Registered Retirement Savings Plan (RRSP) - maximize your refund
A RRSP is a type of Canadian account for holding savings and investment assets. Introduced in 1957, the RRSP's purpose is to promote savings for retirement by employees. It must comply with a variety of restrictions stipulated in the Canada Income Tax Act. Rules determine the maximum contributions, the timing of contributions, the claiming of the contribution tax credit, the assets allowed, and the eventual conversion to a Registered Retirement Income Fund (RRIF).
A few key points:
- Contributions (within allowable limits) can be deducted from your marginal tax rate when filing your income tax return. The best plan is to have this deduction during high income periods (at a higher percentage of marginal tax rate) and to take the money out of the plan during a lower income period (at a lower percentage of marginal tax rate). Usually in retirement but perhaps during a lay off or sabbatical.
- Interest or other forms of returns like capital gains and dividends earned inside the plan grow tax deferred. This means no taxes are paid on the return until the money is taken from the RRSP. This allows for the compounding effect to be much greater on your investments.
- Money can also be "borrowed" from your RRSP to purchase a first home or return to school. Of course rules do apply to these special options to avoid heavy taxation.
- Contributions can be made up to 60 days into the new calendar year and used against the previous year's income. Contributions can also be carried forward to a year when tax rates might be higher.
- Like all of Canada's registered plans, they work well when worked properly. Please make sure to consult a professional for advice.
- For those who are not blessed with a large pension plan through an employer, this is your most logical choice in saving for retirement. As a side note, it would be expected that the Canada Pension Plan will likely fall short of providing you with the needed retirement income.
Spousal Retirement Savings Plan (Spsl RSP) - set up by one spouse on behalf of the other.
The purpose of this type of plan is to try and balance the RRSP holdings between the two spouses. At retirement each can draw 50% of the household income required. This has significant tax advantages over one spouse drawing down 100% of the required household income.
When you set up a spousal plan you use the available contribution room of spouse A. The tax deduction is then given to spouse A, but the investments are put in the name of spouse B who then manages the RRSP. Upon retirement, spouse B withdraws the funds and pays the tax on these funds.
There is a very important consideration with spousal plans. You must cease any further contributions and leave the money in the spousal for a government specified period prior to redemption or the withdrawals will be taxed back in the hands of spouse A.
With the introduction of income splitting these plans are not as common, but they can still hold merit in certain circumstances. Perhaps one spouse is planning on taking some time off work in the future and would like to have the income from the plan at that time. There are a number of issues here to talk to your advisor about.
Registered Retirement Income Fund (RRIF) - say good bye to work
Well you have done all that work saving for retirement and now it is time to reap the rewards. The government makes it mandatory for people stop contributing to their RRSP and start taking the money out by a specified age. So that all of the money does not have to be taken out of your RRSP at the same time causing a huge tax penalty, the RRIF was created. This allows you to roll all of your current RRSP holdings into a RRIF.
By setting up a systematic withdrawal of your money from your RRIF you can spread the tax cost out over time. There is a certain minimum amount that must be taken out each year based on your age. You can also create a RIF at any age if you want to start to create the income stream from your RRSP.
It is important to note that upon the death of a spouse money can be rolled to a surviving spouse without tax consequence. However, single people may want to discuss the concept of a faster melt down of their RIF as any money still held in the RIF upon death does become fully taxable to the deceased. This area leads to a lot of estate planning strategies that are best discussed with a financial planner.
Registered Education Savings Plans (RESP) - 20% free money
Your children's education is no doubt one of your top priorities. Post-secondary education will make a big difference to your children's earning potential and standard of living. In fact, some would estimate that those with a bachelor degree earn one and a half times more than those with a high school degree alone. Yet, government funding to universities is dropping and post-secondary institutions are making up the shortfall by raising student fees. By setting aside education funds for your children now, you can ensure their opportunity to attend a trade school, college or university and ease the debt they may carry upon graduation.
An RESP is an effective way to maximize the money available to your children when they enrol in a post-secondary program. Although your contributions are not tax-deductible, money inside the plan will grow tax-free until it's withdrawn for your children. At that time, only the grant and growth portion of the withdrawal is taxed and it is taxed in the child's hands helping to minimize the overall taxation. In addition, the Government of Canada offers a 20% matching grant on the first $2500.00 deposited each year, per child to the account. Multiple plans can be set up for a child and anyone can set up a plan, however, special care is required to make sure the combined contribution amounts do not exceed the preset limits. You can set up plans for individual children or as a family plan. The family plan allows the money to be used by any family member (within certain limits) There are many rules associated with RESPs so you should consult an expert to make sure your plan is set up correctly and stays onside to the rules set out by the Government of Canada. You can set up a plan using a lump sum contribution or regular monthly amounts. Use the calculator on this website to see how much your investments could potentially grow.
TAX FREE SAVINGS ACCOUNT (TFSA) - finally tax free means tax free
The tax free savings account was created in 2009 and are available to Canadian residents age 18 and over. The government has set contribution levels for each calendar year. Unused contribution room carries forward. Like all Government plans there are rules governing the contributions and withdrawals. You should talk to an expert. Although the contributions are not tax deductible, the withdrawals are tax free. Your investment can grow tax free as well and any withdrawals create extra contribution room for the next calendar year. The investment options within these plans are limitless, talk to a Certified Financial Planner about all of your options.
Registered Disability Savings Plans (RDSP) - a plan to help for those with special considerations
The Registered Disability Savings Plans were set up by the Federal government and are a form of registered savings plans. Often people with disabilities are limited in their earning capacities and these plans allow money to be put aside on behalf of a disabled person either by themselves or by others. Only one plan can be created per disabled person. However, through special contribution letters anyone can contribute to the plan on behalf of that person. The plans have non tax deductible contribution limits, can receive some matching government grants, grow tax deferred and have time line rules that must be followed. These are a good option for family members who are concerned about building an investment fund to help provide for the long term financial support of someone with special considerations. As these plans have many rules associated with them, talking to a financial expert is a must.
TAXATION OF NON-REGISTERED INVESTMENTS - now how to make your money grow tax efficiently
All forms of investing can be non-registered. The terminology strictly means not registered as a plan through the government. Typical savings plans, term deposits, stocks, bonds, mutual funds, segregated funds and real-estate are but a few examples. The secret is to understand how to make your investing more tax efficient.
Once you have sat down with a financial planner and identified your risk tolerances, created your RRSP and TFSA, set up your RIP to maximize your contributions and are happily looking forward to retirement, what should you do with extra money? Yes I said extra money! Any money not allocated within a registered plan will be subject to taxation on an ongoing basis. It is important to understand how investments are taxed as it is the after tax return that is important to you.
Interest: as would be earned from a basic savings account, term deposit, savings bond or even a bond fund is added to your taxes at 100% of the earned amount and taxes are paid on the whole amount. This is really tough on building savings in a low interest rate environment. Consider you invest $10,000.00 at 2% interest for the year and earn $200.00 in interest. Now add that $200.00 to your income for the year and pay at a 33% tax rate your $200 just became $133.00.
Dividends: are a payment made to a stock holder from the "profits" of the company whose stock you hold. For eligible Canadian dividends, the government allows the use of a special formula when calculating how dividends are taxed. Without going in to a long explanation, suffice it to say you pay tax on only about 2/3rds of the dividends received. So using the example above if you earned $200.00 in dividends you would keep closer to $156.00.
Capital Gains: is what is earned after you take the selling price less your cost of the investment. This works with real-estate (that is not your personal residency), stocks, bonds or collectibles to name a few. The nice thing here is that Canada Revenue allows us to add 50%, not the full 100% of capital gains to our income when calculating taxes. So again with $200 in capital gains you would only include $100 on your tax return costing only $33.00 (33% tax rate) in taxes leaving you with a net gain of $ 167.00.
Pre-Authorized Contribution (PAC) or Regular Investment Plan (RIP) - is your "retirement in progress"
This is a system of convenience. It allows an investor to make regular contributions without putting a large lump sum of money into an investment plan all at once. Many mutual funds and segregated funds will allow investors to set up a RIP for as low as $50.00 per month. Once set up, the money is automatically withdrawn from the investor's bank account and invested in the pre-established funds. As there is no contract entered into, the amount can be increased or decreased (to within minimums or limits in the case of registered investments) at any time. The plans can be suspended for a specific period or halted at any time. This is an ideal system for all of your investing needs as it works by structuring your cash flow towards a positive result. Plans can be set up to come out monthly, weekly or to match pay days. This makes it very easy to learn to PAY YOURSELF FIRST. Call your advisor to get yourself going.
DOLLAR COST AVERAGING (DCA) - nervous? reduce the risk
Dollar cost averaging is described as the contribution of a fixed amount of money at a set regular interval to purchase a fluctuating priced item. This sounds complicated but it is really not. It is a proven strategy of investing especially when there is volatility in the markets or you are perhaps nervous that your investment choice may go down in value over the short term before heading back up in value.
To give an example: If you invest $ 100.00 every month into a fund, you will buy fewer shares when the prices are up and more shares when prices are down. The shares you bought when prices are down will provide better returns than those bought when prices are up. This averaging of high priced and low priced shares is the best known way to ride out the peaks and valleys associated with any market (stock, bond, and real-estate) type of investing that is subject to fluctuation.
This is primarily associated with the set up of a PAC/RIP when investing new money into a new investment. However, it can also be done with larger sums of money by placing the lump sum in a very low risk investment and then systematically transferring over some or all of the money to a riskier asset over a period of time to provide the potential for better returns.