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Those RRSP blues once again.

March 1, 1993, is almost upon us. This is the last day when contributions to an individual's registered retirement savings plan (hereinafter: RRSP) may be made and the amount deducted for the purposes of computing 1992 taxable income. This article focuses on the principal rules governing an RRSP. Since my comments can only be considered a primer at best for understanding the RRSP, I recommend that you consult your tax or investment specialist for detailed advice.

Recall that in the November 1992 issue of ACCN, the author reviewed the rules dealing with registered education savings plans, or RESPs as they are commonly called. The major advantage of the RRSP over an RESP is that a contributor may deduct the contributions to the plan in computing income. As well, an RRSP allows an individual to put aside capital amounts that generate income tax-free, and the effect of compounding can result in the availability of substantial sums of money during retirement. Also, even though the withdrawals are ultimately taxable, one can expect the individual's marginal tax rate to be lower at retirement than the applicable tax rate at the time of contribution, so there would be a tax savings associated with an RRSP, regardless of the tax free compounding effects.

An individual can contribute for each year starting January 1 generally up to 18% of his or her so-called "earned income" based on the preceding taxation year, up to a yearly maximum of $12,500 for 1992 and 1993 (the maximum increases by $1,000 every year until 1996) less the individual's pension adjustment (value of pension benefits accruing as an employee for the preceding year). This amount is increased under the rules relating to carryforwards. Earned income in simple cases is composed of employment income, business income and real estate rental property income. You should have already received your 1991 Notice of Assessment from Revenue Canada. Generally, the Contribution Limit Statement on that notice will correctly identify the maximum amount of contributions you may make to an RRSP and be entitled to a deduction for 1992. Remember that contributions to an RRSP for deduction in a given year, may be made on or before the day that is 60 days after the end of the year.

If an individual did not contribute his or her maximum for 1991 and subsequent taxation years, then the unused portion may be carried forward generally for seven years and added to the individual's maximum contribution amount for a particular taxation year occurring later. Obviously, the tax-free compounding benefits are reduced if amounts are contributed via this carryforward, rather than contributing the maximum amounts in the first available year. However, an individual might not have the cash to put money into an RRSP in the first available year to take a deduction in the future. Also, under the statutory scheme, the maximum contribution may be made in a given year but may be claimed in a future year. Normally, you would want to claim the deduction immediately unless you expect to be in a higher tax income bracket in the immediately ensuing years. In this latter case, deductions may rather be claimed in the future within seven years against the carryforward amount.

An individual will be subject to a 1% penalty tax every month calculated on his or her cumulative excess amount. In the most simple terms, there will be a penalty if the individual contributes more than $8,000 into the RRSP than is allowed to, as was explained before. Although this $8,000 is seen as a"cushion" so individuals will not be penalized for any minor error in determining contributions, they may use this as a tax planning vehicle by over-contributing by $8,000 as soon as possible to get the benefit of tax-sheltered savings on this amount. An over-contribution will eventually be taxed when it is ultimately withdrawn. Since no deduction for this amount has ever been taken, this approach only makes sense if the time is maximized before the funds are ultimately withdrawn. Typically, the individual should be able to keep the over-contributed amount in the plan for at least nine years, assuming today's interest rates and that the individual is subject to a 50% tax rate, a rate that will fall to about half when the amounts are withdrawn.

Spousal plan

As a suggestion just in time for Valentine's Day, an individual may make his or her contributions, as described above, but to his or her spouse's RRSP instead. It is the spouse that will benefit from the tax-sheltered savings and capital amounts although the spouse will be taxed on the ultimate withdrawal of amounts. It is anticipated that at the time of withdrawal, both of the spouses will be able to split the overall retirement income at the lowest rates possible, instead of having only one annuitant being taxed at a possible higher rate. Also, a spousal RRSP may be useful if a taxpayer has a younger spouse because when the taxpayer turns 71 years old, the individual must collapse his or her RRSPs, but under the spousal rules, the individual may still continue to contribute to a spousal RRSP.

However, if the spouse withdraws amounts from an RRSP to which his or her spouse had contributed to and that latter person had contributed any amount to any spousal plan within the year or the last two calendar years, then withdrawn amounts, to the extent that contributions were made in that three-year period to any spousal RRSP, are not taxed in the hands of the spouse that makes the withdrawal, but rather in the hands of the contributing spouse unless the spouses are living apart by reason of the breakdown of their marriage. Hence, to avoid "tainting" an existing RRSP, a contributor should set up a separate RRSP on behalf of the contributor's spouse.

Home buyers' plan

For the current and subsequent taxation years, it is proposed that a so-called common law spouse, i.e., a person of the opposite sex who is cohabiting in a conjugal relationship and has cohabited for the preceding 12 months with the individual or is a parent of a child of whom the individual is also a parent, qualifies as the individual's spouse for RRSP purposes.

Announced in the 1992 federal budget, the government is allowing individuals to remove up to $20,000 (applicable to each spouse) from their RRSPs in order to acquire a "qualifying home", with the stipulation that equal amounts must be repaid on an annual basis for 15 years commencing December 31, 1995 (the commencement period for the repayment period had been extended by one year by a federal announcement dated December 2, 1992). The rules are rather technical in this area and there are periods where no contributions to your RRSP may be made, without you being subject to penalties. Essentially, if you take advantage of this possibility, you are getting an interest-free loan from your RRSP. However, you are also negating some of the tax-free compounding benefits associated with RRSPs.
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Title Annotation:Talking Tax; taxation of registered retirement savings plans
Author:Yip, Douglas
Publication:Canadian Chemical News
Article Type:Column
Date:Feb 1, 1993
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