Friday, February 27, 2009

The Registered Disability Savings Plan – A great plan for Persons with Disabilities

This year’s RRSP contribution deadline of March 2nd is looming. Monday March 2nd, is also the deadline for the lesser known Registered Disability Savings Plan (RDSP.) While some are waffling on a RRSP contribution this year the RDSP is a must for most of those who are eligible.

The RDSP is a savings plan intended to help Canadians with a severe disability to save for their long-term security. Anyone who is Canadian, under 60 and a recipient of the Disability Tax Credit (DTC) is eligible for the RDSP.

What is the DTC?

The DTC is a non-refundable tax-credit that reduces the amount of tax that an individual with a severe and prolonged physical or mental impairment may have to pay. This tax credit is transferable to a supporting relative if Persons with Disabilities (PWD) have no income. It is estimated that approximately 1,000,000 Canadians could qualify for this tax credit but have not been certified.

Why was the RDSP introduced?

The financial situation for PWD might be surprising for people not familiar with the rules. A person receiving PWD benefits can receive disability support for dental and medical benefits, prescription drugs, transportation passes, access to the Disability Tax Credit and other benefits. However, if a PWD exceeds certain asset and income levels they can lose these benefits. For example a beneficiary who is receiving PWD benefits can only have a maximum of $3000 in the bank, one motor vehicle (a Chevette or a Porsche are equally acceptable) a primary residence, one or more trusts and specified assets.

Given these strict conditions it can be difficult for PWD to obtain financial security and independence. Most families offer “under the table support” in order to provide assistance and not disqualify the beneficiaries from government support.

Trusts are a great tool but are not very accessible for lower income PWD. In a PWD trust assets are held on behalf of the beneficiary but do not reduce government benefits if set up properly. This is a complicated area and only a few lawyers really know what they are doing. Setting up these trusts can require assets of at least $200,000. This is because the set up costs and fees for managing the trust assets are how lawyers derive income. These fees put trusts out of reach for most PWDs and their families. Enter the RDSP. First promised in the Federal budget of 2007, BMO became the first institution to offer it in November of 2008.

How much can a family contribute?

Family, friends and beneficiaries will be able to contribute up to a lifetime maximum of $200,000. Most people will want to contribute on a yearly basis, however, in order to maximize the Government Funded Benefits; the Canada Disability Savings Grant (CDSG) and the Canada Disability Savings Bond (CDSB.) Investment income earned in the plan accumulates tax free but the contributions are not tax deductible. Once funds are paid out of the RDSP, family contributions are not included in the beneficiary’s income for taxation, but the CDSGs, CDSBs and the investment income is taxed at the beneficiary’s personal tax rate. A great benefit of this plan is that RDSP payments, depending on your province, do not affect disability benefits, nor affect federal income tested benefits such as the Canada Child Tax Benefit, Old Age Security or Employment Insurance Benefits.

How much are the Government Funded Benefits?

The government will contribute both Canada Disability Savings Grants (CDSG) and Canada Disability Savings Bonds (CDSB) based on the family’s contribution and the family or the beneficiary’s net income.

· If the family’s income (if the beneficiary is under 18) or the adult (18 or over) beneficiary’s income is less than or equal to $75,769 the government will provide a CDSG of $3 for each $1 dollar contribution, for the first $500.
· The next $1000 family contribution is matched $2 to $1.
· So a $1500 family contribution will attract a matching government contribution of $3500. Surprisingly generous!
· If the family or beneficiary’s income is over $75,769 the government contribution is limited to $1 for each $1 contributed, up to $1000.

Depending on the family or PWD income the government may also contribute a CDSB annually into the RDSP.

· If your family income is $21,287 or less, a $1000 CDSB is contributed
· If your income is between $21,287 and $37,885 then the CDSB is a prorated amount based on a formula in the Canada Savings Act.
· For income over $37,885 no bond is paid.

All of the above income thresholds will be adjusted annually for inflation.

The lifetime limit for the CDSG is $70,000 and $20,000 for the CDSB. So this plan really favours someone who has 20 years to go until they turn 49, the last year in which the Government will provide benefits.

How can I access these funds?

If the beneficiary is 27 or older and if the family contribution is greater than the government bonds and grants (Assistance Holdback Amount) a Disability Assistance Payments can be withdrawn for any purpose. This situation is probably not likely for most people, though.

Most beneficiaries will start to receive annual Lifetime Disability Assistance Payments at a certain age, such as 40, 50 or 60. The CDSG and CDSB are only accessible after 10 years.
As an example take Sarah, a young adult with a learning/ mental disability who starts RDSP contributions at age 21. Sarah is the beneficiary but Sarah’s Mom is the Account Holder because Sarah has not been good with money in the past and has had a “boyfriend” and several multilevel marketers convince her to make poor financial decisions. Sarah has annual income of less than $21, 287. She contributes $100 per month from her part time job and her family contributes an additional $50 per month in lieu of birthday and Christmas presents. This total annual family contribution of $1800 attracts a matching CDSG of $3500 and a CDSB of $1000 for a total yearly contribution of $6300.

Let’s assume that Sarah and her mom invest for the long term with an asset mix of 50% Canadian equity and 50% fixed income. The expected return is 7.5% annually. Sarah will contribute for 20 years in order to maximize the government contributions of $90,000 and then start to receive payments from the plan at age 42 in order to improve her quality of life. This is also the age in which her parents are expected to pass away so Sarah’s sister will become the Account Holder to help manage the funds. There are lots of Will and Estate planning issues here for the family to consider but this is a simple example. The funds in the plan will have grown to $272, 820 by age 42 and will provide a yearly income of about $6700 at age 42, rising to about $10,000 at age 80. Again, assuming a return of 7.5%.

The actual payout will differ as it is based on a RRIF-like formula with the RDSP balance as the numerator and the life expectancy of 80 plus 3 years minus the current age of the beneficiary as the denominator. For example $272, 820 / [(80 + 3) – current age (42)} equals $6,654 in year one. Total payments over the life of the plan in this example are about $320,000.

If Sarah were to make no further payments from age 42 but keep the funds invested and only start withdrawals at the required withdrawal start age of 60, the funds will have grown to $1,002, 832 at a return of 7.5%. This provides an approximate payout of $25,000 at age 60 rising to about $36,000 at age 80.

These are rough calculations as its getting late and I’m on my second chardonnay but it illustrates the tremendous effects of the government contributions and the power of time and compounding investment returns.

Common issues with the plan

· New Canadians / children with no tax history – You need two years of tax history and for children under 18 you need to apply for the Child Tax Benefit in order to qualify. CRA seems to be lenient in this regard provided you promise to file tax returns for the previous year and apply right away for the CTB

· Beneficiaries over the age of 18 but not mentally competent – Often parents are not legal guardians of their adult children but want to be the account holder in order to be responsible for the funds. So far, CRA and the financial institutions are being lenient, basically accepting the word of the account holder that the adult beneficiary is mentally incompetent. Most likely this will change in the future with proof such as the copy of the DTC application or legal papers needed in order to prove mental incompetence.

· Little or no funds available to contribute given the short deadline – a loan for $1500 will maximize the Government Funded Benefits. This equates to a $125 payment per month plus interest over a year. This is not an issue for someone 28 years or younger but should be considered for someone older.

· The RDSP really favours the young. If you are 49 or older and cannot receive CDSGs and CDSBs, the decision to open an account is not clear cut. You have to consider “disability benefit reducing” saving plans such as RRSPs and the TFSA, compared to “non-disability benefit reducing” plans such as trusts and the RDSP. It can be quite complicated and really requires a full financial plan with additional support from a knowledgeable trust attorney and an accountant familiar with disability benefits. Most professionals are not up to date with these issues.

· The DTC has been criticized for the difficult and or unfair application process. Especially for those with a mental impairments.

· Investing too conservatively and not considering the effect of inflation. Most people are scared witless about the market and are funnelling their funds into GICs, if anything. Historically, stock market downturns of this magnitude have been followed by returns of 20% to 30% in the following years. The RDSP is a long term savings plan and should incorporate equity investments to create growth. The effect of a 4% return compared to a return of 7.5% is remarkable.

· Lack of knowledge and participation. At writing, only one financial institution is offering this plan. Kudos to BMO, but not many people are aware of this plan and virtually all financial advisors have not taken the time to study the plan. Hopefully this will change.

Sign me UP!

At the time of writing it is just BMO who offers the plan. You can reach their Investment Center at 1-800-665-7700.

1 comment: