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CFP® Study Tip

In the February e-newsletter, I discussed characteristics of Registered Retirement Savings Plans (RRSPs). You were given the following question pertaining to RRSP contribution limits:

Question

Assume that Mary had earned income of $80,000 in 2010 and $90,000 in 2011. In 2010, her employer contributed $1,000 to her RPP and she matched this contribution. In 2011, her employer contributed $1,201 to her RPP and again she matched. In 2010 and 2011, Mary’s employer contributed the maximum to her DPSP, on her behalf. What is the maximum that Mary can contribute to her RRSP for the 2011 calendar year? Assume that all of her earned income is from salary and that she belongs to a money purchase plan RPP.

Solution

Mary’s RRSP limit for 2011 is $1,175 and is determined as follows:

Step One: Lesser of 18% of earned income for 2010 ($80,000), or $22,450.
The lower number is $14,400 ($80,000 x 0.18)
Step Two: Deduct Pension Adjustment (PA) for previous year (2010), which is *$13,225.
Deduct Past Service Pension Adjustment (PSPA) for current year (2011), which is zero.
Add Pension Adjustment Reversal (PAR) for the current year (2011), which is zero.
Add RRSP carry forward for previous years, which is zero.

This equals $1,175 ($14,400 - $13,225)

* Determining Pension Adjustment

The Pension Adjustment for 2010 is the total contributions to the Registered Pension Plan (RPP), which is $2,000 ($1,000 by the company and $1000 by Mary) and the DPSP contribution, which is $11,225. The DPSP contribution is the lesser of 18% of Mary’s 2010 salary, which is $14,400 ($80,000 x 0.18), or $11,225 (the DPSP limit for 2010). This assumes that Mary’s salary and earned income are the same number. When you combine the RPP contributions of $2,000 for 2010 and the DPSP contribution of $11,225 for 2010, you get $13,225. Therefore, $13,225 is the Pension Adjustment for 2010 for Mary.

General Facts About RRSPs

I. Carry Forward of Unused RRSP Limits

  • For 1991 and subsequent years, every individual’s unused RRSP contribution limit may be carried forward as unused deductions.

II. Over-Contribution Limit “Cumulative Excess Amount” (CEA)

There is a $2,000 lifetime over-contribution limit without penalty. This $2,000 contribution is not tax-deductible if it is in addition to the individual’s RRSP limit. Earnings on over-contributions are tax-sheltered. The over-contribution is fully taxed when the RRSP is cashed in.

III. Transfer of Assets to a Self-Directed RRSP as a RRSP Contribution

  • The transfer of assets to a RRSP as a contribution, in lieu of cash, is classified as a “deemed disposition”.
  • If the market value of the transferred assets is higher than the original cost price, the plan holder is deemed to have realized a taxable capital gain. For example, Joan paid $10,000 for ABC stock in her personal account, which she eventually uses as a contribution to her RRSP, in lieu of cash, when the ABC stock is worth $12,000. This will trigger a $2,000 capital gain and a $1,000 taxable capital gain.
  • If the market value of the transferred assets is lower than the original cost price, the plan holder’s capital loss for tax purposes is deemed to be zero. If Joan pays $10,000 for ABC stock but transfers it to her RRSP when it is worth $8,000, the capital loss would be disallowed.

IV. Qualified and Non-Qualified RRSP Investments

The following are qualified investments for a RRSP based on CRA standards:

  • Money on deposit in a bank/trust company.
  • Bonds, debentures and similar obligations guaranteed by the Government of Canada, a province, municipality or Crown corporation.
  • Shares and debt obligations of Canadian public companies.
  • Shares of certain investment corporations.
  • GICs issued by a Canadian trust company.
  • Shares of foreign public corporations listed on an exchange outside of Canada
  • Units of any Canadian mutual fund or insurance pooled fund.
  • Mortgages or an interest in a pool of mortgages on real property in Canada, including mortgage-backed securities.
  • Shares, bonds, debentures or similar obligations issued by cooperatives or credit unions.
  • Limited partnership units listed on a stock exchange
  • Some life insurance policies.

The following are non-qualified investments for a RRSP based on CRA standards:

  • Gold and silver bars, coins and certificates whose quality falls below a certain grade quality: gold 99.5%; silver 99.9%.
  • Shares and debt obligations of private companies – unless certain conditions apply.
  • Commodity and financial futures contracts.
  • Listed personal property, such as art, jewelry, etc.
  • Real estate (REIT units are qualified investments).

Rules pertaining to the acquisition or retention of RRSP non-qualified investments:

  • When acquired, the fair market value of the investment at the time it was acquired is included in the plan holder’s income for the taxation year in which the investment was made.
  • When sold, the plan holder may deduct the lesser of:
    • The cost of the investment or the proceeds of the disposition, in calculating taxable income for the year

V. Spousal RRSPs

Here, a high income spouse makes a contribution to the low income spouse’s spousal RRSP plan. The spousal RRSP benefits are the property of the receiving spouse. The contributing spouse obtains the tax write-off.

Contribution Limit for Spousal Plans

  • A contributor’s maximum RRSP contribution limit to a spousal plan is the unused amount of their RRSP limit. For example, assume that Mr. Smith’s limit is $11,500 for his own RRSP while Smith’s RRSP contribution is $9,000 to his own RRSP plan. His unused limit is $2,500 and the spousal RRSP limit would therefore be $2,500.
  • When the spousal plan is cashed in, the proceeds are taxable in the beneficiary’s hands, with one exception: according to RRSP attribution rules, any contributions made in the year of surrender and in the two previous calendar years are taxed in the hands of the contributor.

Example: Spousal RRSP

  • Sally, a high income earner, contributed to her husband Mike’s spousal RRSP when Mike attended college as follows:
2007  2008  2009  2010 2011
$5,000 $5,000 $5,000 $5,000 $5,000
  • The contributions are tax deductions for Sally, the contributor.
  • In 2011, Mike cashes in the $38,000 RRSP ($25,000 in contributions and $13,000 in earnings).
  • According to the attribution rules, Sally, as the contributor, must pay tax on $15,000. This equals the contributions made in the year of surrender, 2011, and the two previous calendar years (2009 and 2010).
  • The 2007 and 2008 contributions and the RRSP earnings of $13,000 are taxed in the hands of the receiving spouse, Mike. This equals $23,000.

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Question

The following deposits were made into a spousal RRSP.

Year 2007: $4,000
Year 2008: $2,000
Year 2009: $3,500
Year 2010: $1,000
Year 2011: $0

The deposit of $4,000 made in the year 2007 is withdrawn in the year 2011. In whose hands is it taxed?

  1. Taxed in the hands of the contributing spouse
  2. Taxed in the hands of the recipient spouse
  3. Taxed only when all deposits in the spousal plan are withdrawn
  4. Taxed on a 50/50 split basis between spouses

VI. Locked-in RRSP or Locked-in Retirement Account (LIRA)

  • The LIRA is similar to an RRSP except that you cannot withdraw funds from the LIRA. The person must usually reach age 55 to qualify for early retirement under this plan. The funds, however, must be transferred out no later than the end of the calendar year when one turns 71.
  • The funds in a LIRA may be transferred to a:
    1. Life Income Fund (LIF)
    2. Locked-in Retirement Income Fund (LRIF), or
    3. Annuity
  • LIFs are not available in some provinces & territories.
  • A LIF has a maximum (as well as a minimum) withdrawal limit, to provide a regular income. In some provinces, the holder must annuitize the LIF plan at age 80.
  • A LRIF, on the other hand, has no termination date, and may or may not be transferred to an annuity at any time.
  • Some LIF/LRIF plans may be unlocked, subject to federal/provincial & territorial pension rules.

VII. RRSPs and Home Purchase Loans

  • Each individual can borrow up to $25,000 from their RRSP for a down payment on a house, if they are deemed to be a first-time home buyer. Numerous individuals could borrow money from their RRSPs and use this money as a downpayment for the same house. For example, a wife and husband could borrow up to $50,000 from their RRSPs for a downpayment on the same house [(2 x $25,000). Effective Jan. 27, 2009]
  • A first-time home buyer is a party who is either purchasing a house for the first time, or
    who has not owned a house and lived in it as a principal residence in any of the five calendar years up to and including the year the funds are withdrawn from the RRSP.
  • The RRSP loan must be repaid to the RRSP within 15 years, in equal annual installments. The repayment period starts the second calendar year following the year the withdrawal was made. A loan of $15,000 from a RRSP would require annual payments of $1,000 per year. Any payments in excess of the amount required will lower the required payments in future years.
  • If there are any payments below the minimum required, the shortfall becomes taxable income for that year. If the individual is required to pay $1,000 and only pays $600, the $400 shortfall becomes taxable income for that year.

Example: RRSP Home Buyers’ Plan

Which of the following statements is (are) correct about the RRSP Home Buyers’ Plan?

  1. The plan is only available to the first-time purchaser of a Canadian principal residence.
  2. The maximum withdrawal is $15,000.
  3. All withdrawals must be made in the same calendar year.
  4. The maximum repayment term is 15 years.
  1. 1 and 3
  2. 1 and 4
  3. All of the above
  4. 3 only

Concluding Comments

On the FPE™1 and FPE™2 examinations, there are several questions on retirement plans. I hope this information provides you with a good review of RRSPs. Answers to the two questions will be provided in the April e-newsletter.

Sincerely,

Ron Foran, CFP, CFA, CLU, FCSI
President, Foran Financial Institute

Note: Advocis does not award the CFP® and Certified Financial Planner® designation. The right to use the marks CFP®, CERTIFIED FINANCIAL PLANNER® and CFP(logo) is granted under licence by FPSC to those persons who have met its educational standards, passed the FPSC's Certified Financial Planner Examination, satisfied a work experience requirement, and agreed to abide by FPSC Code of Ethics.