Registered retirement Savings plan (RRSP)
An RRSP is a voluntary registered retirement savings plan that allows you to defer tax. You can annually contribute up to 18% of your previous year’s earned income, minus any Pension Adjustment (for members of a company pension plan), plus any portion of your unused contribution room from previous years. This amount may be subject to certain other limitations, and can be claimed as an income tax deduction on your tax return. A variety of RRSP investment options are available, such as mutual funds, GICs, stocks, and bonds. Funds withdrawn from the plan are taxed as income in the year you redeem them. An RRSP must be converted into a registered retirement income fund (RRIF) by the end of the year in which you turn 71 years of age.
Spousal RRSPs are essentially the same as RRSPs, except that you make contributions into an RRSP in your spouse’s name (annuitant), while you are able to claim the tax deduction for the contribution. The contribution limits for spousal RRSPs are the same as the RRSP limits, less any amount that the contributor spouse has used for himself or herself. Spousal RRSPs allow the higher income spouse to obtain the much needed tax deduction while at the same time ensuring that the lower income spouse has an amount set aside from which to draw a retirement income. This allows you to take advantage of a technique called “income splitting.”
There are four good reasons for contributing to a spousal RRSP:
- To allow the spouse with the higher income to take the tax deduction.
- To split income more evenly during retirement between you and your spouse and take advantage of the lower income tax brackets.
- To remove funds from an RRSP at a lower tax rate prior to retirement.
- In the case where you are over age 71 and no longer permitted to contribute to your own plan but your spouse is younger, you can make a contribution into a spousal RRSP and still obtain a tax deduction.
The objective of this strategy is to provide both of you with similar retirement incomes and thus similar income tax rates. There are certain consequences if you contribute to a spousal RRSP one year, and your spouse withdraws any funds within two years of a spousal RRSP contribution. As the contributor you will be taxed on the funds withdrawn, and not your spouse who actually withdrew the money. You have the same investment options as with RRSPs, and your spouse must convert the plan to a RRIF by the end of the year in which your spouse turns 71.
Locked-in retirement account (LIRA)
A LIRA is a tax-sheltered investment where the proceeds originate from a registered pension plan (RPP) and are transferred when you leave employment prior to retirement. These funds are considered “locked in” until you retire. Your investment options are similar to a regular RRSP; however, in a LIRA, you are required to keep the locked-in funds as if they were still in a pension plan, and therefore cannot withdraw the monies until retirement. Your funds grow tax sheltered until you retire, at which time you can convert the LIRA into an income source, such as a LIF (life income fund), LRIF (locked-in retirement income fund), or a life annuity. Conversion must occur by the end of the year in which you turn 71.
Registered retirement income fund (RRIF)
A RRIF is the natural extension of an RRSP. While an RRSP exists for the purpose of accumulating tax-sheltered funds for retirement, a RRIF exists for the purpose of making payouts to provide an income during retirement. Each year you must withdraw a minimum amount from the plan, and these proceeds are taxed as ordinary income to you, including the earnings. There are no maximum limits to the amount that you can withdraw; it is therefore possible to deplete the entire plan prior to death.
Life income fund (LIF)
A LIF is a government-regulated plan that allows you flexibility in withdrawing locked-in pension funds. Similar to a RRIF, you are required to withdraw a minimum amount annually. The same investment choices are available to you, thus allowing you to make the decisions on how the assets are managed. A LIF differs from a RRIF in that, unlike a RRIF, the government imposes limitations on the maximum amount that can be withdrawn in any one year. Depending on the province that your LIF is regulated in, you may be required to convert your LIF to a life annuity, thus ensuring that a regular income stream is available for as long as you live. Keep in mind that unless there are guarantees in place, a life annuity terminates when you die, leaving nothing to your heirs.
Locked-in retirement income fund (LRIF)
LRIFs are similar to both RRIFs and LIFs, in that you are allowed to maintain full control of investment decisions. You are also required to withdraw a minimum amount each year. Similar to a LIF, there are limitations on the maximum amount that you can withdraw annually. However, the primary difference is that you do not have to convert your LRIF to a life annuity at age 80; it can be held indefinitely. This provides you with added flexibility throughout your retirement, and also allows any remaining funds to be distributed to your heirs upon death. LRIFs are not available in all provinces.
Tax-free savings account (TFSA)
Starting in 2009, If you are a Canadian resident aged 18 and older, you can save up to $5,000 every year in a TFSA. Your contributions to a TFSA are not deductible for income tax purposes but the investment income, including capital gains, earned in your TFSA is not taxed, even when withdrawn. Your unused TFSA contribution room is carried forward and accumulates for future years. You can withdraw funds available in your TFSA at any time for any purpose,- and the full amount of withdrawals can be put back into your TFSA in future years. Neither income earned in a TFSA nor withdrawals affect your eligibility for federal income-tested benefits and credits. You can provide funds to your spouse or common-law partner to invest in their TFSA. TFSA assets can generally be transferred to a spouse or common-law partner upon death.
On January 1, 2013 the TFSA limit increased to $5,500 a year. For more info: www.tfsa.gc.ca
Defined contribution pension plans
Defined contribution plans operate very much like RRSPs; however, employers will frequently match contributions to encourage employee participation. For example, an employer may match $.50 on every $1.00 you contribute up to 5% of your salary. Both your contributions and your employer’s are accumulated in the plan and are used to purchase a retirement income, such as a LIF, LRIF, or life annuity. In reviewing your retirement needs, accurate estimates of your expenses in retirement is the key starting point. Many expenses in your pre-retirement period will end, such as office parking, business lunches, etc. On the other hand, other expenses may increase. Retirement may also consist of an active period early on where travel and other leisure activities are the major new expense items. The later part of retirement may include increased health care costs and reduced leisure expenses.
A segregated fund is an investment fund that you hold within an insurance contract. The term “segregated” refers to the fact that your investment is separated from the general assets of the insurance company. Your insurance contract dictates the insurance protection you receive. So segregated funds are an insurance contract that provides you investment management plus protection.
Registered Education Savings Plan (RESP)
A Registered Education Savings Plan, or RESP, is a tax deferred income investment vehicle used by parents to save for their children’s post-secondary education in Canada. The principal advantages of RESPs are the access to the Canada Education Savings Grant (CESG). The Canada Education Savings Grant (CESG) is provided to complement RESP contributions, wherein the government of Canada contributes 20% of the first $2,500 in annual contributions made to an RESP. After changes introduced in the 2007 Canadian federal budget, the government may contribute up to $500 per year to a participating RESP, to a lifetime maximum of $7,200. This income is available upon withdrawal from the RESP by a post-secondary recipient, with a maximum lifetime contribution of $50,000. Any contributions over this amount are subject to taxation. The government grants introduced in 2005, entitled Additional CESG, allowed an additional 10% or 20% for a total of an extra 30 or 40 cents on each dollar of the first $500 contributed to an RESP, depending on the family income of the beneficiary’s primary caregiver. An application is made through the promoter of the RESP, which is often a bank, mutual fund company or group RESP provider.