Leaving your RRSP to charity

Couples have the ability to name each other the beneficiary on their Registered Retirement Savings Plans (RRSP) and Registered Retirement Income Funds (RRIF). One of the main benefits of this is on the first passing, the RRSP or RRIF can be rolled into the surviving spouse’s registered account on a tax deferred basis.

For singles and surviving spouses, planning your estate to avoid a large tax bill becomes more challenging. Naming the beneficiaries of your RRSP and RRIF accounts should involve some strategy and should be integrated into your overall estate plan.

If you have charitable intentions, then your RRSP and RRIF accounts can be a source of funds for this purpose. One way to not pay the government nearly half of your registered account on the second passing is to gift your RRSP or RRIF to charity.

I have outlined two different methods of using your registered accounts for charitable giving – and both are tax effective.

■ Mrs. Wilson is a recent widow and is in the process of updating her legal documents and investment accounts. She has two children and has significant charitable donation intentions. She has a projected estate valued at $1.5 million. This figure is based on her personal residence being valued at $800,000, and the projected value of her non-registered investments at $400,000, and RRIF account $300,000. When her husband died she received his RRIF plan assets on a tax deferred basis and this is currently valued at $600,000.

With the assumption that Mrs. Wilson lives to age 90, we have projected that the value of her RRIF will be $300,000 and will represent the largest tax liability in her estate. In addition to wanting to leave the majority of her estate to her two children, she would like to leave a specified amount of $300,000 to charity, and the balance to be split equally between her two children.

Through the updated estate plan and our discussions, it was advised that Mrs. Wilson name her “estate” the beneficiary of her RRIF account. Naming Mrs. Wilson’s estate ensures that all of her assets are in a single account and get distributed according to the wishes outlined in her Will.

The advantage of this method is that Mrs. Wilson could leave donations to multiple charities at the specific dollar amount she wanted.

Mrs. Wilson also has non-registered investments with significant unrealized capital gains that she would also like to use as part of the funding of the specific dollar amount.

The benefit of charitable donations of investments in-kind is that the capital gain is not taxed and Mrs. Wilson would get the full market value of the investments as a donation tax credit. In the year of death, capital losses may be converted to non-capital to offset against all sources of income, including RRIF income. One disadvantage we saw of Mrs. Wilson naming her estate as the beneficiary of her RRIF is that this method inflates the value of Mrs. Wilson’s estate, which may increase executor and probate fees.

Typically, a bequest through the Will takes longer to be distributed to Mrs. Wilson’s chosen charities than the direct designation method of naming a charity the beneficiary (see Mr. Baker below). The benefits of naming the estate outweighed the additional costs (i.e. probate, executor) and potential time delays.

In reviewing the calculations for Mrs. Wilson, the advice provided was for her to name her estate the beneficiary of her RRIF account. Mrs. Wilson’s estate plan first involved the transfer of investments in-kind from her non-registered investments (with capital gains) directly to charity. If this is insufficient then additional capital can be used from the estate. Any net unrealized capital losses will convert to non-capital on death to reduce taxes on the deemed disposition of her RRIF. Mrs.Wilson can also accomplish her goal of leaving a specific dollar amount, versus the balance of a RRIF account.

■ Mr. Baker has been a life long bachelor and has no children. He has accumulated a significant nest egg in his RRSP at age 70. A couple years ago he talked with a large charitable foundation and has made plans regarding his current financial and estate plans. In reviewing both plans, it was recommended that he directly designate the charitable Foundation as the beneficiary of his RRSP. A direct designation gift of an RRSP or RRIF plan is done by naming one or more charities as beneficiaries on the plan’s documents. With this method assets will bypass Mr. Baker’s estate and will be paid directly to his named charity. The assets do not form part of Mr. Baker’s estate and, thus, avoids probate. In addition, a direct designation will help preserve privacy which is important for Mr. Baker.

Mr. Baker receives significant income from other sources. He does not require the capital in his RRSP to live off today, or in the future. Mr. Baker’s plan involves him contributing to the charitable Foundation throughout his lifetime to obtain the maximum tax benefit. He is executing the plan by initially doing small lump sum contributions to offset his taxable income in the current year. In addition, he has mapped out a plan to contribute in-kind donations of investments from his non-registered account. The investments selected are those that are in a significant unrealized capital gain position – to be donated to the Foundation over time. The donation of securities in-kind means that Mr. Baker does not pay tax on the capital gains and the full market value of the investments are eligible for the donation tax credit. Periodically he plans to contribute securities in-kind that have unrealized capital gains to the Foundation in-kind to offset income each year. When Mr. Baker is 71 he will have to convert his RRSP to a RRIF and then begin taking minimum payments when he is 72. Mr. Baker would like to offset this additional income with annual donations to the Foundation to be at least the amount of his scheduled RRIF payment.

In addition to planned donations while Mr. Baker is alive, he also plans a gift of his RRSP/RRIF plan assets to the Foundation upon his death. This would generate a tax credit at least equal to the tax owing on the registered accounts at the time of his death. Donations can be claimed against 100 per cent of net income in the year of death. If the donation is too large to claim in the year of death, it is possible to carry back donations to claim against 100 per cent of net income in the preceding year. The 100 per cent contribution limit can eliminate all tax in the final two years if the gift is large relative to income. With proper planning, and early contributions, Mr. Baker should be able to obtain the full tax benefit of his donations to the Foundation. By taking full advantage of tax rules, the Foundation will receive a greater portion of Mr. Baker’s net worth.

Only consider a direct designation gift of RRSP/RRIF assets in the context of an overall estate review. For Mr. Baker, it was fairly straight forward as he had no children and he wanted to leave all of his assets to one Foundation. Naming a charity the beneficiary of your RRSP/RRIF should only be done after completing an estate plan and obtaining professional advice.

Don’t rely solely on pensions for retirement

Retirees have become reliant on their employer sponsored pension plan(s), Old Age Security (OAS), and Canada Pension Plan (CPP) for a comfortable retirement. When these pensions are threatened in any way it can have a significant impact on your retirement. These plans are changing – and not necessarily for the better.

Financial analysts have come out with reports showing how many companies in Canada have real problems with their defined benefit plans and funding benefits. With interest rates at extremely low levels, and uncertain equity markets, it has put many employers in a material pension shortfall position. To address these problems, companies are looking at how the pension is structured and making decisions that do not favour the employees. Employers are also looking to reduce benefits such as health care and dental as a way for companies to save costs.

The biggest change that a company can do with a pension is to change it from a defined benefit plan to a defined contribution plan. Below is a brief description of each type of plan:

Defined Benefit Plan

With a defined benefit plan, the employer is committed to providing a specified retirement benefit. The “benefit” is established by a formula, which normally takes into account the employee’s years of service, average salary and some percentage amount (usually between one to two per cent). The key point to take away is that the employer bears the risk of pension fund performance. Another key point is that the employee is able to calculate their benefit with more certainty than a defined contribution plan.

Defined Contribution Plan

The “contributions” made into this type of pension plan are established by a formula or contract. Many defined contribution plans require the employer and/or employee to contribute a percentage of an employee’s salary each month into the pension fund. The employer does not make a promise with respect to the amount of retirement benefits. This leaves the employee to bear the risk of pension fund performance in a defined contribution plan.

Between the two types above, the defined benefit plan is normally viewed as the better type of plan for employees. As noted above the employer bears the risk with defined benefit plans. Employees have more certainty with a defined benefit plan. Unfortunately, most companies are choosing the defined contribution plan to avoid having unfunded liabilities and shortfalls as a result of low interest rates and market conditions. With the defined contribution plan, employees are generally given a choice amongst different types of investments (i.e. conservative, balanced, and aggressive). It is up to the employee to select their own investments (from the group plan offering), even if they have no knowledge in this area.

In planning for the most likely outcome it appears that pension plans will offer less for retirees in the future. As pensions deteriorate it is even more important to look at other ways to supplement your income at retirement.

Registered Retirement Savings Plans

(RRSPs) should be used by all individuals without an employer sponsored pension plan. Even if you are a member of a pension plan, an RRSP may be an effective way to build additional savings and gain investment knowledge. With defined contribution plans, many employees are required to transfer the funds to a locked-in RRSP upon retirement. If you have both a defined contribution pension plan and an RRSP, we recommend that you periodically look at these accounts on a combined basis to review your total asset mix (the percentage in Cash, Fixed Income, and Equities). This is a wise exercise because it helps in the investment selection for both the pension plan and your RRSP. As an example, you may choose to have the defined benefit pension plan invested 100 per cent in fixed income, and rely on your other accounts to provide the emergency cash reserve and equity exposure.

Tax Free Savings Accounts

(TFSA) are a great type of account to build savings on a tax free basis. How you invest within the TFSA is really dependent on your goal. It is important to note that the funds in your TFSA do not have to stay in a bank account as the name somewhat suggests. What is your current goal for the TFSA account? How does it fit into your overall retirement plan? Is the purpose of this account to act as an emergency cash reserve currently? At some point, these accounts are going to be significantly larger, exceeding most recommended emergency cash amounts. The investment approach in this account should be consistent with your objectives and risk tolerance. If the funds are not required immediately then we encourage clients to have a combination of growth and income. Purchasing a blue chip equity with a good dividend (four per cent or higher) can provide both growth and income over time. If income is not needed today then it can be reinvested until you need it at retirement.

Non-Registered Accounts

are as important as RRSP accounts at retirement. When we talk about non-registered accounts, we are referring to both investment and bank accounts. Both hold after tax dollars that can be accessed with no tax consequence. When I prepare a financial/retirement plan, one of the important areas I look at is the ratio of non-registered to registered funds. Having funds in a non-registered account at retirement does provide more flexibility. If all funds are within an RRSP or RRIF, it becomes more challenging to come up with funds for emergencies (i.e. medical, new roof, etc.)

Retirees that have built up savings within RRSPs, TFSAs, and non-registered accounts will be better prepared to deal with further changes to pensions. Regular contributions and savings into these three types of accounts over time will put more certainty on being prepared for retirement. Relying solely on your pensions and the government for a comfortable retirement could set you up for disappointment.

Switching RRSPs to RRIFs

Many factors come into the calculation equation when determining when to convert your Registered Retirements “Savings” Account (RRSP) into a Registered Retirement “Income” Account.  An RRSP is used as a way for many Canadians to save for retirement and is essential for individuals without an incorporated business or a registered pension plan.

After all the years of saving, many people are still somewhat uncertain of when to begin drawing the savings out as regular income through a RRIF account.  Maximum deferral to age 72 can result in a shock in the rise in taxable income once RRIF minimum withdrawals begins.

To illustrate we will use Martin Hitchon, who turned 71 this year and is required to convert his RRSP account to a RRIF account before December 31 but is not required to take a payment in the first year.  Martin currently has $500,000 in his RRSP that will be rolled into his RRIF account.  Next year Martin is required to withdraw 7.48 per cent of the value of his account on December 31 of the year he turned 71.  The required annual minimum payment is stated as a percentage of the previous year end value.  These percentages increase slightly until age 94 where the maximum rate of 20 per cent is reached.  Assuming Martin’s portfolio is at $500,000 at the end of the year, he will have a minimum payment equal to $37,400 that will be considered taxable.

The perfect RRSP strategy is to contribute in high income and upper tax bracket years, and to pull funds out when you’re in a lower tax bracket.  The sudden increase in income with RRIF minimums left until age 72 may result in many people being in a higher tax bracket.  Many people may be wondering if waiting until age 72 is the best decision, especially knowing that this income will be on top of CPP, OAS, and other income.   The purpose of a financial plan when you’re younger is to map out the required savings to reach your shorter term goals and projected retirement needs.  The plan may also include a protection strategy for your family.  As you approach retirement the focus often shifts to understanding where cash flows will come from and which pools of capital you should access first.

Our clients who have taxable income over $125,000 annually are typically advised to wait until age 71 to convert and to take the first payment at the end of the year in which they turn 72.  In setting up the RRIF for high income couples we elect to use the younger spouses age to obtain maximum deferral.   Once clients are in the top marginal tax bracket (43.7 per cent in BC) the best strategy is to defer the tax liability by continuing to tax shelter within the registered account.

When income is expected to be below $125,000 then the decision on whether to convert your RRSP early to a RRIF is not straight forward.  Once you convert to a RRIF you are then obligated to begin taking income out for all future years.  It is possible to convert from a RRIF back to an RRSP prior to age 71 if your circumstances change.  The following are the key items to discuss when we are talking with clients:

■ Watching Thresholds – The Guaranteed Income Supplement (GIS) and the allowances are not based on net worth.  Many high net worth individuals have equity in real estate, corporations, and trusts that result in personal net income being low.  The GIS and the allowance stop being paid at $39,600 and $30,576, respectively.  Pulling funds out of an RRIF early could result in you losing these benefits.  Pensioners with an individual net income above $69,562 will have a portion of their Old Age Security payments clawed back if RRIF income is taken early.  The full OAS pension will have to be repaid if net income is $112,966 or above.   Projecting your income in the future will help in mapping out a strategy factoring in these thresholds.

■  Ratio of Non-Registered to Registered – Ideally as you enter retirement you have savings in both non-registered and registered accounts.  The non-registered savings are already after tax dollars and can be accessed with less tax consequences then registered funds.  This is especially important as you factor in potential lump sum needs in the future (i.e. new car, roof repair).  The greater the funds you already have in non-registered funds the easier it is to manage emergencies and to smooth out your income during retirement while at the same time fulfilling your cash flow needs.  If you have limited non-registered funds then earlier withdrawals may make sense.

■  Liquid Assets – High net worth is often locked up in real estate or assets that are not easily converted into cash.  Often at times the number one deciding factor in whether to pull funds out of a RRIF early is a result of cash flow needs and access to liquid funds.

■ Tax Free Savings Account (TFSA) – People without TFSA or non-registered accounts should consider pulling $5,000 out of their registered accounts annually to fund the Tax Free Savings Account.  Growth in a TFSA can be tax sheltered while at the same time building up a reserve of funds for you to access if an emergency arises.

■ Pension Income Amount – Beginning at age 65, investors without any other qualifying pension income are able to effectively withdrawal $2,000 annually from their RRIF account tax free.  This is because the income would be offset by what is referred to as the pension income amount.  Couples can withdrawal $4,000 annually with no taxes.

■ Pension Splitting – With the introduction of pension splitting the strategy for many couples has changed.  Up to fifty per cent of eligible pension income can be shifted from the high income spouse to the lower income spouse.  RRIF withdrawals beginning at age 65 qualifies as eligible pension income.

■ Couples – RRIF accounts are 100 per cent taxable upon death.   Nearly half of a RRIF balance of a single individual could go to taxes.   Couples have significant less risk of paying a large tax bill as they have the ability to elect a tax free roll-over a RRIF to the surviving spouse provided their spouse is named as a beneficiary.  This becomes trickier with second/third marriages with children from previous relationships/marriages.  The tax on the RRIF would be deferred when a spouse is named until the second passing and would likely be depleted slowly over time at more favourable marginal tax rates.

■ Other Estate Factors – Various other estate factors can result in different strategies for your RRIF account.  Some people may leave a RRIF account to a charity which would offset the large tax liability.   Insurance (i.e. joint last to die) is often a useful tool to cover the tax liability for a RRIF’s deemed disposition upon death.  Understanding your own health and family genetics is a factor that should be considered in the timing of when to withdrawal funds from your RRIF.

Tax Free Savings Account: Three different approaches

The Tax Free Savings Account (TFSA) has been around since January 2009 and many are still confused about what it is and types of investments that can be held within it.

The TFSA is different than a bank savings account that holds cash earning a small amount of interest.  The TFSA has the flexibility of holding cash like a bank savings account, but can also hold a variety of different types of investments, similar to an RRSP with bonds, equities and mutual funds.

When the TFSA was launched, the TSC/S&P Composite Index was at 8,987.70.   Frank, James, and Clare all open a TFSA on the first day, and each had a different view on how to invest within the account.   We have outlined how each of their accounts have performed over the January 1, 2009 to January 2, 2011 period.

■ Frank opens up a TFSA savings account on January 1, 2009 and deposits $5,000.  For purposes of this article, we will assume the savings account earns 1.3 per cent every year.  After the first year, Frank’s TFSA is valued at $5,065.  Frank deposits a further $5,000 into his savings account on January 1, 2010.  On January 1, 2011 Frank deposits another $5,000.  On January 2, 2011 Frank’s TFSA is worth $15,196.

■ James opens up a transactional TFSA account on January 1, 2009 and deposits $5,000 into a three year compound GIC (maturing on January 2, 2012) earning three per cent.  At the end of the first year, James’ TFSA is valued at $5,150.  James deposits a further $5,000 on January 1, 2010 and purchases another three year compound GIC (maturing on January 2, 2013) earning three per cent.  On January 1, 2011 James deposits another $5,000 into his TFSA and buys another three year GIC (maturing on January 2, 2014) earning three per cent.  On January 2, 2011 James’ TFSA is worth approximately $15,454 and he has three GIC’s that are laddered (maturities in early 2012, 2013, and 2014).

■ Clare likes the idea of having a lower risk equity that pays a dividend and also has some growth potential within her TFSA.  On January 1, 2009 Clare deposits $5,000 into her fee-based TFSA and purchases 150 shares of TransCanada Corp (TRP) at a price of $33.17 per share.  We recommend that Clare sets up the Dividend Reinvestment Plan (DRIP) on TRP.  After the first year, Clare’s TFSA has three additional shares from the DRIP program, and a total ending market value of $5,525.  Clare deposits a further $5,000 on January 1, 2010 and purchases another 141 shares of TRP at $36.19 per share.  During 2010, Clare receives a further ten shares of TRP through the DRIP program.  On January 1, 2011 Clare deposits another $5,000 and purchases 133 shares of TransCanada Corp at $37.99 per share.  On January 2, 2011 Clare’s TFSA is worth $16,469 and has 433 shares of TRP.

Each of the above people put in a total of $15,000 of original contributions and took a conservative approach.  The ending market value as of January 2, 2011 for the three investors range between $15,196 and $16,469.  Not illustrated above, are those people who have decided to assume more risk within the TFSA account by holding more aggressive equities.  Given the strength in the markets over the last couple of years, some of these people have already built up a sizable TFSA.  With proper management, early contributions, and time to grow, the TFSA can become a significant account to factor into your financial plan.


Fee-Based TFSA:  If your TFSA is a fee-based account then you should have the fee’s being paid from a non-registered account.  If you have not done this already then you should be able to speak with your advisor on having an amount transferred in to cover fees.  This will enable you to avoid tax on even a greater base amount.

Dividend Reinvestment Plan:  If you choose to invest in a large company paying a dividend then you should discuss setting up the DRIP program.  Many companies also offer a discount for shareholders participating in the DRIP.

Registered Account:  The TFSA is a “registered account”.  If you have a capital loss in a TFSA, you will not be able to claim it like you could in a non-registered account.  You also will not receive new TFSA room for trading losses.  We feel it is important to factor this in when making TFSA investment decisions.

Coupons or Compound GICs:   When you are purchasing direct holdings rather than mutual funds you will have periodic income payments come into the account.  In the TFSA it may be difficult to reinvest a small amount if you purchase direct fixed income (GICs’, bonds, etc.) within your account.   Two good fixed income solutions are coupons (also known as strips or residuals) that are purchased at a discount and mature at a greater value.  Look at compound GICs that are for periods greater than a year.

Property Taxes:  If you are 55 years or older then you are able to defer your property taxes.  Often at times, cash flow is restricted and contributing to a TFSA is not easy.  One strategy that we like is for clients to defer their property taxes and deposit the funds into a TFSA. Even if invested in GICs, similar to James above, you would be further ahead.  The interest rate for the property tax deferment program for the period October 1, 2010 to March 31, 2011, is 0.50 per cent (and 2.5% for certain families with children).

Naming Spouse as Beneficiary and Successor Annuitant:  If you are married then we would recommend that you understand the benefits of naming your spouse as beneficiary and successor annuitant.  Let’s use Frank as an example from up above.  He is married to Louise who has a TFSA valued at $20,000.  Frank has named Louise as both the beneficiary and successor annuitant of his TFSA.  If Frank were to pass away, Louise would be able to roll Frank’s entire TFSA valued at $65,730 into her own TFSA.

Understanding Withdrawals:  If you require cash to live off of then the first place you should look at is your bank accounts and non-registered investment accounts.  The second place you should look is the Tax Free Savings Account (TFSA).  If you do withdraw funds from a TFSA in a given year, you must wait until the next calendar year prior to replenishing the amount withdrawn.

Should business owners and professionals contribute to an RRSP?

Registered Retirement Savings Plans were initially deisgned for people who did not belong to a pension plan, including self-employed business owners. But some financial advisors and accountants encourage incorporated business owners and professional clients to avoid RRSPs because:

  • B.C.’s small business income threshold increased from $400,000 to $500,000 as of January 1, 2010. 
  • Effective March 19, 2007 the Lifetime Capital Gains Exemption increased from $500,000 to $750,000 for small business corporation shares. 
  • Effective January 1, 2010, B.C.’s small business corporate tax rate on active business income (up to $500,000) is 13.5 per cent.

Let’s take a step back in time when B.C. corporate tax rates were higher and the small business income threshold was lower. Most owner managed businesses would have regular payroll set up to pay themselves. This was an added administrative cost. It also meant remitting income tax and CPP (both employee portion and employer portion for owner managed businesses). An owner of a business would effectively be paying twice the amount into CPP, with only one half of this amount being tax deductible for the corporation. At year end, it was common to give the owner an additional management fee or a bonus to reduce taxable income in the corporation, and increase income personally.

The regular payroll/wages, plus any management fees or bonuses were all considered “earned” income. This is significant in how it relates to RRSP accounts. Your annual RRSP deduction limit is increased by multiplying your previous years earned income by 18 per cent (up to a yearly maximum). Annually it made sense for business owners to contribute to an RRSP. This effectively reduced current year income personally, and allowed business owners to tax shelter funds for retirement.

Let’s fast forward to today. With corporate tax rates so low, many accountants are advising to have the income taxed fully in the corporation and avoid paying any wages or bonuses (or at least a reduced amount). The one main exception to this would be professionals who pay an annual fee into an association that provides a matching RRSP program. As an example, doctors who pay British Columbia Medical Association dues have an RRSP matching program. In these cases we recommend that doctors take advantage of this program to make paying the dues worthwhile. This results in some wages which need to be paid in order to generate the RRSP deduction limit.

Assuming no wages, management fees, or bonuses are paid then the total net income would be taxed within the corporation. The net income after tax is added to retained earnings. If the owner/shareholder required cash then a dividend would be paid from retained earnings. Dividends are taxed at a considerably lower rate then wages.

The downside to dividends is that they are not considered “earned income” and as a result no RRSP deduction is created. The other component to factor in is that you are not paying into CPP (both employee and employer) annually when dividends are paid. The maximum employer portion of CPP is $2,163.15, and maximum employee portion of CPP is $2,163.15. Self employed business owners effectively pay a combined maximum of $4,326.30 for 2010 if earnings are $47,200 or greater.

By paying dividends, this comes with CPP saving today, but a sacrifice in the future. Unlike OAS which is based on residency, CPP is based on your reported earned income and CPP contributions. If you do not pay into CPP, then you should not expect to receive CPP at retirement. If you pay only a little into CPP, then you should expect to receive a little CPP at retirement.

Every time legislation changes people should take a pause to determine if what they have always done still makes sense. Is there a better strategy to provide for flexibility or to reduce taxes longer term?

An example of this is the introduction of the Tax Free Savings Account and Registered Education Savings Plan. Business owners can use both of these types of accounts to tax shelter income and to obtain the deferral benefit that an RRSP provides.

One of the benefits of corporate investment accounts is that investment counsel fees and interest expense, relating to the investments, may be tax deductible. These are not tax deductible within an RRSP.

Margin account agreements are not possible within an RRSP. With RRSP accounts, you are forced to begin pulling funds out at age 72. In some of these cases, this results in OAS being clawed back. With a corporate account there is no requirement to pull funds out. After going through some periods of volatility, investors should appreciate the ability to claim a loss if they have them.

Net capital losses in a corporation may be carried back up to three years or to offset taxable capital gains in the future. Losses within an RRSP cannot be claimed.

When we are talking to business owners, the number one misconception we come across is the belief that when the active business is done, the corporation is wound up at the same time. This is generally not the recommended strategy. In some cases where shares are sold, then the financial assets would typically have been moved to a holding company and only the active company is sold.

There are other reasons to have a holding company in addition to an operating company – cleansing for the lifetime capital gains exemption, income splitting, creditor protection and ease of selling. In many cases we are assisting people with the investments within the holding company as they get built up and through retirement.

Building up equity within a corporation provides flexibility and it makes sense today. There are some tax efficient ways, utilizing insurance products, to move retained earnings out during your lifetime and at death that are certainly more appealing then paying 44 per cent (or more) of your RRIF to the government on death.

Pre-authorized contribution make sense

The easiest way to implement savings and investments into your routine is to set up a pre-authorized contribution – often referred to as a PAC.  Begin by looking at monthly cash-flows and determining a comfortable amount to set aside.

A PAC can be set up for most types of accounts – the most common being Registered Retirement Savings Plans, Registered Educated Savings Plans, Tax-Free Savings Accounts and non-registered accounts.

PACs can help individuals reach specific goals, such as retirement, education planning and emergency reserves.  If you are unsure of the savings required to reach each one of your goals, complete a financial plan with a list of savings required to meet your goals.

A typical financial plan may recommend that a couple each maximize annual TFSA and RRSP contributions, and save $500 per month in a non-registered savings account.

Dollar-cost averaging is used in finance to explain the purchase of the same investment on more than one day.  As an example, if you would like to purchase $20,000 of a particular stock but you feel it may be a bit expensive, one approach is to purchase a half position today at $10,000.  If the stock declines then you have the ability to buy $10,000 more without being overweight in the position.  By buying the stock on two different dates you are effectively dollar-cost averaging.

If you are contributing every month into a mutual fund then you are buying at different points in the market cycle.  For dollar-cost averaging to work it is important to continue contributions even if we are experiencing difficult financial markets.

Financial illustrations demonstrate the benefits of contributing early, even if those contributions are smaller.  The compounding effects of investment returns are an important component to consider when developing a savings strategy.

Decision 1:  How much can you afford to contribute?  Setting aside ten per cent of your monthly income may be a guideline to get some investors started.  It is important to look at your financial plan and available cash flows.  You can always start with a conservative amount and increase the dollar amount over time.

Decision 2:  How often would you like to contribute?  Most investors who establish a PAC contribute either once or twice a month.  We recommend that individuals consider their cash inflows and match the PAC accordingly.

Decision 3:  What type of investment would be most appropriate to set up as a PAC?   The three most common options are cash, high interest savings accounts, or a mutual fund.

Typically the people who contribute the amount as cash are looking to purchase individual holdings, once funds accumulate, rather than a mutual fund.  Some high interest savings accounts allow investors to set up a PAC.  If you choose to do a PAC in a mutual fund it is important to pick a quality fund and review this regularly.  Small PACs can turn into a significant nest egg over time if managed correctly. Some fund companies have policies where an initial purchase is required (i.e. $500) to establish a PAC.

Decision 4:  What type of an account would you like to set up a PAC for?  Many investors choose to PAC for their Registered Retirement Savings Account.  If an investor knows their maximum Registered Retirement Savings Plan deduction limit then a PAC can be set up to contribute one twelfth of this amount each month over the year.  Another example may be parents or grandparents who want to fund a RESP for a child or grandchild, through a monthly PAC.

One of the main reasons we like PACs is that it sets up forced savings.  With the amount automatically coming out of your bank account it also becomes part of a routine that is factored into your cash flows.  After a few months, some investors may even forget that they are saving automatically.


Balance risk against return

One concern worth discussing is the degree of risk within your registered accounts.  Registered Retirement Savings Plans are typically designed to fund your retirement.

It’s not a question of how to invest your hard-earned dollars, but more specifically, how much risk should you take within your RRSP account?

Tom and Linda Green both have RRSPs.  Tom, 46, is an engineer and Linda, 45, is a teacher.  They have been married for 11 years.  Tom is not interested in fixed income as he considers the rates too low.  Tom would like his RRSP to be 100 per cent equities.  Linda had a bad investing experience two years ago and prefers 100 per cent fixed income.

The following summarizes some of our discussion points we had with both Tom and Linda.

Household Investments:  The first question that we asked was whether or not they viewed their investments individually or as a household.  Both said household.   After that response we went on to explain how most of the portfolios we design have a balance of fixed income and equities.  The way the portfolios were currently structured, one portfolio would likely be outperforming the other in any given year.

Fixed Income:  We asked Tom why he objected to fixed income in his portfolio.  He responded by saying that a three per cent GIC doesn’t earn anything after taxes and inflation are factored in.  We explained to Tom that over the last year we were able to purchase fixed income for our clients with yields of up to ten per cent.  We discussed corporate bonds, debentures, and other fixed income options that provide a better return, with a little risk.  Tom was open to adding a fixed income component to his portfolio.  There are times in the market cycle when there are growth opportunities in the fixed income markets.

Equities:  We asked Linda why she was so cautious about equities.  She had invested in some technology stocks and sold all of her equities after a one-year period at a significant loss.  We explained to Linda that equities are typically classified as low, medium and high risk.  The stocks she had invested in were all “high beta” or “high risk.”   We also noted that she had some bad timing when she bought the investments initially.  We outlined a few low risk, high dividend paying stocks.  We also reviewed market cycles and the importance of focusing longer term when equity investing.  Linda was open to adding a few low risk equities to her portfolio.

 Time Horizon:  Tom and Linda both plan on working another 15 years each.  We talked about how the overall asset mix should become more conservative as they approach retirement.  We refer to the five-year period before retirement as the “risk zone.”   We discussed a disciplined approach and documented this through an Investment Policy Statement.  The statement covered their investments as a “household.”

Other Accounts:  The only accounts that Tom and Linda currently have are registered (both have an RRSP and TFSA).  Tom and Linda are nearly debt free.  They have been aggressively paying down their mortgage.  In about three years time they will be debt free and plan on directing excess cash to a joint with right of survivorship (JTWROS) non-registered investment account.  We explained that once they begin saving outside of registered accounts they should consider shifting the higher risk equities out of their RRSP into the JTWROS account.  We explained that losses within an RRSP are wasted.  A loss within a non-registered account may be carried back three years or forward indefinitely.

Return versus Risk

It was obvious in our initial conversation with Tom and Linda that they both viewed investing from different angles.  Tom looked at returns first, where Linda looked at risk first.  Together they compromised on a balanced portfolio with a moderate level of risk.

Check documentation when topping up your TFSA

The Tax Free Savings Account survived its first year.  The rules with respect to the annual TFSA limit after 2009 is that it will be indexed to inflation, while additions to contribution room will be rounded to the nearest $500.  For 2010, the TFSA additional contribution limit will remain at $5,000.

Studies have shown that the majority of people did not open a TFSA in 2009.  As many people still have debt, or other obligations, the TFSA was obviously not the top priority.  Based on the phone calls we received last year, some people felt that they needed to open an account up in 2009 to actually get the $5,000 contribution room.  That is not the case; if you are among the majority who did not contribute at all in 2009 then your eligible TFSA contribution room for 2010 is now $10,000.

We are seeing many situations where people do not have the documentation completed correctly with respect to their TFSA.  Two areas in particular stand out as incomplete:  naming beneficiaries and successor annuitant/holder.

Some tips:

■ TFSA Beneficiary

If you opened your account in early 2009 it was not possible to name a beneficiary on your TFSA.  Legislation has now been passed in British Columbia, but this was done after many had already opened their TFSA.  Advice given at that time was to update their wills to include the assets within the TFSA.  Most people likely felt the $5,000 was immaterial to their estates when compared to the costs and time associated with getting their will updated.

The benefit of naming a beneficiary is the ability for the assets to bypass the estate of the deceased and transfer directly to named beneficiaries.  If no beneficiary is named then the TFSA will be part of the deceased’s estate.  Assets flowing through your estate are typically subject to probate and other fees.

For our clients who opened a TFSA in the initial stages, we sent the beneficiary forms later.  Updating, or changing, your beneficiary should not cost anything.  We recommend you check your original TFSA forms to ensure a beneficiary has been named.  The form is easy to complete and will simplify the asset distribution of your estate.

■ Beneficiary is Not Spouse

If the beneficiary of your TFSA is not a spouse then the assets of the TFSA will transfer to your named beneficiary with no tax consequences to your estate.  If the beneficiary wishes to keep the assets as they were, then an in-kind transfer should be requested.  If the beneficiary wishes to have cash, then instructions to that effect should be provided.  The beneficiary has the option to transfer the assets into their own TFSA, provided that contribution room exists.  If no room exists then the assets can be transferred to a non-registered investment account.

■ Beneficiary is Spouse

There are some distinct differences to naming a spouse as your TFSA beneficiary versus another family member. We recommend most couples name their spouse as a beneficiary.  In addition to naming your spouse as a beneficiary we recommend setting up your spouse as a successor annuitant.

■ Successor Annuitant

For couples, understanding the term successor annuitant is essential.   This is a separate part of the TFSA form, or it could be another form altogether.  A spouse who is named as a successor annuitant is able to roll their spouses TFSA into their own TFSA without using up their own contribution limit.  The plan continues exactly as is with the rights being passed onto the successor.  All income will continue to be tax sheltered after the TFSA holder’s death.

An example:  Mr. Newman has a TFSA and has named his spouse as the beneficiary and a successor annuitant.    At the time of Mr. Newman’s death, his TFSA was valued at $42,000.   Mrs. Newman’s TFSA was valued at $39,500 prior to her husband’s death.  We estimate Mrs. Newman will have a combined $81,500 in her TFSA that is completely tax sheltered.

By naming your spouse as a successor holder it also ensures that income earned after the original holder’s death is not taxed.  If the successor holder is not named then legislation requires taxation of income earned in the TFSA after death.

Just to give you an idea of how new the TSFA account is, some holders have already passed away without having the proper documents completed.  We recommend spouses in this situation speak with their accountant to complete the required CRA form (RC240) to ensure that the TFSA rollover would be treated as an exempt contribution.

As you are depositing top-up contribution for 2010, or setting up a new account, you should ensure that the beneficiary is set up correctly.  If you are married, and naming your spouse as the beneficiary, you should ensure that the successor annuitant form is also completed.


  • Canadian residents age 18 or older can contribute up to $5,000 annually to a TFSA
  • Investment income earned in a TFSA is tax-free.
  • Withdrawals from a TFSA are tax-free.
  • Unused TFSA contribution room is carried forward and accumulates in future years.
  • Full amount of withdrawals can be put back into the TFSA in future years.
  • Choose a range of investment options such as mutual funds, GICs and bonds.
  • Contributions are not tax-deductible.
  • Neither income earned within a TFSA nor withdrawals from it affect eligibility for federal income-tested benefits and credits, such as Old Age Security, the Guaranteed Income Supplement, and the Canada Child Tax Benefit.
  • Funds can be given to a spouse or common-law partner for them to invest in their TFSA.
  • TFSA assets can generally be transferred to a spouse or common-law partner upon death.

Source: Government of Canada



Invest in RRSPs if….

Registered Retirement Savings Plan accounts can be an effective savings strategy for most investors.  Here are a few examples of events and situations where an RRSP contribution makes sense:

■ Disciplined Savings: We like RRSP accounts for the reason that it provides a pool of capital ear-marked for retirement.  In the absence of this type of an account, some people may not have the discipline to set aside savings.  The fact that RRSP withdrawals are taxable could also be viewed as a positive component as it encourages people to keep the money invested.

■ 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.  It’s possibly that you have held onto a particular investment for years and then suddenly it is taken over involuntarily creating a deemed taxable disposition.  What if you sell some real estate not considered your personal residence for a large taxable gain?  Perhaps you receive a large bonus at work.  RRSP contributions during high income years can bring your income tax liability down considerably.  RRSPs 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 and debentures.  All of these types of investments create interest income, which is taxed annually if held in a non-registered account.

■ 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, 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 a 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 Tax Free Savings Account 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.

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.