Introduction: Registered Retirement Savings Plans (RRSPs) and Subsection 146(1) of the Income Tax Act
Registered retirement savings plans (RRSPs) are specifically designed to promote and encourage retirement savings for Canadian taxpayers. Under subsection 146(1) of the Income Tax Act, RRSP means a retirement savings plan that is accepted by the Canada Revenue Agency (CRA) for registration for the purpose of the Tax Act and is in compliance with the requirements under subsection 146(1) of Act.
RRSPs allow taxpayers the opportunity to contribute a portion of their earned income into a tax-deferred trust (being the RRSP) which is held for the benefit of the taxpayer by their financial institution (also known as the issuer). In addition, taxpayers who contribute a portion of their earned income into their RRSPs are eligible for a deduction for their contribution. As mentioned below, amounts contributed to an RRSP may be deducted from the taxpayer's earned income for the relevant taxation year or carried over to a future taxation year.
RRSPs can hold various types of investments. Some RRSPs allow taxpayers to hold only mutual funds while other RRSPs allow taxpayers to hold only guaranteed investment certificates (also known as GICs). However, a self-directed RRSP is an RRSP account that allows Taxpayers to hold various types of investments, including mutual funds and GICs, within one single RRSP. Self-directed RRSPs are often preferred by Taxpayers who are looking to diversify their retirement savings by holding various types of potentially income generating investments inside their RRSP.
Significant Legal Concepts - Issuer, Earned Income
An issuer is the financial institution with whom the taxpayer has a contract or an arrangement which constitutes a retirement savings plan, pursuant to the Act (subsection 146(1), Income Tax Act).
For the purpose of RRSPs, earned income means the "total of all amounts each of which is" the taxpayer's income for the year, subject to certain restrictions including, but are not limited to, property income and the taxpayer's Canadian resident status (Subsection 146(1), Income Tax Act). This article provides tax guidance related to RRSPs.
The Advantages of RRSPs
As discussed below, RRSPs are tax planning tools that can be used for various tax planning reasons. First, RRSP contributions are tax deductible. That is, RRSP contributions may be deducted from the taxpayer's income, at the time the contributions are made, to the extent of the taxpayer's "RRSP deduction limit." Pursuant to section 146 of the Income Tax Act, amounts contributed to an RRSP may be deducted from the taxpayer's earned income for the relevant taxation year or carried over to a future taxation year. Accordingly, taxpayers in the highest tax bracket can reduce the taxes paid on each dollar contributed into their RRSPs, to the extent of their "RRSP deduction limit." Whereas taxpayers in the lowest tax bracket can carry forward the deduction room, arising from their RRSP contributions, to a future year when their income increases.
Second, once funds are contributed into and invested in an RRSP, the Income Tax Act provides comprehensive tax deferral treatments for investment income earned within the RRSP. In this context, investment income and capital gains are realized and accumulated in the RRSP and are not subject to tax until they are withdrawn. This comprehensive tax deferral treatment allows taxpayers to grow their savings faster.
Third, taxpayers can withdrawal funds from their RRSPs to purchase their first home and for education. In this context, taxpayers will not have to pay any taxes on these withdrawals, to the extent that he or she pays the withdrawn amount back into their RRSP, within the specific time period (paragraph 56(1)(h) Income Tax Act).
RRSP Contributions and Deduction Limits
Taxpayers can contribute to their RRSPs until December 31st of the year in which they turn 71 years of age, to the extent that he or she has not exceeded their RRSP deduction limit. In addition, taxpayers can contribute to their spouse or common-law partner's RRSP until December 31st of the year their spouse or common-law partner turns 71 years of age.
RRSP Contributions may be made to a maximum limit of the lower of:
- 18% of the taxpayer's earned income for the preceding taxation year; and,
- The RRSP contribution limit for the relevant taxation years
The 2020 RRSP contribution limit is $27,230. Taxpayers may contribute to their RRSP at any time in the year. However, March 1, 2021 is the deadline to make RRSP contributions for the purpose of claiming a deduction on the taxpayer's 2020 personal income tax returns.
An RRSP issuer must provide taxpayers with a T4RSP slip, annually, setting out the total amount of RRSP contributions made during the year. In addition, Taxpayers who file their personal income taxes should receive a statement with their notice of assessment showing the calculation of their RRSP contribution room limit.
A taxpayer who contributes more than their deduction limit permits to their RRSPs will have an excess contribution. Excess contributions that exceed the taxpayer's RRSP deduction limit by more than $2,000 are subject to tax of 1% monthly, unless the taxpayer (1) withdrew the excess amounts, or (2) contributed to a qualifying group plan. Taxpayers who made excess contributions into their RRSPs must pay the 1% tax within 90 days after the calendar year (during which the excess contributions were made) to avoid potential late filing penalties and interest charges. The CRA allows a $2,000 grace amount for over contributions into RRSPs. However, this amount is not tax deductible.
Taxpayers who have excess contribution in their RRSPs can ask the CRA, in writing, to consider cancelling or waiving the tax on their excess contribution amount if (1) the excess contributions, on which the tax is applicable, were made due to a reasonable error; or (2) the Taxpayer has taken the necessary steps to eliminate the excess contribution amount from the RRSP. In other circumstances, Taxpayers can remedy excess contributions by immediately withdrawing from their RRSPs amounts contributed that exceed their RRSP deduction limit. Yet, since amounts withdrawn from RRSPs are subject to taxation, Taxpayers can claim an offsetting deduction, provided that certain conditions are met. For example, excess contribution must be withdrawn (1) in the year it was made; (2) in the year in which the Taxpayer receives an assessment for the relevant year of contribution; or (3) in the year following those mentioned in (1) and (2). Taxpayers who meet the conditions for the offsetting deduction, can withdrawal excess contribution amounts from their RRSPs without having tax withheld at source by filing Form T3012A. Alternatively, Taxpayers who do not file Form T3012A can claim the tax withheld at source, as tax paid, on their tax returns.
Spousal or Common-Law Partner RRSPs
A spouse or common-law plan is defined under subsection 146(1) of the Income Tax Act as an RRSP to which a taxpayer contributes to the plan that is owned by their spouse or common-law partner.
Spousal or common-law partner RRSPs are tax planning tools that can be used for specific tax planning reasons. Spousal or common-law partner RRSPs allow higher income-earning spouses to contribute to the retirement savings of their lower income-earning spouse. They also permit lower income-earning spouses to reduce the income taxes paid on withdrawals from the plan. In addition, spousal or common-law partner RRSPs allow both spouses to make RRSP contributions into the plan.
However, there are disadvantages associated with spousal or common-law partner RRSPs. In particular, contributions made into a spousal or common-law partner RRSPs that are withdrawn before the third calendar year (from the year when the contributions were made) are taxed in the hands of the contributing spouse. Spousal or common-law partner RRSP withdrawals made after the third calendar year (from the year when the contributions were made) are taxed in the hands of the spouse who is entitled to the assets in the RRSP (also known as the Annuitant). An annuitant of an RRSP is the person for whom the plan provides a retirement income. Accordingly, our expert Canadian tax lawyers recommend that spousal or common-law partner RRSP contributions are not to be withdrawn for three calendar years, from the year when the contributions were made. In addition, in a family law context, upon the breakdown of a marriage or a common-law partnership, spousal RRSPs are included in the net family property calculation under the family's assets. Accordingly, a couple's RRSPs are split evenly between the spouses and can be transferred tax-free from one spouse's RRSPs to the RRSP of the other spouse. However, this can be problematic if the recipient spouse maximized their RRSP contribution limit, in which case the recipient spouse or common-law partner will not be eligible to receive the RRSP transfer on a tax-free basis. This demonstrates how contributions to a spousal RRSP can are create tax implications for the contributing spouse and can be inherently no different from a spouse contributing to a personal RRSP.
Amounts withdrawn from RRSPs must be included in computing the taxpayer's earned income for the relevant year (paragraph 56(1)(h) Income Tax Act). However, this rule is subject to certain exemptions including, but not limited to:
- The Home Buyers' Plan;
- The Lifelong Learning Plan; and,
- The rollover of RRSPs into Registered Retirement Investment Funds (RRIF).
Taxpayers who have RRSPs in the year during which they reach the age of 71 will be required to collapse the plan by December 31st of that year. However, to escape potentially having to report a large income inclusion and the subsequent tax burdens, the Income Tax Act provides for a rollover tax free treatment of RRSP assets into RRIFs.
Registered Retirement Investment Funds (RRIF)
Registered Retirement Investment Funds (RRIFs) allow taxpayers to rollover their RRSPs into the RRIF on a tax-deferred basis. The key distinction between RRSPs and RRIFs is that taxpayers are required to make ongoing annual withdrawal from their RRIF account. Annual withdrawals from a RRIF are determined at a minimum rate each year based on various factors including, but not limited to, the taxpayer's age and the total balance in the RRIF on December 31 of the preceding year. However, similar to RRSPs, withdrawals from a RRIF must be included in computing the taxpayer's personal income tax returns for the relevant year.
The Income Tax Act includes provisions that restrict RRIF contributions. While new contributions into RRIFs are prohibited, the following are permitted:
- Assets can be transferred from an RRSP into a RRIF.
- Assets may be transferred from an individual or a spousal or common-law RRIF into another RRIF.
- Assets in a deceased's spouse's RRIF or RRSP may be transferred into his or her surviving spouse's RRIF, to the extent that the surviving spouse is the beneficiary of the deceased spouse's plan.
Pro Tax Tips - Tax Guidance and RRSPs
RRSPs are tax planning tools that can be used for various tax planning objectives. Yet over contributions into RRSPs and spousal or common-law partner RRSPs can create immense financial consequences for taxpayers and their spouse or common-law partner.
If you have been (re)assessed by the CRA for over contributing into your RRSPs you may qualify for relief from the 1% monthly penalty, please contact our tax law office for tax guidance from one of our top Canadian tax lawyers.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.