Tuesday, May 6, 2008

Registered Disability Savings Plans

A parent of a disabled child has no bigger fear than the fear of what the child’s future will be after the death of the parent.

Of course, addressing this fear involves much more than just financial security for the child. Many adult disabled individuals will need someone – or a network of someones – to assist them in dealing with their disability. Nevertheless, finances will be important and for that reason, the Registered Disability Savings Plan (RDSP) is a welcome initiative.

An RDSP can be established for any resident of Canada who is under 59 years of age and who qualifies for the federal disability tax credit. There is no tax deduction for contributions to the plan, but investment income is earned in the plan on a tax-deferred basis (the income is not taxed until it is paid out of the plan). The benefit of this tax deferral is that it will allow a larger pool of funds to be accumulated for the financial security of the disabled individual. Subject to certain limits, contributions to the plan can also generate contributions from the federal government.

Anyone – friends or family -- can contribute to an RDSP for a specific individual. However, the person who contributes funds to an RDSP does not have any right to a return of those contributions. All amounts in the RDSP belong to the disabled individual and must be used for the benefit of the disabled individual. If the disabled individual dies while assets are still in the RDSP, the remaining RDSP assets (after payment of tax on the accumulated income) pass under the will of the disabled individual (or under intestacy laws, if the individual dies without a will). If the disability could result in a loss of testamentary capacity, the disabled individual should be encouraged to make a will as soon as the individual comes of age. The assets in the RDSP could potentially become a sizable asset.

Contributions to an RDSP are limited to $200,000 for any one disabled individual. Government contributions could add up to another $90,000, for a total capital base of $290,000. The actual financial value of any one RDSP will depend on the amount of tax-deferred income earned in the plan (less any fees incurred). The earlier the plan is started, the more potential there is for the building up of income. As there is no annual limit on contributions, one could theoretically inject $200,000 into a plan in order to maximize tax-deferred accumulations. However, timing considerations must be taken into account if there is a desire to maximize eligibility for the government grants.

An RDSP must start to pay out distributions in the year in which the disabled individual turns 60, although distributions can start earlier than age 60 if desired. Each distribution will be a mix of capital (not taxable) and accumulated income (taxable). Once annual distributions start, distributions must be paid each year and are subject to annual maximum limits based on life expectancy. Unless a medical practitioner certifies that a beneficiary has a shorter life expectancy, life expectancy will generally be based on tables published on the Canada Revenue Agency web site.

The above sets out a very brief overview of RDSP’s. Like any registered plan, an RDSP must be administered by a qualifying financial institution. Various institutions are currently developing and registering plan types, which should become available to the public later this year. Expect some variations within the statutory framework, and be careful to consider internal fees when evaluating any specific RDSP as any fees inside a plan will reduce the rate of net return. The goal, of course, is to have the capital generate enough income to provide a measure of financial security for the disabled individual.

-- Blair P. Dwyer

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The above article provides general commentary of an educational nature. It does not constitute advice for any specific person or any specific set of circumstances. Because circumstances vary, readers should consult professional advisers in order to obtain advice that is applicable to their specific circumstances.