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RRSP to Pay Down Credit Cards

Often once you get behind on a credit card it is hard to catch back up at the often high interest rates.  In some circumstances an RRSP (Registered Retirement Savings Plan) can help. If you are making a credit card payment each month at a high interest rate, it is often close to the payment required for an RRSP loan.  Let’s say you were at a 40% tax bracket, if you were to take a $10,000 RRSP loan, you would likely get $4,000 back in taxes.  You could use the $4,000 to pay off your credit card and the RRSP loan would usually be at a much lower interest rate.  Replacing a credit card payment with a payment on an investment and wiping out the credit card debt can be a good option.

The key to any plan that involves paying off credit cards, is keeping the credit card balance at zero.

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RRSP Calculator

It is common to wonder how much difference your RRSP (Registered Retirement Savings Plan) contribution will make.  Below is a link to a great online tool that can help you plan and make sure you get the most from your money.

http://www.fidelity.ca/cs/Satellite/en/public/education_planning/calculators/tax

Are RRSP’s Creditor Protected?

It wasn’t too long ago that pensions, some locked in retirement accounts and insurance products were the only protected option for Canadian investors in the event of bankruptcy.  For the individual investor only the insurance options were available, as the rest would need to be set up by their employer (if they have one).  However as of July 2008, Bill C-12, an amendment to the Bankruptcy and Insolvency Act changed this.  This change provides the same protection for RRSP’s, Spousal RRSP’s, RRIF’s and some other registered accounts.

Hopefully no one invests with the intention of going bankrupt, but managing risk is about handling what we did not intend.  What this protection provides is a planning opportunity for those who want to protect themselves from this risk.  This could be a business person who wants to protect his retirement savings from business risk or a family hit by the financial devastation that can follow illness or injury.

The money does need to be place into a protected account a year before, and before you know of the pending issue.  The main purpose of this change as I understand it was to extend the same benefits of retirement savings offered to employees with a pension to those who do not have access to a pension.  As always before counting on this protection I would recommend discussing your unique financial situation with a professional as the smallest detail can make a big difference.

A last point would be to consult with a professional before accessing your money if you find yourself struggling financially.   Too often I see people cash out there RRSP’s and other protected investments trying to turn things around, when they could have saved those assets and used them to jump start a new financial life.

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How much can I contribute to my RRSP?

Instead of calculating how much RRSP (Registered Retirement Savings Plan) room you have and risk getting it wrong, I recommend looking on your “Notice of Assessment” which is sent out each year after you file your tax return.  On this form you will find both your TFSA (Tax Free Savings Account) contribution limit as well as your RRSP contribution limit.

If you contribute to an RRSP plan or Pension Plan at work will also need to be considered when determining how much you can contribute.  You are also allowed to over contribute up to $2000.  This is allowed without penalty, however you do not get to deduct the over contribution from your income.  I would use this as a safety net and do not usually recommed intentionally using this room.

Your RRSP contribution room is made up of 18% of your taxable income from the previous year to a maximum in 2010 of $22,000, added to the unused room from previous years as far back as 1991.

The RRSP contribution limit has worked as a great annual savings target for many.  It is very rare to see someone contribute the maximum to their RRSP each year and not have a sizable retirement savings.

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Repaying RRSP Home Buyers Plan

After borrowing from an RRSP (Registered Retirement Savings Plan) with either the HBP (Home Buyers Plan) or LLLP (Life Long Learning Plan), there comes a time when you need to either put the money back into the plan or pay tax on the money.  I do believe saving for the future is good, however putting the money back is not always the best option, here is a common example of when back these plans do not make sense.

Example.  A young couple wants to buy a house; they decided to use the Home Buyers plan for part of their down payment.  A few years later it is time to start putting the money back into their RRSP.  Often they have had kids by this time and one of them may be staying at home with the kids.  If staying at home they likely have no income, in this case I recommend not contributing to the RRSP for this person, but instead make a contribution in the spouses name who is working.

 

What ends up happening is the spouse not earning any money will have to pay tax on the RRSP payment that was owed; often this is nothing or small.  The RRSP room is lost.  However the spouse who has an income makes a RRSP contribution and since they are in a higher tax bracket they receive a bigger tax break.  As a result the same money put into an RRSP gets a bigger tax benefit.

I do believe in saving, however just because there is tax owed if the funds are not returned does not mean it is the best place for you to put your money.  A little planning here can make a big difference.  As always I recommend talking to a professional.  If you have any questions and are in BC I am happy to help.

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Should I take money out of my RRSP?

Taking money out of your RRSP (Registered Retirement Savings Account) can cause create a tax bill and loss of that RRSP room.  So it is important to consider carefully before taking this step, however if done right it can be beneficial.  RRSP is a tax deferral tool, eventually you will have to pay tax on the money, so if it makes sense to pay the tax now it can be a big win.  Some of the reasons you may want to take money out or your RRSP and pay the tax now are;

  • Home buyer plan, if it for a down payment on a home you may qualify to take the money from your RRSP, you will need to pay it back, however this is a way to get the funds without the tax issues.
  • Life long learning Plan, if the funds are for your schooling this may offer an option to borrow the money without the negative tax implications.  You will need to repay the funds once you are finished school.
  • Low income year.  If you have a low income year you may wish to take the funds out of the RRSP.  This should be carefully consider as you give up that RRSP room, tax deferred growth of the funds and could owe taxes on the money.  With all the drawbacks it can often make sense and leave you with more money long term.
  • Just need the money.  RRSP’s are not ideal for short term saving.  If you choose to take money from your RRSP you may face fees, loss of retirement savings, and a tax bill.  With all this if you need the money and the RRSP is the best place to get it then it may be necessary.  To prevent this we should all have savings to draw from when unexpected expenses strike.
  • Preparing for Retirement.  Once you hit retirement you not only have income tax, but pension claw backs.  For many moving from the RRSP.

When looking at making a withdrawal for your RRSP it is important to consider the negatives before making your decision, and discussing with a professional that understands your situation and the implications of the withdrawal is the best way to ensure you make the right choice.

  • money out of the RRSP before retirement can make sense.  This is usually the case when your income will be higher in retirement, or you have an offsetting deduction in the years you make withdrawals.

 

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RRSP’s and Education

The Life Long Learning plan can be a great option, although I rarely see a fit for it.  The Life Long Learning Plan allows you to borrow money from your RRSP (Registered Retirement Savings Plan) without the tax consequences that you incur when withdrawing the funds.  Below I have listed the common benefits and negatives to make it assist anyone who is considering the LLP.

The benefits

        –  You can borrow from your RRSP to fund your schooling (College, university, trade school).

        –  No need to pay back the funds until after you finish school.

The down side

        –  You do need to pay back the money of face tax issues

        –  If you are not working your income may be low enough paying the tax makes more sense to get the money.

        –  The money does not earn interest while you are using it.

        –  There may be fees involved in accessing the money.

If you are not working while going to school, often it is a low enough income year that taking the money out of your RRSP can make more sense, and if you are working it is usually possible to pay for school out of your existing income.  When it does make sense it works great and then I would recommend talking to a professional planner and visiting the Canadian Government website for the current details as they can change over time.

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Do RRSP Loans make sense?

Every year a many people run out and get RRSP (Registered Retirement Savings Plan) loans, so do they make sense.  Like most financial tools they work some times and not others.

So why would I want an RRSP loan?

  • Some can only save through debt
  • To save tax in a high income year
  • Temporary for “Gross up” Strategy (covered in a later blog)
  • Make a contribution now, when expecting money soon
  • Other unique life situations

 

What to watch for in an RRSP loan?

  • Cost of the loan compared to the the tax savings
  • Increased debt can reduce cash flow and ability to get debt
  • Loan payments must be made, no breaks in hardship
  • Lumping money into the markets at one time has risk

 

What to consider before taking out an RRSP loan

  • Can I afford the payment?
  • How long will it take to pay off the loan?
  • How much interest will you pay?
  • How does interest compare to the tax deduction?

 

I believe that it is often better to contribute to your RRSP monthly instead of making loan payments long term.  By putting money into your RRSP every month you get the benefit of dollar cost averaging and waste none of your money on interest.  The biggest benefit I have found to RRSP loans is the level of commitment people have to loan payments.  A debt payment is a commitment, but a monthly contribution is easily set aside for any other priority.  If you are committed to saving, the monthly contribution is likely the best option.

As a general rule I try and keep RRSP loans below 2 years, this usually reduces the interest rate, keeps the interest costs down and by keeping debt low it allows us flexibility in life as something unexpected always seems to be around the corner.

RRSP loans can be a great option in many cases, personally I can think of a few different situations where I would use an RRSP loan, but to date have never used one for myself as I prefer to avoid debt in my life. The right answers for this, like most, is the solutions that fits with you.

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My RRSP or My Spouses?

When making an RRSP (Registered Retirement Savings Plan) contribution we often just set it up in our name.  However if you are married or common-law, working towards your financial goals can have a huge impact on your financial life.  If you and your spouse are working together towards your financial goals and considering an RRSP then this simple step could save you a lot of tax.

To understand how this works, we need to understand how our tax rates work.  Tax rates increase as your income increases at set income levels.  What is important to note is as the rate goes up it is always on the next dollar earned.  This means if you make $30,000 or $130,000 you pay exactly the same amount of tax on the first $30,000 in both cases, the only difference with $130,000 is you need to also pay tax on the next $100,000 as well.

So contributing to an RRSP in your name or your spouse’s name becomes a tax question, who saves the most tax?  In many cases the simplest way to save on tax is make both incomes the same.

If a couple has the annual earnings of $150,000 a year and they each made $75,000 they would pay the same amount of tax each and this would be the lowest amount of tax  they could pay on $150,000.  If you increase either income as it moves into the next tax bracket, even if the total income still equals $150,000 the total tax payable increases as the income shifts to either spouse.

With this we know that it is optimal to bring both incomes to the same level.  This is where RRSPs can help, if you want to contribute to an RRSP, contribute to the RRSP of the higher income earner.  This will bring the higher income earners tax bracket down, once you and your spouse are being taxed at the same rate you can apply any additional RRSP contributions equally to both spouses RRSP’s.

Example;  If one spouse makes $60,000 and the other makes $50,000, if you were going to make up to a $10,000 RRSP contribution you would want to make it on the $60,000 income, any more and you would want to split it equally between both spouses.

Considering the tax consequences of any of your important financial decision, especially investments are important when planning your finances.  Income splitting now and in the future is a simple income splitting tools commonly overlooked.

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Should I take money out of my RRSP?

Taking money out of your RRSP (Registered Retirement Savings Account) can cause create a tax bill and loss of that RRSP room.  So it is important to consider carefully before taking this step, however if done right it can be beneficial.  RRSP is a tax deferral tool, eventually you will have to pay tax on the money, so if it makes sense to pay the tax now it can be a big win.  Some of the reasons you may want to take money out or your RRSP and pay the tax now are;

  • Home buyer plan, if it for a down payment on a home you may qualify to take the money from your RRSP, you will need to pay it back, however this is a way to get the funds without the tax issues.
  • Life long learning Plan, if the funds are for your schooling this may offer an option to borrow the money without the negative tax implications.  You will need to repay the funds once you are finished school.
  • Low income year.  If you have a low income year you may wish to take the funds out of the RRSP.  This should be carefully consider as you give up that RRSP room, tax deferred growth of the funds and could owe taxes on the money.  With all the drawbacks it can often make sense and leave you with more money long term.
  • Just need the money.  RRSP’s are not ideal for short term saving.  If you choose to take money from your RRSP you may face fees, loss of retirement savings, and a tax bill.  With all this if you need the money and the RRSP is the best place to get it then it may be necessary.  To prevent this we should all have savings to draw from when unexpected expenses strike.
  • Preparing for Retirement.  Once you hit retirement you not only have income tax, but pension claw backs.  For many moving from the RRSP.

When looking at making a withdrawal for your RRSP it is important to consider the negatives before making your decision, and discussing with a professional that understands your situation and the implications of the withdrawal is the best way to ensure you make the right choice.

  • money out of the RRSP before retirement can make sense.  This is usually the case when your income will be higher in retirement, or you have an offsetting deduction in the years you make withdrawals.

 

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