February 2016 Newsletter


What to do with an instalment reminder from the CRA

The early months of the new calendar year can feel like a never-ending series of bills and other financial obligations. Credit card bills from holiday spending, or perhaps a mid-winter vacation, are due or coming due. The RRSP deadline of February 29, 2016 is approaching, and the May 2, 2016 deadline for payment of any final balance of 2015 income taxes owed is not far behind.

As if that series of financial hits wasn’t enough, many Canadians must also contend with an instalment reminder received from the Canada Revenue Agency (CRA) around the middle of February. While many of those who receive such reminders are already familiar with the tax instalment process, that doesn’t make the reminder any more welcome. For others, the idea of paying taxes by instalment is unfamiliar and often puzzling.

For most Canadians, income taxes they owe are deducted by their employer from their paycheques and remitted to the CRA on their behalf. While that system is efficient, it’s also largely invisible to the individual employee/taxpayer. Consequently, taxpayers, especially the newly retired, are sometimes surprised to find that they must make arrangements to ensure that taxes are paid throughout the year, in order to avoid having a large tax balance owed when the return for 2015 is filed in the spring of 2016.

The instalment payment system is one way in which those taxes can be paid throughout the year. Generally, a taxpayer will receive an instalment reminder when deductions made at source (that is, deductions made by the payor and remitted on the individual payee’s behalf to the CRA) are not made at all (as in the case of self-employment income) or are not sufficient to cover the individual’s income tax bill for the year (as often occurs with retirees, especially the newly retired). However, no matter what kind of income one receives, or the reason that sufficient tax has not been deducted at source, the options available to a taxpayer who receives such a reminder are the same.

Canadian federal tax rules provide that a taxpayer may be required to pay income tax by instalments where the amount of tax which was or will be owed on filing is more than $3,000 for the current year (2016) and either of the two previous years (2014 or 2015). Essentially, the requirement to pay by instalments will be triggered where the amount of tax withheld from the taxpayer’s income is at least $3,000 less than their total tax liability for the current and either of the two previous years. Such instalment payments of tax are then due on March 15, June 15, September 15, and December 15 of each year.

An Instalment Reminder issued by the CRA in February 2016 will specify two amounts—one to be paid by March 15, and the other to be paid by June 15. Each of these amounts represents the Agency’s best estimate, based on the taxpayer’s return filed for the 2014 taxation year, of one quarter of the net tax will which be payable by the taxpayer for 2016. The taxpayer then has the following three options.

First, the taxpayer can pay the amounts specified on the Reminder, by the respective due dates of March 15 and June 15. A taxpayer who chooses this option can be certain that he or she will not face any interest or penalty charges, even if the amount paid turns out to be less than the taxes actually payable for the 2016 tax year. If the instalments paid turn out to be more than the taxpayer’s net tax liability for 2016, he or she will of course receive a refund on filing.

Second, the taxpayer can make instalment payments based on the amount of tax which was owed for the 2015 tax year. Where a taxpayer’s income has not changed significantly between 2015 and 2016, and his or her available deductions and credits remain the same, the likelihood is that total tax liability for 2016 will be slightly less than it was in 2015. That reduction in tax payable results from both the lowering (from 22% to 20.5%) of a federal individual income tax rate for 2016 and from the indexation of tax brackets and personal tax credit amounts.

Third, the taxpayer can estimate the amount of tax which he or she will owe for 2016 and can pay instalments based on that estimate. Where a taxpayer’s income will decrease from 2015 to 2016 and there will consequently be a reduction in tax payable, this option may be worth considering.

A taxpayer who elects to follow the second or third options outlined above will not face any interest or penalty charges where there is no tax payable when the return for the 2016 tax year is filed in the spring of 2017. However, should instalments paid have been late or insufficient, the CRA will impose interest charges, at rates which are higher than current commercial rates. (The rate charged for the first quarter of 2016—until March 31, 2016—is 5%.) As well, where interest charges are levied, such interest is compounded daily, meaning that on each successive day, interest is levied on the previous day’s interest. It’s also possible for the CRA to impose penalties, but this is done only where the amount of instalment interest charged for the year is more than $1,000.

Most Canadian taxpayers are understandably disinclined to pay their taxes any sooner than absolutely necessary. However, ignoring an Instalment Reminder is never in the taxpayer’s best interests. Those who don’t wish to have to involve themselves in the intricacies of tax calculations can simply pay the amounts specified in the Reminder. The more technical-minded (or those who want to ensure that they are paying no more than absolutely required, and are willing to take the risk of having to pay interest on any shortfall) can avail themselves of the second or third options outlined above.


Planning to avoid the OAS clawback

Millions of Canadians receive Old Age Security (OAS) benefits, meaning that millions of Canadians may be subject to the OAS “recovery tax” or, as it is more commonly referred to, the clawback. Unfortunately, very few Canadians are familiar with that tax or how it works, and even fewer incorporate the possibility of having to pay the tax into their retirement income planning. There are, however, strategies which allow taxpayers to minimize or avoid the OAS clawback in retirement.

For taxpayers who are not yet retired, the start of such planning (as it would be in any case) is to get a sense of what one’s income from all sources will be in retirement. Where the total amount of that income approaches the level at which the clawback could apply (for 2016, that income threshold is $73,756), it is necessary to consider some planning strategies. The overall goal of those strategies is to arrange the timing and character of income received in a way which keeps the total income figure each year below the OAS clawback threshold.

The first such strategy is to use tax-free savings accounts (TFSAs) to accumulate savings which will be tapped into in retirement. Amounts withdrawn from a registered retirement savings plan (RRSP) or registered retirement income fund (RRIF), or paid to a taxpayer in the form of an annuity are included in the total income figure used to calculate the clawback. Withdrawals from a TFSA are not. While no deduction is available for TFSA contributions, such as can be claimed for contributions to an RRSP, it may still be advisable to contribute to a TFSA rather than an RRSP. Depending on the taxpayer’s circumstances, it’s possible that the tax payable by forgoing a current deduction may be less than the combined effect of tax payable and loss of OAS benefits (and other federal and provincial credits) which would result from withdrawing those funds from an RRSP or RRIF after retirement.

Taxpayers who may be subject to the clawback should also carefully consider the age at which they want to begin receiving OAS and Canada Pension Plan benefits. It’s now possible to defer receipt of such benefits anytime up until the time the taxpayer turns 70 and the later the start date, the higher the annual benefit. The taxpayer should consider whether that higher benefit obtained from deferring the receipt of benefits (especially when combined with required withdrawals from RRSP savings which will begin at age 71) will push total annual income over the OAS clawback income threshold.

Other strategies will come into play once the taxpayer is retired and receiving OAS. Taxpayers who are over the age of 71 must withdraw income from their retirement savings at a prescribed rate. While those withdrawals will be included in income for purposes of the clawback, they can be contributed to a TFSA if not needed to meet current expenses. Once in the TFSA, any investment income earned by the funds will be sheltered both from income tax and from being counted for purposes of the clawback.

Taxpayers who are married and have private pension income (generally meaning income from an employer pension, an RRSP or RRIF or an annuity, but not government source pension income) may benefit from pension income splitting. Such pension income splitting allows the higher income spouse to reallocate up to 50% of such private pension income to his or her spouse, on a “notional” basis, meaning that no actual transfer of funds is required. The transferred income is then taxed in the hands of the lower income spouse and counts as that spouse’s income (and not that of the transferor) for purposes of the OAS clawback.

There are a lot of considerations which go into structuring income in retirement, and everyone’s financial and tax situation is different. That said, however, the overall goal for most taxpayers will be to create a relatively level flow of income from year to year, sufficient to meet current cash flow needs and maximize eligibility for available tax credits and benefits, but below the threshold at which those credits and benefits will be eroded or clawed back.


RRSPs and TFSAs – making the annual choice

Canadian taxpayers don’t need a calendar to know that the registered retirement savings plan (RRSP) contribution deadline is approaching — the glut of television, radio and internet ads which fill the airwaves and screens this time of year are reminder enough. And, while RRSP planning and retirement planning generally are best approached as an ongoing, year-round activity, it is true that an imminent deadline tends to focus the minds of taxpayers on such issues

This year, an RRSP contribution for 2015 can be made any time up to and including Monday February 29, 2016. The allowable current year contribution to be made by any individual for 2015 is equal to 18% of income earned in 2014, to a maximum contribution of $24,930. However, many if not most Canadian taxpayers have contribution “room” carried over from previous years, and such carryover amounts can also be added to the 2015 contribution amount and deducted from income for 2015 .

Every taxpayer who filed an income tax return for 2014 received a Notice of Assessment from the Canada Revenue Agency (CRA), and the total amount of one’s allowable RRSP contribution for 2015 (including any carryover amounts) can be found on page 2 of that Notice of Assessment. Taxpayers who didn’t keep or can’t find their Notice of Assessment can call the CRA individual enquiries line at 1-800-959-8281 to obtain that information. When making that call, it’s important to have a copy of the last return filed on hand, as the CRA representative who takes the call will request information from the return, as part of the Agency’s information security procedures. At a minimum, a taxpayer will be asked to provide his or her social insurance number, date of birth, and the figure which was entered on line 150 of the previous year’s tax return.

Any amount contributed to an RRSP for the 2015 tax year is deducted from income for that year and then is allowed to grow, tax-free, once it’s in the RRSP. It doesn’t matter how the funds in the RRSP are invested or what kind of investment income (interest income, dividend income, etc.) is earned by those funds— no tax is payable on such investment income as it accumulates. However, when a withdrawal is made from the RRSP, all amounts withdrawn, whether original contributions or investment income earned, are subject to tax.

While RRSPs have been around for a long time, a newer tax savings vehicle in the form of Tax Free Savings Accounts (TFSAs) became available to Canadians starting in 2009. TFSAs are, in many ways, the mirror image of RRSPs. No deduction from income is permitted for contributions made to a TFSA, but investment income earned within such a plan is not taxed as it is earned, and amounts withdrawn from a TFSA (whether original contributions or investment income earned) are received free of tax. As is the case with RRSPs, where a contribution is not made to a TFSA for a particular taxation year, the contribution amount is carried forward and may be contributed by the taxpayer in any future year. However, TFSAs have one feature which completely distinguishes them from RRSPs: where an amount is withdrawn from a TFSA, that amount is added to the taxpayer’s contribution room and may be re-contributed in any subsequent taxation year. Finally, while an RRSP contribution for 2015 must be made on or before February 29, 2016, there is no such deadline for TFSA contributions—such contributions for 2015 can be made at any time during 2015 or, given the very flexible carryforward rules which apply to such plans, at any time in the future.

There is also a new “wrinkle” to TFSA planning in 2016 since the maximum annual TFSA contribution has, for the first time, been reduced. When TFSAs were introduced in 2009, the maximum yearly contribution amount was set at $5,000. That limit was increased in 2013 and 2014, and nearly doubled for 2015. However, for 2016, the contribution limit returns to pre-2015 levels.

Overall, the list of annual contribution limits looks like this:

The annual TFSA dollar limit for the years 2009, 2010, 2011, and 2012 was $5,000.

The annual TFSA dollar limit for the years 2013 and 2014 was $5,500.

The annual TFSA dollar limit for 2015 was $10,000.

The annual TFSA dollar limit for 2016 is $5,500.

It’s understandable, given the frequent changes in TFSA contribution limits, to say nothing of the calculations required to deal with the re-contribution of withdrawn amounts, that taxpayers would be confused about just what their total current and carryforward contribution amount limit is at any given time. Fortunately, the CRA keeps track of that information, and information on one’s current overall limit can be obtained by calling the CRA’s individual income tax enquiries line at 1-800-959-8281.

A decision about making a contribution isn’t, and shouldn’t be, an either/or choice, as it’s perfectly possible for Canadians to contribute to both an RRSP and a TFSA in the same year. The financial and cash flow limitations faced by most Canadians, however, mean that making the maximum contribution to both kinds of plans in the same year just isn’t a realistic possibility. Where that’s the case, it’s necessary to decide which kind of contribution, or combination of contributions makes the most sense. As is almost always the case in tax planning, there is no one “right” answer for everyone and no “one-size-fits-all” solution. That said, there are some general considerations which may help in determining which savings/investment vehicle is preferable for a particular individual for 2015/16.

  • The minority of taxpayers working in the private sector who are members of registered pension plans (RPPs) will likely find the TFSA option particularly attractive. The maximum amount which can be contributed to an RRSP for the 2015 tax year is calculated as 18% of earned income for 2014, to a maximum contribution of $24,930. However, that maximum contribution is reduced, for members of RPPs, by the amount of benefits accrued during the year under the pension plan. Where the RPP is a particularly generous one, RRSP contribution room may be minimal, and a TFSA contribution the logical alternative.
  • For younger taxpayers, where the savings goal is short-term—for example, a down payment on a home or paying for next year’s vacation or a new car, the TFSA is clearly the better choice. While choosing to save through an RRSP will provide a deduction on that year’s return and, probably, a tax refund, tax will still have to be paid when the funds are withdrawn from the RRSP a year or two later. And, more significantly from a long-term point of view, using an RRSP in this way will eventually erode one’s ability to save for retirement, as RRSP contributions which are withdrawn from the plan cannot be replaced. While the amounts involved may seem small, the loss of compounding on even a small amount over 25 or 30 years can make a significant dent in one’s ability to save for retirement.
  • Taxpayers who are expecting their income to rise significantly within a few years (e.g., students in post-secondary or professional education or training programs) can save some tax by contributing to a TFSA while they are in school and their income (and therefore their tax rate) is low, allowing the funds to compound on a tax-free basis, and then withdrawing the funds tax-free once they’re working, when their tax rate will be higher. At that time, the withdrawn funds can be used to make an RRSP contribution, which will be deducted against income which would be taxed at the much higher rate, generating a tax savings. And, if a need for funds should arise in the meantime, a tax-free TFSA withdrawal can always be made.
  • For taxpayers aged 72 and older, the RRSP vs. TFSA question is simply irrelevant, as taxpayers who are older than 71 years of age cannot make RRSP contributions. Many of those taxpayers, however, have savings accumulated in a registered retirement income fund (RRIF) and are required to withdraw a specified percentage of funds from that RRIF each year. Particularly in cases where the required RRIF withdrawals exceed the RRIF holder’s current needs, that income can be contributed to a TFSA. While the RRIF withdrawals must be included in income and taxed in the year of withdrawal, transferring the funds to a TFSA will allow them to continue compounding free of tax and no additional tax will be payable when and if the funds are withdrawn. And, unlike RRIF or RRSP withdrawals, monies withdrawn in the future from a TFSA will not affect the planholder’s eligibility for Old Age Security benefits or for the federal age credit.
  • Lower income taxpayers who are in a position to put some money aside are likely better off using a TFSA for those savings. A major benefit of saving for retirement through an RRSP results from the assumption that one’s income—and therefore one’s tax rate—will be lower after retirement than it was before, meaning that a permanent tax savings will be achieved. Where that’s not the case—where there isn’t likely to be a great difference between pre- and post-retirement income—that benefit is lost. As well, lower income taxpayers who would otherwise be eligible for means-tested government benefits like the Guaranteed Income Supplement or tax credits like the GST credit or age credit could find that making withdrawals from an RRSP pushes their income to a level which reduces or eliminates eligibility for such benefits or credits. Since monies withdrawn from a TFSA are not included in income for the purpose of determining eligibility for any government benefits or tax credits, saving through a TFSA will ensure that receipt of such benefits is not put at risk.

There are, clearly, a number of factors, both present and future, to consider when deciding which savings vehicle best suits one’s circumstances. To meet the need for information in making that determination, the CRA has dedicated sections of its website to information about both TFSAs and RRSPs. That information can be found at www.cra-arc.gc.ca/tx/ndvdls/tpcs/tfsa-celi/menu-eng.html and www.cra-arc.gc.ca/tx/ndvdls/tpcs/rrsp-reer/rrsps-eng.html.


New mortgage financing rules to take effect February 15

As the time for the traditionally strong spring housing market approaches, the current state of Canadian real estate is on the minds of a lot of Canadians these days. It’s also a concern for Finance Canada, which has made a change to Canadian mortgage financing rules which will take effect on February 15, 2016, in time for that spring housing market.

For a number of reasons, Canada’s mortgage financing market never experienced the excesses which occurred in the United States, and which culminated in the mortgage and financial market meltdown in 2008-09. Nonetheless, the Canadian government was sufficiently concerned that it made a series of changes to the rules governing Canadian mortgage financing between 2008 and 2012. Those rules, all of which were aimed at ensuring that Canadians could actually afford the homes they wanted to buy, included the following:

  • increasing the minimum down payment to 5%;
  • decreasing the maximum amortization period to 25 years;
  • limiting the maximum insurable house price to below $1 million;
  • applying maximum debt service-to-income ratios; and
  • applying a mortgage rate stress test for mortgages with terms of less than 5 years or variable rates.

The latest change in mortgage financing rules, announced in December 2015, is more targeted in nature. Specifically, the change affects only homes sold for more than $500,000. Since the average price of a home sold in Canada in October 2015 through the Multiple Listing Service was $453,000, this latest change will likely have the greatest impact in major metropolitan markets, particularly Toronto and Vancouver.

While the minimum down payment for purchasing a home in Canada is 5%, mortgage insurance is required where that down payment is less than 20% (The exception is homes purchased for $1 million or more, where the minimum down payment is 20%.) Such mortgage insurance is provided through a federal government agency, the Canada Mortgage and Housing Corporation, and backed by the federal government.

That new rule provides that the minimum down payment for new insured mortgages will increase from 5% to 10%, but only for the portion of the house price above $500,000. In other words, the minimum down payment on the first $500,000 paid for a home remains 5%, or $25,000. Once the home price is over that threshold, the required down payment effectively rises with increases in the price of the home.

The Department of Finance press release announcing the change can be found on the Finance website at www.fin.gc.ca/n15/15-088-eng.asp, and that press release includes a link to a Backgrounder providing additional details of mortgage financing rules in Canada.