The Registered Disability Savings Plan (RDSP) can be life changing if used correctly. However, the account is also new, niche and complex. This often leads to both account holders and advisors misusing the account, resulting in incorrect financial projections or missed opportunities.
To other advisors, I describe the RDSP as a blend between the Registered Education Savings Plan (RESP) and a Registered Retirement Savings Plan/Registered Retirement Income Fund (RRSP/RRIF) that is available only to beneficiaries who qualify for the Disability Tax Credit (DTC).
The RDSP resembles the RESP in its ability to receive bonds and matching grants while the beneficiary is young. Withdrawals from the account are divided into a non-taxable portion and a taxable portion, like the RESP. Similar to an RRSP/RIF, the RDSP is intended to provide regular retirement income to a disabled beneficiary later in life. It mimics both in its value as a tax-shelter.
In speaking with clients and peers I have found most focus is given to the accumulation phase of using the account but very little is given to the decumulation phase, which can cause problems.
Here I’ll explore both phases, bringing to light the common misunderstandings and missed opportunities I’ve observed with clients and peers.
The headline feature of the RDSP is the grants the government provides to match funds contributed to the account. These grants vary based on income where total grants could be as much as 3x the contribution (a $500 contribution can attract $1,500 of grants) if the beneficiary’s family income is under $100,392 as of 2023. Grants are capped at $70,000 for the lifetime of a beneficiary – that’s a lot of government contributions!
The support isn’t limited to grants. Beneficiaries with incomes below $32,797 in 2023 can also receive $1,000 per year in the form of a Canada disability savings bond just for having the account open, no contributions required. The lifetime limit for bonds is $20,000.
A beneficiary with perpetually low income could receive $90,000 of grants and bonds while only contributing $30,000 to the account over 20 years:
These contributions often come as gifts from a parent, grandparent, or guardian. A minimum funded RDSP is a fantastic start but there are reasons a contributor would choose to add funds beyond the minimum to get grants.
Like both the RESP and the RRSP, investments are not taxed while they grow in the RDSP account. The account defers tax until withdrawals are made from the RDSP, just like the RESP and RRSP.
Though not as immediately notable as the grants and bonds, a well invested RDSP will result in the cumulative investment growth making up the lion’s share of the balance at retirement:
The RDSP is intended for the beneficiary of the account but often they do not fund the account themselves. The taxable portion of withdrawals are taxable to the beneficiary, regardless of where the contributions to the account came from.
Say a wealthy grandparent funds the RDSP on behalf of their disabled grandchild. Since the grandparent is in a high tax bracket and the beneficiary is in a low tax bracket, funding the RDSP can be a way to reduce the total lifetime tax paid across both parties. By moving funds from a grandparent’s taxable investment account to the RDSP they are moving funds from an account that would be taxed annually at high tax rates to one that will be tax-deferred and eventually taxed at lower rates.
Of course, this is also a change of ownership and control. The contributor would need to intend to gift the funds to the beneficiary in addition to the tax benefits of this strategy.
Provincial disability benefits may be a large proportion of a disabled person’s income. These benefits have asset tests to determine the benefit an individual is entitled to. An asset test looks at the total assets a beneficiary holds and if they are over a threshold, this can result in a reduction of benefits. Having savings can cost a beneficiary money!
The RDSP is exempt from the asset test in all provinces and territories. If you move funds from a non-exempt account to the RDSP this helps maximize benefits. In some provinces, funds removed from the RDSP are also exempt – this requires a clean paper-trail.
Regardless, transferring additional funds owned by the beneficiary to the RDSP not only has the previously described benefits of tax-deferred growth and matching grants but could also potentially maximize their benefits outside of the account.
Before everyone rushes to add extra funds to the RDSP, things get complicated when there isn’t a clear drop in tax rates between now and the future. It is possible a beneficiary could have high income today and at the time of withdrawals as eligibility for the disability tax credit is not tied to one’s ability to work (like disability insurance) but rather to the eligibility for a tax credit.
The RDSP provides a tax-deferral but when funds are withdrawn, the growth is taxed as income. This is regardless of if the growth was capital gains, dividends or interest. In Canada, capital gains and Canadian dividends are given favorable tax treatment vs other types of income. The question then becomes: is it better to pay tax at preferred rates each year or on 100% taxable income in the future?
Rather than being simple, this analysis depends on 3 variables:
We built a calculator at PWL to compare across these variables and integrate it into recommendations when planning where the next dollar should go for clients in this situation.
Picture loading a fridge with cans of pop. You start at the back and work your way to the front. When you take the first one to drink, you take from the front. The last one in is the first one out. This is referred to as LIFO (Last In First Out) in accounting.
Contributions to the RDSP are treated the same way, the last funds deposited that attract grants are the first funds that are taken out. This is crucial to understand to avoid repaying any of the grants attracted in the account.
It takes 10 years for grants in the RDSP to ‘vest’. If you make a deposit, receive grants, and make a withdrawal within 10 years of the deposit then the grants must be repaid. If you made 2 equal deposits, one 11 years ago and one 9 years ago, you could take the full amount out and only the grants on the most recent contribution would need to be repaid as the other half would be fully vested.
This can be confusing as RDSP account balances display the total funds in the account, both vested and unvested. It is crucial to note that the grants do not belong to the beneficiary until after they have been in the account for 10 years. This is why the RDSP can be funded up to age 49 and withdrawals are set to start after age 59, 10 years later.
At age 60 the beneficiary is required to take out Lifetime Disability Assistance Payments (LDAPs). These payments are like a hybrid between RIF payments and RESP withdrawals. Like a RIF, the beneficiary is required to remove an escalating percentage of the account with age. Like an RESP, the income will be made up of contributions (non-taxable), grants, bonds, rollovers and growth (taxable).
There is another way to remove funds from the RDSP: the Disability Assistance Payment (DAP). A DAP is a flexible, discretionary withdrawal from the RDSP that can be requested anytime. This is a very attractive feature and brings us to another benefit of making additional, non-matched, contributions to the RDSP. However, the rules around DAPs differ depending on where the funding of the RDSP came from. If the government grants and bonds exceed the total amount of contributions made to the RDSP, it is classified as a Primary Government-Assisted Plan (PGAP).
Grants + Bonds > Contributions = PGAP
The maximum lump-sum withdrawal, the maximum DAP, a beneficiary can take from a PGAP is capped at either 10% of the account balance at the start of the year or the year’s LDAP, whichever is higher. This can be inconvenient – a beneficiary may see the funds they need in the account but be unable to access them to cover large expenses!
If total private contributions exceed government contributions the account will not be a PGAP. With a non-PGAP, the beneficiary can make a DAP of any size. We wouldn’t recommend draining the entire account on day 1, as withdrawals are still subject to increasing personal tax rates. However, the added benefit of being able to withdraw however much the beneficiary wants, whenever the beneficiary needs, is a potential motivation to adding funds to the RDSP beyond what is required for maximum grants and growth.
Many investors tend to focus on the accumulation phase of the RDSP without a clear plan for withdrawals. If resources are available, additional funding can lead to a larger account through tax-deferred growth, greater provincial disability benefits and flexible withdrawals in retirement by avoiding classification as a PGAP. It is crucial to contrast these benefits with the potential higher tax rate on investment income and 10-year vesting schedule of contributions to the account.
PWL offers RDSP accounts and integrates them into financial planning projections for both beneficiaries and contributors. If you would like to schedule a call with a PWL planner, please send us a note at this link.
Information Source: RDSP Provider User Guide – Canada.ca
