Actually tax time never ends. We should be thinking about potential tax liabilities and tax savings all year, but as we are now in January of 2013, we don’t have much choice regarding 2012 taxes other than buying Registered Retirement Savings Plans (RRSPs).
RRSPs are an excellent tax deferral arrangement. Tax is saved in the current year in hopes greater growth will occur on your investments because the investment is larger due to no tax being collected on the investment or any accruing income as long as the money remains in the RRSP. Tax will be paid when the investment is cashed in, hopefully when you have retired and incidentally may have lower income. If you withdraw the RRSPS earlier, you pay taxes at that time.
I mentioned “hopefully …have a lower rate.” If you save tax at a marginal rate of 25.8% (lowest rate in Manitoba) and pay back at 46.4% there is less of an advantage than if the situation is reversed. Although the time value of having money protected from tax can be considerable and the tax free earnings add to this benefit.
As well, you can make contributions out of your calculated limit to a spouse. This can assist in splitting income for couples on retirement although splitting is not as important now that we have a provision for calculating and spitting income. My concern is government can always change the rules and permanently putting the RRSP contribution in your spouse’s names avoids a possible change of government policy, however unlikely. The purchase of a spousal RRSP also make sense as it allows the high earner to buy a spousal RRSP and take advantage of the higher deduction from their income at the time of purchase while transferring future income to their spouse.
The amount of your contributions is limited, calculated at the lesser of 18% of the previous year’s earned income and, in 2012, $22,970. If a contribution is not made in any year the limit is accumulated and added to future years. Earned income is calculated according to specific rules and includes:
– Employment income less union dues and employment expenses
– Research income less research expenses
– Net income from self-employment and active partnership income
– CPP/QPP disability payments
– Net rental income
-Alimony and separation allowances received
-Employee profit sharing allocations
-Supplementary unemployment benefit plan payments but not EI Less:
– Current year’s from self-employment and active partnership income
– Deductible alimony and maintenance payments
– Current year rental losses.
Over contributions are strictly limited to a maximum of $2,000 in any year with the intention of avoiding the abuse of putting more money into RRSPs where interest is protected from taxation. The penalty is 1% per month of the over contribution.
There are some limits placed on where you can invest your RRSP contributions, mostly designed to ensure security of the investment. Allowed investments include GICs, cash, term deposits, bonds, publicly listed shares, some private shares of corporations, mortgages and precious metals. One cautionary note for RRSPs and other investments in foreign investments, which have been allowed since 2005 in RRSP portfolios, is to approach them with caution. A good knowledge of foreign currency should be a prerequisite for investing in foreign currencies. Several years ago, I and a staff member arrived at a client’s office. In the process of working on the year end, we found the client had invested in some U. S. investments at a time when the Canadian dollar was increasing in value relative to the U. S. Although the investment had increased in the U.S. market by some 10 to 15%, converting to the Canadian dollar resulted in a loss of over $20,000.
Part 2 on RRSPs will follow in the next edition.
Terry Robert B.A., C.M.A., C.G.A.
R. T. Robert Certified General Accountant
Please note that this column deals with details and circumstances in a general way and comments are meant solely as a guide. For your protection, a professional accountant is recommended and should be consulted before making any decisions regarding anything discussed in this column.