Many of us set New Year’s resolutions for ourselves and often those resolutions have to do with finances. January is the month we say, “Ok, this year I am going to save more and spend less”. This article won’t tell you how to spend less, but it will outline two government sponsored programs available to help you save for retirement or even just a rainy day! Of course these are not the only vehicles you can accumulate money with – those include anything from putting dollars under the mattress to the most sophisticated tax shelter schemes – but these two are the most popular.
Tax Free Savings Accounts (TFSA)
This is the new kid on the block established by the government as of January 1, 2009. Canadian residents age 18 or older could contribute up to $5,000 into a TFSA. The funds would grow tax free and although there is no tax deduction for the contribution, withdrawals can be made at any time without paying tax. Also, there is no earned income requirement for an individual to contribute. For those years where no contribution is made, it can be made in later years. Any withdrawals can be paid back in addition to current contributions. Be careful not to do this in the same year as the money was withdrawn so as to avoid a tax penalty for over payment.
There are a wide range of investment options, from mutual funds, GIC’s bonds, segregated funds etc. Since withdrawals are not taxed as income, they do not affect any income tested government benefits such as Old Age Security, Guaranteed Income Supplement or the Child Tax Benefit. In addition, funds can be given to a spouse or common-law partner to invest in a TFSA. For families where the children are 18 and over, signficant total contributions can be made.
When the program was first introduced it was intended that the contribution limits be indexed for inflation. As a result the contribution limit since 2013 was increased to $5,500. For those that have not yet started a TFSA, a total contribution of $36,500 (total contribution room since inception) could be made in 2015.
Even though there is no tax deduction for the contribution, the fact that funds accumulate with no tax payable on the growth and no tax owing on the withdrawal, make this vehicle ideal for rainy day savings or for retirement savings over and above other registered plans such as a Registered Retirement Savings Plan.
Registered Retirement Savings Plans (RRSP)
With this vehicle contributions can be made equal to 18% of the previous years earned income subject to a maximum contribution. The maximum contribution has been increasing and for 2015 is $24,930. Unlike a TFSA, contributions made to an RRSP are tax deductible against earned income. Withdrawals from an RSP are taxable as earned income and taxed at an individual’s top marginal rate. Contributions can be continued to be made until the year in which the contributor turns age 71, at which time, the RRSP must be converted to a Registered Retirement Income Fund or Life Annuity.
Spousal contributions may be made to lower income spouse but contributions of both spouses may not exceed the maximum RSP room of the primary contributor. If your spouse is younger, contributions may be made to his or her plan until he or she reaches the age of 71. Contributions can be borrowed from a lending institution but the interest paid will not be tax deductible. This is also true of TFSA’s and, in fact, with any registered plan.
Phew! That was pretty dry, but these are government programs and, as everyone knows, the government has no sense of humour! Next month we’ll look at a direct comparison between TFSA and RRSP just in time for the deadline. If you want to beat the rush you can call me to discuss the strategy that works best for you.