Depending on your school board/district and collective bargaining agreement, you may be entitled to receive a gratuity at the beginning of your career, or upon retirement. We can help you come up with a financial plan to make the most of the gratuity you receive in order to minimize tax implications, and maximize interest potential through investing.
Avoid paying unnecessary tax by ‘rolling over’ your gratuity
Since gratuities are paid in a lump sum, they create extra taxable income, which is taxed at your marginal tax rate or top dollar earned. Fortunately, tax minimizing opportunities exist.
The Canada Revenue Agency (CRA) offers special tax treatment for eligible amounts of retirement gratuities. You may be allowed to directly transfer, or rollover $2,000 to an RRSP (above and beyond your RRSP contribution room) for every year or part-year of work you did for a publicly funded school board, prior to 1996. Even a single day of work is considered a “part-year”. This way, the portion you rollover is immediately tax-free.
We generally suggest you rollover as much of your gratuity as you can, thereby lowering the amount which will be taxed as incremental income. Thankfully, any amount which is exposed as taxable can be put towards your RRSP, as long as you have contribution room available. For example, if you received an eligible gratuity of $25,000, your school board will issue a T4 for that amount. Educators Financial Group will then offset that amount by issuing you a (RRSP) contribution receipt, which in effect ‘cancels out’ the gratuity amount as taxable income.
If you decide to rollover all or part of your gratuity into an RRSP, you will be sheltered from any immediate tax consequences. A rollover to an RRSP is considered in addition to – not instead of – your annual RRSP contribution room, which means that even if you have no contribution room left, you may still rollover. Another option is to accept your gratuity in cash and have your spouse contribute it to their RRSP. Though you will be the one taxed, your spouse can claim a tax deduction.
When should you withdraw from your RRSP?
Having transferred your gratuity to your RRSP, the next step is figuring out how to draw from it. One option is to maximize tax-deferred growth within your RRSP by waiting until the year you turn 71, at which point you’re required to convert the plan into a RRIF. Consider this: an investment of $30,000 earning an average annual rate of 7% could grow to more than $82,000 in 15 years.
An alternative option is to withdraw smaller amounts each year to level out your income and possibly stay in a lower tax bracket (especially before you begin receiving OAS and CPP).
The best solution for you will depend on your individual circumstances, such as your income needs, other income sources and your expected tax bracket for the current and future years.
How we can help
As you can see, gratuities, while advantageous, can be somewhat difficult to manoeuvre. With our expert knowledge of educator pension plans and gratuities, we can help you determine the ideal amount of gratuity you should transfer to an RRSP, as well as when and how to transfer funds during your retirement. While we don’t advise usually saving up all of your RRSP contribution room, we can certainly help you plan to leave a little extra room, which in turn will result in you paying fewer taxes. And don’t worry about all the tax documents and paperwork – we’ll help you with that too.
