Tag Archives: RRSP

Random thoughts – keeping you on your toes

Managing your money

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The basic framework to money management begins with your overall objective.  This is supported by specific goals, overtime as performance to the overall objective is measured the specific goals may be modified.

Some go with multiple objectives, personally I have always been a believer in simplicity and focus.  You might have a number of specific goals (shorter term and changing over time) but the objective should be straightforward and longer term (15 to 25 years).

How it could work

Objective:  Have more than a million in joint net financial assets by age sixty-five

Goals:

  • maximize registered retirement saving plan contributions each year
  • maximize tax free savings contribution each year
  • Achieve a dividend return for total net financial assets of 3% a years
  • Minimum internal capital growth rate (i.e., net of new investments) of 5% (both realized and unrealized gains)

And so on …….  (You could have goals around asset mix, interest income, etc)

The key thing to note is each goal is very specific and easily measurable, that is either it was obtained or it was not.

What Next

Use the specific goals for detailed planning.  Consider how to achieve the goals using the tools at hand.  I have previously done a number of posts about things like financial and retirement planning.  This posts provide some good ideas about the many of the tools and techniques you can use to assist with achieving your goals.

For example, if a specific goal is to maximize your TFSA contribution each year, financial planning tools can assist is defining an approach and the associated steps to achieving this goal.  Intuitively it’s pretty obvious you are more likely to achieve the goals with planning than otherwise (although with luck goals can be achieved randomly too).

Why Bother?

One of my favorite sayings is “If you don’t know where you are going, how can you plan to get there and when you arrive how will you know it?”  Setting your objective is the first step in answering that question.  Specific goals provide the flexibility to change direction over the long term,  as to how you achieve the objective.

 

Random thoughts – keeping you on your toes

More about RRSP’s

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In my series of posts about retirement planning,  back at the beginning of August, I reviewed pensions, registered accounts, income funds and life annuities.

Today I am going to drill down a bit more on Registered Retirement Savings Plans (RRSP’s)

Currently you can contribute 18% of your income to a maximum of $24,270 (the limit can change each year).  The thing to note here is the Canadian Revenue Agency (CRA) will calculate your next years contribution limit each year when you submit your tax return.  The calculation for the upcoming year is based on the income reported on the submitted return.  Or more simply put, when you submit your 2013 tax return in April 2014, on the confirmation the CRA sends you back they will indicate the 2014 contribution limit (calculated based on 2013 income).

Some things to note:

– contributions to employer pension plans that are not taxed are counted toward the limit (say you contribute $6000 to the company plan through payroll deductions and your Registered Plan  limit was $24,000 than you only have $18,000 room left for your personal RRSP.  It does not matter if the employers plan is defined contribution or defined benefit.)

– additionally unused amounts from previous years are held over and accumulate.  So you don’t loose unused contribution room, it just adds to the next years 18% max $24,270 calculation,  making the contribution room higher.

Although you can calculate the maximum contribution limit the best way is to let the CRA do it for you.

Reasons for Contributing

As noted in my previous blog you defer taxes on the refund you get.  And you get the investment growth on the amount you contributed.

Another key value of your RRSP contribution is the tax refund you get, that is basically calculated as your marginal tax rate times the amount contributed.  You can use it to buy things (e.g., payment toward a new car) or you can invest it.

For future use (for example when you retire), investing the tax refund works best , that being said though using the refund to buy something you want now (a little luxury), but were not able to save up enough during the year, can be appealing too.

The bottom line is to make a conscious and informed decision  of how to best use your RRSP tax refund (basically invest or spend) in the context of your overall financial plan.

Contribution Strategies

Given unused contribution room accumulates in cases where your income is rising over time you can benefit by for example contributing extra savings to a TFSA initially instead of an RRSP and building your RRSP contribution room along side your income growth year over year.  Then at some point,  make a big contribution to your RRSP.  At this point assuming your income has put you in a higher tax bracket this maximizes your refund (which is based on your marginal tax rate).   The balance here is not to wait too many years as the value of the refund is having it to spend or save.

This strategy balances the contributions to both of the key Canadian savings vehicles that help reduce your tax burden (i.e., RRSP and TFSA).   The values and benefits of TFSA versus RRSP will be explored more fully in a future blog.

Random thoughts – keeping you on your toes

Getting ready to Re-tire (continued)

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This post continues the theme I started yesterday about the basic tools and practices to reduce or even eliminate financial stress in retirement.

The basic income source (pensions, which I wrote a post about yesterday) can be supplemented by  retirement saving options both taxable and tax free and potentially government allowances.

Today I will cover the last pension type (I did not get to yesterday) and retirement saving options both taxable and tax free.

In future posts I will talk about how these savings can be used to create income funds and/or purchase annuities, resulting in additional income streams to those of your pensions.

Pension Continued/ Allowances

Old Age Security (OAS) Pension

OAS has wide eligibility and requires neither that you have worked nor contributed.  Associated with this pension are a couple of government allowances with more restrictive conditions.

If you are living in Canada and a citizen or legal resident who has resided in Canada for at least 10 years since age 18, at age 65 you are eligible to receive the Canadian Old Age Security Pension.

To get the full pension amount, which is currently paid monthly to a total of about $6,800 a year, you need to have resided in Canada for 40 years; otherwise it is reduced based on the number of years you resided since age 18.   (The eligible age changes to 67 in 2023).  You can also defer OAS up to 5 years and get a higher payout based on long you deferred the start after you reached age 65.

Note: If your annual income exceeds $72,000 the OAS payment is clawed back in increments up to annual taxable income of just over $118,000 when it is %100 clawed back.

 Guaranteed Income Supplement (GIS) and Allowance

At age 65, if your single or joint income is lower than prescribed thresholds  and you are receiving OAS you are eligible for an additional supplementary amount (GIS).

If your spouse is receiving OAS and GIS then you are eligible to receive the “Allowance”.

Check out Service Canada website for the prescribed income thresholds, amount paid, etc. Service Canada OAS, GIS Allowance Info Page

Retirement Saving Options

Registered Retirement Savings Plan (RRSP)

The Government of Canada encourages residents to supplement pension income with savings.

The encouragement is in the form of a refund of tax paid on the amount saved in the year it is saved.  In the year the savings are withdrawn, tax is collected.

For example, if you save $10,000 in a year when your marginal tax rate for all your income is 30% the government will refund you the $3000 tax paid on the $10,000.   If you withdraw those $10,000 in savings 20 years later when your income and marginal tax rate is lower overall, say 25%, you would only pay tax of $2500.

So, the incentive is that you get “present value” from a tax refund (20 years of investment opportunity) and potentially reduce the tax on the saved amount when you withdraw it (the theory is your income is lower in retirement than while working).

Additionally, all capital gains, interest and dividend income earned on the registered savings is tax free until withdrawn.

There are tons of rules covering registered retirement savings plans in Canada.  These include things like; how much can be put in a registered retirement savings plan, withholding tax for lump sum withdrawals, penalties for over contributions, documentation and filing requirements, spousal plans and so on.  If you want more info on these things, the Government of Canada web site is a great source or if you are not so much a self serve person there is always a financial services professional, accountant or such.   I might do a future post about it but would need to be on request.

Regular Retirement Savings

Saving money to supplement your pension income probably should start with an RRSP  ( because of the great incentives noted).  However, given the restrictions to how much you can allocate to an RRSP additionally saving some amount of after tax money as part of your retirement nest egg can make sense as well.

The things to consider are what are my post retirement income sources and about how much will they be?  Based on this analysis you can get an idea how much savings is desirable to supplement your government, company pensions and registered plan savings.

Example:

Here is a hypothetical case assuming someone with both a defined benefit pension and from a second employer a defined contribution pension used to buy an annuity and RRSP savings of $120,000 :

CPP                                                             – $12,800                           OAS                                                            –  $6,800                                   Defined Benefit Pension                –  $30,000                             Annuity                                                    –   $6,000                          RIF (from RRSP)                                   –  $6000                                    Total  –  $61,600

If $61,600 before taxes is going to provide enough income you are done (this of course is dependent on estimated expenses).

If you want more income after tax savings come into play.  In the above example if the target income was $75,000 the $13,400 shortfall per year could be covered by purchase of a $200,000 annuity (individual, no guarantee, at today’s rates) or savings of say $500,000 savings assuming an annual return of 3% (probably a realistic assumption).  

If additional after tax savings is needed to get the retirement income target you seek  the next question of course becomes how to invest it to minimize risk and maximize return.  You guessed it, the subject of future posts.

A final note about retirement savings:

You can always withdraw your money from your RRSP or other retirement savings to spend on things you need at any point in time (e.g., a vacation, car, etc).

In the case of an RRSP though this requires paying withholding tax where applicable  (I should also note there are special rules about using your RRSP funds to make a down-payment on a house without triggering tax).   And of course, early withdrawals reduce savings and the money won’t be available for something else later should you need it (e.g., cosmetic surgery to make you look better as you age).

That being said, I do want to end this topic with a lead in to my next post which will be about options to get a regular income streams from your RRSP or non registered savings through fixed income vehicles (i.e, registered income funds or life annuities).

Random thoughts – keeping you on your toes

Not about your car – Re-tire info

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Over the past couple of years I have had conversations with a number of folks younger than myself, about the basic financial tools Canadians can use to ensure their retirement does not include money worries.

I am invariably surprised at how little they know about the topic.  The point being, the best time to have an understanding and awareness of funding your retirement is well before you get there.  It’s kinda like the boy scout motto, “be prepared”.

Today’s blog is a simple (but comprehensive) primer about pensions.

In a future blogs (probably tomorrow and the next day to keep the momentum) I will review retirement saving options both taxable and tax free, government allowances, income funds, annuities and of course throughout all the blogs, tax implications associated with these things.

All of this is leading to death which ends the taxes, for you anyway but maybe not for your beneficiaries (that will be the topic of even another blog. )

Let’s Start with Pensions

 Canada Pension Plan (CPP

Everyone with earned income in Canada contributes to the Canadian Pension Plan (CPP).  Employer’s contribute on your behalf too.  The money you contribute to CPP is not taxed and the earnings from investment on the CPP capital is not taxed.  You can elect to receive an annual income from CPP starting at age 60 – 64 (reduced) or age 65 (full) or 70 (enhanced).  The amount paid depends on your contributions from employment income over the years.  The current maximum is about $12,700 year. (not including the post retirement benefit if you start after 65)

Employers Pension Plan

Many  employers in Canada offer benefits above and beyond  your basic compensation, like medical/ dental insurance, special time off options and pensions, among other things.  When your employer offers a pension plan these come in two flavors (described below) and each is somewhat unique in the details but the basic concepts are the same.  I also describe with each type what happens if you leave the company (and thus the plan) before retirement.

Defined Benefit

In this plan you contribute and your employer contributes monthly, both tax free (usually a % of your salary).  The investment of the funds and the return on investment is managed by the plan’s administrator (a paid third party -e.g.,  like Sunlife).  All earnings of the fund are tax free.

The pension society oversees the operation of the plan and determines the pension payout and this is usually based on your years of service and annual income when you retire (or average of several years near retirement).  The risk that the pension fund won’t have received enough contributions or earned enough money from interest, dividends or capital gains is on the employer and they need to make up any shortfalls in the pension fund over-time.   That is the benefit is fixed, good for the employee.  (Of course if the company goes bankrupt and the pension fund is not fully funded, that is part of the bankruptcy, like Nortel,  it is not good)

If you quit the company before retirement you have two options:

1) Have the money contributed by you and your employer and associated earnings on that money (interest and dividends) deposited to a Locked In Retirement Account (LIRA)  You can manage your LIRA’s investments but cannot withdraw any money until age 65.  You have to start taking annual withdrawals after age 72 at the latest.  Money earned in the LIRA is tax free.  Withdrawals, when they start are taxed as income and can be in the form of a life annuity or a retirement income fund (RIF) which will be explained in future blogs.

2)Elect to receive the pension due to you based on years of service and salary when you leave the company.  This pension would not start though until the normal age of retirement (e.g 65) or if you choose early retirement age with a penalty (e.g. 60)  or later than the normal retirement age (e.g, 70) but usually no benefit to doing this, except as it relates to your taxable income overall at the time the pension starts.

(Note: you need to have been in the plan at least two years to be vested.  Otherwise you get what you contributed but not what the employer contributed.  Also the take a pension option does not apply.

Defined Contribution

In this plan you contribute and your employer contributes monthly, both tax free (usually a % of your salary).  The investment of the funds is directed by you.  The plan is usually administered by a third party (e.g., Sunlife)  All earnings of the fund are tax free.

Since you oversee the operation of the plan and determine how it is invested, the amount of money available to create an income when you retire is determined by you.  (If you invest badly and lose money, oops)  Basically  the risk that the pension fund won’t have received enough contributions or earned enough money from interest, dividends or capital gains to pay what you need, is all on you.

When you retire how the money is paid to you as income is also decided by you – either an annual % usually paid monthly until the income is gone or through purchase of a life annuity (both of these options will be explained more fully in the next blog.

If you quit the company before retirement you have two options:

1) Have the money contributed by you and your employer and associated earnings on that money (interest and dividends) deposited to a Locked In Retirement Account (LIRA).  Some of the money can go to an Registered Retirement Savings Plan (RRSP).  This is based on provincial rules as to how much can be unlocked (so varies) and also your spouse (if you have one) must give a waiver.

You can manage your LIRA’s investments but cannot add or withdraw any money (beyond capital gains, dividends and interest being reinvested) until age 65 (i.e., it is locked).  You have to start taking annual withdrawals after age 72 at the latest and these are through a Locked In Retirement Income fund (LRIF) explained in  a future blog. Money earned in the LIRA is tax free.  Withdrawals from the LRIF, when they start are taxed as income.

If you did choose to put some of the money in an RRSP you can withdraw it any time (but pay tax when you do) or transfer it to a Retirement Income Fund when ready to do so (not a locked income fund).

2)Elect to take the cash and pay the full tax.  In this case though most Provinces (again this varies) require the spouse (if you have one) to give a waiver saying collapsing the retirement account is okay.

(Notes: You need to have been in the plan at least two years to be vested.  Otherwise you get what you contributed but not what the employer contributed.  Also the take a pension option does not apply.

That’s all for today, more than enough I am sure.  Check in the future blogs to get the rest of the story.