The Now Newspaper “Best of Your Neighborhood Award 2013″: http://issuu.com/surrey-now/docs/srysthu20140130
“Your retirement should be enjoyed because you’ve earned it”
Your questions have been piling up in the Investor Clinic inbox, and today I’ll answer two of them.
Actually, because they’re somewhat technical, I reached out to a couple of tax experts at BMO Nesbitt Burns: John Waters, head of tax and estate planning, and his colleague Linda Leung, director of U.S. tax planning.
When I make a withdrawal from my registered retirement income fund (RRIF), can I split the income with my spouse? What other sources of income am I allowed to split?
The ability to split RRIF income for tax purposes between a spouse or common-law partner depends on the age of the transferor spouse.
If the transferor is 65 or over (regardless of the age of the transferee spouse), it is possible to achieve pension income-splitting for RRIF income provided both spouses are Canadian residents for tax purposes.
The pension income-splitting rules provide a simple strategy for couples to reduce their overall family tax bill by taking advantage of the transferee spouse’s lower marginal tax rate.
Under the rules, you can allocate up to 50 per cent of eligible pension income to a spouse. Each spouse must make an election on his/her income tax return each year.
For income tax purposes, the amount allocated will be deducted from the income of the spouse who actually received the eligible pension income and added to the income of the other spouse.
Sources of pension income other than RRIFs are also eligible.
If you are 65 or over and receive payments from a registered pension plan, life income fund (LIF), locked-in retirement income fund (LRIF) or lifetime annuity in a registered plan, the income will qualify for splitting. The income portion of certain annuities in a non-registered account may also qualify.
However, if you are under 65, generally, only payments from a registered pension plan will qualify for pension income splitting. RRIF, LIF, LRIF or annuity income will only qualify if received as a result of the death of a spouse.
The Canada Pension Plan has its own set of rules for income “sharing.” Click here for more information.
I have heard that U.S. citizens living in Canada do not have a tax treaty that recognizes the tax-free savings account (TFSA). I also understand that even capital gains on principal residences may be fully taxed by the U.S. Internal Revenue Service on sales of homes in Canada that are owned by U.S. citizens. Do I have this right?
You have a lot of it right. U.S. citizens living in Canada must report worldwide income on their U.S. income tax returns as well as their Canadian tax returns.
Canada does have a tax treaty with the United States that allows U.S. citizens to elect to defer the income earned in an RRSP such that the income would not be taxable for federal U.S. income tax purposes until amounts are withdrawn.
Unfortunately, the same election is not available for TFSAs. As such, any income earned in the TFSA would be included as taxable on an annual basis for U.S. income tax purposes.
The U.S. tax rules with respect to the capital gains on the sale of a principal residence are different from the ones applicable for Canadian income tax purposes.
While the capital gain from the sale of a principal residence is typically exempt from taxation for Canadian income tax purposes, you would only be able to exclude up to $250,000 (U.S.) of that gain ($500,000 if you file U.S. income tax returns jointly with your spouse) for U.S. income tax purposes if certain criteria are met.
The factors that are relevant for the purposes of determining whether or not you are eligible to claim the $250,000 capital gain exclusion generally relate to the length of time you own the principal residence and the length of time you have used that residence as your “main home.” The location of the home (i.e., in Canada or elsewhere) is not part of the criteria.
Article: Globe and Mail
Alex Ghani has always taken a long-term view toward saving and retirement. At the tender age of 33, he established a spousal registered retirement savings plan so, as the higher income earner in the family, he could also contribute on behalf of his wife, Sana.
“It’s a great income-splitting tool for our future retirement income, when it will help keep us in a lower tax bracket,” said Mr. Ghani, now a 38-year-old partner with the chartered accounting firm Prasad Ghumman LLP in Thornhill, Ont.
The spousal RRSP is an underutilized, potentially significant retirement savings strategy, experts say.
“People typically scramble at the end of February to make their RRSP contribution, to the extent they’re making a contribution, and don’t really stop to think, ‘What’s going to be our tax situation when we retire?’ They’re just focusing on today,” said Lorn Kutner, a partner with Deloitte LLP in Toronto.
The spousal RRSP not only provides an immediate tax deduction, and a way for investments to grow on a tax-deferred basis, it can also provide flexibility for income splitting in retirement.
For example, pension income can be split only to a maximum of 50 per cent. So if you’re receiving $1,000 a year in pension income, you can move only a maximum of $500 annually to your spouse. But if you’d managed to make spousal RRSP contributions for several decades, and that money had grown inside the RRSP, that provides the potential for a lot more income splitting, with the additional money coming out of your spouse’s RRSP as their income, Mr. Kutner said.
The spousal RRSP also encourages couples, including those in common-law relationships, to anticipate what their income levels and corresponding tax brackets are going to be in retirement. Typically the higher income spouse will make the contribution on behalf of the partner, allowing for an opportunity to pay a lower tax rate when those funds are ultimately withdrawn, as Mr. Ghani has done.
The spousal RRSP works particularly well for those who are not a member of a pension plan because they are not allowed to split their own RRSP until they are 65 or older, said Cherith Cayford, a facilitator for CMG Financial Education in Victoria. “So if they retire earlier than 65, there’s an opportunity to split some income.”
Conversely, many people are living and working longer, earning income past age 71. RRSP rules state that plans must be terminated by the end of the calendar year in which the plan holder turns 71. Proceeds can then be rolled over into a registered retirement income fund, which requires minimum annual withdrawals starting at age 72. Or they can be invested in a fixed-income annuity.
The spousal RRSP, however, provides the potential for continuing contributions. “I think most people think, ‘Seventy-one, I’m done. I can no longer do contributions.’ [But] as long as your spouse is younger, you can make spousal contributions,” Mr. Kutner said.
And the earlier such contributions are made to a spousal RRSP, the better. “If you start doing this rather late in your RRSP contribution life, then you’re not going to be able to accumulate significant enough assets in your spouse’s RRSP to be able to take advantage of his or her marginal tax rates when they start to withdraw money out of the plan,” Mr. Kutner said.
“So if you’re pretty certain your spouse’s income level in retirement is going to be relatively low, the earlier you start making spousal contributions, the better,” he elaborated.
However, there is a special three-year attribution rule attached to the spousal RRSP that contributors need to understand, or it can catch them off guard. If you make a contribution to your spouse’s RRSP and your spouse withdraws that amount, or a portion thereof, from their RRSP within three calendar years, that withdrawal is treated as income on the contributor’s personal tax return, Mr. Kutner said.
“If I made a spousal contribution to my spouse’s RRSP and I’m in a high tax bracket and she’s in a low tax bracket, CRA doesn’t want her to take it out the next year and be taxed at her rates. This is meant to ensure that you’re doing this within the spirit of the rules, which basically says, ‘This is going to allow income splitting in retirement, not so much in current years,’” he explained.
If, for instance, a $5,000 contribution is made to a spousal RRSP on Dec. 31, 2013, the first $5,000 taken out of the spouse’s RRSP in 2014 or 2015 would be taxed in the contributor’s hands, rather than the spouse’s, because the three calendar years attached to attribution would be 2013, 2014 and 2015. The spouse would then need to wait until at least January of 2016 for the better tax benefit.
But if the spousal contribution was made in January of 2014 – contributions for the previous taxation year can still be made up to 60 days hence – then the three-year attribution rule would apply to 2014, 2015 and 2016, and January, 2017, would be the earliest to avoid attribution back to the contributor.
“If you’re thinking of making a spousal contribution and you have the funds available, it’s probably a good idea to do it by December 31 rather than 60 days past the start of the year,” Ms. Cayford advises.
The only exception to this rule, aside from situations that involve death, is when the taxpayer turns an RRSP into a registered retirement income fund (RRIF) or annuity, with the former requiring statutory annual withdrawals.
A major misperception about the spousal RRSP concerns contribution limits. The eligible amount that can be contributed is based on the contributor’s limits, not the spouse’s, said Robert Snowdon, a chartered accountant in Kanata, Ont.
If, for example, the higher-income earner was eligible to contribute $15,000 to an RRSP, they can apportion that $15,000 any way they wish, to either or both of their own or spousal RRSPs as long as they don’t exceed that limit.
“Be careful not to taint the plans. Keep the spousal contribution plan separate from the plan that the partner contributes to on their own,” said Ms. Cayford. Otherwise, she warned, the high-income earner may end up footing the entire tax bill.
Depending on a couple’s potential retirement incomes, the spousal RRSP could also be an effective strategy to reduce income and therefore also reduce or avoid the Old Age Security clawback, which begins at $70,954 of income and is totally clawed back at $115,716, Ms. Cayford said.
Mr. Ghani said he also views the spousal RRSP’s potential to reduce the OAS clawback he and his wife will eventually face as an important part of their retirement savings strategy.
Article: Globe and Mail
For most, hitting your 50s is a period marked by expanding waistlines, mounting aches and pains and the first genuine bouts of nostalgia. It is also the time to get serious about establishing a retirement nest egg.
Most Canadians earn more money in their 50s than in any other decade, a statistic that, when combined with a honed investment strategy and a retirement game plan, can make for a very lucrative window of opportunity.
Unfortunately, not everyone makes the necessary adjustments to their investing strategy at this milestone, which can prove to be a costly oversight. RRSPs serve as a good step in bridging the gap between expenses and government payments in retirement (see chart). But getting prepared for retirement is not as simple as opening an RRSP account and making an annual contribution.
“The industry has taught us to think about how much money we have accumulated in our RRSP. But it’s really all about the plan,” says Doug Dahmer, founder and chief executive officer of Emeritus Financial Strategies, in Burlington, Ontario.
Most Canadians don’t consider tax planning for retirement, even though taxes will remain their largest expense. RRSPS are just a savings vehicle. One of the biggest challenges for people in their 50s is to figure out how they will turn their savings into an efficient income stream, he says.
Many people put far too much money in their RRSPs, “and what they don’t realize is that they are building a huge tax trap for themselves in the future,” Mr. Dahmer warns, because every dollar coming out of the account upon retirement will get taxed. Spreading some savings out into different investing vehicles can reduce taxes on retirement income flow.
For example, if a retired couple needs to buy a new car for $30,000 and is relying on their RRSP investments, they may have to withdraw $45,000, depending on their tax bracket. That additional income can trigger a government clawback on OAS, pushing the cost of the car to more than $50,000.
Mr. Dahmer advises many of his clients in their mid 50s to stop contributing to RRSPs and instead maximize payments to their tax free savings accounts (TFSAs) and pay down their mortgages. Ten years before retiring, Canadians need to be asking themselves what they want to do and where, because only then can they know how much money they will need, he says.
Lifestyle considerations are essential, agrees Adrian Mastracci, president and portfolio manager at KCM Wealth Management Inc. in Vancouver. Among the questions he asks clients: How will you replace the fulfillment from your work? And what accomplishments do you envision during retirement?
Adrian Mastracci, president and portfolio manager at KCM Wealth Management Inc. in Vancouver, says that turning 50 is the time to ensure that each spouse will have similar assets at retirement. Balancing income streams in advance of retirement will ensure a couple pays the lowest possible tax, regardless of what happens to the government’s “income-splitting” rules. That means that before retirement, the lower-income spouse is better off doing more of the family’s saving and investing and the higher-income spouse should pay more of the household expenses, Mr. Mastracci says.
The goal is to accumulate investment assets of between six and 10 times your annual family income, he adds.
A couple retiring at 65 and planning to spend $75,000 a year, with a life expectancy of 95, will need $1.24-million in savings upon retirement, Mr. Mastracci calculates. This assumes they do not sell their house, receive two-thirds the maximum CPP/OAS payments ($25,000 a year) and achieve an annual return of 5 per cent, in an environment of 2-per-cent inflation.
The 50s “are the critical years for the big push to accumulate your nest egg. If you miss out on the finances during this decade, you may fall short of your family’s retirement goal,” he says.
Investors tend to be more risk-averse as they get closer to retirement. Yet, advisers say it’s important that investors don’t take their foot off the gas when they reach their 50s, especially in today’s low-interest environment. Many direct their clients to balanced funds that hold stocks and – to a lesser extent – bonds, as well as offer international exposure.
To maintain their purchasing power in retirement, fiftysomethings should make sure growth stocks are part of their portfolio today, says Marc Cevey, CEO of HSBC Global Asset Management (Canada) Ltd. He also likes dividend stocks, even though they may look expensive today, because yields are historically high. As a class, dividend stocks will continue to attract aging investors seeking income – in both the developed and developing world, he says, providing support to prices.
Meanwhile, some exposure to bonds will act as a cushion during any rough periods. HSBC continues to favour corporate bonds over government bonds, even though the premium that corporates traditionally offer above governments has narrowed. Default rates are low in North America right now because many companies have strengthened their balance sheets since the financial crisis. Among government bonds, a mix of international holdings with a range of maturities should offer slightly higher returns than Canadian bonds on their own, Mr. Cevey says.
CPP yearly max (couple): $24,920
+ OAS yearly max (couple): $13,237
= Total gov’t payments: $38,157
– Avg retired couple yrly expend.*: $54,100
= Shortfall: $15,943
(*2009; all other figures are for 2014; Source: Service Canada, Statistics Canada)
Article: Globe and Mail
Is now the time to get your household debt under control, or does building up a retirement fund take priority?
“It’s an age-old debate. It happens every year,” says Jeffrey Schwartz, executive director of Consolidated Credit Counseling Services of Canada in Toronto.
But perhaps this is the year that discussion is set to take a new turn. In the third quarter of 2013 the ratio of Canadian household debt to disposable income rose to 163.7 per cent, a new record. Simply put, it means that for every dollar of disposable income we have, we spend $1.63.
This number worries Mr. Schwartz and other debt-watchers here and abroad. Indeed, it has spooked foreign investors who no longer see Canada as a sure bet. The recent plunge in the value of the loonie is one indication of this wariness.
“What am I afraid of? I’m less worried in the short term about interest rates. I’m more worried about a reduction in people’s income,” says Mr. Schwartz.
At the heart of the problem is risk. As debt levels rise, risk rises, too. Lose your job while paying off $1,000 worth of credit card debt, and that’s a pain. Lose your job while trying to pay down $26,000 worth of debt, and that can lead to financial disaster.
“If a lot of Canadians lose that paycheque or it shrinks, then they’re not going to be able to service that debt. They won’t be able to make that minimum payment each month,” he says. “That’s where the real trouble starts.”
Even so, no one is saying retirement planning is unimportant. With some studies claiming that two-thirds of Canadians aren’t saving enough for their golden years, socking away money in a registered retirement savings plan (RRSP) or tax-free savings account (TFSA) seems just as important as debt reduction.
So where should your money go? Here’s a list of what financial advisers tend to look at before steering money one way or another.
You might want to make RRSP contributions if:
- You’re in a higher income tax bracket. The RRSP was made for you. Reduce the amount of tax you pay today and owe less tax when you’re in a lower tax bracket upon retirement. (By the way, there’s no debt-payment write-off at tax time.)
- Your employer matches your contributions or offers a group plan. Yes, this is called free money. If a company offers its employees this benefit, investing in the future is much more tempting. If your portfolio does well, the return on investment grows even larger.
- You are planning to buy a house or go back to school. You can take up to $25,000 out of your RRSP to use as a down payment without having to pay taxes on the funds with the Home Buyers’ Plan. Or withdraw $20,000 to go back to school with the Lifelong Learning Plan. Granted, if you’re swimming in debt already, buying a home is likely not the best move.
- You don’t trust yourself. “Are you addicted to debt?” asks Rhonda Sherwood, a wealth adviser with ScotiaMcLeod in Vancouver. “If you pay down your debt, will you turn your focus to savings – or just rack up more debt?”
It may seem counterintuitive, but paying yourself first, even if it’s just $100 a month, might be the better option than throwing all your money and energy into debt repayment. Set up an automatic payment plan with the bank; you can’t spend what you can’t see.
You might want to pay off debt instead if:
- Your debt is expensive. A high-interest credit card is a balance sheet’s worst enemy – and it can seriously undermine retirement savings, particularly if your RRSPs have hit the doldrums. “If you’re getting low returns on your RRSP and you’re paying high interest rates on your debt, you’re effectively financing your retirement at a very high rate. I can’t put it any simpler than that,” Mr. Schwartz says.
- You can’t stomach the risk. Those living paycheque to paycheque have much more to lose if their investments show lower returns or losses, particularly if they’re entering into their preretirement years and they’ll need the money soon. But that 25-per-cent credit card? Pay it off and you’re getting a rate of return few investments can touch, particularly after taking fees into account.
- You’re in a low income tax bracket this year. Reducing your taxes may sound like a good idea, but if you’re making less money right now, this is not the year to contribute to your RRSP. Your tax savings will be low or even zero. Pay down your debt in 2014 and save that RRSP contribution room for a year when it will do you more good.
So, debt repayment or retirement planning for 2014? Maybe neither, says Stephanie Holmes-Winton, author of Defusing the Debt Bomb, from Dartmouth, N.S. She believes there’s one more option that many Canadians overlook at this time of year: an emergency fund. Without one, more people will either go further into debt when life throws a curve ball, or will take money from their RRSP, thus paying expensive withholding taxes and missing out on years of compounding returns.
Even if you’re heavily in debt, she recommends setting up an automatic savings plan to build the fund before thinking about retirement planning.
“Everyone needs a cushion before they can start long-term savings,” she says.
Decades before LOL and FYI and IMHO, there was RRSP – a four-letter acronym that’s become an everyday term in the country’s lexicon. But while most Canadians today know about RRSPs, there are still plenty of misconceptions and questions about them, say financial planning and investment experts.
“There are technical issues that people don’t always understand,” says Howard Kabot, vice-president of financial planning, at RBC Wealth Management Services in Toronto. “There are rules that need to be followed, and sometimes there’s confusion about the rules.”
Having a good grasp of these rules and technicalities can help investors ensure they get all the benefits of an RRSP and avoid unnecessary penalties, the experts say.
1. Contributions are based on which year’s income?
RRSP contribution room for each tax year is based on earned income from the previous year. Plain and simple, right? Not to everyone, Mr. Kabot says. Some Canadians get mixed up because RRSP contributions for a given tax year can be made until the end of February or beginning of March the following year.
“Where it gets confusing is, in the first 60 days of 2014 you’re allowed to make RRSP contributions for the 2013 tax year and your 2013 contribution is based on your income in 2012,” Mr. Kabot explains. “So if you had a pretty good income in 2012, but earned less in 2013, you may think that you don’t have as much contribution room, which isn’t the case.”
2. Nope, you can’t double up with a spousal RRSP
A spousal or common-law partner RRSP is a good way to split investment income or capital gain from registered retirement savings between a couple and reduce their overall tax bills later in life. What it doesn’t do, however, is double RRSP contribution room and allowable tax deductions, Mr. Kabot says.
If, for example, you’re allowed to contribute $10,000 for the 2013 tax year and your spouse is allowed to contribute $2,000, the most you can put into both of your RRSPs is $12,000. Also, the person who made the contributions is the only one who can claim a tax deduction.
3. Yup, you can hang on to those tax deductions
Most Canadians know they can carry forward unused RRSP contribution room. What’s less known, Mr. Kabot says, is that tax deductions on RRSP contributions can also be applied to future tax returns, in particular against high-income years. But this means resisting the temptation to claim an RRSP contribution – which likely means getting a cheque from Canada Revenue Agency – during low-income years, Mr. Kabot says.
4. It’s a holding account, not investment product
This may seem like semantics, but it’s one that has practical and financial implications, says Michael Wiener, the Ottawa-based blogger behind Michael James on Money, which focuses on saving, spending and investing. Mr. Wiener says understanding that an RRSP holds investments but is not by itself an investment can help Canadians take better control of their retirement funds.
“People think they go to their bank or financial adviser and ‘buy an RRSP’ and that will be that – they don’t have to worry about it any more,” Mr. Wiener says. “Once you understand that the RRSP itself is not an investment, then hopefully you’ll take the time to figure out what sort of investments you should be making and putting into your RRSP.”
5. It isn’t all yours: The taxman wants some, too
Mr. Wiener says some people plan their retirement based on the entire predicted value of their RRSP and are unpleasantly surprised by their tax bill when they convert their registered savings into a registered retirement income fund (RIFF). “They feel they’ve been scrimping and saving all this time and now the government is taking it away,” Mr. Wiener says. “What they’re forgetting is all those tax breaks they got over the years every time they made a contribution.”
This oversight may cause some people to retire sooner than they should or dream up a retirement lifestyle that exceeds what they can afford on their after-tax retirement income, Mr. Wiener says. His advice: Crunch the numbers, and be sure to factor in the government’s share.
6. Turning 71? You can still contribute to your RRSP
The rules say you have to convert your RRSP to a RRIF by Dec. 31 of the year you turn 71. But what if you’re still working at 71 and creating RRSP contribution room for yourself?
One option, Mr. Kabot says, is to put additional money into your RRSP before it’s closed and turned into a RRIF. CRA may apply a 1-per-cent over-contribution penalty but this should be offset by the deduction you’re allowed to make the following year. For those with a younger spouse or partner, another option would be to put that money into a spousal or common-law partner RRSP, providing there’s contribution room.
It’s not that complicated – really
Even with all the rules, RRSPs aren’t as complicated as some people think, says Peter Aceto, chief executive officer of ING Direct Canada. He suggests visiting CRA’s website to learn how RRSPs work.
“They don’t give you advice about what you should put in your basket, but they actually have some good content which explains RRSPs,” Mr. Aceto says.
Your bank, financial adviser or accountant are also good sources of RRSP information. Don’t be afraid to ask questions, even ones you think are stupid, Mr. Aceto says. “And above all, don’t let something that seems complicated stop you from doing something, because that’s the worst thing you can do,” he says. “Start saving, even if you’ve still got some questions.”
Article: Globe and Mail
There’s nothing like an education about money while you’re still young. Consider the story of Lael Desmond, a graduate student from Indianapolis who set up a discount brokerage account with Ameritrade several years ago. He eventually filed a complaint against Ameritrade to recover the $40,000 he lost when investing in high-risk Internet stocks using money borrowed on margin. Mr. Desmond’s lawyer acknowledged that his client had read and signed a disclaimer that explained the risks, but he said that’s beside the point. “Yes, he agreed to it. But they shouldn’t have let him,” he said.
I’m a firm believer in educating kids at a young age about investing – and starting them investing early in life. Aside from helping young people make wise decisions about their investments, starting young can lead to a much larger portfolio down the road. Time is an investor’s greatest ally. As we head into registered retirement savings plan (RRSP) season, encourage your adult children to contribute to their RRSPs. Here are some stories about the value of starting young.
Laurel and Hardy
Laurel and Hardy are friends, both of them 30 years old. Laurel has wanted to get a head start in saving for retirement and has decided to invest $5,000 each year, starting this year. Suppose he invests $5,000 annually in his RRSP or TFSA for 10 years (to age 40). His total investment will be $50,000 ($5,000 per year for 10 years). Suppose he then stops contributing to his plan and simply watches his portfolio grow until he reaches age 65. If he earns 7 per cent on his money annually, he’ll have $374,940 in his portfolio at age 65.
Now, consider Hardy. Like many, he’s a procrastinator, and let’s assume he waits eight years, until age 38, before he starts saving for retirement. At that time, he starts saving $5,000 per year, every year, until he’s age 65. So, Hardy will have invested $135,000 in total ($5,000 per year for 27 years). Assume he earns the same 7 per cent return on his portfolio and he also invests inside his RRSP or TFSA. At age 65, Hardy’s portfolio will be worth $372,420.
You’ll notice that Laurel and Hardy each have about the same-sized portfolio at age 65, but Laurel had invested just $50,000 while Hardy invested $135,000 to achieve the same results. The fact that Laurel started eight years earlier makes a huge difference in how much he needs to invest to achieve his retirement goals. By the way, if Hardy were to wait just two more years to start saving at age 40, he’d end up with just $316,245 – a full $56,175, or 15-per-cent less than what he’d have by starting at age 38.
Laverne and Shirley
Let’s take a look at this from another perspective. Laverne and Shirley are friends, both 35 years old. They have each decided that they’d like to accumulate $1-million by age 65, 30 years from now. Laverne is pretty disciplined about her savings and has decided to start right away, investing in her RRSP. She’ll have to set aside $10,600 annually to reach her $1-million target, assuming she can earn 7 per cent on her portfolio over that time.
What about Shirley? She has decided to wait five years to start saving at age 40. If Shirley hopes to accumulate the same $1-million by age 65 she’ll need to invest $15,850 annually at the same 7 per cent return. That is, she’ll need to invest 50-per-cent more annually than Laverne to accomplish the same goal, since she’s starting five years later.
As an aside, what if these two women want instead to save $2-million each by age 65? Laverne would have to invest $21,175 annually starting today (at the same 7-per-cent return), and Shirley would have to invest $31,650 annually starting in five years.
Shirley could also run into another problem: She might not have enough RRSP contribution room to allow herself to invest that much in an RRSP annually. The amount she needs to set aside could exceed her RRSP contribution limits. RRSPs are best designed for use over many years, not for “hyper-savings” in the last years leading up to retirement.
How much to save
Be aware that $1-million will provide a pretax annual income of $60,000 for 28 years (assuming a 4-per-cent annual return in retirement). To accumulate this $1-million, it will take just over $10,000 set aside annually, invested at 7 per cent, for a period of 30 years, or $5,000 annually for 40 years.
Original Article: Globe and Mail
The big push is on to convince Canadians to load their extra cash into registered retirement savings plan (RRSP) investments before the Mar. 3 deadline. But though it may seem as though contributing is the only option when it comes time to decide what to do with the money, it’s not.
Many financial planners, accountants and other experts suggest there’s an even better way to work toward a well-heeled retirement down the road: Pay off the mortgage first. And do it as fast as you comfortably can.
That’s exactly what Rock Lefebvre, vice-president of research and standards for the Certified General Accountants Association of Canada, in Ottawa, did when he was younger. Rather than invest in stocks, bonds or mutual funds, he developed a financial strategy that meant paying off his mortgage early. To this day he still advises that most people eliminate consumer debt and then go on to tackle mortgage debt before investing.
“Some people might argue that’s not the most strategic approach, but my defence is that any unused RRSP contribution room can always be used in the future. It’s never lost,” he says.
For homeowners, it pays to ask a few questions before deciding how to use that money.
Q. What gets a better return?
Anyone looking at their mortgage today might be wondering, “Why make pre-payments? My mortgage rate is so low, it’s costing me next to nothing to borrow this money.” That’s the wrong way to look at it, says Cynthia Kett, a chartered professional accountant with Stewart & Kett Financial Advisors Inc., in Toronto.
“If you have a mortgage balance that will need to be renewed upon maturity, think about the interest savings based on the renewal rate, not the current rate,” she explains.
If mortgage rates climb to 5 per cent in the coming years – a definite possibility – and you’re in the 35-per-cent marginal tax bracket, paying off the mortgage faster means you’ll be getting a guaranteed pre-tax rate of return equivalent to 7.69 per cent, says Ms. Kett. (Extra mortgage payments reduce the principal amount so you’re actually saving not just future interest, but the tax on that interest because you pay the mortgage with after-tax dollars.) Not too shabby, especially since the rate is guaranteed.
Even if your RRSP investments make 9 per cent, a typical mutual fund charges fees, which could actually knock down the return by a couple of percentage points. Suddenly that return isn’t looking so good, nor is it a sure thing.
Q. What gives me the tax advantage?
RRSPs are a good option for people who are in a high tax bracket now and expect to be in a much lower one when they retire. But paying off a mortgage early has tax benefits, too.
“An RRSP is a tax deferral. It’s not actually free money,” Ms. Kett says. “You’re just paying it later instead of now, whereas the capital gains on your principal residence are going to be tax sheltered permanently.”
Q. Can I afford to take a risk?
Risk tolerance is going to be different for everyone. On one hand, a younger investor with a growing family or unsteady job prospects might think twice before investing in anything that even hints of risk. On the other, someone who has amassed some wealth and can afford to take a hit without going to the poorhouse, might decide to max out that RRSP. Risk tolerance often changes many times over a person’s lifetime.
“If you’re affluent and can afford to pay that investment game, that’s okay, but if you don’t have the money, you probably want to be more conservative and pay off your mortgage,” Mr. Lefebvre says.
Q. How much financial flexibility do I need?
Once funds are deposited in an RRSP investment, forget withdrawing them before retirement without incurring some expensive fees and fines. Indeed, RRSPs were created to be that way so investors would be less likely to dip into their long-term savings.
Paying off a mortgage, however, offers huge advantages in terms of financial flexibility, both today and tomorrow. Not only does it reduce your fixed monthly costs (leaving more money in the bank to pay for kids’ educations or vacations), but you can then dip into your home’s equity to borrow at preferred rates with a homeowner’s line of credit. Once that debt is paid off, you can borrow again.
Q. Does the idea of having a mortgage burning party make me deliriously happy?
If you answered yes, start making those pre-payments now. Becoming mortgage-free is an emotional relief for many Canadians – and offers more bang for the happiness buck than any bullish market.
“I can forgo a 9-per-cent return if I’m getting up this morning and I don’t owe anybody money,” Mr. Lefebvre says. “That’s much more liberating than knowing you made 5 per cent that you might be able to withdraw in 25 years.”
The bottom line? No matter which way you lean – mortgage or RRSP – you will almost certainly come out ahead in the long run compared with doing nothing to prepare for retirement.
“There’s not really a wrong answer,” Ms. Kett says. “Either option will improve your financial security and is better than leaving the cash in a bank account.”
Article: Globe and Mail
Here’s a tool most people don’t think of when drawing up a financial plan: taxes.
But consider this: Buy a GIC in a non-registered account and the interest will be taxed as income, the highest tax rate. Buy a stock that pays dividends and those dividends will be taxed at a much lower rate, from about 30 per cent to 40 per cent, depending on which province you live in.
That, wealth-management experts say, is just one of the powerful ways tax planning can help you earn better returns.
“People do acrobatics to try to make an extra 1 per cent on their investments,” says Tom McCullough, the Toronto-based chairman of wealth-management firm Northwood Family Office and the co-author of Family Wealth Management: 7 Imperatives for Successful Investing in the New World Order.
But for wealthy families, especially those who own a business, there are opportunities to make much more through tax savings, he says. It’s the reason that many banks and wealth-management firms have brought tax advisers on staff to advise clients.
Here are the basics you should consider if you’re in this tax bracket:
How assets are taxed
There is a “substantial difference” in how assets are taxed, says Jason Safar, a specialist in high-net-worth taxation at PricewaterhouseCoopers LLP. Investment income is taxed at the highest rate – the same rate as income – followed by dividend stocks and capital gains, which are taxed at about half the rate of investment income.
Mr. McCullough cites bonds as a prime example of how tax planning can help the investor. People don’t realize that by purchasing premium bonds and redeeming them for less than the purchase price, they not only have a capital loss but they also have converted the return into interest income, which is taxed at the highest rate.
Another key for investors, Mr. McCullough says, is to not only consider asset allocation – where to put your money – but also “asset location.”
Tax rates can help determine whether to put an asset in a non-registered or registered account – the higher the rate, the more likely it should be protected in a registered account – and help decide which family member should hold the asset.
The richer the person, the bigger the impact a small percentage difference in your tax bill can make. “If I’m making $100,000 a year, and I can save one per cent on my taxes, that’s $1,000,” Mr. Safar says. “How much heartache and suffering and planning am I willing to incur for that? Whereas if I’m making $10-million a year, and I can save 1 per cent of my taxes, a substantial effort becomes worthwhile.”
One way that all experts cited to minimize taxes is to defer capital gains as long as possible, by holding on to investments and assets. “The longer you can defer taxation, the better off you are,” Mr. Safar says.
Let’s say you owe $100,000 in capital gains tax, Mr. McCullough says. Pay it now or pay it in 10 years – you still have to pay $100,000, but in 10 years, factoring in inflation, the payment will be worth a lot less. In the meantime, you can let that money work for you.
This is an important tax strategy for wealthy families, especially in entrepreneurial families, Mr. McCullough says. One person, the founder of the business, has the bulk of the money – and that person’s large income is taxed at the highest marginal rate. Other members of the family don’t earn as much so they are taxed at a lower rate. The idea is to split the income so some of that money is taxed at a better rate.
“When you think about income splitting, the goal is to get all of the related family members up to the top marginal tax rate,” Mr. McCullough says. “At that point, it really doesn’t matter where the income goes.”
One way to do this, he adds, is to set up the business to be owned by a trust, with family members as beneficiaries.
Family trusts that don’t involve a business can see members lend money to the trust, which also has the benefit that you can take the money back, removing any risk.
Outside of a trust, a family can choose to lend each other money. If a family has a high-income spouse and low-income one, for example, one spouse can lend money to the other at a “prescribed rate.” That rate, which is set by the government, is 2 per cent this quarter – but will drop again to 1 per cent, said John Natale, assistant vice-president of tax, retirement and estate-planning services at Manulife Financial. Once you lock into a rate, Mr. Natale said, it’s set for life – and you can continue to reap tax advantages by having the spouse with the lower income pay tax on the money that is lent.
Setting up a trust or corporation
For business owners, setting up a trust can have other benefits – including the potential for massive tax savings through capital-gains exemptions.
Say the business owner set up a trust that divided the ownership – every family member could get capital-gains exemptions of $750,0000 each, Mr. McCullough said. Mr. Safar says owners can also set up trusts where future growth is included in the trust and split among family members, also a tax saving.
Another option is to set up a corporation to hold your assets. Mr. Safar says that in Ontario, for example, someone earning more that $500,000 would have to pay close to 50 per cent tax; the highest tax rate for a corporation is just over 46 per cent. For someone who is generating a lot of money, that 3 per cent a year “could be worth setting up a corporation.”
The downside, however, is that the advantages of doing so seem to fluctuate from year to year, “so to change your whole investment structure for something that would be a short-term issue doesn’t make a lot of sense,” Mr. Safar said.
Then there is the possibility of “dividend sprinkling,” which is when, in a family corporation, dividends are paid to family members who are shareholders. Mr. Natale said that rules differ by province, but in Ontario you can give a family member up to $49,000 in dividend income, tax-free.
Article: Globe and Mail
Most retirees who make the annual pilgrimage to the sunshine states already know how long they’re allowed to stay in the United States without making immigration officials testy: fewer than 183 days.
But that limit could change – maybe just not this year.
Last summer, the U.S. Senate passed immigration legislation that stated Canadian retirees 55 and older who were willing to spend at least $500,000 on a residence could spend up to 240 days in the United States without a visa – almost two months longer than the current limit. While the legislation eventually died in the House of Representatives, Roy Berg, director for U.S. tax law at Moodys Gartner in Calgary, says he’s convinced that the JOLT Act (Jobs Originated through Launching Travel) will eventually become law. It’s just a matter of time.
The so-called “Canadian retiree visa” is a revenue raiser for the American economy, he explains, initially proposed in 2011 (and carted out each year since) to sweeten the pot for wealthy Canadians who might be tempted to buy real estate south of the border.
“Will the snowbird visa come around? I think so. Why? Because they keep proposing it,” Mr. Berg says. “It will be resurrected next year just like it was last year.”
Perhaps the delay isn’t such a bad thing, however. According to some financial advisers and tax lawyers, there could be some potentially serious and financially brutal repercussions for snowbirds who are unaware of all the tax and health-care issues that go along with the legislation. By having another year to get educated, they could save themselves headaches and money.
The primary problem?
“The tax laws are not lined up with the immigration laws,” says Abby Kassar, vice-president of high-net-worth planning services at RBC Wealth Management in Toronto.
In other words, just because from an immigration standpoint, you’re allowed to stay in the United States for up to eight months, it doesn’t necessarily mean the taxman will turn a blind eye. Just the opposite, Mr. Berg says. In fact, he goes so far as to call the snowbird visa “a trap” and even a “tax bomb” for the unwary because it can automatically turn a Canadian into a U.S. resident, subject to tax on worldwide income.
The formula for determining U.S. residency can be complicated. Take the number of days you were in the United States this year, a third of the days you visited last year and one sixth of the number of days the year before. If you come up with an average of at least 120 days over the three years, you are a resident. The same applies if you’re in the United States for 183 days or more in one year.
Snowbird, say hello to the Internal Revenue Service.
“These visas say you have to be in the U.S. for at least 180 days in a calendar year and no more than 240. You’re going to be a U.S. resident so you have all the tax and filing obligations that U.S. people do,” Mr. Berg says.
Although there are ways to offset tax in another jurisdiction – snowbirds are often advised to file a Form 8840, Closer Connection Exception statement with the IRS – it doesn’t always work out cleanly. For instance, some people are unaware they’re U.S. residents and fail to file a foreign bank account report.
“That’s a $10,000 ticket. Between the U.S. and Canada, it’s not the taxes that are the killer, it’s the penalties for failing to file,” Mr. Berg says.
Then there’s estate tax. As a U.S. resident with property, if you were to die, you would not be taxed on capital gains, as you are in Canada, but on the total value of your assets. This can have a huge impact on wealthy Canadians with assets at the date of death of more than $5,250,000, since they’re taxed at 40 per cent, Mr. Berg says.
And don’t forget Canadian departure taxes, which are also based on residency. If you are no longer considered a resident in Canada, you’re deemed to have sold all of your assets and you must pay taxes on your capital gains. In effect, the Canada Revenue Agency treats you as though you’ve died.
“So you get a snowbird visa, you’re fat and happy living down in the U.S. for 240 days – and then you get a knock on the door from the CRA that says, ‘Hey, where’s our money?’ ” Mr. Berg says. “That’s a super nasty surprise.”
The possibility of losing provincial health-care coverage already keeps snowbirds up at night, and the retiree visa wouldn’t help. Currently if someone is out of province for more than six months, they may no longer qualify until they establish Canadian residence again.
Again, staying past that 182-day mark very possibly means losing coverage, Ms. Kassar says.
“From the Canadian perspective, we have provincial health-care programs that are in line with the immigration laws, but this throws that off. The question is, will [health-care rules] be changing in the future to accommodate the changes in the U.S.?” she asks.
Thinking that when the retiree visa eventually comes to fruition, you’ll find a way to fudge the time you live south of the border to avoid taxes and penalties, and keep your health-care coverage? Think again. This coming summer, as part of the new joint entry/exit system between Canada and the United States, border officials will be tracking not only when you enter each country by land, air or sea, but also when you leave. Until now, countries only tracked entry.
It will be much harder to cheat the system, explains Mr. Berg. Canada can tell whether you’re no longer eligible for provincial health-care coverage, and the United States can tell whether people have become illegal aliens or residents.
“It’s going to change everything,” he says. “You’re going to have to swipe in and swipe out.”
Original Article: Globe and Mail