17.5 Tax Planning Strategies, Pension Plans & the RDSP
Key Takeaways
Tax planning uses three main ideas: defer tax, split income with lower-taxed family members, and convert income into more lightly taxed forms.
Income earned on money given or lent to a spouse is attributed back to the giver; for minor children, interest and dividends are attributed but capital gains are not.
A prescribed-rate loan avoids attribution if interest is charged at the prescribed rate and paid by January 30 of the following year.
Up to 50% of eligible pension income can be split with a spouse, and donating listed securities in kind eliminates tax on the capital gain.
RDSPs attract Canada Disability Savings Grants of up to $3,500 a year ($70,000 lifetime) and Bonds of up to $1,000 a year ($20,000 lifetime).
Tax planning means arranging affairs to pay no more tax than the law requires. It is legal, unlike tax evasion (hiding income or making false claims). Good planning also respects anti-avoidance rules, which the CRA can use against arrangements that abuse the Act.
Three Basic Strategies
| Strategy | Idea | Examples |
|---|---|---|
| Deferral | Pay tax later, letting money compound in the meantime | RRSPs, RPPs, holding growth assets instead of interest-paying assets |
| Income splitting | Shift income to family members in lower brackets | Spousal RRSPs, pension income splitting, prescribed-rate loans |
| Conversion | Earn income in a more lightly taxed form | Capital gains and Canadian dividends instead of interest |
The Attribution Rules
Without limits, a high earner could simply give investments to a spouse or child in a low bracket. The attribution rules prevent this:
- Spouse or common-law partner: if you give or lend money or property to your spouse, the income and capital gains it earns are generally attributed back to you and taxed in your hands.
- Minor children (under 18): interest and dividends on property you give or lend are attributed back to you, but capital gains are not. Investing gifts for children in growth assets therefore shifts some tax to the child.
Common Exceptions
- Prescribed-rate loans: lend money to a spouse at the CRA's prescribed interest rate in effect when the loan is made; the spouse must pay the interest by January 30 of each following year. Investment income above the interest is then taxed to the spouse.
- Fair market value sales: sell property to a spouse at fair market value for fair consideration and elect out of the spousal rollover.
- Second-generation income: income earned on income that was attributed is not itself attributed.
- TFSAs: giving a spouse money to contribute to their own TFSA does not cause attribution while the funds stay in the TFSA.
- Spousal RRSPs: withdrawals are taxed to the annuitant spouse once the three-year rule is met.
- Canada Child Benefit: CCB payments deposited into an account for the child are not subject to attribution.
Other Planning Techniques
- Pension income splitting: a taxpayer can allocate up to 50% of eligible pension income to a spouse or common-law partner on their returns. Lifetime pension payments from a registered pension plan qualify at any age; RRIF and annuity income generally qualify from age 65.
- CPP sharing: spouses receiving CPP can share their retirement pensions.
- Donating securities in kind: giving publicly listed securities directly to a registered charity eliminates tax on the capital gain and produces a donation receipt for the full fair market value.
- Interest deductibility: interest on money borrowed to earn income from a business or property (for example, to buy dividend-paying shares in a non-registered account) is generally deductible. Interest on money borrowed for an RRSP or TFSA, or for personal use, is not.
- Tax-loss selling: selling losing positions before year-end to offset realized gains, while watching the superficial loss rule and the settlement deadline (the trade must settle by December 31).
- Asset location: holding interest-paying assets in registered plans and Canadian dividend payers and growth stocks in taxable accounts.
Registered Pension Plans (RPPs)
An RPP is an employer-sponsored pension plan registered with the CRA.
| Defined benefit (DB) | Defined contribution (DC) | |
|---|---|---|
| Promise | A pension based on a formula (for example, 2% × years of service × average earnings) | A pension based on contributions plus investment returns |
| Who bears investment risk | The employer | The employee |
| Contributions | Employee contributions are deductible; employer funds the shortfall | Employer and employee contribute set amounts, both deductible within limits |
Membership in an RPP or a deferred profit sharing plan creates a pension adjustment (PA) that reduces the member's RRSP room, so members of rich pension plans have less RRSP room than people without pensions.
Registered Disability Savings Plans (RDSPs)
An RDSP helps people who qualify for the disability tax credit save for the long term.
- Contributions: not deductible; lifetime limit of $200,000 per beneficiary; no annual limit.
- Canada Disability Savings Grant (CDSG): matching grants of 100% to 300% of contributions, depending on family income, up to $3,500 a year and $70,000 over the beneficiary's lifetime.
- Canada Disability Savings Bond (CDSB): up to $1,000 a year for lower-income beneficiaries, with no contribution required, to a lifetime maximum of $20,000.
- Grants and bonds are paid until the end of the year the beneficiary turns 49.
- Holdback rule: if the plan is terminated or withdrawals are made, grants and bonds received in the previous 10 years generally must be repaid.
- Withdrawals: contributions come out tax-free; grants, bonds and investment growth are taxable to the beneficiary, usually at low rates.
A high-income parent gives $50,000 to her 12-year-old son, which is invested in a growth fund. During the year it pays $1,000 of dividends and the son later realizes a $5,000 capital gain. How are these amounts taxed?
The capital gain is attributed to the parent, but the dividends are taxed to the son
The $1,000 of dividends is attributed to the parent, but the $5,000 capital gain is taxed to the son
Both are taxed to the son
Both are attributed to the parent
A high earner lends $200,000 to her lower-income spouse to invest. Which arrangement avoids attribution of the investment income?
A loan documented with a promissory note but with no interest charged
A prescribed-rate loan, with interest paid by January 30 each year
A gift of the money instead of a loan
An interest-free loan repaid within five years
A parent contributes $1,500 this year to an RDSP for a child who qualifies for the disability tax credit, and the family qualifies for the maximum matching rate. Which statement is correct?
RDSP contributions are deductible, like RRSP contributions
Grants never have to be repaid
Grants can reach $3,500 a year, to a lifetime maximum of $70,000
There is no lifetime contribution limit
A 66-year-old retiree receives $40,000 a year of RRIF income and her husband has little income. What strategy can lower their combined tax?
Withdrawing the entire RRIF in one year
Pension income splitting with her husband
Converting the RRIF back into an RRSP at 66
Transferring the RRIF to a TFSA tax-free
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