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[H&R Block Insight - January 2009]
[Understanding the Tax Free Savings Account]

In previous issues, we discussed the new Tax Free Savings Account, some of the rules, and differences between a TFSA and a RRSP. In this third installment, we highlight some additional key features of the new plan.

  • TFSAs are not geared towards retirement savings and amounts can be withdrawn at any age and for any purpose.
  • The RRSP Home Buyer's Plan (HBP) is specifically designed to allow first-time home buyers to use RRSP funds to make a deposit on a house. But funds withdrawn using the HBP must be paid back or bought back into income. TFSA have no such restrictions and are the preferred vehicle for savings towards a house.
  • The interest earned by your Tax Free Savings Account is not included in your earned income. This means that if you receive benefits such as the Child Tax Benefit or GST/HST, the interest earned by your TFSA does not affect the amount of the benefit you receive.
  • Amounts withdrawn from a TFSA are added back into your contribution room for the following year. So you can make withdrawals without losing your contribution room - unlike RRSPs - but it is brought forward into the next calendar year. For example, if you deposit $5,000 into a TFSA on January 1, 2009 and withdraw $2,000 on June 30, then you cannot make another deposit in 2009 to bring the account back to $5,000. However, you contribution limit for 2010 would be $7,000.
  • Interest paid on loans taken out to open a TFSA is not tax deductible.

 

[Understanding your Registered Retirement Income Fund]

According to recent statistics, many Canadians contribute to a Registered Retirement Savings Plans (RRSPs) to save for retirement. There are a number of options for RRSPs and how to save your "nest egg" but what happens when you actually need to access the funds and start living your retirement plans?

An RRSP must be either collapsed or converted into a form of retirement income by the end of the year in which you turn 71. Collapsing your RRSP means you withdraw all of the funds. Once you liquidate your RRSP and deposit the funds into a non-registered account like a savings account, you would be required to report the total withdrawal as your income on your tax return. Depending on the size of your RRSP, this could place you in a higher tax bracket. And you would be subject to a tax withholding amount at a higher tax rate at the time you withdrew the money.

Most taxpayers choose to convert their RRSPs into a form of retirement income. This can take the form of either an RRSP annuity or a Registered Retirement Income Fund (RRIF). Because of the greater flexibility, most taxpayers choose the RRIF option.

A Registered Retirement Income Fund (RRIF) is basically a continuation of your RRSP with the limitation that you can no longer contribute to it. Income earned by the RRIF continues to accumulate tax-free. However, you must withdraw a minimum amount each year. This is calculated by multiplying the RRIF's value at the beginning of the year by a factor that varies with the taxpayer's age.

In light of the current economic conditions, many RRIFs have declined significantly in value but the income payouts for this year were based on the plan's value as of January 1, 2008. There may also be a decrease in the minimum amount paid next year when the calculation is completed using the account values on January 1, 2009.

To help Canadians with RRIF holdings, there is a proposal by the Federal government to reduce the required minimum withdrawal. More details should be available in the New Year and we will provide updates in Insight.

This has been a year of great economic turmoil so it is important to understand the impacts on your retirement savings and plans. For more information on RRIFs and minimum withdrawals, please see www.hrblock.ca.

 

[Interest Expenses]

Many of our readers had questions about borrowing money for investment purposes. Since many of the questions are the same, we have compiled some information to help clarify when expenses incurred to borrow money for investments are deductible.

Interest on money borrowed to earn interest, dividend, and royalty income is deductible as an investment expense for tax purposes. This includes the following:

  • Interest paid during the year by an employee who has purchased Canada Savings Bonds through a payroll deduction plan, where the cost of the bonds is borrowed and repaid, with interest, through payroll deductions;
  • Interest paid on money borrowed to purchase stocks, bonds and other securities including interest paid to a securities broker unless the purchase is of stock in a corporation that has a stated policy not to pay dividends; and
  • Interest paid on money borrowed to earn investment income from foreign sources.

If your borrowing meets one of the above criteria, then you will need to report the interest you paid as an expense on the Schedule 4 form.

If you borrow money to contribute to your Registered Retirement Savings Plan (RRSP), the interest is not deductible.

For taxpayers who decide to borrow money from a family member for investment purposes, you can claim the interest if you meet certain conditions.

  • there has to be an agreement of interest to be paid on the funds borrowed.
  • the interest rate charged must be similar to market rates.
  • the lender must claim the interest as income on their tax return.

And you must be prepared to prove the loan agreement and show periodic payments or the interest payments if the Canada Revenue Agency (CRA) asks for more information.