker 2
In most years, the 60 day mark falls on March 1st, but with 2024 being a leap year, it falls on February 29th. Okay, so keep that in mind when you wanted to make an RSP contribution against your 2023 taxes. Switching to the RSP contribution limit. Yes, there are limits on how much you can put into the accounts. The contribution limit for a year is a lesser of 80% of your prior year's income.

00;09;39;27 - 00;09;57;07
Speaker 2
So if you made up $100,000 of net income, that qualifies for that. Your RSP contribution limit for the next year would be $18,000. However, there is an overriding maximum for all tax payers, which goes up to each year and for 2023 that amount is $30,780.

00;09;57;12 - 00;09;57;25
Speaker 1
Okay.

00;09;58;06 - 00;10;25;27
Speaker 2
If you made $1,000,000 of income in 2022, you don't get $180,000 virus contribution. You maxed out at that limit of $30,780. And again, that creeps up each year. However, the amount of your RSP contribution limit that you that you don't use carries forward indefinitely to tip for future years. So let's say that your contribution limit was $18,000. You make a $10,000 contribution.

00;10;26;04 - 00;10;37;05
Speaker 2
That $8,000 gets added to your your carry forward. And you can use that. And that can grow and grow. And sometimes people get into situations where they've got hundreds of thousands of dollars of RSP contribution. Right.

00;10;37;13 - 00;10;50;01
Speaker 1
Okay, cool. And another thing that you've mentioned, but I certainly don't know how it works, spousal RRSP is like how how are how are they different from just a regular RSP?

00;10;51;08 - 00;11;12;14
Speaker 2
Yeah. So a spousal RSP can be used part of an income splitting strategy when you have one spouse that is making significantly higher income than the other and therefore in a higher tax bracket and it's expected to continue to be for for most years, including their retirement years. A spousal RSP account is opened up in the name of the spouse with the lower income.

00;11;13;06 - 00;11;41;02
Speaker 2
So if Mrs. Smith is making significantly more than Mr. Smith, the spousal RSP would be open in Mr. Smith's name. The general principles of the tax treatment of those three activities that I referred to before are the same reduction of taxes on contribution tax, deferral of investment, income pay, taxes on withdrawal. However, with the spousal RSP, who gets the tax deduction at the time of contribution differs from who pays the tax at the time of withdrawal.

00;11;42;05 - 00;12;08;06
Speaker 2
Going back to the example of the Smiths, Mrs. Smith, who is paying tax, the higher tax rate gets the reduction at the time of contribution. But Mr. Smith, who is paying tax at a lower rate, pays the tax on withdrawal. Now for people thinking of ways to use a spouse RRSP contribution to come up with strategies for quick turnaround times of income splitting, there are rules to how the money, how long the money needs to be held in the account before it can be withdrawn.

00;12;08;23 - 00;12;14;20
Speaker 2
And get this special tax treatment. I won't get into those details here, but just keep those thoughts in mind. Right.

00;12;15;28 - 00;12;40;10
Speaker 1
I think that's a great point because I think we're all thinking always thinking of ways to make our situation a little bit better. So kind of going back to almost our first episode. One of the things that we're up to, Grove, especially where wealth management prides itself on, is, is integration with the accountants award not to go specifically on tax related matters.

00;12;41;01 - 00;12;51;07
Speaker 1
Maybe you could provide some, you know, some examples of strategies that you would formulate surrounding RSP in working with our firm's accountants.

00;12;52;14 - 00;13;07;18
Speaker 2
Certainly, yeah. And there are a number of different ways that we work with the accountants to utilize the attributes of the RSP accounts to create strategies that we expect to better the overall tax position of our clients. The main one of course is just working with the accountant determines the ideal RSP contribution for a client for the year.

00;13;07;18 - 00;13;29;20
Speaker 2
When factoring their different sources of income in tax brackets like gets a pretty straightforward easy one. However, there are some more sophisticated planning that we can do for our clients, and that involves accounts that are part of a longer term tax strategy. And I can touch on a couple, a couple of those. The first one is the exercise, what we refer to as a rrif drawdown strategy.

00;13;29;20 - 00;13;58;20
Speaker 2
So that's when your strategy related to pulling money out of out of the account in your retirement years. An important item to note that that I haven't mentioned yet is a tax treatment of an IRS private account in the event of a death involving a married or common law couple. On the first death, any balance in the deceased RRSP horrific account can roll over to the surviving spouse or partner on a tax deferred basis, meaning no immediate tax consequences.

00;13;58;28 - 00;13;59;08
Speaker 1
Okay.

00;13;59;13 - 00;14;19;28
Speaker 2
However, if there is no surviving spouse or partner at the time of death, whatever balances in the IRS preferred count, all must be treated as taxable income in the year of the death. So if there is a sizable balance in that RSP account at death, it could work out that over 50% of the balance has to go towards tax.

00;14;20;11 - 00;14;44;04
Speaker 2
Oh yeah. Is right. So in order to avoid that scenario, we will work to develop that rrif drawdown strategy, which becomes a balancing act of trying to limit tax, including old age security, clawback both in our client's living years on and on estate settlement targeting and amount to draw out of the accounts on an annual basis to strike the appropriate balance.

00;14;44;24 - 00;15;07;29
Speaker 2
This can be a little bit more complex for our clients that only have riskier accounts but also have investments within a corporate account in a holding company that they also plan on using to fund the retirement. So it is an important planning strategy. Another item is carrying forward RRSP contributions. And Amy, this ties to the point that you made earlier in the podcast when you talked about that tax deferral within the account.

00;15;08;11 - 00;15;28;24
Speaker 2
You know, people often think about contribution, but not the tax deferral. So this this incorporates that into it. So sometimes our clients find themselves in a position where they suddenly have significant cash available to invest. Whether that might be from the sale of a business or a property or from even an inheritance. Right. And in those situations, they may also have a large RSP contribution.

00;15;28;24 - 00;16;00;21
Speaker 2
Where am I talking about those carry forward? So maybe that that's carried forward and great. Okay, we've got all this money that we can now put in. So we might make the suggestion to put that money into the RSP contribution all at once to immediately start benefiting from that tax deferral on the income that's being earned. However, we might not want to take the our all the RSP contribution in that year, the contributions made because maybe you put it in, you're putting so much in that you're getting yourself down to maybe no tax or really at a low tax bracket where, you know, let's let's save those for future years.

00;16;01;00 - 00;16;18;13
Speaker 2
What you're allowed to do to carry forward to when when it's just and use that at the higher, higher tax bracket. So that might be a strategy that we incorporate often with the business. Now there are special advantages of capital gains, lifetime capital gains exemption. So the tax might not be that high in the year or with the inherits.

00;16;18;13 - 00;16;38;19
Speaker 2
There might not be any tax or for the sale of a house or tax, but it might be make sense. So when you are we're looking at this strategy, we've got to consider what future income they're expected to earn so that we can apply those contributions. And then also consider what other options they have for investing, including their tax free savings accounts, because maybe it may be more advantageous to put it in there.

00;16;39;00 - 00;16;39;13
Speaker 1
Right.

00;16;40;00 - 00;17;06;17
Speaker 2
And then maybe the last one that I'll just touch on it is that related to alternative minimum tax. So another planning strategy that that we work with utilizing RSP is, you know, sometimes clients find a situation where they again saw the business or saw the property and they've got caught on with this, this alternative minimum taxes. And it's a tax that you have to pay and if you have income in the future, you can you can get that tax money back by having this additional additional income.

00;17;06;19 - 00;17;26;23
Speaker 2
I won't get into the specifics. It's pretty technical, but using RRSPs to draw that money out to make sure that we're getting that alternative minimum tax that was prepaid back and getting the money out of the RSP. There's there's a timeframe where you have to do that so we can put strategies in place that will cover that off and do that as well.

00;17;26;24 - 00;17;44;17
Speaker 2
So as I say, there are a number of different ways that we can incorporate RRSPs into overall tax planning as part of our overall integrated approach. But those are just a couple. But certainly, you know, considering the ISP's and the tax advantages that come with that account are things that need to be incorporated with the plan and certainly are with our integrated approach.

00;17;45;00 - 00;18;10;15
Speaker 1
Yeah, definitely. And you know, the more you talk about it, the more I realize it's way more complicated than I ever realized. So it's definitely the kind of thing that you want to be talking to a professional about for sure, to make sure that you're making the right decision. And, you know, you also said something a little bit earlier about tax in the in the year of the death of a spouse or the second death.

00;18;10;15 - 00;18;38;16
Speaker 1
And if that's something that our listeners are interested in, we have a really great episode with Tim Bridge, one of our tax partners on that topic specifically. So again, if you're listening and that pique your interest, please go have a listen. Lots of great information in there, too. Yup. So again, Luke, another information packed episode. So I think we'll leave it there and hopefully you don't get too many calls in your busy season after this.

00;18;38;16 - 00;18;43;25
Speaker 1
But maybe Will and it'll be for the better of everyone. So thanks again for taking the time to join us.

00;18;44;17 - 00;18;53;07
Speaker 2
My pleasure. Thanks, Amy.