Many people decide that they are going to start saving, but rather than figuring out how much to save, they simply set up automatic contributions to their Registered Retirement Savings Plans (RRSPs) and Tax Free Savings Accounts (TFSAs) for random amounts, often overestimating how much they can afford to save. This can create some negative consequences.
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It’s tax refund season again and it’s always nice to get some extra money back from the government. We got a refund this year because we both contributed to an RRSP. If we had not contributed to an RRSP, we would likely have had to pay taxes this year as our employers only take off the bare minimum required from our paychecks to cover taxes.
Getting a tax refund due to overpaying on taxes throughout the year is a bad thing. It means the government has owed you money all year long and rather than it being in your bank account, the government has benefited from it. One way to ensure that this doesn’t happen to you is to make sure your employer only takes off the minimum required taxes. Some people opt for the maximum taxes to be taken off in order to ensure a tax refund at the end of the year. I wouldn’t recommend this option unless you know that you are a horrible saver and this is the only way you can save.
A Registered Disability Savings Plan (RDSP) is a relatively new plan offered by the Canadian government that is intended to help parents and others to save money for people who are eligible for the Disability Tax Credit. The plan is designed for long-term savings and it’s best to keep any contributions in the plan for at least 10 years.
Contributions are not tax deductible, however the major advantage to an RDSP is that the government will pay matching grants of up to 300% depending on the beneficiary’s family income and the amount contributed. Over the beneficiary’s lifetime, they can receive up to $70,000 in grant money and they may also be eligible for Canada Disability Savings Bonds of up to $20,000.
The grants and bonds can be paid into the plan until December 31st of the year the beneficiary turns 49. For specific details on when the government grants or bonds would need to be repaid, check out this link.
In order to qualify as a beneficiary of an RDSP, you must be eligible for the Disability Tax Credit, have a valid SIN, be a Canadian resident, and be under the age of 60. Anyone can contribute to an RDSP as long as they have the permission of the plan holder.
There is no annual limit on amounts that can be contributed to an RDSP of a particular beneficiary. However, the overall lifetime limit for a particular beneficiary is $200,000. Contributions are permitted until the end of the year in which the beneficiary turns 59 years of age.
For more information on RDSPs, click on this link. RDSPs are a great way to help people with disabilities to become financially secure. Partnering with the government, you can ensure that you or your loved ones can achieve their financial goals.
There are all kinds of interesting things you can learn about investing and economics. The Rule of 70 is one such fascinating tidbit that might be of interest to you.
If you want to be able to estimate approximately how long it will take for your money to double in an investment with a set interest rate or a fixed rate of return, you can get a fairly good idea by dividing the number 70 by your fixed interest rate.
For example, if you are currently earning 1% in your savings account, that means it would take 70 years for your money to double. If you are earning 2%, it would take 35 years to double your money, and if you are earning 3%, it would take 23 years.
Although the Rule of 70 isn’t perfect, it does provide a good indication of how long it will take for your money to double. Note that the interest rate must be fixed in order to do this calculation. So, if you have any investments with an annual compound interest rate, do this calculation to see how long it would take for your money to double.
At the beginning of this year, the Canadian government introduced the Tax Free Savings Account (TFSA). While it definitely has its perks, there are some disadvantages to the TFSA as well.
Here are the basics about TFSAs:
*Canadians 18 years of age and older can invest up to $5000.00 every year in a TFSA
*The money can be withdrawn at any time.
*You can contribute to your spouse’s TFSA
*There is not a lifetime contribution limit
*Assets from a spouse’s TFSA will transfer upon death to the other spouse without tax implications
*Any funds withdrawn can be put back into the account at a later time without reducing your contribution room
*You don’t have to pay taxes on the investment gains regardless of whether they are capital gains, dividends, or interest income.
*Money contributed to the TFSA are not tax deductible
*If you don’t invest the full $5000.00 for any one year, it can be carried forward to a future year
The Good, the Bad, and the Ugly
TFSAs are generally a great concept because they encourage people to save. The fact that you’re not being taxed on the earnings is also very appealing. However, there are some other aspects to TFSAs that you need to consider. You don’t want to be paying hefty fees for your TFSA, so you need to be mindful of what your financial institution charges. Feel free to shop around before opening your TFSA.
Another thing to consider is that if your investment in a TFSA experiences a capital loss, there is no tax cushion to buffer the loss.
Lastly, when you contribute to a TFSA you are likely to be at a fairly high tax bracket and most people want to decrease their tax bracket by contributing to something such as an RRSP. Unfortunately, TFSAs don’t give you that benefit. In essence, you will be paying more tax if you contribute to a TFSA as opposed to an RRSP.
Each investment option has its pros and cons. TFSAs can be a great method of investing, but like any other option, it’s not perfect. Check out your local financial institution’s website to see what they have to offer and start saving for your current and future goals.