2018-01-10 00:00:00 Pro Accounting English Maximize your clients' savings for future disability and help them earn a fairly hefty return on investment with an RDSP. https://d1bkf7psx818ah.cloudfront.net/wp-content/uploads/2018/01/15075901/accountant-explains-government-RDSP-contributions.jpg How Does the Government Make Contributions to RDSPs?

How Does the Government Make Contributions to RDSPs?

4 min read

The government has an interest in protecting citizens who have become disabled to the point of being unable to work. In Canada, this is mostly done through registered disability savings plans. These plans are not state charity, nor do they put all of the burden of looking after disabled former workers on the workers themselves. Instead, RDSPs are a productive mix of public and private investment. If your client has one, they can deposit a fraction of their paycheque now, while still able to work, and receive matching (or more) funds from the government. In the unfortunate event they become disabled, their burden is made somewhat easier by the extra money in the plan. The way these plans get funded – and the potential benefits to ordinary and low-income Canadians – make them very attractive, not just to workers who might get disabled, but as investments in themselves.

Matching Funds Make Great Investments

RDSPs are run at the national level, though each province has its own quirks where it comes to administering them. Your client’s deposits to a plan may be the best investment in the financial world. Thanks to matching funds, deposits are immediately worth much more than the client paid into them, and the bond only increases in value with time. Certain limits and exclusions apply, but most Canadian workers are in a position to benefit from an RDSP.

Say your client is a low-income worker who made less than $91,831. For every $1 they invest in your RDSP, up to $500, the government deposits $3. This has the effect of quadrupling the investment overnight, from $500 to $2,000. On the next $1,000, the government deposits $2 per $1 contribution, up to $2,000 a year. If they deposit more, or if your client makes over $91,831 a year, the government matches each $1 contribution with another $1.

Tripling and quadrupling an investment isn’t the only way the government helps your client can save against a future disability. People who earn less than $25,356 a year can receive a straightforward donation of $1,000 a year, regardless of deposit activity. Thus, if a worker at a fast food restaurant in Saint John, where the average home price is around $170,000 as of 2018, did nothing but stay employed, the government gives him $1,000 a year in potential disability benefits. If he contributes $10 a week from his cheque, the total amount added to his RDSP that year is $3,000. If he deposits $1,500 a year, or $30 a week, his plan increases in value by $6,000 each year, up to a maximum value of $200,000.

Further Benefits at Tax Time

The usefulness of RDSPs doesn’t stop with free money from the government; there are tax benefits, too. Many means-tested government programs are subject to clawbacks at tax time. That is, the Canada Revenue Agency effectively adds the cost of some of your client’s benefits to their tax bill to manage the cost of the programs your client has taken advantage of. RDSPs are largely exempt from such clawbacks. In this way, RDSPs are similar to registered retirement savings plans, but there are some key differences.

RDSPs Versus RRSPs

RRSPs are straightforward retirement plans that let clients deduct money from their pre-tax income and lay it up against future withdrawals. RDSPs take their contributions from money left after paying taxes, so they don’t provide immediate tax relief in the year the money was earned. This actually comes in handy later. Because the client has already paid taxes on the money, taking the money back out of the RDSP doesn’t trigger a tax bill like it does with an RRSP, which hasn’t been taxed yet. Any earnings your client makes from the RDSP is considered investment income for tax purposes, and it can be taxed like any other capital gains.

While RRSPs have an annual contribution limit, RDSPs don’t. Your client can shovel money into the RDSP, though the funds are capped at a maximum of $200,000 in benefits at any given time. Your client can’t get around this limit, even if they’re married or if their parents had RDSPs of their own. Workers can actually roll the unused balance of one RDSP into another – say, when a parent dies and leaves the RDSP to a child, or when a spouse dies – without it counting against their own $200,000 limit.

To put this in perspective, imagine your client, your client’s spouse, and an elderly parent all have RDSPs. The spouse and parent are both enthusiastic about contributing to their plans, and each has hit the maximum $200,000 limit, while the client has been slacking and only has $100,000 saved. If the parent and spouse both died and left the client as their beneficiary, their $400,000 would be added to the client’s own RDSP, which would still have space for another $100,000 of personal contributions.

Caveats and the 10-Year Rule

RDSPs aren’t entirely free money. The money the government paid into your client’s plan in the last decade can be clawed back if:

  • The RDSP is terminated.
  • The RDSP changes into another type of plan, such as an RRSP.
  • The listed beneficiary stops being eligible for the Disability Tax Credit, and no extension is filed.
  • The plan is allowed to expire.
  • The client dies.

Despite the relatively relaxed exclusions relating to income and the possibility of having to repay the annual grants if something goes wrong, RDSPs have a lot of potential. If you can bring this remarkable form of contingency planning and investment to your clients’ attention, you could significantly increase the annual return you earn for them – especially for low-income clients.

Information may be abridged and therefore incomplete. This document/information does not constitute, and should not be considered a substitute for, legal or financial advice. Each financial situation is different, the advice provided is intended to be general. Please contact your financial or legal advisors for information specific to your situation.

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