TFSA or RSP?

September 7, 2016

With students heading back to school and all of us moving into a different type of routine, this is a great question to ask around the family dinner table. A blank stare means you just may have a lively discussion.

I remember when an individual could earn up to $100,000 of Capital Gains tax free! – that all ended in 1994 – those were the good old days! Of course I was in my 30’s paying a mortgage and raising two kids so I didn’t have much money to invest. So along comes the Tax Free Saving Account and the good old days are kind of coming back.

RSP and TFSA strategies offer significant tax benefits but from different perspectives. It’s important to understand the differences and use them accordingly.

A TFSA can be used a number of ways – while an RRSP is typically only for long term investments, or for first time home buyers (see why below) A self-directed TFSA can hold short and long term investments. Investments held in both an RRSP and a TFSA grow tax free. However, RRSP contributions receive a tax deduction and are taxed as income (100% taxable) when withdrawn. TFSA contributions do not receive any tax deduction at contribution but are withdrawn tax free.

The main advantage of an RRSP is the tax deduction of each contribution (up to an individuals’ maximum allowable) – and the long term tax free growth until withdrawal. This allows you to invest more (due to the tax refund) and have this amount growing in your account. You would not want to use an RRSP for short term savings because of the tax impact of a withdrawal (unless buying your first home – under the Home Buyers Program – see below!)

A TFSA is ideal for short to medium term savings – a car, a future trip, renovations or retirement etc. If the plan is to use funds in 1 to 3 years, there are investments providing returns better than savings accounts – if you can accept a little volatility. These investment returns can all be earned tax free in a TFSA. The decision to use a TFSA for long term savings (retirement) depends on a number of factors and variables – beyond the scope of a short article. However, it would not be wrong and would not limit future RRSP contributions to start saving in a TFSA and be able to decide later to move money to an RRSP when income and tax deductions would be greater.

If you were 18 in 2009 your maximum allowable contribution room in a TFSA is $46,500 this year and will grow by $5,500 each future year until a Federal Budget stops it. What’s also great is if you contributed the maximum $46,500 and earned a return of 3% and withdrew all of your original contribution and the growth – you could re-contribute the amount you withdrew back into your TFSA after the end of that calendar year!

A TFSA could be for short term or long term savings purposes and how you use yours depends on how much extra cash you have, how many years before you might start withdrawing, your sources of income in retirement and your tax rate at withdrawal.

Generally, if you expect your tax rate to be higher or about the same in retirement then maximizing contributions to a TFSA first before the RRSP is recommended. Investments in the TFSA should then be considered long term and growth oriented.

Couples that use retirement income splitting typically pay less tax in retirement even when drawing healthy incomes, so in most cases, maximizing an RSP for long term retirement income planning is still preferred. But any extra cash for short or long term savings should go into a TFSA.

However, if you are single before retirement and plan to stay that way, the TFSA needs to be considered for long term retirement income planning. When too much has been invested in an RSP or merged with a deceased spouse’s assets, no income splitting is possible and higher tax in retirement is possible – along with Old Age Security claw back!

If you have extra cash, no or little debt, have maxed out your RSP contributions then using a TFSA for short term financial goals or long term retirement income planning is recommended.

If you are saving for a car or any other short term financial goal (and don’t have a lot of extra cash) then using a TFSA may be ideal again – unless you are using the TFSA for your long term plan.

If you are a first time home buyer and saving for a down payment on a home and you have a lot of extra cash, then contributing to an RSP may be your best option as you get a tax deduction and can withdraw from the RSP without penalty – certain timing rules regarding contributions and withdrawals apply.

Under 30 somethings have a real opportunity to create a tax free retirement income. For most other than the professionals with high incomes, using a TFSA may be their best long term retirement planning strategy. Contributing $10,000/yr. for 30 yrs. at 8% grows to $950,000. Which, given expected inflation will not be enough to fund a 40 year retirement but it’s a great start! The disadvantage of a TFSA is it’s too easy to withdraw the hard earned savings.

RSP and TFSA investment accounts offer us another way to save tax – but using them correctly and with some thought is recommended. Each individual’s tax situation needs to be considered before a long term strategy is put in place.   A competent Financial Planner is always a good resource to help!

Richard WR Yasinski CFP

The Seven Key Areas of Financial Literacy

November 20, 2015

The following are seven key areas of basic money management skills every individual needs to strive to have a basic understanding in order to develop money confidence.  Encourage you to review each of these areas with respect to your own situation. If you need clarification specific to your situation, please give me a call.

Cash Management – How is a cash flow plan prepared for your household?

Cash Management is about knowing what comes in and what goes out.  This simple budget planning worksheet is a great way to get a handle on your income and expenses.

Tax Planning – What is your tax bracket and how does it impact your financial decisions? Bonus question – What are the three types of income and how are they taxed?

Our tax system is based on brackets of “bands” of income that is taxed at a higher rate.  The best way to understand your tax brackets and how you pay tax is to go to your full tax return and to schedule XX for your Federal tax and Schedule XX for your Provincial tax.  These schedules will tell you your marginal tax rate (MTR) which is the highest rate of tax you pay on the last dollar you earned.  The reason knowing your MTR is important is any additional income you earn (by triggering a capital gain or earning a bonus or severance etc.) will be taxed at this rate.

The three types of income and how they are taxed are: 1 – salary and interest @100% 2 – dividends @ 0 to 23% depending on other taxable income and type of dividend and 3 – Capital Gains are taxed at 50%

Risk Mgt – What’s the difference between T10 and permanent life insurance?

Term insurance is provided at a flat rate for the period of the term (i.e. 10 years) then renewed at a higher rate.  It’s ideal for periods when a lot of insurance is needed (i.e. young and with dependents)   Permanent life insurance remains in place for life and is provided at a flat rate for life. When a legacy gift is desired or for final tax to be paid on assets.

Credit Mgt – What’s a FICO score and what impacts this number?

FICO stands for “Fair, Isaac, and Company” and is one of the ways a creditor (bank, mobile phone company etc.) uses to decide the “credit worthy ness of a candidate.” There are two companies (Equifax and TransUnion that provide Canadians with their scores and to any creditor that has authority from an individual.  The kinds of things you would expect go into this score, loans paid or not paid, late bill payment etc.

Investment Planning – What are dividends and how would you get them?

Dividends are the excess profits businesses pay out to shareholders based on the number and type of shared owned.  Canadian Dividends can be received from both public and private companies and attract a lower tax rate then interest income and close to capital gains – depending on the type of dividend.  If you own shares of a company that pays dividends outside your RSP, you may receive them.   If you own dividend paying companies within your investment funds, these dividends may not be paid out but re-invested – but you still pay tax on those dividends!

Estate Planning – What happens if you die without a valid Will?

Dying without a Will means you die intestate.  Provincial laws then take over as does the Public Guardian’s office to manage your estate and decide how to distribute.  In Ontario, for example, assets owned individually go to surviving spouse and children and then parents and siblings and then extended family based on a specific percentage.

Retirement Income Planning – How much income will you need when you stop working and where will it come from?

Typically, a retiree will spend about the same amount of fixed living costs in retirement as was paid while working – which is why know your fixed costs is so important.  Beyond that, it depends on the activities planned for retirement.  As to sources of retirement income, we typically have a combination of private pensions, govt pensions, Canada Pension, Old Age Security, investment income and part time earnings.  Investment income can have very different tax impact which will impact marginal tax rates.

So, how did you do?  Were you comfortable with the questions and answers?  If not, let’s chat and help you get comfortable.

Richard WR Yasinski CFP

Back To Basics – Time Matters

October 16, 2015

This article was excerpted from The One Financial Habit That Can Change Your Life, by Robert Ironside and Edwin Au Yeung.  To help you and your 20 something children with some basic financial literacy, please share it!

When you are young, time is your friend. This is especially true when it comes to your money. Every year that you wait to start saving is a year that you can never recover. If you wait even a few years, until you can “afford to save some money”, the amount that you will have to save each year to achieve the same retirement wealth will grow dramatically.

Consider the following example:  if you were to save $1,000 per year from the age of 15 to 65 and you were able to invest the money to earn 10%, compounded annually, you would end up with a retirement wealth at the age of 65 of $1,163,909.

However, what if you were to wait only five years, until the age of 20, to start saving? Now you would have to save $1,619 per year to achieve the same retirement wealth at the age of 65.

What if you were to wait until the age of 30 to start saving? Now you need to save $4,294 a year to reach a retirement wealth of $1,163,909. Even worse, if you start saving at the age of 40, you need to save $11,835 a year or almost $1,000 per month, you would end up with a retirement wealth at the age of 65 of $1,163,909.

However, what if you were to wait only five years, until the age of 20, to start saving? Now you would have to save $1,619 per year to achieve the same retirement wealth at the age of 65.

What if you were to wait until the age of 30 to start saving? Now you need to save $4,294 a year to reach a retirement wealth of $1,163,909. Even worse, if you start saving at the age of 40, you need to save $11,835 a year or almost $1,000 per month, to achieve the same amount of retirement wealth.

Of course, there is another way to achieve the same retirement wealth and that is to search for a higher annually compounded rate of return. Unfortunately, as we search for higher yield, we almost always have to assume greater risk.  One way to mitigate risk is to control tax efficiency.  A tax and financial advisor working together with the investor can be a valuable resource.

The lesson is clear – time is your friend – and so is tax efficiency. Start saving as early as you can and long before you think you can or should!  This year end, maximizing investments in a TFSA is very important, to offset risk with tax free savings.

Financial Literacy Counts!