As the winter season arrives,
it heralds the arrival of another season we are all familiar
with-the RRSP season and tax time. Yes, it's time to start thinking
about your income tax due and how to reduce this amount by taking
advantage of the tax credits and deductions available to you.
Probably the most popular tax shelter in the country is the Registered
Retirement Savings Plan (RRSP). The idea behind this deferred
income plan is a simple one-you put your money into an RRSP,
and that money, as well as the interest and the other income
it earns, will not be taxed until it is withdrawn from the plan.
Generally speaking, every Canadian should be taking advantage
of deferred income plans including RRSPs. Are you?
RRSPs
No doubt, you are familiar with RRSPs. It has been said that
they are the government's greatest gift to taxpayers, as the
effects of having your money grow, sheltered from taxation, are
impressive over time. So what makes an RRSP so great? The money
your RRSP investments earn is not taxed until it is withdrawn
And, your contributions can qualify for a tax deduction, therefore
reducing your net taxable income. While the RRSP concept itself
is straightforward, there are rules and limitations applicable
to RRSPs. Let's look at some of the limitations applicable to
RRSP contributions.
All things in moderation!
The tax-sheltering RRSPs provide is such a good thing that the government has limited how much we can put into our RRSPs each year. Let's review how your RRSF contribution limit for 2002 is calculated:
· You may contribute an amount equal to your amount of unused contribution room carried forward from previous years, plus
· The lesser of 18% of your earned income and $13,500, plus
· Any Pension Adjustment Reversal
arising from termination of a RPP and/or Deferred Profit Sharing
Plan (DPSP) membership.
Note that if you belonged to an RPP or a DPSP, you must also
subtract your pension adjustment and net past service adjustment
from the above total. If you do not belong to an employer's pension
plan or a DPSP, your pension adjustment will be nil, and you
can contribute either 18% of your previous year's earned income
or $13,500, whichever limit is applicable to you.
As the deadline for RRSP contributions for 2002 approaches, you
will likely hear advice to "contribute your maximum"
to your RRSP. This is generally good advice, as the effects of
having your money grow, earning tax-free income, is certainly
worth taking advantage of. But what are these RPPs and DPSPs
that come into play as a pension adjustment when determining
your RRSP contribution room?
RPPs
Employers set up RPPs for the benefit of employees. When an employer contributes to the pension plans of its employees, the employer is able to deduct the contribution for tax purposes. The contribution amounts are not taxed as benefits in the year in which they were made - rather the employee is taxed on the pension income upon receipt (typically after retirement). Some RPPs are set up to either allow or require employees to make contributions. These employee contributions are tax deductible to the employees in the year of the contribution. There are two basic types of RPPs, the Money Purchase, and the Defined Benefit (DB) plan. Let's take a look.
Money Purchase RPPs are similar to RRSPs
in that the amount of the pension is a product of the contributions
made and the investment income earned. Then there are DB RPPs,
where the employee knows at the outset what the pension amount
will be, as it is typically a product of salary over a specific
number of years. With these plans, the onus is on the employer
and the pension fund managers to ensure that sufficient contributions
and investment returns are made to cover the pensions of the
employees.
If you leave your employment prior to qualifying for your RPP
payments, your RPP can be converted into a locked-in RRSP or
a locked-in Registered Retirement Income Fund, subject to certain
limits. These funds are considered Unlocked-in" because
you cannot withdraw them in a lump sum; instead they must be
used as originally intended-to provide income on retirement.
DPSPs
And then there are Deferred Profit Sharing Plans. This type of plan is not as widely used at the RPP, but it works similarly in that your employer makes the contributions, and the proceeds are taxed when you, the employee, receive them, typically on retirement.
As the name suggests, the contribution amount made by the employer relates to profit amounts. Typically, the maximum contribution an employer makes is the lesser of 18% of your earnings for the year, or $6,750. Employees may not contribute to DPSPs, and DPSPs may not be used for owner/managers of small businesses, or employees with more than 10% of holdings in their company's shares.
In terms of your RRSP contribution limits, the more that you and your employer have placed in your RPP or DPSP, the less that you can contribute to your RRSP. This calculation is your pension adjustment. You can find your pension adjustment on the Notice of Assessment you received following the filing of your 2001 tax return.
For DPSPs, the pension adjustment is the sum of contributions made by your employer The same is true for Money Purchase RPPs, except that the total will also include contributions made by you, if any. For Defined Benefit plans, the calculation involves the amount you will receive on retirement based on your past year's employment.
In any case, all of these types of plans offer the opportunity to defer income and also taxation. If you are not a part of an RPP or DPSP through your workplace, ensure that you are contributing to your RRSP to take advantage of the opportunity for tax sheltered investment growth. In retirement, you'll be glad you did!