Get The Full Picture Of Your Finances
As you go through life, your goals change: buying your first car or first home, saving for education or retirement, starting a family or leaving a legacy for your grandchildren. You'll need to take a different approach for each new step, and the folks who assist you on your journey should take that into account.
Registered Retirement Savings Plan (RRSP) Basics
The deadline to contribute to an RRSP for the 2020 tax year is March 1, 2021.
At the beginning of the calendar year, there's a large focus on RRSP contributions because they are tax deductible: every dollar you contribute comes off your current year's taxable income. Essentially, this investment allows you to delay paying taxes on that income until you retire, when you'll likely be in a lower tax bracket.
In order to maximize your investment, you will want to know your Marginal Tax Rate. This is the tax rate that will be applied to the next dollar you earn and depends on which tax bracket you are earning in, for both federal and provincial income taxes. By making RRSP contributions, you can reduce your taxable income in the higher tax bracket. For example, if you made $60,000 last year and contribute $5,000 dollars to an RRSP, you'll only be taxed on $55,000; you'll save money immediately by paying less tax in a higher tax bracket, in addition to the benefits of saving for your retirement.
When figuring out how much you can contribute, your annual limit is 18% of the earned income you reported in the previous year, up to a maximum amount that is set by the Canada Revenue Agency. If that amount is more than you can manage to invest right now, you're able to carry the unused portion forward indefinitely. You can find your exact RRSP contribution limit on your latest notice of assessment or reassessment.
If coming up with a large lump sum to invest is too daunting, you can also set up a regular savings plan that will make a smaller monthly contribution to your RRSP. It's generally much easier to come up with $100/month, rather than waiting until January or February to come up with $1,200! By contributing more frequently throughout the year, your money will begin working for you sooner thanks to compound growth.
Your RRSP + Your Mortgage
Contributions to your RRSP may be used in the future to buy a home through the federal government's Home Buyers' Plan. This program allows you to withdraw up to $35,000 tax-free from your RRSPs towards the down payment of your home purchase. You are then have a 15-year period to repay those withdrawn funds. While this program is primarily geared towards first-time home buyers, there are other circumstances in which you may qualify, such as a spousal separation or if it has been some time since you owned a property.
Most mortgage agreements these days offer you the ability to pre-pay a certain amount of the loan amount. The good news is that these pre-payments are applied directly to the principal amount of your mortgage, building you equity and reducing the amount of interest you will pay in the long run. If your RRSP contribution results in a tax refund for you, using that refund for your mortgage pre-payment is a win-win for your financial health!
Tax-Free Savings Account (TFSA) Basics
Despite its name, a TFSA does NOT have to be a savings account with your bank. Consider it as another option for an investment account, where your investments can grow without having to pay tax on the earnings. You can have a combination of investments within your TFSA, including segregated funds.
There is a contribution limit to how much you can put in to your TFSA each year, set by the federal government and the same for all Canadian adults regardless of your income. Much like an RRSP, the contribution limit accumulates over time, which means if you don't reach the limit one year, you don't lose it.
Because your TFSA has so much flexibility, you can use it as a savings vehicle for both your short-term goals (your next vacation, a new vehicle, or a home renovation) as well as your long-term goals.
As registered investments, RRSPs and TFSAs are both in the same category so they function in very similar ways. The biggest way they are different is in how they are taxed. With an RRSP, any growth within the portfolio is tax-sheltered and you only pay taxes when you make a withdrawal, which is then taxed as income. With a TFSA, it's the opposite: the deposits you've made have already been taxed as income and when you make a withdrawal, that is tax-free.
Your TFSA + Your Mortgage
Your TFSA can be a great option to help build your down payment. With conventional savings accounts not offering much in the way of interest, the best way to have your money work for you while you save up to buy a home is to have it invested. And if you can grow your investment tax-free, why wouldn't you?
Getting Started With Investing
Whether you are setting up your first registered investment or you want to compare your existing investments with other options, we recommend getting in touch with our trusted partners at Shoreline Financial & Insurance Services. Tami Romanchuk, CFP is extremely passionate about educating clients about their financial planning options. She's been helping clients since 2003.
Ready to make the most of your investments alongside your mortgage? The Auxilium Team is ready to help you achieve your financial goals. Give us a call at 250-590-6520 or make an appointment today.
Auxilium Mortgage Corporation is based in Victoria, BC and works with clients locally and across Canada. The Auxilium team has over 100 years of combined financial experience and access to dozens of lenders to help you meet your goals.