disability-coverage-egg

For clients who are beneficiaries of a registered disability savings plan (RDSP), losing the Disability Tax Credit (DTC) can result in a host of complications. Losing the credit could be due to the beneficiary’s improving health or could be the result of his no longer meeting the conditions for the credit.

While the former reason is cause for celebration, the latter can be avoidable. Advisors should make sure the disabled status of an individual is not temporary before opening an RDSP. If your client loses the DTC when an RDSP is already in place, however, here’s what to do.

(Note: if your client wants to contest the loss rather than take these steps, he or she could file a notice of objection. For more, read All about the disability tax credit and RDSPs: plan your 10 years.)

Closing the RDSP

Once an RDSP beneficiary becomes ineligible for the DTC, the RDSP must be closed within two years, and all grants and bonds paid into the RDSP over the past 10 years must be reimbursed—this is known as the holdback amount.

Grants and bonds paid prior to the past 10 years can be kept. However, all accumulated income will be taxed upon closure in the hands of the beneficiary.

To illustrate this, let’s use an example of a situation in which an RDSP beneficiary loses his DTC Jan. 1, 2021. The RDSP has accumulated income of $15,000, and grants worth $20,000 were paid between 2011 and 2020.

Due to the beneficiary’s loss of the DTC, this RDSP must be closed no later than Dec. 31, 2022, and the grants from 2011 to 2020 must be returned to the government. As well, the beneficiary must pay taxes on the accumulated income of $15,000.

How DTC eligibility loss affects RDSPs chart 1

Extension of closing period

There is a possibility that the RDSP in question can remain open for up to five years, but certain conditions must be met. The ineligible beneficiary must opt to keep the RDSP open  before Dec. 31 of the second consecutive year of DTC ineligibility, and:

  • an authorized medical practitioner must attest in writing that it is likely that the beneficiary will become eligible for the DTC again in the foreseeable future;
  • the beneficiary must have been eligible for the DTC the year immediately prior to the one when he was deemed ineligible;
  • the holder, which can be a different person than the beneficiary, must opt to keep the plan open; and
  • the issuer must inform Employment and Social Development Canada (ESDC) by submitting the appropriate transactions.

Over the five years that the plan remains open, no additional contributions can be made to the RDSP except transfers from the registered plan of a deceased individual of whom the beneficiary was a dependent. Consequently, over the five years, there will be no additional grants or bonds in the plan.

The choice to extend the RDSP open period to five years is particularly important where a notice of objection has been filed so that the beneficiary can become eligible for the DTC again, or, simply, if he wants to postpone taxation of the accumulated income. If the latter reason is the beneficiary’s main focus, withdrawals from the plan can be spread out over five years to stagger taxation.

If the beneficiary regains DTC eligibility within the five years, then he doesn’t have to close his RDSP. If that happens, everything gets reset (e.g., the holdback amount, contributions and grants.)

Using the above example, the beneficiary can choose to wait until Dec. 31, 2026 to close his RDSP, return the grants received and pay taxes on the accumulated income.
How DTC eligibility loss affects RDSPs chart 2

Death of an RDSP beneficiary

If a beneficiary dies, her RDSP must be closed no later than Dec. 31 of the year after death. Similar to when DTC eligibility is lost, grants and bonds for the past 10 years must be returned to the government. Accumulated income in the RDSP will be taxed in the deceased’s estate.

David Truong, Pl.fin, CFP, CIWM, M.Fisc, works as a senior consultant, expertise centre, at National Bank Private Banking 1859. He also teaches at McGill University.
Originally published on Advisor.ca
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