Protecting your money against inflation

We are often asked our opinion on inflation and inflation protection products.  And as with most economic related questions, timing is really the key.   Is now a good or bad time to look at adding inflation protection products to your portfolio? Before we answer, let’s  look at what inflation is, and a few different investment options.

Inflation in Canada is based on the Consumer Price Index which has eight categories:

  • Food
  • Shelter
  • Household operations, furnishings and equipment
  • Clothing and footwear
  • Transportation
  • Health and personal care
  • Recreation, education and reading
  • Alcoholic beverages, and tobacco products.

Each of the above categories has a different weighting within the CPI.  As a simple illustration, food has a greater weighting over clothing and footwear, because most people spend more on food.

Let’s say in 2006 that Jack goes shopping for the day.  He picks up groceries, fills his truck up with gas, gets a haircut, and buys a new pair of shoes.  The entire shopping experience cost him $374.

In 2009 he went out and bought the identical groceries, put the same amount of litres in his gas tank, got another haircut, and another pair of shoes.  This time the total bill came to $412.

The change in the price of these goods can be boiled down to inflation.

In 2006 Jack was earning $63,200 annually, and in 2009 his income is expected to be $69,621.  In Jack’s case, his income kept pace with inflation.

Another case:

Charlie retired at age 65 in 2006 with a government pension and all of his savings in a simple savings account at the bank.  Overall inflation has been relatively low since he retired.  Recently he has been hearing a lot about inflation and is getting worried.  We explained to Charlie that CPI is used to index his company pension, CPP and OAS.  These parts of his income flow are protected.  The portion of his financial situation, exposed to inflation, is the $400,000 he has in the bank earning little to no interest.

If costs rise significantly in the future, the amount he has in the bank will purchase less than what it could purchase now.  One option Charlie has is to look at purchasing some investments that may better protect him, if he is willing to assume a little risk.

Charlie has specifically asked us about Real Return Bonds.  After all, he has read that bonds are less risky and RRBs protect against inflation.  In our opinion we do not feel RRB will be the best option for Charlie over the short term.  With the absence of inflation, RRBs function similarly and are influenced by the market very similar to long-term bonds.  In our last article, we discussed what happens to long-term bonds when yields rise – they decline in value.

If yields do rise as forecasted over the next year, we feel it will not be solely because of inflation.  We feel that if real yields rise, part of this will simply be based on the fact that we are at 50-year lows and the economy is recovering.  RRBs will likely trade similar to extremely long duration bonds and will be quite volatile.  Many investors are being told to buy RRBs because inflation will rise.  Sure, it will rise eventually, but we feel the potential for large losses exist based on the long duration associated with most of these investments.

Another possible outcome is that yields rise as a component of both inflation and real yields.  In this particular outcome, RRBs will likely outperform the nominal long bond of comparable term.  But it is also likely in that scenario that short-term bonds would outperform both!

To illustrate our point, one only has to look at some of the Real Return Bond products available.  In December 2008, many of these products hit a low and have posted nice returns since that date.  The returns have been positive although inflation has been negative.

What has caused the positive returns?  Interest rates have declined since last December causing a profit in most RRB products plus the demand for inflation protection products.

It would be extremely hard for the average retail investor to diversify by purchasing individual real return bonds.  These bonds are generally picked up in the institutional market.  A more practical way to obtain exposure to Real Return Bonds is to look at an investment such as iShares CDN Real Return Bond Index Fund (XRB).  This fund holds a basket of real return bonds and has a low management expense ratio (0.35%).

XRB has a current yield of 2.7 per cent.  To illustrate our point with long-term bonds, 98 per cent of the holdings within XRB have a maturity of ten years or greater.  The weighted average term is 21.23 years with a weighted average coupon of 3.62%.  We are at fifty-year lows when it comes to interest rates – they can only move up from current levels. If you have a short-term time horizon and an active strategy, we do not feel now is a good time for RRBs.

If an investor has a long-term time horizon and wishes to use a passive strategy (buy and hold) then RRBs generally make sense for a portion of a portfolio.  Typically, this type of portfolio would hold a flat percentage of their holdings within RRBs, such as five per cent.  In Jack’s case, with a $400,000 portfolio he would hold approximately $20,000.  We would not encourage overweighting RRBs.  As with other bonds, they are generally best held in a registered account, such as an RRSP or RRIF.   RRBs may help protect the purchasing power of a portion of your portfolio.  The key component that will impact performance is the change in interest rates.

For protection within non-registered accounts, we prefer holding a small portion in gold, agriculture, and energy common shares.  Several types of preferred shares also provide some inflation protection along with tax efficient dividend income suitable for taxable accounts.


If you’re over 65, a GIC alternative

Individual investors who have money invested in term deposits or Guaranteed Investment Certificates through a bank or credit union should also explore insurance contracts often referred to as Guaranteed Interest Annuities, or GIAs.

First off, answer the following questions:

  • What are the fees to sell my investments if I were to pass away before they mature?
  • Are my investments subject to probate fees?
  • If I were to pass away, how quickly could my beneficiaries receive these funds?  4)  What is the best way to structure my affairs to reduce estate costs?
  • Does the interest income I earn qualify for the pension income amount?
  • Am I able to split the interest income with my spouse?
  • Am I able to name a beneficiary for my non-registered term deposit or GICs?

By answering the above questions you will better understand why we feel there is a good alternative for some investors aged 65 and older.  Insurance products have benefits, especially when it comes to estate planning.  Insurance is useful to provide risk management, tax benefits, creditor protection, and the ability to name specific beneficiaries (even for non-registered accounts).  Probate fees may be avoided by naming beneficiaries as opposed to your estate.

Insurance companies offer very similar products to Guaranteed Investments Certificate; but come with some added benefits.  Collectively these products are often referred in the industry as Guaranteed Interest Annuity but each insurance company has a specific name for their products – Manulife’s are Guaranteed Interest Contract; Standard Life calls them Term Funds; and Canada Life has Guaranteed Interest Terms.

GIAs have benefits that term deposits and GICs do not offer and we will illustrate this comparison using Helen Stevenson, a woman who has been widowed.

Helen has a net worth of approximately $1 million split between her personal residence ($600,000) and non-registered bank GIC monthly pay portfolio ($400,000).   Helen is in her mid eighties and came to see us to prepare an estate plan.  She is in the process of selling her home and moving into an assisted living home.   In our estate plan for Helen she was surprised to learn that if she were to pass away today that her entire estate would be subject to probate fees.  We estimate probate fees alone to be approximately $14,000 as all investments, including personal residence, are currently flowing into her estate and subject to a fee of 1.4 per cent.     

Cost Savings:  GIAs are able to bypass the estate.  This will be a considerable cost savings for Helen through reduced fees for executor, probate, legal, and accounting, as well as other costs associated with a typical estate.  By converting her GICs to GIAs she would save $5,600 in probate alone; this does not include other possible savings.

Naming a Beneficiary:  The ability to designate a beneficiary allows you to control who receives the proceeds of your investments.  There is no fee to change beneficiaries, and this process is much easier than changing your Will.  This is especially important for investors who own term deposits and GICs in an individual non-registered account. Helen established four different GIA contracts with different insurance companies, each for $100,000.  The first contract has her four children named as beneficiary, the second contract names her eight grandchildren, the third contract names four friends, and the final contract names four charities.  Helen will live off of the monthly income during her lifetime.  When she passes away, the proceeds from the contract are paid directly to each named beneficiary.  Helen can easily update the beneficiary selection to the contracts with no cost.

Redemption:  There is no cash surrender charges at death for GIA contracts.  Your named beneficiary will receive the original deposited amount plus any accumulated interest.  Proceeds are paid out directly to the beneficiary with minimal delay.

Privacy:  Proceeds distributed from insurance products to named beneficiaries not only bypass probate but also avoid public record.  Every family situation is unique.  Often at times a solution to a complex situation is an insurance product that bypasses the estate and public record.  This is particularly important these days with complicated extended or blended family situations.  Creditor protection is also a benefit of insurance contracts available in most provinces across Canada.

Converting Interest Income to Pension Income:  Interest income earned from GICs is reported as interest income in Box 13 of a T5 slip.  Income reported in this box is not a qualifying source for the pension credit or pension splitting.  GIAs are subject to special rules under the Canadian Income Tax Act (accrued income–annuities reported in box 19 of a T5 slip).  Income reported in box 19 may provide benefits if you are 65 or older, especially if you are married or do not earn other qualifying pension income.  The amounts reported in box 19 qualify as pension income for investors who are 65 or older.  This is important as it enables individuals to claim the pension income amount (if not already claimed).  The pension income amount effectively allows investors to exempt up to $2,000 of eligible income each year.  Note that couples can each take advantage of this.

Pension Splitting:  An additional benefit of GIAs is the ability for couples eligible for the pension income amount to also split the income with their spouse.  This can be done without the concern of the Canada Revenue Agency applying the attribution rules of one spouse in the household earned the base capital earning the income).   The attribution rules are complex but effectively prevent inappropriate income splitting.

Flexibility and Protection:  You may choose between different payment options such as monthly, quarterly, semi-annually, or annually.  You may also choose from different issuers and maturity dates with a wide selection of terms that fit you.  GIAs can typically be purchased to a maximum age of 100.  GICs have CDIC coverage for up to five years.  GIA contracts do not have a time limitation for coverage through Assuris (see for further details).

Insurance companies have features relating to their GIA product that may be different from the general information above.  Not all investment advisors have the required license to sell GIAs.  When we are selling life insurance products we are acting as Life Underwriters.

Prior to acting on information in our columns we recommend you obtain professional advice to determine if GIAs may be suitable in your estate plan.


Keep more of your OAS pension

The clawback is a term often used for repayments on income-tested benefits.  The Old Age Security basic pension is one of those benefits subject to the clawback.  For 2008, benefits begin getting clawed once net income before adjustments (line 234) exceeds $66,335 – and fully clawed back once net income reaches $107,692.

According to both Human Resource and Skills Development Canada and Canada Revenue Agency, as of June 2007 there were 4,272,000 seniors that applied and were deemed to be eligible for OAS pension benefits. Of those,  4,190,900 received benefits – and 81,100 had to repay their pension benefits in full.  As of December 2008, 210,230 taxpayers had to repay only a portion of their OAS benefits for the 2007 tax year.  Surprisingly only two per cent of taxpayers receiving OAS benefits are required to fully repay their OAS due to high income, and only approximately five per cent of people have to partially repay OAS benefits.

For the seven percent of pensioners who are subject to partial or full repayment, there are ways to structure your finances to reduce or eliminate the repayment amount.  Some tips:

Plan Ahead –  The OAS repayment calculation is based on individual income, not on family income.  This essentially allows couples more planning options throughout their lifetime.  At retirement couples should work towards equalizing both incomes, rather than one spouse having the majority of the taxable income.  Having equal incomes should reduce your household tax liability and reduce the amount of OAS clawback.

CPP Sharing – Couples have the flexibility of electing to share future Canada Pension Plan benefits with their spouse.  This is a one-time application and is generally done to decrease income (line 234) on the higher income spouse and to increase income on the lower income spouse.

Pension Splitting – These rules enable you to move some of your eligible pension income to your spouse.  This reduces line 234 for the higher income spouse and increases it for the lower income spouse.

Investment Holding Company – Some individuals may consider setting up an investment holding company. The company would report some of the income you would otherwise report on your personal tax return.  With the correct structure and a little planning, your personal income may be lowered enough for you to retain 100 per cent of your OAS. It is important to look at all costs to determine if the benefits outweigh the costs. You should discuss all benefits and costs with your accountant prior to considering this strategy.

Defer RRSP Conversion – At some point before age 72, all people have to convert their RRSP to an income source.  If you are subject to the OAS clawback then you should consider keeping your funds in an RRSP for as long as possible.  At age 72, you should consider withdrawing the minimum amount each year to minimize your net income.  You may elect to use the younger spouse’s age to reduce payments as well.

Tax Free Savings Account (TFSA) – Every individual who is subject to the clawback should open up a TFSA to shelter as much income from tax.

Dividend Income – Dividend income is considered one of the most tax efficient forms of income.  It is the dividend tax credit that makes this form of income advantageous.  One component to consider is that eligible dividend income is grossed up by 1.45 for the calculation on line 234.  The dividend tax credit is applied after line 234.  If you receive actual dividends of $20,000, for tax purposes you must report $29,000.  This is a negative for the OAS clawback calculation.  You could consider putting the highest dividend paying stocks in your registered accounts.

Structure Investments – The lower income spouse should consider having more of the higher dividend paying stocks.  If you are having some of your OAS partially clawed back because of investment income, consider shifting your highest dividend paying stocks to your registered accounts.  Investment choices for the higher income spouse should focus on growth stocks with deferment possibilities and generating primarily capital gains over time.

Gifting Assets Early – If you are having some of your OAS clawed back you may want to consider gifting securities, or money, early to adult children.  By gifting assets to adult children or grandchildren, they may be able to purchase a personal residence or pay down non-deduction debt on their home.  The benefit to you is that your income may be low enough to receive partial or full OAS.  Give a bit now and get a little more OAS.

Charitable Giving – If you are ultimately wanting some funds from your estate to go to charity you may want to consider gifting assets gradually over time.  If your income continues to grow this may allow you to obtain full credit for your donations and keep your income low enough to obtain partial or full OAS.

CPP Sharing – Sharing your Canada Pension Plan with your spouse may enable you to lower the income of the highest income earning spouse.

RRSP Contribution – Do you have income above $66,335 that is subject to the clawback?  If so, consider making an RRSP contribution up until and including age 71.  If you have unused RRSP deduction room, discuss with your investment advisor whether you should make an RRSP contribution.

Fee-Based Accounts – One of the benefits of fee-based accounts may be the ability to deduct the cost of investing annually on your tax return (line 221).  In addition to speeding up the deduction, the full amount of the fee may be deducted for non-registered accounts.

Resource Investments – Certain resource investments enable the investor to take advantage of exploration and development expense deductions.  The underlying resource companies essentially flow-through these deductions to the investor to claim (line 224).  This strategy is considered high risk and is only suitable for investors who could withstand a complete loss of capital.

Retire Earlier

At times we see individuals working longer than they need to in order to comfortably retire.  In some cases, income levels are extremely high at retirement primarily because the individual worked longer than needed.

Old Age Security provides cash flow

The Old Age Security Act pension is a monthly benefit available o most Canadians 65 or over and provides a monthly cash flow.  The pension – part of the Old Age Security Act introduced in 1952 – is distinctly different from Canada Pension Plan retirement benefits, which have the flexibility of collecting as early as age 60.


OAS will not automatically start on your 65th birthday if you have not applied in advance.  It is recommended that you apply six months prior to turning 65.  Human Resource and Skills Development Canada have regional offices where you may pick up a package and apply in person, or you can download from the HRSDC website, or request a package through phoning the toll free 1-800-277-9914.

Employment History

Your employment history is not a factor in determining whether you are eligible for OAS.  Someone who has never worked before is eligible for OAS.  People who plan to keep working at age 65 are still eligible.


To be eligible for OAS, you must be a Canadian citizen or a legal resident of Canada on the day preceding the application’s approval.  If you are no longer living in Canada, you must have been a Canadian citizen or a legal resident of Canada on the day preceding the day you stopped living in Canada.

The amount of your OAS will be determined by how long you have lived in Canada.  If you have lived or worked in another country, then your OAS may be reduced.  You should contact HRDC regarding these rules and determine if you are still eligible for the full OAS.  If you are considering working in another county or retiring abroad, you should contact HRDC to discuss your plans and determine if they impact your OAS.


Once you begin receiving OAS basic pension, you will also have to pay federal and provincial income tax on these amounts.  You will receive a T4A(OAS) slip with the total amounts to report on your income tax return.  If your net income before adjustments (line 234) is more than the limit adjusted annually then you will have to repay part of your benefits.

For 2008 this limit is $66,335 (2007: $63,511).   Canada Revenue Agency uses the term repayment – this is often referred to as the “clawback”.

The clawback occurs if your net individual income is above the annual threshold set each year.  For every $1.00 of income above the threshold, the amount of OAS you receive is reduced by 15 cents.  When net income reaches $107,692, all of your OAS will be repaid or clawed back.  The formula is designed so that higher income pensioners also repay part or all of their benefit through the tax system.


OAS benefits are adjusted for inflation quarterly in January, April, July and October (measured by the Consumer Price Index).  OAS payments are paid monthly.  The standard way to receive your payment is to have it directly deposited into your bank account.  The maximum monthly benefit is currently $516.96.


The repayment calculation is based on the difference between your income and the threshold amount for the year.  Using the threshold for 2008 of $66,335, Margaret has earned $80,000 this year.  She must repay 15 cents for every dollar that exceeds the annual threshold.  Margaret’s income exceeds the threshold by $13,665 ($80,000 – $66,335).  The repayment amount for 2008 is estimated at $2,049.75 ($13,665 x .15).

In our next column, we will outline a few different ways pensioners can structure their finances to reduce the repayment amount.


Sharing your CPP can be beneficial

Beginning in the 2007 taxation year, pensioners were able to split qualifying pension income in conjunction with filing your tax return.  Form T1032 is required to be signed by both married or common-law partners who are together (not separated or divorced), but does not cover your retirement Canada Pension Plan benefits.  The ability to share CPP is not new and the process is different than pension splitting.

We were recently speaking with a representative at Service Canada regarding splitting CPP for a local couple.  The representative corrected us in letting us know that the term “splitting CPP” is used when couples are getting divorced and that the proper term is “sharing CPP,” which sounds a little friendlier than splitting.

In order to share your retirement CPP benefits, both of you have to be at least 60 years of age and receiving CPP.  You can make an application to share the portion of your pension benefits earned during your time together. The reason we like this idea is that it may result in tax savings for the household.  This program applies even if only one of you contributed to CPP.  In this case, the one CPP would be shared.  The ability to share your benefits does not increase or decrease the combined amount.

We will use an illustration to explain how the pension sharing works.  Pension sharing adjusts the amount of the monthly CPP each spouse or common-law partner receives.

Romeo and Juliet have been married since 1966 and are both receiving CPP.   Romeo’s monthly CPP benefit is $724, while Juliet’s is $212.  The combined benefit payments are $936, which equals their total “shareable” pension. With CPP sharing, they would each receive half of $936, or $468.  Romeo’s monthly CPP benefit has declined from $724 to $468.  Juliet’s monthly CPP benefit has increased from $212 to $468.

On a monthly basis this may not seem all that significant.  But let’s annualize this amount and see what the before and after T4A(P) slips would look like.

Before income splitting Romeo and Juliet would have had T4A(P) slips with $8,688 and $2,544 in taxable income, respectively.  After income splitting the T4A(P) slips would be $5,616 for both Romeo and Juliet.  Romeo’s annual income is reduced by $3,072 and Juliet’s increases by this same amount.  Most importantly, the overall tax for the household is lower.

Remember, you must apply to share CPP.  Application forms are available online along with some additional information regarding pension sharing.   The process is simpler if you are both collecting CPP.  If you are applying for CPP benefits at the same time, you will need to provide a pension sharing application along with some additional documents, such as retirement CPP application, social insurance number, marriage certificate or proof of your common-law relationship.   If you are both already receiving retirement CPP then only your original marriage certificate or proof of your common-law relationship is needed with the pension sharing application.

There are two significant administrative differences with CPP sharing and the pension splitting rules.  With CPP sharing the actual “cash-flows” will equalize after the application is processed.  This is different than pension splitting that is done through form T1032 where there is no change in cash-flows (paper adjustment at year end for tax purposes).

The other significant difference is that the CPP sharing applications only need to be done once.  Other types of eligible pension splitting will require you to sign and file the T1032 form on an annual basis.

Once the forms are completed for the CPP sharing arrangement it only ends if you and your spouse/common law partner separate or divorce, or when one of you dies.   CPP sharing may also be cancelled if both of you request it.  This may be one of the easiest ways to reduce the amount of tax you pay.


Collect CPP early if you can

Before you turn 60, take a good look at your Canada Pension Plan options.  You may want to take a reduced monthly amount at age 60.  Or you may want to wait until 65 to have a full monthly payment.  Here are a few steps we review with clients who are torn between the ages of when to begin collecting.

To start the process you should request a current CPP statement  online at or phone 1-800-277-9914 for general information.

This statement provides some information and estimates regarding what you are entitled to based on your past earnings.  The statement includes an estimate of your monthly CPP payment if you collect at age 60 versus age 65.

The formula for collecting CPP early (before age 65) involves a .5 per cent reduction for every month that you collect CPP before the age of 65.  The earliest you may begin collecting CPP is at age 60.  Collecting CPP at age 60 would result in a 30 per cent reduction, calculated by multiplying .5 by 60 months (5 years multiplied by 12 months).  This formula is a little too simple and doesn’t factor in a few important components that we will discuss below.

Before making a decision it is important to review the impact of low-earning years on the benefit formula.  Calculations are based on how much you have contributed and for how long.  If you do not work after the age of 59 and choose not to begin collecting CPP early then you will be adding years with 0 earnings.  If you add five years with 0 earnings then you should not expect to receive 30 per cent more by waiting.  If you plan on working, consider estimating your potential earnings between age 60 and 64 to assist you with making the decision to collect retirement CPP early.

One way to qualify for early CPP (between the ages of 60 and 64) is to earn less than the current monthly maximum CPP retirement pension payment in the month before your pension begins and in the month it begins.  Another way to qualify for early retirement CPP is to stop working.  The term stop working means that you are not working by the end of the month before the CPP retirement pension begins and during the month in which it begins. For example, if you want your pension to begin in September, you have to stop working by the end of August and you cannot work during the month of September.  You could begin working part time or full time after September and continue to collect CPP at the same time.

If you are in a position to stop working at age 60 for a period of time you may want to consider applying for CPP early.  One component that is often missed in the decision process is the ability to stop paying into CPP.  CPP began in 1966 and chances are you have paid into CPP for many years through small withholdings on each paycheque.  The amount paid in is based on your earnings up to a yearly maximum.  Self-employed individuals pay based on their net business income, after expenses.

On November 3, 2008 Canada Revenue Agency announced that the maximum pensionable earnings for 2009 will be $46,300 ($44,900 in 2007). Individuals who earn more than $46,300 in 2009 are not required or permitted to make additional contributions to CPP.  Individuals earning less than $3,500 annually do not need to contribute to CPP. The employee and employer contribution rates for 2009 will remain unchanged at 4.95 per cent.   This essentially means that you as an employee may have to pay up to the maximum of $2,291.85 in 2009 ($2,049.30 in 2008).  These contributions are generally withheld from your paycheque.

Let’s look at an example.  Jill is soon turning 60 years old.  This year her employment earnings are expected to be approximately $40,000. This figure is between the minimum contribution level of $3,500 and the maximum of $46,300 for pensionable earnings.  If Jill’s earnings are the same in 2009, then Jill will be required to make contributions to CPP of $1,806.75 calculated as follows: (40,000 – 3,500) x .0495.  If Jill were self-employed, her required contribution amount would be 9.9% or $3,960.

Important point:  One of the biggest benefits of collecting CPP early is that once you begin collecting CPP you are no longer required to remit CPP if you begin working again. This is especially important if you think you may work part time after age 59 and before age 65.

If you are already exempt from paying into CPP you should notify your employer to ensure they are not withholding a CPP portion from your pay cheque.  At the end of the year you should also double check to see if your employer has the CPP correctly stated on your T4.  Individuals who are not yet exempt from CPP may want to discuss with their employers a short term retirement period.  This would benefit the employer as well because they would not have to pay the employer portion of CPP.  If this can be coordinated during a slow period for the business then everyone wins.  More people are choosing this type of arrangement.  By working part time, after your one month retirement period, you may be in a lower tax bracket with no CPP withheld on each of your pay cheques.  In Jill’s case, she could save at least $1,806.75 each year by stopping work once for the period required by CPP.

The decision to collect CPP early is often dependent on whether you have stopped working or whether you can stop for a period of time to qualify.  Once you reach age 65 you automatically qualify regardless if you continue to work.  We like the idea of the government paying you money for five additional years.  This is certainly better than the alternative of having to continue to fund CPP.


How to stay ahead of inflation: Contribute to your TFSA early

One of the best features of the Tax Free Savings Account is its flexibility, such as the ability to withdrawal funds without any tax consequence.  If you need funds for short-term goals, such as buying a new car, renovating your home, or taking a holiday, then the TFSA account may be the desired choice for putting cash away for easy access in the near term.

Depending on how you look at it, this feature may not be a benefit.  A person first has to decide how they want to fund their retirement.  It may be too easy for people to dip into their TFSA.  There is no tax consequence for withdrawals and people may replenish the account in subsequent years with no penalty.

For most people, the main purpose of an RRSP is to provide retirement income in the future.  The very purpose of this account is designed for a long-term goal, and not for short-term goals.  Due to RRSP contributions being tax deductible, there is a limit to how much you can contribute.  All RRSP withdrawals are considered taxable income.  A young person withdrawing an RRSP early would have to pay tax on the dollar amount taken out.  This provides an incentive for people to leave the account for its original purpose.  Withdrawals from an RRSP account should generally be the last resort for people needing cash.

If a person makes a withdrawal from their RRSP they are not able to get the contribution room back.  It is lost permanently – it is not replenished like the TFSA.  The tax consequence and the lost room are two key reasons people are encouraged to keep RRSP funds for retirement.

In an earlier column we mentioned how we like the TFSA more then RRSPs for people in the lower income tax brackets.  We also like the idea of people beginning to save for retirement early in life.  The key thing that young people can note is that although this is a “savings” account, you should consider using this for a retirement account.  The TFSA annual contribution limit will keep pace with inflation, rounded to the nearest $500 increment.  The follow chart highlights some simple compounded growth assuming 3 per cent inflation and investment growth of 6 per cent:











 Inflation Amount

Limit (Nearest $500)

TFSA Beginning Balance

Annual Contribution        


 Investment Return

TFSA Ending Balance












      5,000.00       5,000


          5,000          5,000        300.00          5,300



      5,150.00       5,000        5,300           5,000         10,300        618.00        10,918



      5,304.50       5,500       10,918           5,500         16,418        985.08        17,403



      5,463.64       5,500       17,403           5,500         22,903      1,374.18        24,277



      5,627.54       5,500       24,277           5,500         29,777      1,786.64        31,564



      5,796.37       6,000       31,564           6,000         37,564      2,253.83        39,818



      5,970.26       6,000       39,818           6,000         45,818      2,749.06        48,567



      6,149.37       6,000       48,567           6,000         54,567      3,274.01        57,841



      6,333.85       6,500       57,841           6,500         64,341      3,860.45        68,201



      6,523.87       6,500       68,201           6,500         74,701      4,482.08        79,183



      6,719.58       6,500       79,183           6,500         85,683      5,141.00        90,824



      6,921.17       7,000       90,824           7,000         97,824      5,869.46      103,694



      7,128.80       7,000     103,694           7,000       110,694      6,641.63      117,335



      7,342.67       7,500     117,335           7,500       124,835      7,490.13      132,326



      7,562.95       7,500     132,326           7,500       139,826      8,389.53      148,215



      7,789.84       8,000     148,215           8,000       156,215      9,372.90      165,588



      8,023.53       8,000     165,588           8,000       173,588    10,415.28      184,003



      8,264.24       8,500     184,003           8,500       192,503    11,550.20      204,053



      8,512.17       8,500     204,053           8,500       212,553    12,753.21      225,307



      8,767.53       9,000     225,307           9,000       234,307    14,058.40      248,365



      9,030.56       9,000     248,365           9,000       257,365    15,441.90      272,807



      9,301.47       9,500     272,807           9,500       282,307    16,938.42      299,245



      9,580.52       9,500     299,245           9,500       308,745    18,524.72      327,270



      9,867.93     10,000     327,270          10,000       337,270    20,236.21      357,506



    10,163.97     10,000     357,506          10,000       367,506    22,050.38      389,557



    10,468.89     10,500     389,557          10,500       400,057    24,003.40      424,060



    10,782.96     11,000     424,060          11,000       435,060    26,103.61      461,164



    11,106.45     11,000     461,164          11,000       472,164    28,329.82      500,494



    11,439.64     11,500     500,494          11,500       511,994    30,719.61      542,713



    11,782.83     12,000     542,713          12,000       554,713    33,282.79      587,996



    12,136.31     12,000     587,996          12,000       599,996    35,999.76      635,996



    12,500.40     12,500     635,996          12,500       648,496    38,909.74      687,405



    12,875.41     13,000     687,405          13,000       700,405    42,024.32      742,430



    13,261.68     13,500     742,430          13,500       755,930    45,355.78      801,286



    13,659.53     13,500     801,286          13,500       814,786    48,887.13      863,673



    14,069.31     14,000     863,673          14,000       877,673    52,660.36      930,333



    14,491.39     14,500     930,333          14,500       944,833    56,689.98    1,001,523



    14,926.13     15,000  1,001,523          15,000    1,016,523    60,991.38    1,077,514



    15,373.92     15,500  1,077,514          15,500    1,093,014    65,580.86    1,158,595



    15,835.13     16,000  1,158,595          16,000    1,174,595    70,475.71    1,245,071



    16,310.19     16,500  1,245,071          16,500    1,261,571    75,694.26    1,337,265



    16,799.49     17,000  1,337,265          17,000    1,354,265    81,255.91    1,435,521

We caution everyone who looks at the above table to understand projections, returns, and inflation.  The term real rate of return factors in taxes and inflation.  As the TFSA has no taxes, the real rate of return above is three per cent (six per cent return less three per cent inflation).  The inflation component can be illustrated by looking at the inflation amount in the year 2050.  We project that in 2050 one would need approximately $16,799 to purchase the same equivalent items that $5,000 could purchase today.  In other words, young people today will have to become millionaires in the future to fund a modest retirement.


Choosing the right savings account

This year we have a new reason for people to update their financial plan.  The new Tax Free Savings Account should be factored into your savings, especially if you intend to use some of these funds for retirement.

Most financial plans encourage people to contribute to a Registered Retirement Savings Plan.  The number one advantage of RRSP accounts is the tax-deferred growth over time.  The second benefit is the initial deduction for making the contribution.

The new Tax Free Savings Account offers the same tax-deferred growth advantage of the RRSP.   The one downside to the TFSA is that no tax deduction is given for contributions.  The offsetting benefit for the TFSA is that withdrawals are not taxed like they are with RRSPs.

The idea behind an RRSP is that you should be in a lower income tax bracket when you retire than when you put the money in.

Let’s use Jack who is in the 30 per cent marginal tax bracket while he is working.  When he retires he anticipates he will be in a lower tax bracket, say 20 per cent.  If Jack’s income really is in the 20 per cent range at retirement, then the RRSP contributions worked the way he planned.

Unfortunately, we see the opposite happening. People are making contributions when they are in relatively low marginal tax bracket (10 or 20 per cent) while working and pulling the funds out at retirement at a higher marginal tax bracket.

At retirement you’re likely to have income from different sources, although your employment income may be lower.  Most Canadians will be eligible for CPP retirement benefits and the OAS pension.  Most people will have to add other income sources including, investment income, rental income, part time work and registered account withdrawals.

The best part about the TFSA is that it enables people to tax shelter investment income.  It also enables people to have more flexibility to choose when to pull RRSP funds out. Having both a TFSA and RRSP may allow people to take amounts out of both accounts at retirement.  The TFSA is the buffer needed to manage cash flows without the income tax consequence.

Most financial planning software packages do not yet have the TFSA factored in, as it is too new.  Once the software programs are updated we would anticipate savings to be split between RRSP and TFSA.  The deciding factor is likely to be your level of income to determine what type of account you should direct your savings to first.

Low Income

Consider setting up a monthly pre-authorized contribution for the TFSA only.  The reason for this is that you may have little disposable income for savings.  We would recommend you avoid RRSP contributions if your income is below $38,000.  Your RRSP deduction limit will grow so you may utilize deductions in the future when your income is higher.  If you have set up an RRSP monthly pre-authorized contribution, talk to your advisor about changing these monthly savings to a TFSA.

Medium Income

Consider setting up a monthly pre-authorized contribution for the TFSA.  If you have excess cash to invest then making periodic RRSP contributions may make sense.  Prior to making an RRSP contribution you should ensure that the funds are committed to your retirement plan.  It is often people who fall in this category who make last minute RRSP contributions.  The last day to make a 2008 RRSP contribution is March 2, 2009.

High Income

If you are in the top marginal tax bracket then it generally makes sense to take advantage of all tax deferral type accounts.  Most high-income earners will benefit from maximizing both the TFSA and RRSP.   Consider making a lump-sum contribution early in the year for both the TFSA and RRSP.  The maximum 2009 RRSP contribution limit is $21,000.

To summarize the above, nearly everyone should have a TFSA.  People with average income should have a TFSA, and possibly an RRSP provided the funds are committed for retirement.  High-income earners may benefit from contributing the maximum amounts to both an RRSP and TFSA early each tax year.

The first decision you will have to make is the type of investment account to put your savings in, and then decide which investments to purchase in that account.  Over your life, the direction of your savings may change primarily based on your income level.  With each significant change, your financial plan should be updated.


The right situations to invest in RRSPs

A Registered Retirement Savings Plan has traditionally been a great way for young couples to get a head start on retirement.  But the RRSP seems to be taking a back seat these days.

Young couples may have placed greater attention on accumulating funds for a down payment for a home.  It isn’t just housing costs, improvements to accounts such as the Registered Education Savings Plans (RESP) help direct excess savings to grant eligible accounts.  We anticipate that the introduction of the Tax Free Savings Account (TFSA) will reduce the amount of RRSP contributions even further.

RRSP accounts are still an effective savings strategy for some individuals all of the time.  Here are a few examples of events and situations where an RRSP contribution makes sense.

Top Marginal Tax Bracket – Individuals who are in the top marginal tax bracket (43.7 per cent) should contribute to an RRSP.  The main reason for this is that if you cannot avoid tax, the next best option is to defer it.  The main risk of contributing to an RRSP when a person is in the top tax bracket is that personal tax rates may change in the future.  We feel this is minimal and that the deferral advantage outweighs this risk.

Spike In Income – RRSP contribution room can be a tax saver if you find you have a sharp increase in income one year.  Possibly you have held onto some investments for years and then suddenly one of them is taken over involuntarily and creates a deemed taxable disposition.  What if you sell some real estate not considered your personal residence for a large taxable gain.  Maybe one year you receive a large bonus at work.  RRSP contributions during high income years can bring your income tax liability down considerably.  RRSP are great if you can get a deduction when you are in a high income tax bracket and withdraw the amount when you are in a low income tax bracket.

Couples – One of the downsides to RRSPs is the income inclusion of the entire account upon death.  Couples have the ability to defer tax on the first passing.  Single people generally have no ability to avoid a large tax bill upon premature death.  With the ability to share RRIF income for couples, there is certainly more flexibility for couples to have at least one RRSP account.

Fixed Income – RRSPs are more suitable for investors who do not require immediate income and prefer fixed income investments such as federal bonds, provincial bonds, corporate bonds, GICs, term deposits, debentures, etc.  All of these types of investments create interest income, which is taxed annually if held in a non-registered account.  By putting these types of investments in an RRSP, you may defer this taxable income.

Equities – One of the best features of Canadian taxation of equity investments is that they are not taxed until the investment is sold.  Many investors choose not to take advantage of this feature and frequently buy and sell securities.  Every time an investment is sold in a non-registered account, there is a tax consequence (capital gain or capital loss).  If the equity investment is held within an RRSP then there is no tax consequence.  Note that this is a negative if the investment is sold at a loss.

Minimum Amount – At age 65 investors who do not have pension (or a spouse with a pension) should have a minimum of $30,000 in their RRSP.   Investors should have enough in their RRSP to convert to a RRIF and pay an annuity for life of $2,000 per year.  This portion will be offset by the pension income amount and will essentially be tax-free.  This is, of course, if the rules do not change.  The last time the rules changed the pension income amount was increased from $1,000 to $2,000.

TFSA Maximized – The new Tax Free Savings Account (TFSA) should be maximized each year if cash flow permits.  For some investors, their savings should be directed to a TFSA first.  If this account is maximized then looking at RRSP options certainly boils down to the above points.  We would see few cases for recommending an RRSP and avoiding a TFSA.  In most cases the TFSA and RRSP should be complimentary to each other.  It is possible that the TFSA could be eliminated one day.  If this is the case, then some investors may feel they missed out on their RRSP deduction opportunities. There is always the risk that the government will change the rules.  Better to cover all your “savings” bases.

Tax-free savings enhance pensions

The simplicity of the Tax Free Savings Account is a great advantage because it is easy to explain.  Your contribution limit is the same whether you are a member of a pension plan or not.  This provides one of the first opportunities for people who belong to good quality pension plans to tax shelter additional savings from tax.

The RRSP contribution room formula is designed primarily to assist those individuals without a pension. The formula is straight-forward – you are able to contribute 18 per cent of your earned income.

Let’s look at Alice who works for a company without a pension plan.  Last year Alice earned $60,000 so her maximum RRSP contribution limit would be $10,800 (18 per cent x $60,000).

Alice’s husband Peter also earned $60,000 last year working for a company with a pension plan.  The main difference is Peter is a member of a pension plan.  Peter’s maximum RRSP contribution limit this year is reduced by a pension adjustment of $6,940.  Peter’s maximum RRSP limit is $3,760 ($10,800 – $6,940).   The pension adjustment varies depending on many factors.  The better the pension, the greater the adjustment on the RRSP room.  The key point is that Alice will be able to contribute more to her RRSP.

Employees belonging to municipal, government, or private pensions may benefit the most from the TFSA.   One of the disadvantages to belonging to a pension plan is the above illustrated pension adjustment (PA).  The PA grinds down the amount you can tax shelter in your RRSP.  For people who belong to a good pension, this leaves very little room to contribute to their own RRSP.

The TFSA will benefit people like Peter who have not been able to shelter all of their savings from tax.  Several strategies could be used to implement the TFSA for early retirement.  Different bridging options are generally available as you near retirement.  The TFSA can certainly be a source of cash if you choose to take a reduced pension or retire early.

Many of the good quality pension plans are starting to disappear.  These are often referred to as defined benefit plans.  With a defined benefits plan, you as the employee do not have to make investment choices.

In the future you will see less of these types of plans.  Instead, companies may provide defined contribution (money purchase) plans with you as the employee making the investment decisions.  Companies would rather shift the level of investment risk to their employees rather then incur the risk of poor markets.  This essentially means that people who belong to defined contribution pension plans have to assume more of the responsibility for their investment decisions.

We encourage people to look closely at the quality of their plan and the different investment options available.   When speaking with clients with defined contribution pension plans we ask them to provide us copies of periodic pension statements, along with the investment choices they have.

The main reason we ask for this information is to ensure that we are looking at their complete investment holdings.  Often at times we see that people do not fully understand the investment choices they have made within their pension.  Prior to doing any investing in a non-registered account, RRSP, or TFSA, it is important to obtain an understanding of the investments within your pension.  The biggest reason to do this is to ensure that all of your investments are combined for purposes of determining your asset mix (percentage of cash equivalents, fixed income, and equities).  This exercise often reveals improvements for your portfolio, including strategies to minimize tax, reduce investment costs, and avoid duplication within accounts.  Having a complete picture enables your investment advisor to discuss risk and design an appropriate strategy.

Members of pension plans should consider working with an investment advisor to assist them in mapping out a comprehensive financial plan.  The plan should include the TFSA and possibly an RRSP.  Payments from a pension plan are fully taxable (other than the pension income amount currently at $2,000 annually).  If your spouse is not receiving a pension then you may split the income with your spouse.  Add some tax-free withdrawals from a TFSA and you should be able to considerably enhance your after tax cash flow at retirement.