Should I contribute to a TFSA, RRSP or both?
Should I contribute to a TFSA, RRSP or both?
With the Tax-Free Savings Account (TFSA) available for saving in a tax-free environment, does it still make sense to contribute to a Registered Retirement Savings Plan (RRSP)?
RRSPs can work well if you contribute while you are in a high tax bracket and withdraw when in a lower tax bracket. You can generate a higher net rate of return with an RRSP when the effective tax rate at the time of withdrawal is lower than the effective tax rate at the time of contribution. A TFSA can provide a higher return if the reverse occurs.
For example, if you contribute $1,000 to an RRSP when you are in a 20 per cent tax bracket, your net cost is $800 after the tax savings. If you are in the same tax bracket when you make a withdrawal from your RRSP, your net withdrawal will be equal to your net cost after paying the taxes ($800). However, if you are in a higher tax bracket when you make the withdrawal, say 40 per cent, then your net withdrawal will only be $600 after the taxes are paid (assuming market is flat and there is no return).
TFSA, RRSP OR BOTH?
A TFSA can be an ideal savings vehicle if you are in a low income tax bracket. RRSPs may not be well suited to low income Canadians. The RRSP tax savings are insignificant and you may be in a higher tax bracket when you make withdrawals, as the earlier example demonstrates. You may also want to consider that TFSA withdrawals do not impact income tested benefits and credits, such as child tax benefits and credits, Old Age Security (OAS) or Guaranteed Income Supplement (GIS).
If you now find yourself in a lower tax bracket, such as when on maternity leave, and have made RRSP contributions in the past, you may want to consider withdrawing from your RRSP to make a TFSA contribution. However, remember that funds withdrawn from your RRSP cannot be re-contributed at a later date.
One strategy would be to contribute to your TFSA now and accumulate RRSP room to be used later when in a higher tax bracket to optimize the tax benefits.
This is a situation where you may want to maximize both your RRSP and TFSA contributions. In fact, the tax savings or refund received from the RRSP contribution could be used to fund the TFSA.
YOU MAY WANT TO RETHINK YOUR HOME BUYERS PLAN SAVINGS
If you are saving for a down payment on a house, a TFSA might be a better option than saving in an RRSP and withdrawing under the Home Buyers Plan (HBP). There are several reasons for this.
■ The flexibility to recontribute the TFSA withdrawal without time limits.1 If HBP repayments are not made on time, the annual repayment amount is added into your income and any missed repayment amount means the RRSP room is lost forever
■ There is no restriction on how much you can withdraw from your TFSA while the HBP restricts you to $25,000 from each your RRSP and your spouses RRSP. Alternatively, you could each contribute $5,000 a year for 5 years to a TFSA and then withdraw $25,000 plus any investment earnings tax free and with no required repayments
■ There are no conditions on TFSA withdrawals, whereas the HBP requires you to be a first time home buyer.
Similar logic could be applied to the Life Long Learning Plan. By using a TFSA to save and fund continuing education, contributors can gain increased withdrawal flexibility while eliminating any enrollment requirements or repayment conditions.
Whether to save in a TFSA, RRSP or both may depend on your savings needs, your eligibility for income tested benefits and your current and expected future financial situation and income level.
1 Amounts withdrawn in a taxation year will be reflected in contribution room in the following year.
Article courtesy of Manulife Financial and should not be relied upon for investment or tax advice. It is recommended to speak to a financial planner to review your particular situation.
Bank of Canada Maintains it's overnight rate
The Central bank has released its latest rate decision.
The Bank of Canada said Wednesday it will maintain its target for the overnight rate at %.
The global economy is progressing largely as the Bank anticipated in its January Monetary Policy Report. Financial market volatility, reflecting heightened concerns about economic momentum, appears to be abating, the bank said in a release. Although downside risks remain, the Bank still expects global growth to strengthen this year and next. Recent data indicate that the U.S. expansion remains broadly on track.
At the same time, the low level of oil prices will continue to dampen growth in Canada and other energy-producing countries.
The BoC also noted recent rebounds in oil and other commodities. Coupled with slight appreciation for the loonie, the central bank said economic conditions are evolving as assumed in its January policy report.
Canadas GDP growth in the fourth quarter was not as weak as expected, but the near-term outlook for the economy remains broadly the same as in January, the bank said. National employment has held up despite job losses in resource-intensive regions, and household spending continues to underpin domestic demand. Non-energy exports are gathering momentum, particularly in sectors that are sensitive to exchange rate movements.
However, overall business investment remains very weak due to retrenchment in the resource sector.
Overall, the bank said risks are balanced.
The Banks Governing Council judges that the overall balance of risks remains within the zone for which the current stance of monetary policy is appropriate, and the target for the overnight rate remains at 1/2 per cent, the BoC said.
Fixed Vs. Variable - The Age-Old Question
Courtesy - www.genworth.ca
Mortgage holders and homebuyers have enjoyed three years of fixed-interest rates under three per cent. As this low-rate environment continues the age-old question of whether to opt for a fixed- or variable-rate mortgage is still the most common question asked.
According to RobertMcLister, mortgage planner andfounder ofintelliMortgageInc., there is no simple answer. It boils down to individual clients, their personal situations and how they manage risk. We ask a lot of questions to determine the appropriate term for a borrower, because only then can you present them options, says McLister.
Here are some of the questionsMcListerexplores with his clients:
Can you manage a potential rate hike?According to a recent survey, 16 per cent of respondents said they would not be able to afford a 3-percentage point increase in interest rates, while roughly 27 per cent would need to review their budget. Another 26 per cent said they would be concerned, but could probably handle it. We look at a clients payment today, factor in amortization and make sure they can handle the potential increase, both during the term and at renewal, he said. If a client is set on a floating rate we also find ones with fixed payments, but a fixed payment doesnt mean risk-free.
Do you have three months of savings put aside? Cash reserves enhance ones ability to withstand higher rates. The last thing you want is a soaring variable-rate at the same time as other budgetary stress, like a layoff, separation, illness, new baby or some other unforeseen expense.
Where will you be in five years? Clients who break a fixed-rate mortgage early, can face a steep interest-rate differential penalty. By contrast, terminating a regular variable-rate mortgage costs you just three months of interest. Thats a key consideration if you want refinance flexibility, may sell and rent or cant port for some reason. In many cases, its more prudent to choose a three-year term.
Whats the spread between a 5-year fixed and variable? The current spread is about half a percentage point, far below the long-term average. That makes the relative cost of a fixed-rate certainty historically cheap,McListersaid. But it also suggests that the market is expecting low rates to persist. Over the long run, variable rates have easily outperformed fixed rates, but one notable exception is when the spread is very small.Whats the break-even point?Theres a point when a long-term fixed rate becomes cheaper than a variable rate. Today, that would happen if prime rate shot up over three-quarters of percentage point,McListerestimates. If inflation becomes a threat, the Bank of Canada could easily take rates higher than that. Thats the risk.
The choice of fixed versus variable remains a personal decision. Everyones circumstances are unique. If a client stays awake at night worrying about their payments increasing, then a fixed rate is the way to go. If theyre financially fit and have a shorter amortization, then a variable may be the right call. Either way, you cant put a price on peace of mind.
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