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A new policy idea – Tapping the wealth of RRSPs

It should go without saying that the system for charity regulation in Canada is extremely complex. Part of the reason for this situation is that the system is essentially part of a larger one dedicated to the imposition of an income tax. Typically this is seen in the registration of a charity with the Canada Revenue Agency so that the organization can issue charitable donation tax receipts. This relationship exists in other states as well so that certain policy ideas that arise outside our borders may be useful as policy ideas here. From time to time we raise these ideas to help contribute the policy discussion in Ottawa and so a new development in the US has gotten our attention. (Not to mention that when we do raise these ideas in articles we often get thank you acknowledgements from our readers for paying attention to such foreign developments).

The United States has a method of retirement saving somewhat similar to our RRSP / RRIF system called an Individual Retirement Account (IRA). Like the RRSP / RRIF system the IRA requires that a certain amount of the capital of the account be withdrawn each year so that eventually the entire amount is depleted. The American Taxpayer Relief Act of 2012 proposed that a distribution from an IRA directly to certain charities could count toward the required withdrawal amount each year.

In a different context the same proposals could be used in Canada. As it stands now the amounts withdrawn from an individual’s RRIF get added to the individual’s income in the year. Indeed, this makes sense as contributions to plan are deducted from tax as they are made and none of the income earned by those contributions is taxed until withdrawn. However, there are significant ramifications of the income inclusion as a result of the required withdrawal.

The most obvious of these is the tax payable on the amount withdrawn. However, more interesting is the effect on the Old Age Security (OAS) Pension amount. The OAS is available to all qualifying Canadian seniors but as the income of the senior rises the amount of the OAS they receive is clawed back. In 2014 if the recipient’s net income was over $71,592 they would repay 15 percent of the difference between their net income and the threshold amount up to a maximum of 100 percent of the OAS. So as income is taken from the RRIF and included in income the amount of OAS is actually reduced (potentially to zero). This is true even if the recipient intended to donate the whole amount to charity.

That is where the American proposal comes into play. If adapted for Canada we could see a further incentive for people to donate to charity directly from their RRIF. Specifically, the Income Tax Act would have to be amended to allow that the distribution from a RRIF directly to a registered charity would count towards the required minimum RRIF withdrawal every year. One would also imagine that as the funds being distributed from the RRIF were never brought into income no donation receipt could be used from their donation.

The general impact of these amendments would be to allow for the owner of the RRIF to meet his or her withdrawal obligations and charitable intent without bringing into income and paying tax on the amount of the withdrawal. This would have the resulting effect that it would not reduce the OAS pension or any other income tested benefits. On the other hand, the government would be denied the ability to tax the income that is distributed from the RRIF and taken into income. But, assuming that the amounts would have been donated to charity in the first place the tax revenue would have been denied to the taxman anyways by virtue of the donation tax credit.

Of course, it is not unusual for seniors to donate large sums from their nest eggs. This is particularly true where the senior’s portfolio may have done better than they need to live on. But by law the banks withhold part of the RRIF payout and send it to the government to ensure that at least part of the taxes on the withdrawal are paid. Unfortunately, this means that even where the recipient had intended to donate 100 percent of the amount withdrawn to charity they may only have 70 percent of that amount. In order to ensure that the tax credits completely offset the tax payable on the 100 percent amount the donor would need to fund the other 30 percent from other sources. (And presumably repay that amount from refund of the amount remitted to the government by the bank for the payment of the taxes in the first place). Clearly, the easier and more efficient route is simply to allow the taxpayer to direct the payment of RRIF amounts directly to the charity and avoid the necessity of withholding in the first place. (Indeed the increased efficiency also leads to increased resources available for donation).

For those that do not deal with these matters on a regular basis it may seem a bit farfetched that someone claiming OAS would rather receive that pension than withdraw the larger amounts from their RRSP but there are many reasons why one would do this. First, the corollary of living on a fixed income is that many seniors also have relatively fixed expenses and do not necessarily need the additional pension income the RRIF may provide. Second, many baby boomers have done exceedingly well in their portfolios and have more than enough money outside of their RRSPs. Third, many people are quite interested in maximizing their OAS simply because it’s not their money. And finally, many seniors are interested in funding their charitable interests while they are still around to see it. We cannot see any valid reason to deny them.

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Drache Aptowitzer LLP

Tax and Charity Lawyers at Drache Aptowitzer LLP
Drache Aptowitzer LLP is one of Canada’s foremost experts in the law related to charities and non-profit organizations. Their team of bloggers is led by Adam Aptowitzer LLB. He is a lawyer practicing in the areas of charity and tax law. He is a member of both the bars of Alberta and Ontario. He has been speaking and writing on the topic of charity law for several years and been published in numerous publications including the Canadian Taxpayer, the Canadian Fundraiser and the Not-for-Profit News and has been cited as an expert in many publications including the National Post.Read more here
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