TFSA vs. RRSP

Do you know which you’ll be contributing to this year? Your TFSA or RRSP… or maybe even both? Both TFSAs and RRSPs have great benefits, but if you are able to contribute to only one account, there are some specific pieces to watch out for.

Below is a great article from the Globe and Mail, which is an excerpt from The Wealthy Barber Returns: Significantly Older and Marginally Wiser, David Children Offers His Unique Perspectives on the World of Money by David Chilton. Copyright 2011 by David Barr Chilton, released September 2011.
“Remember when life was simple? You needed to save and invest for retirement, so you opened an RRSP and contributed as much as you could each year.

“Sure, the saving part was tough. And, of course, investing always had its challenges. But at least we all knew that an RRSP was the way to go.

“Everybody said so. The woman on TV. Your advisor. The Wealthy Barber guy. Even your know-nothin’ cousin.

“Then in 2009, along came the TFSA – totally fantastic savings account (or tax-free savings account).

“Hmm. Suddenly, a second option to house our retirement dollars. What to do?

“Many counsel us to put the maximum allowable amount into both our RRSPs and our TFSAs. For big-income, childless people living rent-free in their parents’ basements, that’s unquestionably solid advice.

“The rest of us are probably going to have to prioritize. We need to figure out which vehicle to focus on first.

“When you make an RRSP contribution, you get to deduct that amount from your taxable income. The investments inside your RRSP grow free of tax while they stay in the plan. Down the road, however, when money is withdrawn directly from the RRSP or from the registered retirement income fund (RRIF) or annuity to which the RRSP has been converted, it will be taxable.

“I’m alarmed by how many Canadians still don’t fully grasp that last point. Over and over again, I see net-worth statements where the full value of an individual’s RRSP is listed on the Assets side, but no corresponding eventual-tax-owing amount is recorded on the Liabilities side.

“You may have a $110,000 RRSP but you also have a partner – the government – waiting patiently for its share. Annoying, but true.

“In essence, a TFSA is the mirror image of an RRSP. You contribute after-tax dollars. In other words, you don’t get a deduction for your contribution. But once the money is in the plan, it not only grows free of tax, but also comes out free of tax. No tax ever! Fantastico!

“If you don’t love TFSAs, sorry, you’re nuts. But that doesn’t necessarily mean you should love them more than RRSPs.

“When the federal government introduced TFSAs, it created a chart similar to this one:

“I’ve spent almost two full books trying to avoid number-laden charts, but this simple, little table is quite illuminating. It neatly shows how a TFSA contribution is made with after-tax dollars, while withdrawals are tax-free. And an RRSP contribution is made with pre-tax dollars, while withdrawals are taxable. Yes, I’ve already explained that, but I thought it best to repeat.

“The chart also demonstrates that if your marginal tax rate at the time of the RRSP contribution is the same as at the time of the withdrawal, TFSAs and RRSPs work out equally well.

“Even the numerically challenged can understand that if the marginal tax rate is lower at the time of withdrawal than at the time of contribution, the RRSP will win. Conversely, if the marginal tax rate is higher at the time of withdrawal than at the time of contribution, the TFSA will win.

“Easy, right? You just need to guess your marginal tax rate at the time of potential withdrawal and base your decision on that.”

To continue reading the article, please click here: The Wealthy Barber explains: TFSA or RRSP?

Helpful Tips for Tax Refund Planning

A good way to think about the tax money that you may get back, is that it is not ‘free money’ or a ‘gift’ – rather it is your money that you put away in a forced savings plan throughout the course of the year. Framing it like this can sometimes help one to more rationally plan what to do with the cash once it reaches your bank account. Will you spend every last penny on a new wardrobe, invest it, or save it?

I came across an article by Alan Schram, an author with The Canadian Finance Blog, about this very topic! Alan’s article outlines 6 areas you can consider applying your saved funds to:

• Firstly, it may be wise to consider allotting a small amount to some ‘wants’. Putting 5-10% of your refund into an account for splurge shopping may mitigate the urge to blow larger amounts later on if you’re feeling down or having an ‘off’ day or week.
• Emergency Fund: either start one, or add to your existing fund. You never know what life will throw your way, so keeping some money in line will help you face unexpected financial hardships.
• Debt Repayment: putting your tax refund money towards a debt you have (a car loan, student loan, line of credit, etc), will substantially decrease the amount of interest you will pay on that debt in the long term.
• Savings: reach your savings goals faster with a little boost from your tax refund.
• Retirement: don’t just care for your present, care for your future by putting money aside for retirement.
• Vacation: this option is the last on the list. If you’ve taken care of all other aspects covered above, consider investing in a vacation!

You can read Alan’s full article here: What to do With Your Tax Refund

Disclaimer: This blog should be used for informational purposes only and should not replace the advice of a licensed financial professional.

Retirement Planning

Ah yes – the good old “Retirement Plan”…

Do you have a concrete retirement plan? Most of us don’t – even though we are kidding ourselves that we do because we put a few dollars away in an RRSP account with our bank each month. Or we may be relying on a company or corporate pension plan to take care of us and consider the matter dealt with. But will these ‘plans’ really bring us the income we expect when we need it later on?

The following article from Million Dollar Journey identifies and describes 4 Critical Mistakes in Retirement Planning – including not having a plan, having unrealistic projections, and more.

Click here to read the article – and happy planning

Disclaimer: This blog should be used for informational purposes only and should not replace the advice of a licensed financial professional.

All About Spousal RRSPs

Spousal RRSPs can be confusing, but also very beneficial to families who have a spouse who earns the bulk of the income. Some common questions are: Whose money is it? Where does it come from? What about the tax?

Here are the basics about these plans:

• A Spousal RRSP is just like a regular RRSP except that one person (the higher income earner in the higher tax bracket) contributes to the other person’s plan (and thereby gets the tax credit, while helping their spouse build up their retirement income). For instance, one spouse contributes to their own RRSP and also contributes to his or her spouses RRSP, but each spouse owns their own RRSP.
• A spouse may not contribute more than his or her annual limit to the two RRSPs combined. For example, if the contribution room is $18,000, s/he might contribute $9,000 to each RRSP.
• The recipient of the Spousal RRSP ‘owns’ the money that the contributor has contributed.
• The contributor is able to deduct the contribution from his or her income as the recipient will be taxed on the withdrawal.
• The recipient must wait until two years after the last contribution before s/he makes a withdrawal. If s/he does not, the money will count as taxable income for the contributor.

When does it make sense to set up a Spousal RRSP?

Typically, a Spousal RRSP only makes sense when one spouse makes a significantly higher income than the other does. By contributing to a Spousal RRSP, the contributor lowers his or her taxable income.

When it comes to retirement, the contributor will have less money in his or her RRSP than if s/he had contributed everything to his or her fund. This means his or her monthly retirement income will be lower. The net effect is to lower the overall tax burden for the couple both now and after retirement.

Have you contributed to a Spousal RRSP? Do you have any suggestions or stories to share? If you have questions about Spousal RRSPs or would like to hear about some Spousal RRSP investment options, we’d be happy to talk with you – email us at info@sharethewealth.ca.

Disclaimer: This blog should be used for informational purposes only and should not replace the advice of a licensed financial professional.

Income Splitting – Part II

If your family has a lop-sided income, where one spouse earns a significantly greater amount than the other, it is best to split the total income evenly between both spouses, and sometimes even children. Overall, spouses with lop-sided incomes pay more taxes than spouses who claim equal incomes.

In addition to our earlier saving strategies, here are two more tax strategies for you to implement:

It is possible to split pensions. When it comes time to retirement, splitting a pension will reduce the total amount of family taxation, as now two people will be claiming the income rather than just one.

A great way to split any amount of income, small or large, is the spousal loan strategy. Instead of giving money to the lower income earning spouse to invest, the higher income earner should loan the money to the spouse. The CRA’s current spousal loan rate is 1%, the lowest prescribed rate in CRA history; this allows the higher income earning spouse to loan money to the lower income earning spouse with an interest rate of only 1%. Any income earned or capital gains realized on the loaned money is able to be claimed by the lower income earning spouse, and will therefore be taxed at a lower amount than if claimed by the higher income earning spouse. For this strategy to be compliant with the CRA, money must be loaned at the CRA’s prescribed rate.

Income splitting allows the transfer of income from a high income earning spouse to a low income earning spouse, and therefore allows for the reduction of overall taxation on the family.

Disclaimer: This blog should be used for informational purposes only and should not replace the advice of a licensed financial professional.

Income Splitting

If your family has a lop-sided income, where one spouse earns a significantly greater amount than the other, it is best to split the total income evenly between both spouses, and sometimes even children. Overall, spouses with lop-sided incomes pay more taxes than spouses who claim equal incomes.

A B.C. family, with a sole income earner, making $100,000 annually, will pay approximately $23,075 in taxes. On the contrary, if this money is split between the two spouses, they will pay an approximate total of $16,610 in taxes. This family all of a sudden has an extra $6,465 annually.

To make your savings significant, here are a few tax strategies that you can implement:

You can set up a spousal RRSP. In this set-up, the high income earner is able to contribute to a spousal RRSP while at the same time claiming the contribution as a tax deduction. When it comes to retirement time, both spouses will have approximately the same amount of income, which will reduce the amount of income tax needing to be paid.

The tax free savings account is another great income splitting strategy. The higher income earning spouse is able to make payments into the lower income earning spouse’s tax free savings account, and any money earned is tax free. An added bonus with this strategy compared to the spousal RRSP is that when the lower income earning spouse withdraws his/her money from the account, he/she does not need to pay tax on the amount.

Income splitting allows the transfer of income from a high income earning spouse to a low income earning spouse, and therefore allows for the reduction of overall taxation on the family.  Check back here on Friday, January 22nd for the second half of this post, when we will discuss split pensions and the spousal loan strategy.

Disclaimer: This blog should be used for informational purposes only and should not replace the advice of a licensed financial professional.