Managing Your Personal Taxes 2016-17
Managing Your Personal Taxes 2016-17: A Canadian Perspective
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Whether you’re just starting your career or have years of service under your belt, you need to plan for retirement. And tax planning should be at the centre of your retirement strategy.
Registered pension plans
There are two types of registered pension plan (RPP):
- Defined benefit plans are based on a formula that includes employment earnings and years of service.
- Money purchase plans depend on the amount you contribute and the earnings on those contributions.
For a defined benefit plan, you can generally deduct all contributions you make for eligible service after 1989. You can also deduct up to $3,500 ($5,500 for Quebec tax purposes) in respect of past service contributions for a year before 1990 in which you were not contributing to any RPP.
For a money purchase plan, the 2016 combined contribution that both you and your employer can make is the lesser of 18% of your 2016 compensation and $26,010.The dollar limit is indexed for inflation. You can’t make past-service contributions to this type of RPP.
Your employer will report a “pension adjustment” to the CRA, which will factor into your following year’s RRSP deduction limit. In the case of a defined benefit RPP, the pension adjustment is an estimate of the cost of funding your retirement benefits. The pension adjustment for a money purchase RPP is the sum of your contributions and those of your employer.
- If you’ve made excess past-service contributions to a defined benefit RPP in prior taxation years, you may be able to claim these contributions, subject to an annual $3,500 limit.
Individual pension plans
An individual pension plan (IPP) is a defined benefit registered pension plan established by an employer to provide retirement income to one or more employees on the basis of their years of service.
An IPP is most commonly established for one employee — typically a high-income earner such as an owner-manager, an incorporated professional or a senior executive. However, an IPP may also be established for more than one employee, provided that it meets the definition in the Income Tax Act. A plan is generally considered to be an IPP when it has fewer than four members and at least one of them is related to a participating employer in the plan.
An IPP is sponsored by the employer and funded by employer contributions or by employer and employee contributions. Funding amounts (or contributions) are calculated by an actuary to fund the expected retirement benefits and are based on factors such as the employee's age, employment income, post-1991 RRSP contributions, and actuarial assumptions (such as interest rates, inflation rates, and life expectancy).
An initial lump-sum past-service contribution is permitted for the employee's years of service going back to 1991. An actuarial report is required to support the employer's initial contribution to the plan. For subsequent contributions, a periodic evaluation by an actuary is required.
The cost of past service contributions to an IPP must first be satisfied by transfers from the RRSP assets of the IPP member, or a reduction in the IPP member’s accumulated RRSP contribution room, before any new past service contributions can be made.
The IPP’s key advantage is that it has more room for tax-deductible contributions than an RRSP for those over age 40. You can therefore accumulate more retirement income in an IPP. The large tax-deductible contributions often stem from significant initial contributions used to fund past service. However, the RRSP contributions made in those prior years reduce the deductible past-service amount.
Once a plan member reaches the age of 72, they will be required to withdraw annual minimum amounts similar to current minimum withdrawal requirements applicable to registered retirement income funds.
The IPP rules are complex. Consult your EY tax advisor.
Pooled registered pension plans
Pooled registered pension plans (PRPPs) are intended to operate in a manner similar to multi-employer money-purchase RPPs, but with certain features drawn from the RRSP and RRIF systems. PRPPs are intended to provide a new option for retirement savings that will be attractive to smaller employers and self-employed individuals.
A PRPP enables its members to benefit from lower administration costs that result from participating in a large, pooled pension plan. It's also portable, so it moves with its members from job to job. The total amount that a member or employer can contribute depends on the member’s RRSP deduction limit. The investment options within a PRPP are similar to those for other registered pension plans.
Currently, PRPPs are available to individuals who are:
- Employed or self-employed in the Northwest Territories, Nunavut or Yukon
- Work in a federally regulated business or industry for an employer who chooses to participate in a PRPP
- Live in a province that has the required provincial standards legislation in place
An individual can be enrolled into a PRPP by:
- Their employer (if their employer chooses to participate in a PRPP)
- A PRPP administrator (such as a bank or insurance company).
Registered retirement savings plans
An RRSP is an investment account that can increase your retirement savings in two ways:
- Contributions are tax deductible, subject to statutory limitations.
- The income you earn in your RRSP is not taxed until you withdraw the funds. The investment of the funds that would otherwise be paid as taxes results in your funds accumulating faster in an RRSP than they would outside of one.
The tax advantage will be even greater if you purchase an annuity with accumulated RRSP funds or convert the RRSP to a registered retirement income fund (RRIF). You will continue to defer tax on the accumulated funds until you actually receive the payments. You receive further benefit if your marginal tax rate decreases during retirement.
Timing for contributions
You may deduct RRSP contributions made before the end of the year (to the extent that they weren’t deducted for a previous year) or up to 60 days after the end of the year. This deduction is subject to your yearly deduction limit.
Generally, it is advantageous to make your RRSP contribution in early January of the year, instead of late in February of the following year. That way, you can defer the tax on the income you earned on your funds during that 14-month period. Also, to take maximum advantage of the tax sheltering available through an RRSP, you should make contributions regularly each year, and early in your career.
Your RRSP deduction limit will determine the maximum tax-deductible contributions that you may make in a year. The limit applies to contributions made to either your own or a spousal RRSP. If you make a contribution to your spouse’s RRSP, it does not affect your spouse’s or partner’s RRSP deduction limit for the year.
- The deadline for making deductible 2016 RRSP contributions is Wednesday, 1 March 2017.
- Make contributions early in your career and contribute as much as you can each year.
- Consider making your annual RRSP contribution as soon as you can each year to take maximum advantage of income tax sheltering.
- If you’re an employee, ask your employer to withhold some of your salary or bonus and deposit it directly to your RRSP.
- Consider paying RRSP administration fees outside the plan to maximize the capital in the plan for future growth.
If you’re not a member of an RPP or a Deferred Profit Sharing Plan (DPSP), your deductible 2016 RRSP contribution is limited to the lesser of 18% of your earned income for 2015 and a maximum of $25,370. The dollar limit is indexed for inflation.
In addition to this amount, you would include your unused RRSP deduction room from 2015 (refer to the following section for a description of this amount).
If you’re a member of an RPP or DPSP, the maximum annual RRSP contribution as calculated above is reduced by the pension adjustment for the prior year and any past-service pension adjustment for the current year. In addition, there may be an increase or decrease to your RRSP deduction limit if your company revises your benefits entitlement from the company pension plan.
If you do not contribute the maximum allowable amount in a particular year, you may carry forward the excess. Your maximum RRSP contribution can be a complex calculation. As a result, the CRA provides the computation of your RRSP deduction limit on the Notice of Assessment for your income tax return.
- Contribute the maximum deductible amount to your RRSP. If this is not possible, plan to make up for the under contribution as soon as possible.
- Consider making a contribution of qualified property to your RRSP. However, note that any capital gain on the property transferred will be recognized for tax purposes, but a capital loss will be denied.
Unused deduction room
Generally, if you contribute less than your RRSP deduction limit, you can carry forward the excess until the year you reach age 71. For example, if your current-year RRSP deduction limit is $10,000, but you make a contribution of only $7,000, you can make an additional deductible RRSP contribution of $3,000 in a future year. But if you make up the contribution in a later year, remember that you’ll postpone the benefit of tax-free compounding of income that you would have earned from a current contribution and on any future income earned on this amount.
Carryforward of undeducted contributions
In addition to the carryforward of unused RRSP deduction room, you can carry forward undeducted RRSP contributions.
For example, if you make an RRSP contribution in 2016, but do not claim the full amount on your 2016 tax return, you can carry forward the unclaimed amount indefinitely and claim it as a deduction in a future year. It may be beneficial to delay deduction of your RRSP contribution if your 2016 taxable income is low and you expect to be subject to a higher marginal tax rate in a future year.
Be aware that making a contribution over the limit may result in penalties.
- If your taxable income for 2016 is low, consider carrying forward your deductible 2016 RRSP contribution and claiming a deduction in a future year when you’ll be subject to a higher marginal tax rate.
Determination of earned income
Your earned income for the immediately preceding year is an important factor in determining your RRSP deduction limit for the current year. For example, your 2015 earned income is one of the factors in the calculation of your 2016 deduction limit.
If you were a resident of Canada throughout 2015, your earned income is generally calculated as follows:
- Additions to earned income
- Net remuneration from an office or employment, generally including all taxable benefits, less all employment-related deductions other than any deduction for RPP contributions
- Income from carrying on a business, either alone or as an active partner
- Net rental income
- Alimony and maintenance receipts included in your income
- Deductions from earned income
- Losses from carrying on a business, either alone or as an active partner
- Net rental losses
- Deductible alimony and maintenance payments
Your earned income does not include superannuation or pension benefits, including Canada Pension Plan/Quebec Pension Plan (CPP/QPP) and OAS benefits, or retiring allowances.
If you became a resident of Canada in 2016 and did not earn Canadian income in 2015, you will not be able to make a deductible contribution to your RRSP for 2016, unless you have unused RRSP deduction room carried forward from a previous year.
- In order to make the maximum RRSP contribution in 2016, your earned income for 2015 must have been at least $140,944.
- Consider the impact that alimony or maintenance payments and business or rental losses have on your RRSP deduction limit.
- In certain circumstances, you may be eligible to make deductible contributions to your RRSP in addition to the deductible limit. The more common deductible contributions are retiring allowances and lump-sum receipts.
- If you will receive a retiring allowance, consider making direct, as opposed to indirect, transfers of retiring allowances to an RRSP (up to the deductible amount) to avoid withholding tax.
If you contribute an amount above your RRSP deduction limit for the year, it will result in an overcontribution. If the total RRSP overcontributions exceed $2,000, the excess is subject to a 1% per month penalty tax.
Under certain circumstances, making an RRSP overcontribution of $2,000 could be advantageous because you can earn tax-deferred income on it. Although you cannot deduct the overcontribution in the year you make it, you may deduct it in a future year under the carryforward provisions. However, double taxation may result if you are unable to claim a deduction for the overcontribution in any future year.
If you make contributions to your own or a spousal RRSP in excess of your deductible amount, you may withdraw them tax free only in the same year in which they were contributed, the year an assessment is issued for the year of contribution, or the year following either of these years. Also, there must be reasonable grounds to believe that the amount was deductible at the time you made the contribution.
- Be sure to transfer lump-sum amounts out of an RPP or a DPSP directly to an RRSP.
- Limit your RRSP overcontributions to $2,000.
- If you’ve made an overcontribution and are about to retire, reduce your current-year contribution to avoid double taxation on any undeducted contributions.
It’s important that your RRSP holds qualified investments only. If it acquires a non-qualified investment, a penalty tax equal to 50% of the value of the non-qualified investment may apply.
Qualified investments generally include the following:
- Term deposits
- Any security (other than a futures contract) listed on Canadian stock exchanges and most foreign stock exchanges
- Most government bonds
- Most Canadian mutual funds and segregated funds
- Options for the purchase of eligible investments
- Shares of certain private corporations in limited circumstances
It’s also important that your RRSP does not hold any prohibited investments. A prohibited investment is generally one to which the annuitant is closely connected. An investment may be qualified, but still be considered prohibited.
If your RRSP acquires a prohibited investment, it will attract a 50% penalty tax similar to the non-qualified investment penalty tax.
Owning a prohibited investment may also result in a separate advantage tax. This tax is equal to 100% of certain advantages. An advantage generally includes income and gains attributable to prohibited investments, as well as benefits from certain transactions (such as RRSP swaps and RRSP strips) which are intended to exploit the tax attributes of an RRSP or RRIF.
For more information on these rules, see the Investors chapter.
Transferring between plans
You may transfer RRSP funds from one RRSP to another without attracting tax, provided the funds go directly to the new plan and are not available for you to use. You may choose this as an option when you’d like to change the types of investment in your portfolio, or to change from one plan issuer to another. Remember that while you can transfer property between two RRSPs, if you transfer property between different types of plan (i.e., between an RRSP and a TFSA or other non-registered savings account), it will generally be considered a swap transaction, which may be subject to the advantage tax.
Withdrawing funds before retirement
You may make withdrawals from your RRSP at any time. However, you must include the gross withdrawal amount in your income. The trustee of the RRSP must withhold tax from the amount you withdraw.
If you’re 71 years old at the end of 2016, your RRSP must mature by the end of the calendar year. You must make any final-year contributions on or before 31 December 2016, not 60 days after the end of the year.
Depending on your tax position, and provided you have sufficient earned income to make contributions, you may continue contributing to a spousal RRSP until the year your spouse or partner turns 71.
- Make any transfer between RRSPs directly from one plan issuer to another. Otherwise, the funds will be taxed on withdrawal and may not be returned to your RRSP without using contribution room.
- You may incur financial penalties if you transfer RRSP funds when the underlying investments have a fixed term or if the issuer charges a fee for the transfer.
- If you withdraw funds from an RRSP before you retire, minimize the withholding tax by withdrawing $5,000 or less per withdrawal. Remember, you’ll still be taxed on the gross amount of the withdrawal at your marginal tax rate, regardless of the amount of tax withheld, so you may have a balance of tax to pay as well as a future instalment obligation as a result.
- Remember that if you withdraw funds from an RRSP before retirement, you’ll lose tax-free compounding for the future. Instead, consider borrowing funds if your cash needs are temporary.
- Monitor your RRSP investments to ensure they do not become prohibited, and be aware of transactions with your RRSP (other than contributions or withdrawals) that may result in advantages.
Although your RRSP must mature by the end of the year in which you reach age 71, you don’t have to wait until then to obtain retirement income from your plan. This allows you to take an early retirement and may entitle you to the non-refundable pension income tax credit.
You can withdraw the accumulated funds from your RRSP or, alternatively, you can purchase one or a combination of available maturity options. These options provide you with retirement income in varying amounts over different periods of time. Tax is deferred until you actually receive your retirement income.
When you’re deciding what maturity options would best suit your situation, you need to take into account a number of factors. In addition, consider whether the maturity options you choose will give you flexibility to change your mind should your situation change. In many cases, there is an opportunity to change from one maturity option to another if you properly structure your retirement options.
Maturity options currently available:
- Fixed-term annuities
- Provide benefits up to age 90. If, however, your spouse or partner is younger than you, you can elect to have the benefits provided until your spouse or partner turns 90
- May provide fixed or fluctuating income
- Life annuities
- Provide benefits during your life, or during the lives of you and your spouse or partner
- May have a guaranteed payout option
- May provide fixed or fluctuating income
- Essentially a continuation of your RRSP, except that you must withdraw a minimum amount each year (but there are no maximum limits).
- Provide retirement income from the investment of the funds accumulated in a matured RRSP.
- If you only withdraw the minimum amount each year, your financial institution is not required to withhold tax.
Under federal and most provincial pension legislation, the proceeds of locked-in RRSPs or locked-in retirement accounts (LIRAs) must generally be used to purchase a life annuity at retirement, a life income fund (LIF), a locked-in retirement income fund (LRIF) or a prescribed retirement income fund (PRIF). You generally cannot use them to acquire a term annuity.
LIFs, LRIFs and PRIFs are all forms of RRIF, so there’s a minimum annual withdrawal. However, there are also maximum annual withdrawals for LIFs and LRIFs, and in some provinces LIFs must be converted to life annuities by the time you turn 80.
Tax-deferred transfers are generally permitted between all of these plans, so you might transfer assets from a LIF back to a LIRA (if you’re under age 71) if you change your mind about receiving an early pension. Another option is to transfer funds from a LIF to a LRIF to avoid annuitization when you turn 80.
- If you’re going to be 71 at the end of 2016, make your annual RRSP contribution before 31 December.
- If you are over 71 and your spouse or partner is younger than you — and you have earned income or RRSP deduction room — consider making contributions to your spouse’s or partner’s RRSP until they turn 71.
- If you expect to have sufficient earned income after age 71, consider making the $2,000 overcontribution before the end of the year that you reach age 71 and claim this deduction in later years.
- If you have sufficient earned income in the year you turn 71, consider making a contribution for the next year (in addition to one for the current year) just before the year end. Although you must collapse your RRSP before the end of the year in which you turn 71, you’re still able to deduct excess RRSP contributions in later years. You will be subject to a 1% penalty tax for each month of the overcontribution (one month if the overcontribution is made in December of the year you turn 71), but this may be more than offset by the tax savings from the contribution.
- Investigate and arrange for one or more of the maturity options that are available if your RRSP is maturing in the near future.
- Where the minimum RRIF amount is withdrawn in a year, no tax is required to be withheld at source. Consider the effect of this on your income tax instalment planning.
- Consider receiving RRIF payments once a year in December to maximize the income earned in the plan.
- Give careful consideration with respect to designating the beneficiary of your RRSP or RRIF. Consider whether the named beneficiary qualifies to receive the funds on a tax-deferred basis. If not, be aware that the underlying tax liability will be the responsibility of the estate.
Canada Pension Plan
In June 2016, Canada’s finance ministers announced plans to strengthen the Canada Pension Plan for future generations. Among their proposals, which are scheduled to take effect in 2019, was a measure to provide a tax deduction — instead of a tax credit — for employee contributions associated with the enhanced portion of the CPP.
The Canada Pension Plan (CPP) is an earnings-related social insurance program that provides basic benefits when a contributor to the plan retires or becomes disabled. When contributors die, the CPP may provide benefits to their survivors. The CPP operates in every province in Canada except Quebec, which administers its own program, called the Quebec Pension Plan (QPP).
With very few exceptions, every person in Canada who is over the age of 18 who works and earns more than the minimum amount ($3,500 per year) must contribute to the CPP (or to the QPP in Quebec). You and your employer each pay half of the contributions. If you are self-employed, you pay both portions.
Although employers used to stop deducting CPP when an employee aged 60 to 70 began receiving a CPP or QPP retirement pension, this rule has changed. As of 1 January 2012, employers must continue to deduct CPP from the earnings of an employee who receives a CPP or QPP retirement pension if that employee is 60 to 65 years old, or is 65 to 70 years old and has not filed an election to stop paying CPP contributions.
- Delaying receipt of your CPP pension past age 65 will enhance your monthly benefit. If you start receiving your CPP pension at the age of 70, your pension amount will be 42% more than it would have been if you had taken it at 65.
- Conversely, starting your CPP pension before age 65 will reduce your monthly benefit. If you start receiving your CPP pension at the age of 60, your pension amount will be 36% less than if you wait until you’re 65.
- Individuals aged 65 to 70 are required to pay CPP premiums on their employment or self-employment earnings, but may elect out. In order to elect out, you must complete an election, file the original with the CRA and provide copies to each employer. The election is effective the month following the month of filing with the CRA. You can revoke this election to opt out and resume contributing to CPP.
- Individuals contributing to CPP while collecting benefits will receive a “post-retirement benefit,” which will be effective the calendar year following the premium payment, so their CPP benefits will increase each year they continue their CPP contributions.
Old Age Security
The Old Age Security (OAS) pension is a monthly payment available to most Canadians aged 65 and older. In order to receive benefits, you must apply for OAS with Service Canada. You should apply six months before you turn 65. However, if you apply at a later date, the pension is payable up to 11 months retroactively from the date the application is received.
Canadians may voluntarily defer receipt of OAS benefits for up to five years. Those who take this option will receive a higher, actuarially adjusted pension.
You can download an application package from Service Canada’s website or you can order an application by mail.
Two other programs can provide you with additional income. The Guaranteed Income Supplement (GIS) and the Allowance program were designed to provide further assistance to low-income seniors. For more information, see the Service Canada website.
Financing retirement – additional options
A retiring allowance includes severance payments or an amount paid by your employer on your retirement in recognition of long service or for a loss of office or employment.
If you receive a retiring allowance, you may be able to transfer a limited amount into an RRSP. Any excess would be taxable in the year received at the applicable marginal tax rate.
Retirement compensation arrangement
A retirement compensation arrangement (RCA) is any arrangement where your employer makes contributions in connection with benefits you receive on, after or in contemplation of any substantial change in your services to the employer. This includes your retirement and the loss of office or employment.
In general, contributions to an RCA, and any income and capital gains earned in the plan, are subject to a 50% refundable tax. Your employer would withhold and remit the tax at the time of funding. This tax is refundable at a rate of $1 for every $2 distributed to you.
Distributions from the plan are taxed as ordinary income. You are limited in the amounts you can transfer from an RCA to an RRSP if paid as a retiring allowance.
- If you fall into a lower marginal tax bracket after retirement, receiving payment of a retiring allowance over a number of years may permanently reduce the amount of tax you will pay on it.
- RCAs have prohibited investment and advantage rules that are similar to those that apply to TFSAs, RRSPs and RRIFs.
If you spend part of your career working outside Canada, you may find that working for a foreign company or living outside Canada means changing pension plans and forfeiting regular RRSP contributions. Being able to continue participating in Canadian pension and RRSP plans while working overseas can therefore be a significant benefit.
Canada-US Tax Convention
In 2008, Canada and the US ratified changes to the Canada-US Tax Convention that provided this type of relief, starting in 2009, for Canadians who work in the US. The changes allow short-term cross-border assignees to continue to make contributions to their home country pension plans, such as an RPP, DPSP or a group RRSP, and receive a tax deduction in the host country.
For example, let’s say you’re a Canadian expatriate on a three-year assignment in the US working for a company affiliated with your Canadian employer. You may be able to continue contributing to your Canadian employer’s pension plan, and will be able to claim a deduction on your US tax return for your contributions, provided that you:
- Were a member of the Canadian employer’s pension plan before starting work in the US and the Canadian employer’s pension plan qualifies as a “qualified retirement plan” under the Canada-US Tax Convention
- Were a nonresident of the US before starting your US assignment
- Are on the US assignment for no longer than five out of the preceding ten years
- Deduct only contributions that are attributable to services performed in the US
- Do not participate in any other pension plans (i.e., you cannot also participate in a US 401(k) plan or an individual retirement account)
The rules are similar for US workers on short-term assignment in Canada.
The changes to the Canada-US Tax Convention also provide relief to cross-border commuters who live in Canada and commute to work in the US, or vice versa. If you are a cross-border commuter working and contributing to a pension plan in one country, but you live in the other country, you will also benefit from a tax deduction.
For example, you live in Windsor, Ontario, and commute to Detroit daily to work for a US employer, USco. You participate in USco’s 401(k) plan. As a Canadian resident, your employment income is taxable in Canada. You will be able to claim a deduction for your 401(k) contribution in determining your Canadian taxable income. The amount of the deduction will be limited by the amount of the actual contribution, the amount allowed to be contributed to a 401(k) under US law, and the RRSP contribution limit for the year (after taking into account RRSP contributions otherwise deducted).
Just like an RPP, participation in USco’s 401(k) will limit your ability to contribute to an RRSP, since participation will give rise to a pension adjustment that reduces your RRSP room.
US citizens who are residents of Canada
The changes to the Canada-US Tax Convention also provide relief to US citizens living in Canada who contribute to a pension plan in Canada. A US citizen living in Canada and working for a Canadian employer will be allowed a deduction for US tax purposes for contributions to an RPP, DPSP or group RRSP. The relief is restricted to the lower of Canadian tax relief and the amount that would be deductible in the US for a generally similar US plan. The contributions must be in respect of services taxable in Canada and remuneration for such services must be paid by a Canadian employer in relation to services rendered during the period of Canadian residence.
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