Retirement planning by Kevin Keith
May, 2010
Planning and saving for retirement is an important consideration for all individuals once we become adults. There are many different options available to ensure that you are minimizing the tax implications of retirement savings.
Registered Retirement Savings Plans (RRSP's)
We just came through the time of year when we heard a lot about RRSP's, as the deadline for contributions comes 60 days into the new year. However, RRSP investing goes on throughout the year. The biggest short term benefit to contributing to an RRSP is in the year of contribution, as you are not taxed on any income received that is in turn contributed to your RRSP. For example, if you earned $60,000, you would have to pay tax on the full $60,000. However, if you contributed $2,000 to an RRSP, you would only be required to pay tax on $58,000. You would not be required to pay tax on the $2,000 or the investment income your RRSP earns until you take the money out of the plan at some point in the future. Individuals are restricted on the amount they are able to contribute into RRSP's each year. However, RRSP contribution room that is not used by an individual in the current year can be carried forward from one year to the next.
RRSP's can also be used by individuals to finance their first home (up to $25,000 can be withdrawn) as well as to finance training or post secondary education (up to $20,000 over four years can be withdrawn without any tax consequence). However, if RRSP funds are removed for these purposes they must be periodically recontributed to avoid paying tax on the amounts removed.
Tax savings from RRSP contributions depend on your income level. If you have high income, you will save more tax. It is a good idea to contribute into an RRSP in your high income years. Individuals who are planning for low income (for example when a new parent takes paternity leave) may not want to contribute into RRSP's during that low income year. It is also possible to contribute funds into an RRSP in a low income year, but to save the tax deduction for a year when your income is higher.
Tax Free Savings Accounts (TSFA's)
Starting in 2009 individuals were able to contribute up to $5,000 to a TSFA as long as you were 18 years of age or older. The $5,000 is not tax deductible (like an RRSP); however any income earned from the investment is tax free. You can withdraw contributions and income earned without any tax consequences. Your contribution room increases by $5,000 at the start of each new year. The $5,000 limit is planned to increase periodically.
It is confusing as to whether it is more advantageous for you to invest in a TSFA or an RRSP. The decision will need to be made based on your expected income levels in the future compared to your current income. If you expect your future earnings to fall into a lower tax bracket, it would be more advantageous to invest in an RRSP because of the tax deduction you receive for your current contribution. If you expect your future income to increase, a TSFA offers a current tax benefit, leaving you to save your RRSP contribution for future tax deductions.
Individual Pension Plans (IPP's)
Incorporated farm businesses looking to add benefits to their owners or key employees may want to consider an IPP. IPP's are a high income earner's answer to the limited contribution room available in an RRSP. An IPP works just like a defined benefit pension plan that many employees receive at their jobs. However, it is specific for an individual who is employed through their own company.
An IPP is basically an RRSP upgrade, with a few differences. IPP's have significantly higher contribution limits. An individual that should consider an IPP would be an individual over the age of forty who has employment income from their company greater than $100,000 and historically maximized their RRSP room.
Benefits of IPP's include: interest on borrowed funds used to make contributions to an IPP are fully deductible to the corporation; an IPP can be topped up if investment returns are not as strong as expected (unlike an RRSP); and contributions are a deductible expense to your corporation.
When starting an IPP, you can go back and make contributions for past years you have worked for your corporation. This can create a large tax deduction for the company in the year the IPP is started. If you are winding down your farm operation, when farm assets are sold, a large tax bill can be created. However, starting an IPP in the year of selling farm assets could create a large tax deduction to offset income realized from the asset sale. This could provide significant tax savings.
As you can see there are many unique tax planning opportunities surrounding retirement savings and planning. Before making your decision, you should consult with tax and investment advisors to ensure you make the best decision for you and your family.
KPMG Lethbridge
kkeith@kpmg.ca
Kevin Keith would like to thank Ryan Stevenson of KPMG for his assistance with writing this article. |
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