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RRSP

Your RRSP Is Not Your Emergency Fund

As I have written before, it is important for all of us to have some funds set aside in case of emergency. If your vehicle breaks down or you find yourself out of work for a while, you do not want to have to use your retirement savings. There are key reasons why you should not even consider your RRSP as your emergency funds.

First, you get penalized for withdrawing. You pay withholding tax to the government when you first make your withdrawal.

Second, you have to pay more tax at the end of the year on the amount you withdraw, depending upon your income tax bracket.

Third, there are other negative impacts as well, including the fact that you lose that RRSP contribution room permanently. So as you can see withdrawing from your RRSP is expensive.

To prevent ever having to make an RRSP withdrawal before retirement, consider putting some money aside every payday and using either a Tax Free Savings Account or even just a regular savings account that still pays you some interest. This way you have the flexibility to make RRSP contributions with excess savings before the deadline without putting you in the position of touching your RRSP prematurely. (Build your emergency funds until you have three to six months of living expenses and then any money above that can be used for your RRSP in the event that nothing comes up throughout the year.)

Before putting money into your RRSP, make a mental note that this money no longer exists to you until you retire. It is not back up savings. Don’t even include your RRSP balance when you calculate how much money you have. It’s best if you forget about it, because there is no point in contributing to your RRSP if you intend to use it as emergency funds. It just doesn’t make financial sense.

September 2, 2010

Investing

The Best & Worst Time To Make an RRSP Withdrawal

Withdrawing from an RRSP can be an extremely expensive option due to the tax consequences. So, unless you are saving for retirement within your RRSP, or you are planning on taking advantage of the Lifelong Learning Plan or the First Time Home Buyer’s Plan, I would not recommend saving within an RRSP investment vehicle.

To illustrate this, suppose you are 25 years old and you have managed to save $5000 in your RRSP. You end up spending too much money over Christmas and find it impossible to keep up with all your bills. You decide to withdraw $2000 from your RRSP.

By doing so, you have lost $2000 worth of RRSP contribution room. You can never get this contribution room back.

As well, you will be subject to a withholding tax of 10% in all provinces (except Quebec where you would have to pay 21%) that would be taken off the top and sent to the government. So, even though you are withdrawing $2000, you would only get $1800 at the end of the day or even less in Quebec.

You will also need to add the full $2000 to your income for the current tax year, and then depending on your income tax bracket, you will likely have to pay more tax at the end of the year unless you deliberately make an RRSP contribution to offset the withdrawal.

February 25, 2010

Investing

Should I Contribute to an RRSP or a TFSA?

With the introduction of the Tax Free Savings Account (TFSA) in January 2009, Canadians now have another investment vehicle option to save for retirement. Whereas before, most people took advantage of the immediate tax deduction for contributing into a Registered Retirement Savings Plan (RRSP), now they have to consider what will be most beneficial to them in the long run. With the RRSP contribution deadline for 2009 fast approaching, it’s important for Canadians to make this decision ASAP.

What are the advantages of contributing to a TFSA?

Although you don’t receive an income tax deduction for contributing into a TFSA, there are some important advantages to consider. All earnings within a TFSA are not taxable, whereas with an RRSP, earnings are tax deferred, but when funds are withdrawn, they are fully taxable.

A second advantage is that there are no expensive tax implications when you withdraw from a TFSA. Since you’ve already paid tax on the money you contribute to a TFSA, when you withdraw the funds it is not a taxable event. By contrast, if you withdraw from an RRSP, not only are you subject to an immediate withholding tax, you also have to add the amount withdrawn to your income for the year and you may end up paying more tax when it is time to fill out your tax forms or prepare your online taxes this year.

February 9, 2010

Investing

Save Money On Your Taxes– Use A Spousal RRSP

If you anticipate that your spouse’s income will be considerably lower than your own during retirement, a great way to save money on your tax bill is to take advantage of a Spousal RRSP. It’s a simple and strategic way to split your income.

How does a Spousal RRSP work?

The higher income-earning spouse contributes to the Spousal RRSP and gets to claim the tax deduction. The money in the plan then accumulates free of tax until it is withdrawn by the other spouse (the lower income earner), which will result in tax savings.

What you should know about Spousal RRSPs:

If you are the plan owner and your spouse is contributing into your Spousal RRSP, if you withdraw money from the plan, any money contributed in the last 2 calendar years as well as the current year will impact your spouse’s taxes. In other words, your spouse’s taxes will end up being impacted. So, it would not be advisable to start up an RRSP unless you are certain you won’t have to withdraw the funds in the short term. (Before investing in an RRSP, it’s important to have an emergency savings account set up so that in the event of an unexpected expense, you wouldn’t be depending on RRSP money.)

February 3, 2010

Debt

Is It Better To Pay Off Your Mortgage or Contribute To Your RRSP?

This is an age-old question and after doing some research on the subject, I have discovered that there are a lot of differing opinions out there. Some say you should pay off all your debt before contributing to an RRSP, while others suggest making RRSP contributions when you are young and then focusing on paying down your mortgage when you are older.

The answer to this question, however, really depends on you and your own personal comfort with debt. There are a lot of people out there who absolutely despise being in debt and will do everything in their power to get out of debt, while others are okay with being in debt, at least to a certain extent.

When considering what to do, it’s a good idea to talk to a tax specialist and/or a financial planner. Sometimes people end up doing ridiculous things in order to avoid paying tax, so it’s important to consider all aspects rather than simply focusing on reducing the amount of tax you pay.

Some specific things to consider when choosing between saving for retirement and paying off your mortgage include your age, current tax bracket, investment returns, mortgage interest rate, and whether or not you have a pension plan.

After skimming through several articles on this subject, I noticed that most people suggest doing both. That way you will feel as if you are getting somewhere, since simply paying down debt is supposedly not as psychologically satisfying. Another opinion I stumbled upon was that it’s better to pay off your mortgage first if your mortgage interest rate is equal to or higher than your RRSP’s rate of return.

It really all boils down to what you deem is most important for your own personal situation. If you want to read chartered accountant David Trahair’s opinion on why you should pay off your mortgage before contributing to an RRSP, check out this link.

If you have come across some extra money due to an inheritance, etc., I would encourage you to do your own research prior to making a decision. There are pros and cons to both sides and it may be wise to do both simultaneously. As the saying goes, it’s not a good idea to put all your eggs in one basket. On the other hand, sometimes it makes the most financial sense to choose one over the other.

November 19, 2009

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