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.


New Tax Free Savings Account is so good we bet it won’t last

The Tax Free Savings Account is the best opportunity for investors today to minimize tax during their life, and into retirement.   The younger an investor is, the greater the benefit of the TFSA.  The long-term benefits of the TFSA seem almost too good to last.   The government has stated that withdrawals from a TFSA are tax-free.  Not only are they tax-free, they will not impact income-tested benefits, such as the guaranteed income supplement or Old Age Security claw back.

In 2007, the mandatory RRIF conversion age was moved from 69 to 71, with the first required minimum payment at age 72.  Pension splitting was also introduced in 2007.  Another minor benefit was the increase to the pension income amount from $1,000 a year to $2,000 a year.  This essentially allows investors to pull $2,000 out of a RRIF account each year tax-free beginning at age 65 (assuming that the pension income amount is not applied to other eligible income).  People should modify their financial plans based on the above announcements and new TFSA.

By combining all the factors noted above, the benefits for people who have a savings plan in place are excellent.  We will use Stephen, who turned 19 on January 1, 2009, to illustrate our point.  In our calculations, we assume inflation of three per cent and annualized rate of return on investments of six per cent.  We also assume that Stephen’s ten highest earning years will be when he is 55 through 64 (when he is in the 30 per cent income tax bracket).  Stephen plans on retiring on his 65th birthday.

Early Years

Stephen should contribute the maximum amount annually to his TFSA every year beginning at age 19 until age 64.  If this discipline is set early Stephen will have accumulated close to $1.9 million in his TFSA by his 65th birthday.  Between 19 and 31, any extra savings should be accumulated for a down payment on a home.  By purchasing a personal residence Stephen will be taking advantage of one of Canada’ best tax-exempt investments.  When Stephen is 30 he meets Sharon and they soon get married.  Sharon is the same age as Stephen.  For illustration purposes, and to keep this scenario realistic, we will assume that they only have the cash flow to fund Stephen’s TFSA (or half in each).

Age 31 – 56

Together they buy a home when they turn 31.  In their middle earning years they should focus on first paying down the mortgage.  By removing their non-deductible debt as soon as possible, they will save thousands of dollars in interest costs.  Assuming a 25-year amortization schedule, they will be mortgage free when they are 56 years old.  Sharon has twins when she is 36 years old.  Sharon has directed some of her excess savings into starting a family Registered Education Savings Plan (RESP) for their children.  During this period we recommend contributing $2,500 for each child for fourteen years to maximize the Canada Education Savings Grant of $7,200 per child.

Age 57-64

After the mortgage is gone and RESP contributions cease, Stephen and Sharon will have a little extra cash flow.  Both Stephen and Sharon should redirect the cash flow previously dedicated to mortgage payments and RESP contributions to making their first RRSP contributions.  We assume Stephen has the higher income.  In today’s dollars, we recommend he contribute approximately $7,000 for six years between the age of 57 and 62.  This should fund two life annuities beginning at age 65 paying $2,000 a year each.  This is equal to the pension income amount and should essentially be tax-free.  The cost of these contributions is approximately $4,900 annually as Stephen will receive a tax refund of $2,100 for each of the six years (30 per cent x $7,000).


When Stephen and Sharon are 64 they should convert their RRSP accounts to RRIF accounts and schedule to take their first payments at age 65 ($2,000 per year each).  Both should apply for Canada Pension Plan (CPP) retirement benefits.  Stephen is eligible for the full CPP; however, Sharon worked part time and qualifies for a lower CPP amount.   Stephen and Sharon should make an application to share CPP, this will reduce the household tax liability.  In addition, they should both apply for OAS to begin once they turn 65.

At the beginning of retirement, Stephen and Sharon will have accumulated approximately $1.9 million in their TFSA account.  Readers should factor in inflation when looking at this number.  $1.9 million in 46 years will not be worth the same amount as it is today.  With a three per cent real rate of return, the equivalent amount (in today’s dollars) is approximately $488,000.  In today’s dollars, Stephen and Sharon will also have $26,900 and $28,500 in their RRIF accounts, respectively.  If we assume that both Stephen and Sharon have life expectancies of 90 years, then the TFSA should fund annual tax-free cash payments of approximately $137,600 (the first payment is approximately $35,173 in today’s dollars).  If Stephen and Sharon were both able to take advantage of the TFSA then the TFSA should fund annual tax-free cash payments of approximately $275,200 (first payment is approximately $70,346 in today’s dollars).  In addition, they will also each receive income from CPP, OAS, and the RRIF annuity.

The TFSA brings planning for low taxable income at retirement to new levels.  People who use the TFSA will pay more annual taxes during their working years from not maximizing RRSP contributions.  This sacrifice will be rewarded at retirement when taxes will be extremely low.  Stephen and Sharon will not have to worry about having their old age security being clawed back.  In fact, if they plan right, their income may be low enough to qualify for medical benefit assistance and/or other income tested benefits.  Better yet, they may qualify for the tax-free guaranteed income supplement (GIS).

After doing the math we came to the conclusion that the TFSA is such a good deal for Canadians that it likely will not last long term in our opinion.  If it does last more than ten years then possibly some of the rules will change.  In the meantime, it makes sense to consider how the TFSA can benefit your overall retirement savings strategy.

Tax-Free Savings Accounts have arrived

Beginning in January 2009 all Canadian residents over 18 will be able to contribute annually to a Tax Free Savings Account (TFSA).

For 2009 the limit is $5,000, and although you do not receive a tax deduction for contributing, all income within the TFSA grows tax-free and there is no tax on withdrawals.  In the following years, the annual limit will be indexed to inflation and the annual additions to contribution room will be rounded to the nearest $500.

Nearly everyone should have a TFSA.

Why?  You can save tax-free and still have the flexibility to withdraw your savings at any time, for any purpose.  The new TFSA should be a very important component of all financial plans and investment strategies.  Although initial contributions may be small, it will grow into a substantial amount over time.

Contributions to a TFSA may be the best option for many people, replacing RRSPs as the first place to save money.  Others may find that the TFSA compliments their RRSP savings.  It really comes down to what your taxable income is today and what you project it will be in the future.  A couple who each save $5,000 a year (at the beginning of each year) for 25 years would have combined accounts of approximately $676,000 if the investments earned a seven per cent annualized rate of return.

Nearly every financial firm today has a campaign marketing these new accounts.  Although small at this stage it is important to map out your strategy for the TFSA and how it fits into your overall financial plan.   Here are 10 tips to consider for the TFSA:

1) Financial Plans – The first step prior to setting up a TFSA is to see how it fits into your current financial plan.  After you go through some future contribution and growth numbers you will see that the TFSA will be one of the most important components of your financial plan.

2) Low or High Risk – Many people are torn between choosing conservative cash equivalents and fixed income investments, or choosing higher risk options such as equities.  The underlying investment options are extremely important.   We would encourage people to look at both short-term and long-term goals when choosing investment options.  The choice should be suitable given your risk tolerance, other investment holdings, and cash flow needs.

3) Investment Flexibility – It is likely that the investment you choose may change over time.  Ask the financial institution, where you are considering opening up a TFSA, what types of investment options they have.  It may be that you are limited to savings accounts, term deposits, and/or proprietary mutual funds.  You may find that direct equities, index shares, bonds, or non-proprietary mutual funds are a better option.  If you deal with a firm offering all options, it provides more flexibility this year.  This is especially important if you feel you may want to make investment changes in the future as your TFSA grows.

4) Understanding Fees – Watch for annual fees, transaction fees, withdrawal fees, and transfer fees (if you move your TFSA to another firm).  Some financial firms may have different account options available including transactional, fee-based or managed.  It is important to obtain an understanding of the account type and all current and future fees.

5) Contributions – Not everyone will be able to deposit $5,000 in early January.  Consider contributing $200 as an initial investment in early January then set up a monthly pre-authorized contribution of $400 per month at the end of every month.  This is a perfect pay-yourself investment account.  Care should be taken not to over contribute to your TFSA, as a penalty tax will apply on the excess amount.

6) Beneficiary – Carefully select the beneficiary of your TFSA.  We are encouraging couples to name each other as beneficiary to take advantage of the tax free roll-over.  If you are single, you should obtain an understanding of what happens to your TFSA is you name someone other than a spouse as a beneficiary.  It is possible to name your estate as beneficiary.  However, fees such as executor and probate are often avoided if a beneficiary is named.

7) Withdrawal – One of the most attractive components to the TFSA is that it may be replenished if a withdrawal is made.  Some restrictions apply relating to replenishing a TFSA in the same tax year.  We envision multiple reasons why someone would need to make a withdrawal, such as: education expenses, home purchase or renovation, vacation, health care expenses, car purchase, etc.  Another reason a person may make a withdrawal is to shift funds into an RRSP.  If you are in a low income tax bracket, it likely makes more sense to contribute now to a TFSA.  If in the future you are in a higher income tax bracket (making greater than $38,000 annually), and can commit the funds for retirement, it may make sense to roll some funds from your TFSA into your RRSP to obtain a tax deduction.

8) Low Income Years – The TFSA will immediately benefit seniors who are currently receiving income-tested benefits and we encourage those with low incomes to take full advantage of the TFSA.  Higher net worth individuals may consider using the TFSA for withdrawals to fund the first few years of retirement.   As an example, a person could have $500,000 in an RRSP at age 65 and $300,000 in a TFSA.   By using the TFSA for the first five years it may be possible that you will also receive income tested benefits (i.e. guaranteed income supplement, old age security) provided the rules do not change.

9) Sheltering Income – If you follow Tip 8 then chances are you have the ability to contribute funds back into your TFSA when you begin pulling funds out of your RRSP and RRIF accounts.  Although the RRSP and RRIF withdrawal is taxable, the proceeds may be deposited into the TFSA to tax shelter the future investment income component.

10) Talk To An Advisor – We encourage you to speak with a financial advisor to discuss opening a TFSA.   An advisor should obtain an understanding of your cash flow needs, taxation matters, goals, and risk tolerance.  With this knowledge they should be able to guide you in the right direction.


Tax-free savings account is very useful

Recently, the federal government released details regarding the 2008-09 Federal Budget.  The highlight to this year’s budget has to be the Tax-Free Savings Account.

Beginning in 2009, people age 18 and older will acquire $5,000 of TFSA contribution room each year.  The annual limit will be indexed to inflation and the annual additions to contribution room will be rounded to the nearest $500.  Unused contribution room will be carried forward to future years.  As an example, if you do not contribute to a TFSA in 2009 then your contribution room will be $10,000 in 2010.

Individuals who contribute to a TFSA are able to make tax-free withdrawals.  The unused contribution room is increased when withdrawals are made.  The fact that withdrawals from a TFSA are tax-free and your contribution room will be replenished creates a higher level of flexibility than RRSP accounts.

Often we see individuals who make RRSP mistakes.  The most common of which is making a contribution in a lower income year and then withdrawing the funds a few years later when income levels are higher.  Younger individuals in a lower tax bracket should first consider the TFSA, which offers the flexibility to withdraw funds.

The exciting news about the TFSA is that all income generated within the account is exempt from tax.  This includes interest, dividends and capital gains.  This type of an account may be ideal for individuals who want to hold investments such as GICs, term deposits, or high interest savings accounts.  The TFSA will also be eligible to hold the same types of qualifying investments that an RRSP may hold, including publicly traded securities, bonds, and mutual funds.

The TFSA provides an income splitting benefit for married couples (and common-law).  The higher income spouse may contribute to the other spouse’s TFSA.  This is one of the exceptions to the “attribution rules” that couples should take advantage of.  Married couples (and common-law) may have the benefit of rolling-over the TFSA to the surviving spouse if one of them were to pass away.  This new tax-sheltered vehicle should support savings as a household.

Contributions into a TFSA do not result in a tax deduction.   Medium and high income earners with likely use both an RRSP and TFSA.  Individuals who are in a higher income

tax bracket will still be attracted to RRSPs, which offer the upfront tax deduction.  Higher income people who are making their maximum annual RRSP contributions may also have a TFSA as a means to shelter more savings from tax.

Individuals who have savings outside of a registered plan should take full advantage of the TFSA when it is available in 2009.  This account may be used for planned activities, such as a home purchase, travels, or a new vehicle.  Keeping funds in this type of an account may be ideal to fund emergency costs, such as unexpected medical bills or periods of unemployment.

The TFSA should benefit everyone who has savings or would like to begin saving.  Younger people will be able to accumulate funds faster if they are not taxed annually on their investment income.  Older individuals who have GICs or term deposits may be able to reduce some of their taxable income by shifting funds that are currently in a taxable account to the TFSA.  A reduction in income may allow older individuals to receive more benefits from income tested credits and supplements.

The TFSA will only benefit those who save and take advantage of it.   We encourage individuals to meet with their accountant and financial advisor to adjust their long-term financial plan to include the new TFSA for 2009.

Deducting contributions will require strategy

Confusion often results between the terms “RRSP deduction limit” and “unused RRSP contributions.”  Both of these terms are used on the RRSP Deduction Limit Statement at the bottom of your Notice of Assessment from Revenue Canada.

Yesterday, our column dealt specifically with the term RRSP deduction limit.  This column outlines how the unused RRSP contributions is integrated with RRSP deduction limit.

Most investors who contribute to an RRSP claim the deduction immediately on their tax return.  Investors should understand that they do not have to claim the deduction immediately.  In some cases it is recommended that you do not claim the deduction immediately.  If you carry forward an amount it is referred to as “unused RRSP contributions.”

Why would you contribute to an RRSP and not claim the deduction immediately?  The main reason is to shelter the income from tax.  Once you have made the contribution into an RRSP all income generated within is deferred regardless if you have claimed the deduction.  Two other main reasons why you may not claim a deduction immediately are the contribution exceeds current year taxable income, and future income is expected to be higher.

We have provided three illustrations below with different situations where a person may have unused RRSP contributions at the end of the year.


Mr. Bloomberg recently received a significant inheritance of $200,000 from his mother who passed away.  Mr. Bloomberg came to see us and asked for our recommendations.  Prior to our meeting we asked Mr. Bloomberg to gather some information together including his mortgage statement and 2006 tax Notice of Assessment.  We noted that Mr. Bloomberg had $78,000 left on his mortgage with a very small penalty for prepayment.  We recommended that Mr. Bloomberg repay this debt.  Next we looked at his Notice of Assessment and noted that he had a $79,754 RRSP deduction limit.   Mr. Bloomberg is earning approximately $58,000 per year, but over the years, he has not been maximizing his RRSP contributions.  Mr. Bloomberg expects to work for at least another five years and believes that his income will increase over current levels.

Based on the information gathered we recommended that Mr. Bloomberg contribute $79,754 to his RRSP.  Based on his current level of income Mr. Bloomberg should speak with his accountant and determine how much of this contribution he should claim in the current year and how much he should carry forward as unused RRSP contributions.


Mrs. Thomson recently became a widow at the age of 55.  Her deceased husband had a life insurance policy with a death benefit of $250,000.  Mrs. Thomson mentioned that she has no debt and approximately $77,300 in RRSP deduction limit.  Mrs. Thomson is planning to work another ten years and has expected income during this period of approximately $50,000 a year.

We recommended that Mrs. Thomson shelter $77,300 from tax immediately.  However, we also recommended that she claim the deduction over the next few working years.  At the beginning of every year we would encourage Mrs. Thomson to roll some of the remaining non-registered funds to top up her RRSP.  Based on $50,000 a year, she will have another $9,000 each year in additional RRSP room.  She may also want to take advantage of the $2,000 excess contribution that CRA allows over the deduction limit.


Over the last 20 years Mr. Reuter has worked hard as a realtor.  His knowledge and expertise has been in real estate and he has focused nearly all of his investments in that area.  Mr. Reuter has never contributed to his RRSP and has an RRSP deduction limit of $143,600.  Mr. Reuter is now in the process of selling one of his rental properties.  We have estimated that his taxable capital gain on this property will be approximately $33,800 and the total proceeds will be approximately $389,000.

We explained to Mr. Reuter that contributions to an RRSP may offset the taxable capital gains.  We also provided Mr. Reuter some information on alternative investments that he could focus on outside of real estate.  We recommended that he could use a portion of the proceeds from the rental property and contribute $143,600 to his RRSP.  He could deduct enough to reduce the capital gains tax and his real estate income in the current year.  The remainder of the contribution he may carry forward as “unused RRSP contributions” to offset against future rental properties that he sells and his real estate commissions.

Excess Contributions

When you have an unused RRSP contribution amount it is important that you monitor this amount along with the RRSP deduction limit line.  Be careful that the unused amount does not exceed your deduction limit by more than the $2,000 buffer that CRA allows.

If the unused amount exceeds the deduction limit amount by more than $2,000 then you have made what is referred to as an excess contribution.  Excess contributions are subject to a one per cent tax on the excess amount for every month they are left in the RRSP.  If you have excess contributions, you may have to complete and send a T1-OVP return with payment to your tax centre no later than 90 days after the end of the year in which the unused contributions exist.  Failure to file this return may result in further interest and penalties.   We would encourage all investors who have an excess contribution to proactively deal with their mistake before CRA sends you a letter.

Understanding RRSP terminology and your existing tax situation may ensure that you take full benefits of your options, including when to deduct your RRSP contributions.

RRSP deduction limit has value

Registered Retirement Savings Plans have been around since 1957, allowing investors to sav for their retirement while providing a shelter on tax.

One of the most significant legislation overhauls to RRSP legislation was in 1991 with the carry forward provision.  Now investors no longer have to make a “use it or lose it” decision.

The provision allowed unused RRSP contribution limits after 1990 to be carried forward.  The RRSP deduction limit is included on your Notice of Assessment that Canada Renue Agency sends after you file an income tax return.

Your RRSP deduction limit may be carried forward indefinitely.  This is an important component for everyone to note, considering most people have incomes that increase over time.

Consider Mr. Samson, who is 25 years old and has been a professional student for much of his life.  He decided in 2006 to start working and earned $40,000.  In 2007, Mr. Samson’s RRSP deduction limit is $7,200 ($40,000 x 18 per cent).  Mr. Samson feels that he will be making a larger salary soon and would rather dedicate his current year earnings to paying off his student loans.  He does not lose the $7,200 RRSP deduction limit.  Every year that he does not contribute to an RRSP he will be accumulating a greater deduction limit to be used in the future.  If his income increases then he may save more in taxes by delaying his RRSP contribution.

Marketing by financial institutions may be one reason people rush out and make last minute contributions.  It may also be recent news question whether Canada Pension Plan and Old Age Security will exist when they retire.  Or perhaps it is some internal fear of having enough to live on at retirement that pressures so many into making RRSP mistakes.

Check your Notice of Assessment and your deduction limit before you make any contributions.  You should understand what each line represents.  If you are a member of a defined benefit plan then your statement will have pension adjustments.  If you are a member of a defined contribution plan you should factor in contributions made through work.

The sum of both of these contributions should be factored in prior to making any additional RRSP contributions.  Care should be taken to ensure that you do not contribute over your deduction limit.  Canada Revenue Agency provides a buffer of $2,000 before an excess contribution is subject to tax.

Here’s another illustration to make the point:

For nearly 20 years Mr. Phillip has focused his after tax savings to paying down his mortgage.  At 50, he is proud that he is mortgage free.  Mr. Phillip has managed to accumulate approximately $97,200 of RRSP deduction limit.  Now that he is mortgage free he would like to accelerate his retirement savings but does not know where to begin.  Mr. Phillips annual income is $85,000 and he has been dedicating approximately $1,500 a month towards mortgage payments.  Annually Mr. Phillip’s RRSP contribution room is increasing by approximately $15,300 (18 per cent x $85,000).   We discussed with Mr. Phillips that since he no longer has to make monthly mortgage payments, he should consider making monthly pre-authorized contributions to his RRSP.   We mapped out a plan that he could contribute $1,950 monthly to his RRSP, claim the amount as a deduction and save taxes.  The net amount would likely be close to his previous monthly mortgage payment of $1,500.  Best of all, by age 61, Mr. Phillip should have caught up and fully utilized his RRSP deduction limit.

Contribute Early

Time has an amazing way of compounding investment returns.  Investors who begin contributing early to their RRSP are more likely to be financially prepared for their retirement years.  The sooner people begin investing; the longer the savings will be able to grow on a tax sheltered basis.  Tax deferred compounding over a larger number of years should naturally result in a greater accumulation of funds.  One benefit to waiting later in the year to contribute is the greater certainty you will have regarding your income levels and your actual deduction limit.

Avoid Mistakes

If a person pulls funds out of an RRSP, they do not recover the deduction limit.  This amount is lost.  Clearly understanding that your RRSP deduction limit will not vanish if not used should ease some financial pressures.

An RRSP should generally be set up to fund your retirement and involves a long-term discipline.  If you feel that you will likely have to make a withdrawal then you should consider waiting until you are confident that the funds are committed until retirement.  We would rather see someone miss out on a little bit of time to ensure they are not making the mistakes that some people make.


The top 10 mistakes made with RRSPs

A Registered Retirement Savings Plan is not for everyone, but for those who are considering RRSPs or have them, it pays to head off some of the most  common mistakes.

Prior to setting up an RRSP, determine whether you are likely to make one of the following 10 common mistakes:

1.  Often people rush to make a last-minute RRSP contribution and give little thought to the underlying investment.  Spend a few minutes to remember how long it took you to earn that money and slow the selection process down.  Solution:  If you are in a rush we recommend that you consider making contributions to your RRSP in cash and look at all your available investment options prior to making an investment decision.

2.  Over contributing to your RRSP may result in T1-OVP penalties and interest.  This past year we noted a campaign by Canada Revenue Agency that resulted in several letters being sent to individuals who have made over-contributions.  Solution:  Before you contribute to your RRSP, be certain of your limit.

3.  Making contributions to an RRSP and pulling the money out before retirement.  Often this results in more tax being paid than what you initially saved as a deduction.  The shorter the time period between the contribution and withdrawal, the less likely you are to have received tax deferment of income.  Contributing funds and withdrawing the funds uses up your contribution room, which is a big negative.  Solution:   Avoid contributing to an RRSP unless you can commit the funds until retirement.

4.  People who have an RRSP account should understand that all income generated in the account is tax deferred.  This is by far the biggest advantage of an RRSP.  Over time, this should save you much more in taxes than the initial deduction for the contribution.  People who have non-registered investments understand that income generated in these accounts is taxable.  Pulling funds out of an RRSP prior to age 72 is generally the wrong decision when non-registered funds are available.  There are some exceptions, such as shortened life expectancy.  Solution:  Using the capital within your non-registered investments first will reduce your current annual income and defer taxes further.

5.  Some people have multiple RRSP accounts held at different financial institutions.  They may have $10,000 at institution A from a 2004 RRSP contribution, $6,000 at RRSP institution B from a 2005 RRSP contribution, and $8,000 at institution C from a 2006 RRSP contribution.  This may result in additional RRSP fees being charged to you and result in you paying more fees than you need to pay.  More importantly, your investments become more difficult to manage.  Solution:  Consolidate your RRSP accounts at one institution for better management, to reduce fees, and to open up more investment options.

6.  Underestimating life expectancy is also a common mistake.  All too often people in their 60’s begin pulling money out of their RRSP solely to avoid paying a large tax bill if they were to pass away.  We encourage people to plan for the most likely outcome rather than the worst-case scenario.  Solution:  Avoid early withdrawals and ensure that you take full advantage of the deferral benefits of your RRSP.

7.  When you open an RRSP account you must make a beneficiary selection.  If you are married or living common law then the natural choice is your spouse for the tax-free rollover provisions on the first passing.  Often widows will still have their deceased spouses named as beneficiary.  We have seen cases where people have remarried and have their ex-spouse still listed as a beneficiary.  In some cases naming your estate may be the best option.  Solution:  Speak with your advisor and ensure you have the correct beneficiary on your RRSP account.

8.  We encourage people to give careful thought to the type of investments they hold within their RRSP and outside of their RRSP.  Good structure decisions are important and are easier when all of your investments are at one institution.  To illustrate this we will use an individual that has equity investments within their RRSP that may generate dividend income and future capital gains (all income within an RRSP is treated as regular income for withdrawals).  Let’s also assume that this same individual has GICs and term deposits at the bank that are not within their RRSP.  Although this individual does not require income, he is being taxed every year on the income.  Solution:  Have interest generating investments within your RRSP along with equities that you may trade from time to time.  Outside your RRSP consider investments that are long term holds that generate primarily capital gains.  For non-registered accounts, Canadians are not taxed on unrealized gains until the investment is sold.  If you purchased a basket of blue chip equities outside of your RRSP and held them for 20 years you would not be taxed on the gain until the investment is sold.  In effect you have created two types of tax deferred plans.

9.  People who do not have pension income (not including CPP and OAS) should ensure that they are taking all planning components into consideration before requesting early RRSP withdrawals.  Withdrawals from an RRSP are not eligible for the pension income amount and they are not eligible for income splitting.  Solution:  If you require funds then we encourage you to wait until at least age 65 and then convert funds to a RRIF before withdrawal.  RRIF income received at age 65 or older may be eligible to be split and qualify for the pension income tax credit ($2,000 each per year).

10.  One of the biggest mistakes we see is failure to make an RRSP contribution.  Individuals who are making large salaries without a pension need to take advantage of their RRSP contribution room.  Not having the discipline to set aside funds for retirement will result in making sacrifices at retirement.  Solution:  Consider making an RRSP contribution.

Building an RRSP was easy; depleting it will take strategy

Registered Retirement Savings Plan contributions are like steps taken to climb to the top of a mountain.  At some point you make it to the top and you have to begin planning your steps back down.

It can be both an emotional and financial decision when entering the retirement phase and choosing when to begin depleting your capital.  Specifically, when does it make sense to begin pulling your funds out of an RRSP?

In 1996 the federal government announced that people aged 69 through 71 must convert their RRSP to a form of retirement income, such as a Registered Retirement Income Fund, by December 31st.  In addition, the new conversion age was reduced to age 69.  It was quite controversial at the time as census data showed that our population was growing older.

Last March the government essentially reversed the 1996 change.  The Federal Budget proposed increasing the age limit to 71 from 69 for RRSPs and registered pensions being converted to a form of retirement income.  This proposal has now become law and is a positive announcement for investors as it adds more flexibility when planning retirement.

Many investors may feel that the greatest benefit of an RRSP is the ability to obtain a tax deduction for the contribution.  In actual fact, the greatest benefit of an RRSP is the ability to defer tax on the amount contributed.  A person aged 21 may defer tax for 50 years.  The benefit of deferring tax works best for investors that keep the funds invested for a significant period (no early withdrawals).

Here’s an illustration:

Using Janet, a 69 year-old single person that has taxable income of $45,000 (pension income, non-registered investment income, CPP and OAS) and an RRSP of $300,000.  This person requires $20,000 over and above the pension income, CPP and OAS received this year.  Let’s also assume that the non-registered investments are in GICs earning 5 per cent.  Jane is contemplating two options:  Use some of the money in her bank and non-registered investments; or de-register an amount from her RRSP.  With Option 1 Janet uses $20,000 of her non-registered investments (currently earning 5 per cent) then her current year’s income will decrease by $1,000 ($20,000 x 5 per cent) to $44,000.  In addition, Janet’s RRSP will have further tax-deferred growth.  Option 2 involves pulling $20,000 out of her RRSP, increasing Janet’s taxable income to $65,000.  With Option 2, Janet will have a higher tax bill to pay as RRSP withdrawals are considered taxable income.

From a financial planning standpoint you should first spend non-registered cash and investments prior to converting your RRSP to a RRIF.  Wait until age 71 to convert your RRSP and withdraw only the minimum amount at age 72.  This allows for maximum tax deferral.   Delaying withdrawals may not be suitable for everyone and the following are a few factors that can change this recommendation:

  • Tax bracket:  If you are in the highest marginal tax bracket we generally recommend waiting as long as possible to convert to a RRIF.  Deferring tax is your best option.  Individuals that have no income may benefit from taking advantage of the basic personal exemption and withdrawing some RRIF savings.    Most people have incomes that are somewhere in-between these two extremes and the decision becomes more difficult.
  • Pension income amount:   In the above illustration, the person already has pension income and is able to utilize the pension income amount.  For those 65 or older without qualified pension income, it may make sense to convert a portion of your RRSP to a RRIF and pull $2,000 a year out (couples may each claim this amount).
  • Income splitting: The income splitting proposals announced for 2007 will have an impact on financial planning books.  Several strategies to minimize tax may be implemented for couples with income levels that are significantly different.  Couples that have been doing their own income tax returns may want to meet with a qualified accountant when the 2007 tax season arrives.
  • Government benefits:  Individuals should use caution when looking at income tested government benefits.  Sometimes receiving a payment from an RRSP or RRIF may cause certain income-tested benefits to be clawed back.
  • Life expectancy:  Individuals should take a good look at their family health history and current lifestyle.  If an individual knew how long they were going to live, a tax minimizing analysis could be done using a few assumptions.  This unknown is one of the main complicating factors. Enjoying your funds while you have quality of life is also an important component to consider.
  • Singles should understand the tax consequence if they were to die.   Couples that name each other as beneficiaries have less risk than single individuals as a person’s RRSP or RRIF may roll over tax deferred to the surviving spouse.  Widowed or single individuals have greater risk of having to pay a significant tax bill as they generally have no option to defer tax.
  • Couples have the flexibility of choosing the younger spouse’s age when calculating the minimum required income amount from a RRIF.
  • Flow-through shares:  Investors who have a high tolerance for risk may find that offsetting all, or a portion of, a RRIF payment may provide the opportunity to defer tax further.  Caution should be exercised prior to making any flow-through investment to ensure suitability with respect to risk tolerance and liquidity.
  • In-kind withdrawals:  Just as you can make an in-kind contribution to your RRSP, consider making an in-kind withdrawal from your RRIF.  This type of withdrawal is still considered taxable and you should have funds available to pay any tax liability when you file your tax return.
  • Available funds:  The size of your RRSP and whether you have outside savings is one factor.  We encourage individuals to analyze their cash flow need and create an income plan.  This will assist you in determining when to take RRIF income and how much.