November 1, 2007---RRSPs for Children

Greetings.

A couple of client questions prompted me to write the following about RRSP contributions for children.

Can a child contribute to an RRSP?

Yes, regardless of age, children can contribute to their own RRSP providing they have RRSP contribution room.

How does a child get RRSP contribution room?

Two things have to happen. A child must earn money and the child must file a tax return declaring that income. After filing, CRA [the federal tax people] will mail a Notice of Assessment. On the bottom of that notice will be the box that identifies any RRSP room for the next tax year. Note that the RRSP room for any year will be calculated as 18% of the child's earned income in the previous year.

Is it a good idea for a child to contribute to an RRSP?

While it's always good to take advantage of an RRSP [unless a person's income is perennially low], the timing has to be right for it to make sense for a child to contribute to an RRSP. If the plan is to put the money in only to take it out soon, that doesn't make sense. But it is a good idea for a child to contribute if the following applies-- [A] the investment is left in the RRSP until retirement, OR [B] the investment is left in the RRSP until a homebuyer's plan withdrawal to buy a house.

Comments about the above--in the case of option [A], this allow years of tax-free compounding and some control over when the money is taken out so as to minimize the tax rate on the withdrawal. It makes sense to make and deduct an RRSP contribution when income is relatively high [see my comments below], and take money out of the RRSP when income is lower since total income determines rate of tax. And, of course, since your RRSP investment should double about every 8 years, the sooner one starts, the bigger the nest egg! In the case of option [B], this allows the money to come out tax-free with repayment of the money you've borrowed from your RRSP over a maximum of 15 years.

One important point. When you file the child's tax return, after having made an RRSP contribution and with the contribution receipt in hand, complete Schedule 7 of the tax return to report that an RRSP contribution has been made. Attach a copy of the contribution receipt to the tax return. The Schedule 7 also allows you to tell the CRA whether you are going to deduct the RRSP contribution from income this year or in a future year. Remember that you don't have to deduct an RRSP contribution from income in the year that you made the contribution.* Now, why would you not deduct the child's contribution this year? The child probably is paying little or no tax. But the child will eventually grow up and make a good salary presumably. When that happens in the future, then is the time to deduct the contribution from income to maximize the tax refund. Between now and then, however long that is, you can wait to make the deduction.

In the meantime, the RRSP contribution made by the child will grow tax free. Finally, if your child is like mine, you may let them take any earnings they made and spend it on something they need or want. So who's going to provide the money for the RRSP contribution?. You might first want to teach the child about RRSPs and convince her to take 18% of what she earned and put it in her RRSP. Or you, a grandparent, uncle or aunt might feel inclined to contribute the 18% knowing that a $100 today can double six times to $6400 by the time the child retires. If you have any questions, please let me know.

Cheers!

Tom

Notes--*by filing the Schedule 7, every future Notice of Assessment will indicate on the bottom the total of any contributions made but not yet deducted from income. This will help you to remember to deduct the contribution at an appropriate time.

--there is a special procedure to follow when opening an RRSP for a minor child, so please consult your financial advisor should you decide to open one.

copyright 2007

Tom Buck, M. Ed. CFP
Certified Financial Planner
Assante Financial Management Ltd
email: tom.buck@ethicalfootprint.ca