T&T: RRSP Edition
P wrote: Gail, my husband was transferred to the U.S. and I’m just about to follow him. Since we will be U.S. residents, how’s that going to affect the money we have in RRSPs in Canada?
Gail says: The amount you’ve accumulated in the RRSP up to the date of your move is not subject to tax. But anything earned in the plan after the move would normally be subject to tax. You can elect to defer paying tax on current earnings of the plan until you withdraw them so you can take advantage of the foreign-tax-credit system. You’d have to figure out what portion of the plan represents earnings since leaving Canada, because these would be subject to tax. The U.S. Internal Revenue Service has a bulletin that explains how this calculation is made.
To elect to defer U.S. taxes, each year you have to attach a note with your U.S. return providing:
• the name and address of your RRSP trust/trustee
• the plan number
• the value of the plan on the day you became a U.S. resident
• the accumulated income for the year.
If you withdraw money from your RRSPs after changing your tax status from Canadian to U.S., you will have to pay a 25% withholding tax on lump-sum withdrawals and a 15% withholding tax on periodic withdrawals, say if you bought an annuity or registered retirement income fund (RRIF) and took out no more than twice the yearly minimum-withdrawal amount.
Since the tax on withdrawals after a change in residence is only 25%, if you anticipate needing the money you should change your residency status BEFORE you make a withdrawal.
Cross-border tax planning can be very complicated, so you’re best off seeking professional help before making a move.
Deena wrote: My daughter has been working part-time since she was 16. I know she has some RRSP contribution room. Would it make sense to make a contribution for her so that money can start growing from now? Suppose she wants to cash it in, can I stop her?
Gail says: Anyone with earned income in Canada can contribute to an RRSP, regardless of age. Whether a child is modeling, shoveling snow or babysitting, as long as the child files a tax return and has qualifying earned income, she can begin to contribute to an RRSP.
Go ahead and make the contribution but don’t claim the deduction since Baby Girl won’t get the biggest bang. Tell her to wait until she’s in a higher tax bracket. A lot of people don’t realize that the RRSP tax deduction that most people take in the year of contribution can be carried forward indefinitely, so that when she is working full-time, she will have deductions she can use to offset the tax on her higher income.
As for cashing in the plan? Hey, once you give it to her it’s her money, so that’s her prerogative. The best you can do is demonstrate the long-term cost of making the withdrawal, in terms of both the lost growth and the tax that will have to be paid. Even if the deduction hasn’t been claimed, the withdrawal is still considered income and, therefore, taxable.
Jack wrote: Could you please provide some information on self administered RRSP’s being used for our personal mortgage. We have enough money in our RRSP’s to cover our existing mortgage. Is this relatively easy to set up? What are the disadvantages/advantages?
Gail says: A self-directed mortgage is a mortgage, just like any other mortgage, except your RRSP holds the paper, and you make the payments back to the plan instead of lining the pockets of some third-party lender. In effect, you are borrowing cash from your RRSP which takes title to any Canadian real estate you own, or that’s owned by your immediate family, as security.
Not everyone benefits from a self-directed mortgage. You should have at least $150,000 left on your mortgage to make this work in the context of the fees involved. And just because you’re writing the mortgage from your own RRSP doesn’t mean you can make up the rules. CCRA has stringent rules you must follow: the interest you pay has to be comparable with current rates, the mortgage must be insured, and you must qualify for the mortgage just as you would if you had gone to a financial institution. Payments must be made on time or your RRSP will be forced to foreclose.
If you decide to go ahead with this, you’ll have to think about what you’re going to do with the mortgage payments trickling into the RRSP every month. If that money sits idle, your RRSP’s return will suffer. There’s also the issue of diversification. A large portion of your portfolio in an SDM would weight you too heavily on the fixed-income side. I’d recommend that you dollar cost averaging your monthly mortgage payments into an equity mutual fund.
Arranging for a mortgage from your RRSP is no small feat. You may very well have to meet with mortgage officers, your financial advisor, and your lawyer to get it all accomplished. While this isn’t a horrendously complex investment strategy, there is a dearth of information out there and most advisors don’t have a clue how to do it. You’ll have to hunt for a body who can lead you through the process smoothly.
One of the biggest drawbacks to the self-directed mortgage strategy is the associated fees. While some are on-going, others are one-time charges. Many people are put off by all the fees associated (mortgage set-up fee, legal fees, appraisal fees, and CMHC insurance premiums, along with the SD RRSP admin fee and the mortgage admin fee). You have to shop around for the financial institution that doesn’t do in your strategy with ridiculously high fees.