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Managing Your Money
Borrowing for your RRSP contribution can make dollars and sense
Here's a question for you: What's the best tax-sheltered savings-builder for most Canadians? If you answered "a Registered Retirement Savings Plan" (RRSP), good for you. And, if you've already set up an RRSP and contribute to it regularly, better yet -- because that is one of the most important financial planning decisions you can make. But, if you're like many Canadians, you may not be taking full advantage of the tax-savings and income-building potential of your RRSP. That could cost you this tax year as well as reducing your retirement income down the road.
Consider this: According to Statistics Canada, in the 2001 tax year, 6,241,050 tax filers contributed nearly $24.5 billion to their RRSPs. That's an impressive figure - but it represented just 9 per cent of the nearly $316 billion in available contribution room. Moreover, only 34 per cent of tax filers with contribution room actually contributed in 2001. Meaning a whole lot of room for RRSP growth went unfilled - 'empty' contribution space that will ultimately reduce the maximum potential retirement income of millions of Canadians by billions of dollars.
What does this mean to you and what can you do about it? For starters, know your contribution limit. Every year, tax-paying Canadians are allowed to make an RRSP contribution based on their income. Let's say your 2003 RRSP contribution limit is $3,000. Depending on your tax bracket, that could generate nearly $1,500 in tax savings as well as adding to the tax-sheltered nest egg growing in your RRSP. You may not think that an additional $3,000 will have much of an impact on your retirement savings, but over 30 years, at an annual compound return of 8 per cent, that one-time $3,000 contribution will be worth $30,188 on a pre tax basis!*
So, your most effective RRSP strategy is to maximize your contributions every year - and you can do that even for your unused contribution room from past years. The government allows you to accumulate and carry forward all your unused contributions from previous years (since 1991). There is no restriction; you can carry forward unused amounts indefinitely, but the sooner you make up for lost time, the better because you'll have more money growing faster inside your tax-sheltered RRSP.
And that's why it can make terrific dollars and sense to borrow money and fill your unused contribution room. Say you borrow $10,000 for one year at 5 per cent and make monthly payments of $856 so you pay off your loan over 12 months. If your marginal tax rate is 40 per cent, that $10,000 contribution will generate an immediate $4,000 tax savings. It gets even better. Over 30 years (at an 8 per cent rate of return, a not unreasonable expectation given that short-term interest rate peaks and valleys smooth out over time) that extra $10,000 RSP contribution would grow to $100,600 on a pre-tax basis*. The math is easy: For a total interest cost of just $273, your 'catch up' RSP loan could generate just over $100,000 of pre-tax retirement savings in 30 years time.
Is borrowing right for you? It depends on your marginal tax bracket, the cost of the loan, the size of your monthly payment and how quickly you pay off your loan, your cash position, the return on the investment you make with your RRSP contribution and other personal financial factors. A financial planning professional can help determine if an RRSP loan is right for you and, if so, how to structure it for your maximum benefit.
*The rate of return is used only to illustrate the effects of the compound growth rate and is not intended to reflect future values or returns on investment.
This column, written and published by Investors Group Financial Services Inc., is presented as a general source of information only and is not intended as a solicitation to buy or sell investments, nor is it intended to provide professional advice including, without limitation, investment, financial, legal, accounting or tax advice. For more information on this topic or on any other investment or financial matters, please contact your Investors Group Consultant.
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You choose when to pay this tax - and it could be to your advantage
Income and property taxes are due on specific dates and must be paid, period. GST/HST must be paid each time you make a purchase. But, there is one tax you can pay according to your timetable, not the government's. It's the tax on capital gains - and taking advantage of the payment options for this tax can reduce your tax bite and enhance your retirement income.
Income tax on capital gains* generally applies when you sell a 'capital property' for more than you paid for it. According to the Income Tax Act, 'capital property' includes securities, such as stocks, bonds or mutual funds that you purchased as an investment, and 'real' property, such as the increase in value of a rental unit that you purchased with the intent of earning income.
A capital gain (or loss) is the difference between what you paid for your capital property (plus the cost of improvements) and what you sold it for (including commission and other selling expenses). So, if you bought a stock for $10 and later sold it for $20, your $10 profit is a capital gain. But, capital gains enjoy preferential tax treatment. Just 50 cents on every dollar of the gain is included in your income as a taxable capital gain. Thus, only $5 of your $10 capital gain on the sale of the stock is subject to tax.
If you suffer a loss on an investment in capital property you can use the loss to offset a capital gain from another capital property investment. You are not required to use capital losses in the year they occur, so you can carry forward those losses and use them to reduce your capital gains in a taxation year when your capital gains are higher than your losses. You can also carry back capital losses for up to three years and recover past tax you've paid on previous capital gains.
Capital gains are not taxed until they are realized, so you can control when you pay tax on those gains - for example, by deferring a sale of a capital property to a future tax year when your income will be lower than it is today.
Taxes on capital gains apply only to non-registered investments. Investments in your registered plans such as RRSPs, RRIFs and RESPs grow on a tax-deferred basis, so gains realized on your investments while within these plans are not taxed, but any withdrawals will be taxed as fully taxable income.
Federally-imposed contribution limits cap the amount you can save in an RRSP, meaning your RRSP may not deliver sufficient retirement income. A mix of non-registered investments can make up the shortfall - and capital gains tax-deferral advantages can be of benefit to you here, as well.
Investing in a mutual fund structure known as tax advantaged funds can be a sound non-registered investment strategy. Unlike most common mutual funds, which trigger tax consequences any time you switch from one non-registered fund to another, funds within the same tax advantaged fund structure are treated as a single entity for tax purposes, allowing you to move assets freely among share classes while deferring taxation of any capital gains.
Consequently, you can rebalance your portfolio or realize a gain on a fund and reinvest it in another fund within the same structure without immediately triggering capital gains tax. You can also reduce taxes on your non-registered investments by choosing a tax advantaged fund that includes investments in Canadian companies qualifying for the federal Dividend Tax Credit.
Building a balanced portfolio of registered and non-registered investments that makes the most of capital gains tax advantages and fits your goals for the future takes careful analysis and planning. A financial services professional can help you decide what's best for you.
* Tax will also be paid on capital gains distributions.
This column, written and published by Investors Group Financial Services Inc., is presented as a general source of information only and is not intended as a solicitation to buy or sell investments, nor is it intended to provide professional advice including, without limitation, investment, financial, legal, accounting or tax advice. For more information on this topic or on any other investment or financial matters, please contact your Investors Group Consultant.
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