S is for Savings Plans
As dentists reach the prime of their careers, they start to focus on maximizing their savings in the most tax-efficient way possible. We will look at the following investment vehicles:
– Registered Retirement Savings Plans (RRSP)
– Registered Education Savings Plans (RESP)
– Registered Disability Savings Plans (RDSP)
– Tax Free Savings Accounts (TFSA)
– Individual Pension Plans (IPP)
1. Registered Retirement Savings Plans
There are four main benefits of an RRSP. First, you receive a tax deduction, deductible either for the contribution year (i.e. contributed during or within 60 days after the contribution year) or in a future year where you expect your income to be higher. Second, income on your contributions accumulates tax-free until you withdraw from the RRSP. RRSPs can also be an effective way to save for a first home or to finance full-time education. Up to $25,000 of pre-tax money per spouse inside the RRSP can be used to pay for the home, repayable to the RRSP over 15 years. RRSP funds can also be withdrawn tax-free to finance full-time study by the plan holder or their spouse/partner, repayable over ten years. Finally, RRSPs permit income splitting by allowing you to contribute to a spousal RRSP, allowing for part of your RRSP to be taxed in the hands of a lower-income spouse upon retirement.
Note that because withdrawals are treated as taxable income, you need to ensure that your marginal tax rate at the time of contribution is higher than the rate at which the withdrawals are eventually taxed. Without planning, you may end up paying more taxes on the withdrawal than you saved on the contribution, depending on your income bracket for the year of withdrawal. For this reason, any withdrawal from an RRSP before actual retirement should only be done with professional advice. Note also that since withdrawals from your RRSP will form part of your income, planning should take into account any Old Age Security clawback once your income exceeds the threshold ($71,592 for 2014).
Annual RRSP contributions limits are capped based on your prior year’s income, up to a maximum amount ($24,270 for 2014). Dentists looking to save more for their retirement may find they need additional investment vehicles besides a RRSP, such as insurance policies, or IPPs (below).
2. Registered Education Savings Plans
RESPs allow you to save up to the lifetime limit of $50,000 towards the cost of your child’s post-secondary education. As with RRSPs, accumulating income in the RESP is not taxed until the funds are withdrawn, (although unlike RRSPs, contributions are made out of after-tax dollars). Withdrawals from an RESP are taxed in the hands of the student who typically has little to no income allowing for income splitting of any investment income.
In addition, the RESP receives a 20% matching grant from the federal government on annual contributions up to $2,500 per beneficiary (to a lifetime maximum per beneficiary of $7,200). In other words, the RESP receives a $500 risk-free return in the year of contribution for each year’s $2,500 contribution.
Note that proceeds from withdrawals can only be used towards reasonable education costs of the beneficiary. If the beneficiary does not pursue a post-secondary education, and there are no other eligible beneficiaries, you may have to withdraw the funds yourself. This means repayment of the matching grants, and tax payable on the investment income earned in the account. RESPs will also affect a student’s application for government loans such as OSAP as it counts as the student’s income.
3. Registered Disability Savings Plans
For families with loved ones suffering from a disability, an RDSP allows you to provide long-term care in a tax efficient manner. A trust is set up for a disabled beneficiary and contributions up to the beneficiary lifetime limit of $200,000 can be made by anyone until the year the beneficiary turns 59. These contributions are not tax deductible, but investment income can grow tax-free until withdrawal.
In addition to contributions made by you, the federal government provides Canada Disability Savings Grants. The government will match contributions dollar for dollar up to $1,000 annually, regardless of household income. Lower income households are eligible for up to $3 for every $1 contributed (depending on income) up to $3,500 annually ($70,000 lifetime maximum per beneficiary). Once beneficiaries turn 18, they are considered to be independent of their parents and therefore their income for this purpose is calculated independent of their parents’ income, no matter how high. Disabled persons are eligible for the savings grant until the beneficiary turns 49.
Withdrawals from an RDSP will be allocated between contributions, investment income, and savings grants, with the beneficiary taxable on investment income earned and any savings grants received, but not on contributions. RDSPs are subject to a 10-year repayment rule: if any funds are withdrawn from the RDSP in the first ten years, if the beneficiary loses eligibility (i.e. is no longer disabled), or if the beneficiary passes away, all grants in the previous ten years must be repaid. All proceeds from the plan would be paid out to the beneficiary and any investment income would be taxed.
4. Tax Free Savings Accounts
TFSAs allow you to earn investment income tax-free. No taxes will ever be paid on withdrawals of contributions or accumulated income. They also provide flexibility since you can withdraw funds from a TFSA at any time without penalty, with no withholding taxes or any obligation to report the transaction on your tax return. For those saving for a large foreseeable expense, TFSAs are a great investment vehicle to use for parking savings until they are required.
TFSAs are paid with after-tax dollars (i.e. no tax deduction). Annual contributions are limited to $5,500 per person aged 18 or older. Finally, while there are no restrictions on withdrawals, note that a withdrawal and re-contribution during the same calendar year is treated as a separate contribution. Any over contribution is subject to 1% per month penalty.
5. Individual Pension Plans
An IPP is a super-sized pension which allows your PC to make tax-deductible contributions to fund your retirement. Similar to an RRSP, income earned inside the IPP is tax-free until withdrawal. Other benefits include:
– Creditor-proof: Assets held in the IPP are protected if you are sued or go bankrupt
– Higher limits: Contribution limits will vary depending on your age, length of service and past salary, but are typically higher than RRSP limits.
– Defined benefit plan: If your investments do poorly, your PC can “top-up” your pension with additional tax-deductible contributions. This provides you with more certainty about your retirement income.
– Deductible fees: Annual IPP maintenance fees paid by the PC are deductible, unlike RRSPs.
Note that IPP providers typically charge both an upfront set-up fee, and an annual maintenance fee. In addition, an actuarial valuation is required every three years to calculate the contribution limits, which must be factored in as another expense. Funds in an IPP are locked-in until retirement and should be viewed as a long-term retirement asset. Your PC also has an annual contractual obligation to fund the IPP, increasing your PC’s cash flow requirements. Income splitting is not available in an IPP unless your spouse is an employee of the PC.
Your saving strategy can involve a combination of approaches, so discussing the right choice and mix for your circumstances with your financial advisors is an important part of the road trip.
This article was prepared by David Chong Yen, CPA, CA, CFP and Louise Wong, CPA, CA, TEP of DCY Professional Corporation Chartered Accountants who are tax specialists and have been advising dentists for decades. Additional information can be obtained by phone (416) 510-8888, fax (416) 510-2699, or e-mail firstname.lastname@example.org / email@example.com. Visit our website at www.dcy.ca. This article is intended to present tax saving and planning ideas, and is not intended to replace professional advice.