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If you or your spouse earns pension income eligible for the pension tax credit, an election can be made to transfer up to one-half of the eligible pension income to the other spouse |
Make a contribution to your RRSP for 2011
Your contribution limit for 2011 is 18% of your 2010 earned income (to a maximum of $22,450) less the value of any benefits that accrued to you in 2010 as a member of a Registered Pension Plan or a Deferred Profit Sharing Plan (your Pension Adjustment — PA). Your PA was reported by your employer on your 2010 T4 slip. Also, your 2010 Notice of Assessment should include the CRA’s calculation of your 2011 contribution limit, with any unused amounts carried forward from previous years. This information is also available on the CRA’s “My Account” service. Your RRSP contribution must be made on or before February 29, 2012 to be deductible for 2011. If you don’t have the necessary funds, consider borrowing to make the contribution. Although interest on an RRSP loan is not deductible, borrowing may still make sense if you can repay the loan quickly. If you receive a tax refund, you can apply it to the loan to reduce the balance outstanding.
If you decide not to contribute for 2011, your ability to do so carries forward indefinitely. However, even if you don’t need the deduction for 2011, you should still consider making the contribution if you have excess funds which would otherwise earn taxable income in your hands. You can claim the deduction in any future year. The income from the funds will accumulate tax-free in your RRSP.
If you have excess investment funds, make your RRSP contribution for next year as soon after December 31 as possible, to maximize the tax deferral of income earned in the plan. For 2012, the RRSP limit is the lesser of 18% of your 2011 earned income (less your 2011 PA) or $22,970.
You can also make a one-time overcontribution to your RRSP. Penalties do not apply if the amount is less than $2,000 and, as noted above, income from the funds will accumulate tax-free in your RRSP. You should keep in mind that the CRA does track RRSP overcontributions, and penalties apply on most overcontributions in excess of $2,000.
Withdraw RRSP funds in low income years
If your income is abnormally low, consider withdrawing funds from your RRSP before the end of the year. This alternative would generally only appeal to someone in the lowest tax bracket who would otherwise waste available deductions and credits.
Keep in mind that once RRSP funds are withdrawn, the amounts can only be recontributed to the extent you have RRSP contribution room available in the future. Also, income earned on the funds withdrawn will no longer benefit from tax-free accumulation in the RRSP.
When you withdraw funds from your RRSP, you’ll receive a T4RSP slip showing the amount of the withdrawal and the tax withheld. When you file your tax return, include the amount in income, calculate the final tax and claim the withholdings as a tax payment.
Ensure that your 2011 earned income allows the maximum 2012 RRSP contribution
Your right to make an RRSP contribution for one year depends on your earned income for the previous year. For 2012, your contribution will be limited to 18% of your 2011 earned income, to a maximum of $22,970. Therefore, you need at least $127,611 of earned income in 2011 to maximize your 2012 contribution. This limit is further reduced by your PA for 2011.
In general terms, earned income is income you receive from employment, business or the rental of real property, as well as any alimony and taxable maintenance. It is reduced by business or rental losses and any alimony and maintenance payments made. If you have some control over your income level make sure that you have factored in the ability to make RRSP contributions into your decision of whether to earn a salary rather than dividends.
Sell non-qualified assets in your RRSP before December 31
There are specific rules as to the types of assets your RRSP can hold. If you have a self-directed RRSP, you may have purchased assets which don’t qualify. If this purchase happened on or before March 22, 2011, then the cost of the asset is included in your income in the year of purchase. You’re allowed a deduction for the amount of the proceeds when the asset is sold, up to the original inclusion. Therefore, if the purchase and sale are in the same year, the deduction may offset a part or all of the income. So, make sure your RRSP sells non-qualifying assets acquired on or before March 22, 2011 before December 31, 2011.
There are proposed changes, arising from the 2011 Federal budget, to the consequences of acquiring non-qualifying investments in your RRSP. For such assets acquired after March 22, 2011, a tax equal to 50% of the amount of such investment will apply to the RRSP annuitant. Where the non-qualifying investment is disposed of, the tax will be refunded. Therefore, if the purchase and sale are in the same year, the tax and the refund will be offset. For these acquisitions, it will be beneficial to dispose of the non-qualifying assets before December 31, 2011.
Changes in eligible investments in your RRSP
The 2011 Federal budget also proposed significant changes which introduce the concept of a prohibited investment for RRSP purposes to make such rules more consistent with the rules for TFSAs. Under the proposed rules, if you and non-arm’s length parties together hold an interest of 10% or more in a particular investment, it may be a prohibited investment. This rule will be of particular importance for investments in privately held companies within RRSPs. Although investments held on March 23, 2011 will generally not be subject to a penalty tax, income on these investments may now be taxable.
If you hold any shares of private companies in your RRSP (or anything else that may be a prohibited investment), contact your BDO advisor immediately, as it may be necessary to determine a plan to remove such investments from your RRSP. The currently proposed rules contain a 10 year transition plan to divest your RRSP of such prohibited investments without incurring a penalty or additional tax beyond the tax that would normally apply when making a withdrawal from an RRSP.
Purchase an annuity or RRIF to claim the pension income credit
If you’re 65 or over, you’re entitled to claim a federal tax credit on your first $2,000 of pension income. The credit is equal to the tax that would be paid on the income at the lowest tax bracket. If you don’t currently receive pension income and are in the lowest tax bracket (income less than $41,544 for 2011 federal tax purposes; threshold varies by province/territory), consider transferring funds to a Registered Retirement Income Fund (RRIF) and withdraw $2,000 per year. If you’re in the low tax bracket, the income will effectively be received tax-free federally. Note, however, that some of the pension income will be taxed as in most provinces, the pension credit amounts are less than $2,000. If you’re in a higher bracket, there will be a tax cost, depending on your marginal tax rate. This strategy will also work if you use a portion of your RRSP funds to purchase an annuity which pays at least $2,000 per year.
Review pension income splitting with spouse
If you or your spouse earns pension income eligible for the pension tax credit, an election can be made to transfer up to one-half of the eligible pension income to the other spouse. This is a joint election that can be taken advantage of when filing your and your spouse’s tax returns. The amount transferred reduces the transferor spouse’s net income, and increases the transferee spouse’s net income so a tax saving should generally arise where the transferee spouse has a lower marginal tax rate. However, one should keep in mind that there can be negative effects that arise from increasing a lower-income spouse’s net income. For example, some tax credit amounts (particularly the age credit) and the OAS clawback are based on net income. With this in mind, in certain cases it may be beneficial to elect to transfer from the lower-income spouse to the higher-income spouse.
Another possibility to consider if you or your spouse is age 65 or over is whether additional amounts should be withdrawn from your RRIF with a view to splitting some of the additional amount. This could allow you to take further advantage of a spouse’s low tax rates, or a spouse’s losses carried forward (other than capital losses). However, you can only split up to 50% of the additional amount received, so some of the extra RRIF withdrawals will be taxed in your hands — this cost would have to be compared with the tax benefit from splitting more income.
If you have questions about pension income splitting, consult with your BDO advisor.
Delay RRSP Home Buyers’ Plan (HBP) withdrawals until after year-end
If you qualify, you and your spouse can withdraw a specific amount tax-free from your RRSP towards the purchase of a principal residence. The limit for HBP withdrawals is $25,000. The home must be purchased by October 1 of the year following the year of withdrawal. Amounts withdrawn must be repaid to RRSPs in 15 equal instalments, starting with the second taxation year following the year of withdrawal (amounts not repaid are taxed as an RRSP withdrawal).
If you’re planning on using the HBP towards year-end, consider deferring your withdrawal until after December 31. This will extend your time period for purchasing your home and repaying the amounts withdrawn by one year. You’ll also want to delay your HBP withdrawal if you won’t have received the full amount by January 2012. Under the HBP rules, multiple withdrawals are possible, but all withdrawals must be received in the same calendar year or in January of the following year. Consequently, if you want to withdraw funds after January 2012, you shouldn’t make an HBP withdrawal in 2011.
Remember to make your required Home Buyers’ Plan repayment by
February 29, 2012
If you participated in the HBP prior to 2010, you have a repayment due in the 2011 taxation year. A repayment made on or before February 29, 2012 will be considered to have been made in the 2011 taxation year. A repayment is made by making a regular contribution to your RRSP. When you file your 2011 tax return, you’ll have to complete Schedule 7. On this form, you’ll designate that the RRSP contribution is to be applied as an HBP repayment and is not a deductible contribution.
If you have already made RRSP contributions during 2011, you can designate an amount to cover your required repayment. The CRA sends an HBP Statement of Account each year with your Notice of Assessment or Reassessment.
Remember to collapse your RRSP if you will turn 71 this year
You can’t have an RRSP past December 31, 2011 if you’re 71 or older at year-end. So, prior to December 31, 2011, you must collapse your RRSP and pay tax on the fair market value of the plan’s assets at that time, purchase an annuity or transfer your RRSP assets to a RRIF. No tax is paid at the time of the purchase of an annuity or at the time of a conversion to a RRIF.
If you will generate RRSP contribution room for 2012 because you have earned income in 2011, but you have to collapse your RRSP before the end of 2011, consider making an overcontribution to your RRSP in December, immediately before collapsing it. The amount of the overcontribution should equal $2,000 plus the 2012 contribution limit. A 1% penalty tax on the overcontribution in excess of $2,000 will apply for December 2011 — however, this will end on January 1, 2012 when the new contribution room becomes effective. The basic $2,000 overcontribution will become deductible when you generate additional RRSP room in the future and will never attract the 1% overcontribution penalty tax. If you won’t have earned income after 2011, then you may not want to make an overcontribution. Ask your BDO advisor if this type of planning makes sense for you.
If you must collapse your RRSP this year, you can still contribute to your spouse’s RRSP if you have contribution room and your spouse has not reached age 71 by December 31, 2011. This is an excellent way to build up your spouse’s RRSP.
If you want more information on RRSPs, read our Answering Your RRSP Questions bulletin.
Consider whether an Individual Pension Plan is right for you
In addition to RRSPs, another retirement savings option is available to owners of incorporated businesses, including professionals who have incorporated. Under the rules for defined benefit pension plans, it is possible to set up an individual pension plan (IPP) for business owners. However, there are proposed changes that will change the benefit that an IPP may have over other plans and this has left many experts wondering whether IPPs are still an advantageous way of saving for retirement. Talk to your BDO advisor to see if IPPs may make sense for you.
Next section: Deductions and credits
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