RRSP’s…
First let’s clear up the difference between an RSP and an RRSP. When people use the term RSP, they are mostly talking about an RRSP, a Registered Retirement Savings Plan, which is an investment vehicle that helps you reduce income tax through contributions and allows your money to grow tax deferred until withdrawals are made. RSP is a general term and simply refers to any Retirement Savings Plan. So, every RRSP is an RSP, but an RSP is not necessarily an RRSP.
If used correctly, RRSP’s can be great tools for retirement savings, but what happens to the RRSP when you die? It’s an important issue, especially when it comes to taxes. The tax consequences really depend on who is listed as the beneficiary. The general rule is that the value of the RRSP or RRIF at death will be included as income in the final tax return of the deceased. But there are 3 exceptions to that rule. If the beneficiary of the RRSP or RRIF is a spouse (including common law), a financially dependent child or grandchild under 18 years old or a financially dependent mentally or physically infirm child or grandchild of any age, a non tax event rollover can take place. While the taxes must be paid eventually, these options can help to defer longer and potentially reduce the amount payable. There is also no rule that you must wait until age 71 to convert your RRSP into a RRIF. You can start taking income earlier and at a potentially lower tax rate than at death.
A strategy that can be used to actually eliminate the tax liability of an RRSP is the RRSP Meltdown. This strategy creates tax neutrality on your RRSP withdrawal by obtaining a personal investment loan that generates an interest deduction equal in amount to ongoing RRSP withdrawals. Since the interest payment from the investment loan is tax deductible (as long as CRA qualifying investments are chosen), it will cancel out the taxable income created by the RRSP withdrawal.
The RRSP Meltdown strategy is not for everyone, but very powerful if executed appropriately. Besides the tax efficiency, there are also potentially additional returns through the leverage. This strategy includes more risk, must be implemented carefully and needs to be managed accordingly.
Everyone’s financial situation is different and should be evaluated in depth before implementing any strategy, but everyone should have a beneficiary on their RRSP.
Next week we will look at Trusts, an Estate Planning tool that can provide legal protection for assets and ensure they are distributed accordingly while saving time, reducing paperwork, and often reducing tax liability. They can help avoid probate, maintain privacy and protect beneficiaries from lawsuits, creditors and divorce. What are the different types, who needs them and how do they work?
