Federal budget and your finances
* Editor's note: This is the second in a three part article on the 2008 Federal Budget
The new federal budget proposes to increase the life span of RESPs in three ways. First, contributions can now be made into the plan for 31 years, up from the previous 21, for individual and family plans. Second, the deadline for the plan termination has been extended from the 25th anniversary of the plan to the 35th anniversary. And third, the maximum age for the beneficiaries of a family plan for which contributions can be made has increased from 21 to 31.
Also, for beneficiaries of individual plans that qualify for the disability tax credit (DTC), contributions can now be made until the age of 35 and the plan must be terminated by the 40th anniversary of the plan. These changes are proposed to be effective for 2008 and subsequent taxation years.
The increased time limits provide flexibility for families wishing to help finance education for older children, those entering graduate school, those starting post-secondary education at a later age or where there is a greater age gap between beneficiaries in family plans.
There is one potential issue to be aware of that results from the increased time frame. Greater growth over the lifetime of the plan may result in a greater amount of excess funds in the plan at termination and the possibility of larger adverse tax consequences if the funds cannot all be used to finance educational needs.
Proposed changes to Educational Assistance Payments (EAPs) would provide a grace period to allow beneficiaries to receive EAPs for up to six months after they have ceased to be enrolled in a qualifying post-secondary program.
Payments must qualify under the rules for EAPs but could give students more flexible access to funds to pay late-occurring expenses and accommodate a wider range of personal circumstances.
The budget proposes to reduce the dividend gross-up factor and the federal dividend tax credit for eligible dividends (generally, dividends received from Canadian public corporations). This is in response to the reduction in corporate tax rates that was announced in the October 30, 2007, Economic Statement.
The dividend gross-up factor will be reduced from its current level of 45% to 44% in 2010, 41% in 2011, and 38% in 2012. The federal enhanced dividend tax credit rate will correspondingly be reduced from its current level of 19% to 18% in 2010, 16.5% in 2011, and 15% in 2012.
These changes will result in an increase in the effective federal tax rate on eligible dividends from 14.55% to 19.29% by 2012, assuming no further tax rate changes.
Consequently, in 2012 the federal tax rate on eligible dividends will almost equal the federal tax rate on non eligible dividends. The federal tax rate on non-eligible dividends is currently 19.59%.
These changes will affect owner-manager tax planning such as bonusing down to the small business limit or whether it is better to receive dividends vs. salaries. The analysis will be different for each province.
Note: The above information is based on the current and proposed tax law in effect as of the date of this article. The article is for information purposes only and should not be construed as offering tax advice. Individuals should consult with a qualified tax and legal advisor before taking any action based upon the information contained in this article.
* David Konning is an investment and retirement planner at Royal Bank. You can reach him by e-mail at David.Konning@rbc.com or by phone at 856-0406.
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