Background
The retirement primer provides general information on retirement planning. For brief explanations of investment, tax and retirement planning terms, consult the Glossary.Topics
- Net Worth
- Canada Pension Plan
- Old Age Security
- Defined Benefit Pension Plan
- Defined Contribution Pension Plan
- Annuities
- Registered Retirement Savings Plan
- Advantages of a spousal RRSP
- Locked-In RRSP and LIRA
- Registered Retirement Income Fund
- Life Income Fund
- Locked-in Retirement Income Fund
- Mortgage or RRSP
- Reverse Mortgage
- Registered Education Savings Plan
- Estate Planning
Net Worth
The net worth is a person's total assets minus total liabilities. Lending institutions require this information to approve credit. Net worth also is a measure of a person's financial well-being.From the balance of all assets and investments is deducted any amount of debt payable, such as unpaid income or property taxes, car loan, credit card balances, personal lines of credit, unpaid bills, or other loans, debt or obligations.
Canada Pension Plan
The Canada Pension Plan or CPP is a contributory, earnings-related social insurance program. It provides benefits to contributors on retirement, disability and death. The CPP applies throughout Canada except in Québec where a similar program, the Québec Pension Plan (or QPP), is in force. The two programs are coordinated under agreements between the two governments.The program covers virtually all employed and self-employed persons in Canada (except in Québec where the QPP applies) who are between the ages of 18 and 70 and who earn more than a minimum level of earnings in a calendar year.
The CPP is financed through contributions from employees, employers and self-employed persons, as well as investment earnings from the Canada Pension Plan Fund. Starting in 1998, a new CPP Investment Board will invest all new contributions in capital markets to achieve a better return.
Human Resources Development Canada administers the Canada Pension Plan through a network of Human Resource Centers of Canada located in principal cities and towns across the country.
Related topics:
- CPP contributions
- CPP death benefit
- CPP disability pension
- CPP retirement pension
- CPP surviving spouse's pension
Old Age Security
Old Age Security or OAS is a social insurance program that provides a basic level of pension income, on application, to anyone age 65 or over who meets residence requirements. OAS is financed from the general tax revenues of the Federal Government. All benefits under OAS are adjusted quarterly each year in line with rises in the cost of living as measured by the Consumer Price Index.Persons that are Canadian residents must include the basic Old Age Security pension in their taxable income. Persons that reside outside Canada are subject to tax withholding on their basic Old Age Security pension. The usual rate of withholding tax is 25%. However, persons that live in countries with which Canada has concluded a tax treaty that specifies a rate of withholding lower than 25% are only subject to that lower rate.
A minimum of 10 years of Canadian residency after reaching age 18 is required to receive an Old Age Security pension in Canada. To receive OAS outside the country, a person must have lived in Canada for a minimum of 20 years.
The amount of a person's pension is determined by how long he or she has lived in Canada. A person who has lived in Canada, after reaching age 18, for periods that total at least 40 years will qualify for a full OAS pension. A person that cannot meet the requirements for the full OAS pension may qualify for a partial pension. A partial pension is earned at the rate of 1/40th of the full monthly pension for each complete year of residence in Canada after reaching age 18.
The amount of Old Age Security pension paid to persons with high incomes is reduced through a recovery provision of the Income Tax Act. The tax recovery applies to persons whose total income exceeds a threshold adjuted annually by the Government. For every dollar of income above this limit, the amount of basic Old Age Security pension reduces by 15¢.
Defined Benefit Pension Plan
A defined benefit pension plan is a registered pension plan that guarantees the employee a certain income at retirement, based on a formula that usually takes into account earnings and years of service with the employer. The employer pays the amount required to provide the promised benefits, as recommended by an actuary who assesses the pension fund's assets and liabilities. Some plans require that employees contribute a percentage of their earnings toward the cost of benefits.Defined Contribution Pension Plan
A defined contribution, or money purchase, pension plan is an a registered pension plan in which each employee holds an account where employee contributions, employer contribution made on behalf of the employee, and investment income accumulate without tax until retirement. Employer and employee contributions are usually based on a percentage of the employee's earnings. At retirement, the balance of the account is used to purchase an annuity or transferred to a life income fund. The level of income provided during retirement depends on the performance of the investments held in the account.Annuity
An annuity is a contract entered upon with a life insurance company to provide periodic income for life. The purchase price of the annuity contract depends on the age of the annuitant, the benefit or survivor pension payable upon death to a beneficiary or spouse, and market rates of interest. The purchase price is lower when interest rates are high, because the amount of money paid to the insurer earns more interest, which is used to pay the monthly income.There are several types of annuities. Life annuities provide income for life and cease on death. A joint and last survivor annuity provides income for the lifetime of the primary annuitant, and upon death a percentage of the pension (such as 50%, 60% or 100%) continues to be paid to the spouse for the remainder of his or her lifetime.
Sometimes annuities are payable for a guaranteed period such as 5, 10 or 15 years. In such cases, the pension is paid for the first 5, 10 or 15 years, whether or not the annuitant is alive. After the expiry of the guarantee period, the pension is paid as long as the annuitant is alive and ceases upon his or her death.
An indexed annuity is an annuity under which payments increase gradually every year to keep up with inflation.
Registered Retirement Savings Plan
A registered retirement savings plan or RRSP is a personal savings plan registered with Revenue Canada in which contributions and investment earnings accumulate on a tax-deferred basis. Withdrawals from an RRSP account are taxed as income. By the end of the year in which the RRSP holder reaches age 71, the RRSP must be closed, converted to a registered retirement income fund, or used to purchase an annuity from a life insurance company.An RRSP holder may make contributions during the taxation year, or 60 days after the end of that year. Contributors who become age 71 during the year may contribute until December 31 of that year, but not beyond.
Related Topics:
- Annual RRSP dollar maximum
- Foreign content restrictions
- Notice of Assessment
- Past service pension adjustment
- Pension adjustment
- Pension adjustment reversal
- RRSP deduction limit
- Registered retirement income fund
- Unclaimed RRSP contribution
- Unused RRSP deduction limit
Advantages of a spousal RRSP
A spousal RRSP is an RRSP to which a spouse makes contributions on behalf of the other spouse. Spousal RRSP contributions are useful for couples that want to save taxes during retirement. It allows drawing smaller amounts from the spouses' respective plans, instead of one spouse drawing a larger amount – and paying more income tax. This strategy is called income splitting.All or part of an RRSP contribution can be directed to the RRSP of a spouse, while maintaining the deductibility of the full amount in the hands of the contributor. The spouse's maximum RRSP deduction is unaffected by such contributions. However, Revenue Canada requires that withdrawals from the spousal RRSP during the current taxation year or preceding two years, be added to the contributing spouse's income in the year of withdrawal.
Contributions to the spouse's RRSP may be deposited until December 31 of the year in which the spouse becomes age 71, without regard to the age of the contributing spouse.
A spouse is defined as a person of the opposite sex who lives with and is engaged in a conjugal relationship for 12 or more months, or is the parent of natural or jointly adopted children.
Locked-In RRSP and LIRA
A locked-in RRSP is an RRSP with funds that have been transferred from a registered pension plan. Provincial legislation requires that these funds be locked-in, which means that no withdrawal is allowed other than for the purpose of paying retirement income. At the time of retirement, funds in a locked-in RRSP are used to purchase an annuity or converted to a life income fund. A locked-in RRSP is also referred to as a locked-in retirement account or LIRA in certain provinces.Registered Retirement Income Fund
A registered retirement income fund or RRIF is a withdrawal plan registered with Revenue Canada in which proceeds accumulated in an RRSP are used to provide an annual income. Investment earnings continue to accumulate on a tax-sheltered basis, but withdrawals are taxed as income.Revenue Canada prescribes an annual minimum withdrawal, which depends on the age and market value of the RRIF at the beginning of the year. Once a RRIF is opened, payments must commence in the following year.
There is no minimum age to set up a RRIF. An individual may hold several RRIFs with different financial institutions. The RRIF holder maintains controls of the investments. Funds held in a RRIF may also be used to purchase an annuity from a life insurance company.
Life Income Fund
A life income fund or LIF is a RRIF for funds originating from a locked-in RRSP or a registered pension plan. Revenue Canada prescribes an annual minimum withdrawal, which is based on age and the market value of the LIF at the beginning of the year. Provincial legislation requires that the annual withdrawal do not exceed a maximum based on age, the value of the LIF and long term interest rates.A LIF holder subject to Newfoundland and Labrador legislation continues to maintain control on the investments until the end of the year of the 80th birthday, at which time the balance held in the fund must be used to purchase an annuity from a life insurance company. A LIF subject to other pension legislation does not have to be converted to an annuity.
The minimum age at which a LIF may be set up depends on the provincial legislation that applies to the member of the pension plan who is transferring funds to a LIF. The person holding a LIF has control over all investment decisions. As with an RRSP, funds in a LIF are tax-sheltered until withdrawn.
Locked-in Retirement Income Fund
A locked-in retirement income fund or LRIF is similar to a life income fund, except that it does not require the purchase of an annuity when the holder of the LRIF reaches age 80. Persons whose locked-in RRSP is subject to Ontario or Alberta legislation have a choice to select either a life income fund or an LRIF at the time of retirement.Mortgage or RRSP
Making RRSP contributions before paying down a mortgage is usually the best strategy according to many financial experts. This is because the tax-sheltered investment growth of RRSP contributions plus the tax refund applied to reduce a mortgage may exceed slightly principal and interest charges saved from applying the same amount to the mortgage. However, this depends on the investment return on the RRSP and the mortgage rate that will apply over time.Similarly, borrowing from an RRSP for a down payment may or may not be preferable depending on the investment rates of return and mortgage rates over time. The federal government's Home Buyers Plan allows first-time buyers to borrow up to $20,000 from their RRSP on an interest and tax-free basis. The amount withdrawn must be repaid within 15 years.
One must look at the impact of the following two scenarios to determine whether one option is better than the other:
- Keep Money in RRSP: Amount accumulated in the RRSP plus investment earnings less taxes on withdrawal, less extra capital and interest payments.
- Borrow from RRSP: the after-tax accumulation of amounts repaid to the RRSP plus investment earnings, but none of the extra mortgage costs.
Reverse Mortgage
A reverse mortgage is a loan taken by a homeowner using as collateral a real estate property. It is called a "reverse mortgage" because rather than making payments on the property, the homeowner receives income from the property, based on the amount of the loan. The person who takes a reverse mortgage continues to own and occupy the home, and benefits from any increase in the equity of the property. The principal and interest are repaid by the estate, or upon sale of the property.A reverse mortgage allows persons with significant equity in their homes to use it as a source of income. It provides immediate access to cash, investment or annuity income or a combination thereof. Initial funds received through the program are tax-free and annuity income does not impact any senior income supplements currently available.
The amount of home equity that can be unlocked ranges between 10% and 45%, and depends on the age, gender and marital status of the applicant. An older person can access a higher percentage.
Certain types of properties, such as leasehold, co-ops and properties with larger acreage are not eligible.
Registered Education Savings Plan
A Registered Education Savings Plan or RESP is a government-sponsored plan that allows parents to contribute each year in an account that appreciates tax free for up to 21 years.Contributions are not tax deductible, but investment income is not subject to income tax. There is no limit on the amount of contribution per year for each beneficiary, as long as the cumulative amount does not exceed a lifetime maximum of $50,000 per beneficiary. The government provides a grant of 20% of contributions, up to a maximum of $500 per year for each beneficiary.
When the child starts post-secondary education, the RESP provides income to pay for tuition and related expenses, taxable at the rate applicable to the child's income, not the contributor. If the child does not pursue a post-secondary education, accumulated earnings can be transferred to the contributor's RRSP, if there is sufficient contribution room available. The maximum amount that can be transferred is $50,000. If RRSP contribution room is not available, income tax must be paid plus an additional 20% penalty tax. The RESP may only be tax sheltered for 26 years.
Estate Planning
Estate planning is the process of developing and maintaining a plan to preserve wealth and provide an orderly transfer of assets upon death to beneficiaries. There are several objectives to estate planning, such as minimizing or deferring taxes; providing liquidity to cover taxes and other liabilities; providing income to dependents; dividing the after-tax value of the estate; and minimizing probate fees and other costs related to settling the estate. An important issue is to implement various strategies while alive with a person's assets in order to minimize taxes at death.These various objectives are accomplished by maintaining a valid up-to-date will, which sets out the disposition of assets in accordance with the intentions of the deceased. Without a will, a person is said to die intestate, and assets are distributed in accordance with the laws of the province of residence, without regard to tax effectiveness.
The estate is responsible for covering liabilities, including taxes, in the year of death. If cash is not available, property may have to be sold. The value of a RRSP or RRIF will generally be fully taxable in the final tax return, unless the spouse is named as beneficiary.
On the date of death, any property is deemed sold at its market value. Thus, 50% of the deemed capital gain must be included in the deceased final tax return. To minimize such adverse consequences, one strategy is to ensure that the principal residence, bank accounts and other assets are jointly owned with the spouse. When one spouse dies, those assets pass to the surviving spouse without triggering a capital gains tax
.
When other capital assets, such as life insurance policies or an RRSP have a idd beneficiary, this result in a direct transfer of these assets to the beneficiary, bypassing the estate and avoiding probate fees on these assets.
There are several common tax-effective strategies. One is leaving the proceeds of the RRSP to the spouse to allow a tax-free rollover of the proceeds into the spouse's RRSP and continue deferring taxes. Another consists in leaving capital assets such as stocks or mutual funds to the spouse, so there is no deemed disposition. Giving money during the lifetime will reduce probate fees payable at death, which are based on the size of the estate. Purchasing life insurance to cover taxes payable at death is another technique used to preserve the value of the estate.
Other related considerations: Upon marriage, an existing will become invalid and must be rewritten. Legislation restricts investments by executors of money held in an estate, unless the will specifically provides for it.
