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Should I save my RRSP Contribution Room? Date posted February 22nd, 2011

Most of us like the idea of saving on tax, so if you have the money to save in a RRSP and you have determined the tax savings are large enough to make it worthwhile, there are still a few situations where you might want to wait to make that contribution. Below I discuss a couple of situations where even if RRSP’s make sense for you, you may want to hold off investing in an RRSP.

Expecting a buyout? Many companies offer significant buyouts to long time employees a few years before retirement when trying to cut back staff, labor costs or shift the direction of the company. Although a large cheque can be exciting it can also create a significant tax issue. One simple solution to this is to take the buyout and put it in a RRSP. With this option the deduction the RRSP creates offsets the taxes on the buyout. As a lump sum like this will often push you into a much higher tax bracket than usual, this is often a great time to use your RRSP room to save tax, that is if you have enough RRSP room.

High income year. If you get a bonus, or sell an asset (such as a rental house) that sends your income into a higher tax bracket than you normally would be in, this could be worth saving your RRSP room for.

Skip a low income year. If you happen to make less one year than normal, then skipping the deduction that year may make long term sense.

When planning your finances it is important to look into the future and plan for low income years, high income years and any future financial transactions that may impact your tax situation.

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IPP versus RRSP Date posted February 21st, 2011

An IPP (Individual Pension Plan) is a tool that can replace an RRSP (Registered Retirement Savings Account) for small business owners. So which one is better to hold your investments in?

Why consider an IPP (Individual Pension Plan).

As you near retirement the contribution limit is greater than that of an RRSP
In some circumstance IPP’s behaves differently in your estate.
Can be used in different tax planning strategies (Accountant is recommended to discuss these, but can include under funding to devalue a business)

Why would you not want an IPP (Individual Pension Plan)

Annual fees are due to maintain IPP’s
Many more rules and restriction than an RRSP
A more complicated tool to understand.

If you are considering an IPP I would recommend talking to both an investment professional that understands this tool and an Accountant that can explain the tax benefits. These can be a great tool if understood and used in the right planning situation.

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Using the RRSP “Gross up” Strategy Date posted February 20th, 2011

This is a simple strategy to increase the size of your RRSP (Registered Retirement Savings Plan) without losing more of your income to savings. The best way to explain the concept is with an example. To keep the math simple we will say the tax rate is 50% (please note that there is no 50% tax rate in BC, the benefit of this strategy should be calculated at your real tax rate, however for the example 50% is much easier to visualize).

Example, John makes a $4,000 RRSP contribution at our imaginary 50% tax rate. With this he can expect to save $2,000 on his income tax. As many put there refund back into their RRSP, the gross up strategy says he should borrow the same amount as the refund and then use the refund to pay back the loan. This increases the tax savings now and gets the money into your account sooner, giving your money longer to earn interest. Now if you add a $4,000 contribution and $2,000 refund together and make that your new contribution you would now get $3,000 at our 50% rate, so we need to run through this a few times until the extra tax savings no longer makes much of a difference.

Normal RRSP contribution of $4,000 would create a $2,000 tax savings

Gross up RRSP contribution of $4,000 would become $8,000, with a refund of $4000 to pay off the $4,000 loan required to make the contribution.

To see if this strategy works for you can work out the difference at your tax bracket and hopefully with this strategy you can save a little more for retirement, without having to find any extra money.

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Are RRSP’s Creditor Protected? Date posted February 19th, 2011

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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Repaying RRSP Home Buyers Plan Date posted February 17th, 2011

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? Date posted February 16th, 2011

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 Beneficiary Designation Date posted February 15th, 2011

RRSP’s (Registered Retirement savings Plan’s) and all registered accounts (RIF, LRSP and other registered accounts) offer the ability to designate a beneficiary, seems simple enough, however there is a list of common and sometimes very expensive mistakes. Below I have listed a few of the common errors. It is simple to fix the beneficiary now, however your estate may or may not be able to correct it later.

No beneficiary designated – This means the RRSP goes to the estate, not to a beneficiary. This eliminates the tax benefits of leaving the accounts to your spouse, and also the creditor protection these accounts often have. It also means it can be contested with the will and in some cases be dealt with by the guardian trustee or a list of other negative issues.

Wrong beneficiary – A common example of this is in a divorce, where the beneficiary is not updated to the current spouse. This not only leaves the account to the wrong person, it also can leave the tax bill.

Out dated beneficiary – Often after marriage updating the beneficiary on an RRSP is not top of mind, but updating this is simple, if something happens correcting it later it can be a real hassle. I have heard of stories of the RRSP account accidently going to the ex wife and the tax bill paid by the current. Have yet to see this, and with good planning hopefully I never will.

Not naming a spouse – With RRSP’s a disabled dependant and the spouse can receive tax preferred treatment. The RRSP can roll over into the spouses RRSP with no tax issues on passing if they are named as the beneficiary. If anyone else is named the beneficiary the RRSP is taxed. It is normal for many people to want to put their children as the beneficiary. It is important to consider the tax benefits of leaving it to the spouse before choosing anyone else to be the beneficiary.

Beneficiaries can be on your RRSP, your work RRSP, pensions and many other accounts. I recommend that you review all your finances at least once a year, and that point check to ensure these details are all correct. It can make a big difference and save lots of money and stress later.

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RRSP’s and Education Date posted February 11th, 2011

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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RRSPs and Buying a Home Date posted February 10th, 2011

Using your RRSP’s for a down payment on your first home is common, and with the home buyers plan you can borrow money from your RRSP (Registered Retirement Savings Plan) account without the tax penalty usually associated with accessing the funds in your RRSP. So does borrowing from your RRSP make sense?

Like so many financial choices it depends on what you want to accomplish and your unique situation. Considering both the benefits and negatives of using this program is likely the best way to see if it makes sense for you.

The benefit is simple.

- if you have money in your RRSP’s it allows you to use this towards your down payment, without having to pay tax on the money withdrawn.

- If you are in a high enough tax brackets, you can contribute to an RRSP and use the contribution as well as the tax return towards your new home, creating an even bigger down payment.

- Larger down payment can save you CHMC insurance fees.

- Larger down payment can reduce the monthly mortgage payment.

- Larger down payment allows you to qualify for a more expensive place

So why would you not want to borrow from your RRSP?

- When you borrow you do not get the growth in your investments you otherwise would.

- You risk putting off the tax issue until a later time if you do not make the repayments, and the repayments will be due once you have a mortgage, making repayment harder.

- You lose the diversification of investing in both your RRSP and I a home.

- RRSP’s are creditor protected, your home is not.

- Possible fees involved in taking the money out of the RRSP account. These vary depending on how you invest and with whom.

- RRSP’s are more liquid. If something unexpected happens you can use the RRSP’s if need be, to get money out of the home you may need to remortgage or sell, both expensive options.

I often recommend clients use the Home buyers plan. Many people pay CMHC fees as they don’t have a large enough down payment to get past these fees. In many cases we use a contribution into an RRSP and or Spousal RRSP. By including the tax refund and using money already saved for the down payment, this creates a much larger down payment. Other times an existing RRSP is the down payment, allowing the purchase of a home to happen sooner. This can save money that would have been wasted on rent or just make for a better lifestyle.

Home buyers plan is a great option, with many benefits, draw backs and restrictions. When planning I believe that discussing your situation with a professional advisor or planner who you trust will help you make a quality and informed decision. The details of the home buyers plan do change from time to time, so I would also recommend looking on the government of Canada website for current information before using this program.

With housing cost in Greater Vancouver as high as they are, often any detail that can help first time home buyers getting into the market can make a big difference.

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Do RRSP Loans make sense? Date posted February 9th, 2011

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.