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Registered tax accounts – explained!

January 12, 2012

There are many kinds of investments accounts. These accounts are designed to help with various stages of life. I’ll explain four major types of accounts:
1) Tax-Free Savings Account (TFSA)
2) Registered Retirement Savings Plan (RRSP)
3) Registered Education Savings Plan (RESP)
4) Registered Retirement Income Fund (RRIF)

1) Tax-Free Savings Account (TFSA)
The TFSA was introduced in 2009 to Canadians 18 and over. This flexible account will enable you to accumulate tax-sheltered investment income and capital gains. Depending on your needs, a TFSA can be used to save for your retirement, to finance your short- or medium-term projects (e.g., buying a house or car, renovating or taking a sabbatical) or simply to build up your savings.
Here’s how it works:
– Individuals can contribute up to $5,000 per year to a TFSA
– Contributions are not deductible for tax purposes (ie, contributing to a TFSA does not reduce your taxes like an RRSP – discussed below)
– Investment income earned in a TFSA is not taxed, even when withdrawn (investment income is typically taxable when generated outside special accounts)
– Unused contribution room can be carried forward to future years (you don’t have to contribute, but your maximum contribution space will grow)
– Funds can be withdrawn from a TFSA at any time for any purpose (again, not like an RRSP)
– Withdrawn funds can be re-contributed without reducing the contribution room (however, re-contributions must be made no earlier than the beginning of the next calendar year to avoid penalties on over-contributions)

2) Registered retirement savings plan account (RRSP)
An RRSP is the best tool to help you reduce your taxes during your high earning years, as it allows you to defer taxes until your retirement when your income and tax rates are generally lower. An RRSP is the best and most efficient way to build your retirement nest egg. Here’s how it works:
– You can contribute a certain amount to your RRSP based on prior year earned income. If you don’t earn income, you will not be able to contribute. Be sure not to over-contribute to avoid penalties on over-contributions.
– Contributions are fully deductible for tax purposes (ie, contributing to an RRSP will reduce your taxes)
– Investment income earned in an RRSP is not taxed, even when withdrawn (investment income is typically taxable when generated outside special accounts)
– Unused contribution room can be carried forward to future years (you don’t have to contribute, but your maximum contribution space will grow)
– Funds cannot be withdrawn from an RRSP without penalty except for the purchase of your first home and prescribed higher education. Even in these cases, the money must be repaid to avoid unwanted tax implications
– You can contribute to your RRSP until you turn 71 years of age, at which time you will need to convert your RRSP into an RRIF (see below) or other retirement account

3) Registered education savings plan (RESP)
The increase in the cost of getting an education makes it increasingly imperative to save for post-secondary studies and to start as early as possible through a self-directed RESP. The Canada Education Savings Grant (CESG) is deposited in the plan on top of your own annual contribution. The grant represents 20% of the first $2,500 of contributions, up to a maximum of $500 per year, per beneficiary. Additional grants can be received depending on the net family income. Here’s how it works:
– Your Canada Education Savings Grant (CESG) will be deposited in your account at the end of the month following the date when you contributed to the RESP. In addition, if eligible, you could benefit immediately from the $500 Canada Learning Bond (CLB), plus an additional $100 grant per year over a maximum of 15 years.
– You can opt for an individual or a family plan. With the individual plan, parents, grandparents, aunts, uncles and friends can contribute to a child’s RESP. With the family plan, the subscriber must be related by blood (parents, grandparents, great-grandparents, brothers and sisters) or by adoption to the beneficiary.
– You can invest up to a maximum lifetime contribution of $50,000 per year, per beneficiary.
– The maximum grant under the CESG program is $500 per year for a total lifetime amount of $7,200 per beneficiary.
– Contributions are not tax-deductible.
– Capital remains accessible at all times (CESG refund may be required).
– Capital and investment income remain tax-sheltered until the beneficiary begins post-secondary studies.

4) Registered retirement income fund (RRIF)
Like every other investor, you will need to convert your RRSP the year you turn 71. A natural continuation of the RRSP, the RRIF is one of the most sensible choices you can make. Besides allowing you to keep deferring taxes on your principal and interest until funds are withdrawn, it also lets you make monthly, quarterly, semi-annual or annual withdrawals of retirement income. It’s up to you to choose the amount you want to withdraw, as long as you meet the government-required minimum payout. Here’s how it works:
– There is no age limit to open a RRIF account.
– You can reduce the annual payout by basing the calculations on the age of the younger spouse.
– You are entitled to make lump sum withdrawals from your RRIF account, which are then taxed as income in the year of their withdrawal.
– The RRIF offers spousal protection under which the amounts invested in the plan are rolled over to the surviving spouse’s RRSP or RRIF at the subscriber’s death.
– Transferring an RRSP to a RRIF does not change your investments, your interest rates or your maturities.

The above accounts can be effectively utilized as part of your tax plan. Please note that the above discussion is not meant to be relied upon and that a discussion of your individual circumstances is strongly urged. I welcome any questions or comments on this or any other topic of interest.

Danny
danielydiamond@gmail.com
416 222 5555

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