H&R Block Insight

The Department of Finance has announced a relaxation of the rules under which taxpayers may withdraw funds from federally regulated locked-in retirement plans. Under the new rules:

Individuals 55 or older with $22,450 or less in a locked-in plan will be able to wind up their accounts (in which case the withdrawal will be fully taxable) or transfer the funds to a regular RRSP or RRIF.
Individuals 55 or older with a Life Income Fund (LIF) will be entitled to a one-time transfer of up to 50% of their holdings into a regular RRSP or RRIF.
All individuals facing financial hardship may withdraw up to $22,450 a year regardless of age (in which case the withdrawal will be fully taxable). Financial hardship includes having a low income or high disability or medical-related costs. The $22,450 threshold will increase in future years with the average industrial wage.

Locked-in retirement plans are essentially no different from regular RRSPs or RRIFs except that the plan member's access to them is restricted. Taxpayers may have them if they were members of a company pension plan and terminated their employment before reaching retirement age. Their pension entitlement will then have been transferred to a locked-in plan.

It should be stressed that the rules announced by the Department of Finance only apply to federally regulated locked-in plans such as those sponsored by crown corporations and companies operating under federal charter. Most plans are regulated by the province in which the taxpayer resided when he or she terminated his employment. However, several provinces have also loosened access to locked-in plans in recent years.

1) What kind of investments are available for the Tax Free Savings Account (TFSA)?

A TFSA is generally allowed to hold the same investments as a Registered Retirement Savings Plan (RRSP). This would include mutual funds, publicly traded securities, GICs, bonds, and certain shares of small business corporations. Some of the investment choices offer more security than others. For example, publicly traded securities have more risks than a savings account.

2) When can I open a TFSA?

Canadian residents, 18 years and older, will be allowed to open a TFSA starting January 1, 2009.

3) Does the interest I earn on a TFSA counts as income when my tax credits are calculated?

No. Any interest, capital gains or dividends earned by a TFSA is not included in calculating your income for tax purposes. It will not affect any tax credits you may be eligible for such as Old Age Security, Child Tax Benefit or the GST/HST Credit. Contributions to the account are not deductible for tax purposes and withdrawals of contributions and earnings from the account are not taxable.

4) Should I contribute to my RRSP or a TFSA?

It depends on your situation and your saving goals. Are you expecting your income to increase or decrease in the next year? Are you going to be able to contribute the maximum amount to your RRSP? Are you planning to buy your first home and take advantage of the Home Buyers Plan? Do you need easy access to your money in case of emergencies? These are some of the questions that will help you to make the right choice.

A TFSA provides more flexibility if you need to withdraw money. There is no penalty for withdrawing funds at any time and you can still save up to $5,000 for the year. For example, if you had $5,000 in the account in January and then withdrew $2,000 in June, you could still re-deposit $2,000 by the end of the year with no penalty.

An RRSP is designed specifically to provide an income during retirement. Money deposited to an RRSP is deductible on personal income tax. This defers the tax implications until you retire and the money as well as the accrued interest is used as income. A withdrawal from an RRSP has tax implications and usually takes longer to withdraw funds. Any contributions to your RRSP are tax deductible.

5) Should I borrow to deposit into my TFSA?

The income earned inside a TFSA is non-taxable so you won't be able to write off any interest expense on funds borrowed for the purpose of investing in a TFSA. TFSA assets can be used as collateral, which may help investors obtain secured credit at more favourable rates.

In every issue of Insight, we ask readers to send us their tax questions. We welcome the opportunity to provide the tax information that is important to you.

Unfortunately, a technical issue has meant many of the emails sent to the Insight editor in the last few months were misdirected. We apologize for any questions that have gone unanswered during this time. We have resolved the technical issue and retrieved the questions.

Over the next couple of months, we will answer some of our "lost" questions in Insight as well as respond personally to others. We encourage you to keep sending your questions and look for the answers in Insight.