I was reading this article in Globe and Mail and though it could benefit our members and hence I am posting it here.


Nine ways to save on taxes using RRSPs
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JIM YIH

The deadline for tax-deductible RRSP contributions is coming up, and while you consider your investments, don't forget the potential tax-planning benefits as well. Here's how to get the most out of your RRSP:

Know your marginal tax rate
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One of the most important benefits of the RRSP is the tax deduction for the current tax year. While most people put money into an RRSP to save tax, many do not know how much tax they are saving.

The easiest way to determine the benefit of your RRSP contribution is to know what your current marginal tax rate is when you combine the federal and provincial taxes. For example, let's look at Jack and Jill. Jack makes $45,000 a year and Jill makes $85,000 a year and they both invest $1,000 into their RRSPs. Even though they put the same amount into the RRSP, Jill will get a better tax savings - 36 per cent - because she is taxed at a higher rate. Jack would get a 32-per-cent savings.

Make your maximum allowable contribution for 2005
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You can contribute 18 per cent of your 'earned income' in 2005, or $16,500, whichever is less (if you're a pension plan member, your maximum contribution may be reduced by a figure known as the pension adjustment, or PA). Watch your tax bracket threshold. If you're making a large RRSP catch-up contribution, consider claiming only enough of the resulting deduction to reduce your taxable income in the higher tax bracket. You can carry forward the remaining deduction for greater tax savings in a future year against income that is taxed in higher tax brackets.

Start early
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Rather than waiting until the next deadline, consider making your 2006 contribution now, or as early as you can, to begin accumulating tax-free income on the contribution as soon as possible. You will be able to contribute 18 per cent of your 'earned income' in 2006, or $18,000, whichever is less.

Understand investment income
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Consider holding more conservative investments such as guaranteed investment certificates and bonds that create interest income inside your RRSP. Alternatively, hold investments that produce tax-preferred investment income, such as capital gains and dividends, outside the RRSP.

Consider a spousal RRSP
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If you expect your spouse's retirement income to be lower or higher than yours, then a spousal RRSP may be the best form of future income splitting. The spousal RRSP will allow the higher income earner to move retirement income into the spouse's account and thus save money on future tax. Using a spousal RRSP requires planning - don't wait until it is too late. If you don't have a spousal RRSP, when retirement comes and you want to withdraw money, you will not be able move money between the accounts.

Consider a self-directed RRSP
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This allows you to hold all your RRSPs in one account. It will give you a broader range of investment options and provide a better way to organize and manage your RRSP portfolio under a consolidated umbrella. While there may be a cost to holding a self-directed account, there are many benefits. Typically, the annual cost (trustee fee) of a self-directed RRSP can be rationalized with accounts totaling more than $25,000.

Make monthly contributions
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Doing so has many documented advantages. Dollar cost averaging - the practice of regularly investing a fixed dollar amount into your RRSP, usually through a payroll deduction or pre-authorized chequing - is one of the best ways to create a forced investment plan. Dollar cost averaging provides three main benefits. From a financial perspective, it is simply a technique to force a systematic disciplined savings plan. From an investment perspective, it can help you to buy more units when prices are low and fewer units when prices are high. From a tax perspective, you will make sure that you take advantage of tax deductions each and every year.

Utilize foreign investments
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The government has made drastic changes to the foreign-content limit. You can now hold as much as 100 per cent of your RRSP in foreign investments. At a time when Canadian markets are doing better than foreign markets it is important not to lose sight of the importance of global diversification. Despite elimination of the foreign content restriction, experts suggest that you hold only up to 30 per cent of your RRSPs globally. At one time, if you wanted to invest more money outside the country, you had to do it outside of the tax sheltered RRSPs. Now, you can do it all within the RRSP.

Use an RRSP loan
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Take out a loan if you don't have the cash. With interest rates at all time lows, such loans may be one of the best deals around. Would you borrow money at 4 or 5 per cent in order to get a tax savings of at least 25 per cent on your contribution amount? Yes, you would.


Jim Yih is an Edmonton-based financial adviser and author of Mutual Fundamentals and Seven Strategies to Guarantee Your Investments.

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Pramod Chopra
Senior Mortgage Consultant
Mortgage Alliance Company of Canada

One thing I have not been able to understand is why would/should a person who has a mortage liability invest in RRSP? While RRSP would give ONE TIME tax benefit to a person depending on their marginal rate of interest (anywhere between 23 and say 45), that money not utilised for payment of mortgage would result in a compounding interest burden for balance of mortgage period.

If I have a mortgage of 250k and a yearly RRSP limit of 10k, wouldn't it be better to use that money (in addition to the regular mortgage payments) to repay the mortgage and reduce principal and therefore be debt free sooner, which in turn would also save a huge amount in interest payment (at today's rate an average of 4.5% per year for balance period of mortgage)? RRSP contribution limit on the other hand never expires and keeps growing, so can be used anytime. And in general, a person's income 10 years hense would be larger than today, so therefore the marginal rate of tax would be higher 10 years hense, than today, so the RRSP limit utilisation 10 years later would give a larger tax benefit.

Is my thinking wrong somewhere?

Chandresh

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Chandresh

Advice is free – lessons I charge for!!

Quote:

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Orginally posted by chandresh

One thing I have not been able to understand is why would/should a person who has a mortage liability invest in RRSP? While RRSP would give ONE TIME tax benefit to a person depending on their marginal rate of interest (anywhere between 23 and say 45), that money not utilised for payment of mortgage would result in a compounding interest burden for balance of mortgage period.

If I have a mortgage of 250k and a yearly RRSP limit of 10k, wouldn't it be better to use that money (in addition to the regular mortgage payments) to repay the mortgage and reduce principal and therefore be debt free sooner, which in turn would also save a huge amount in interest payment (at today's rate an average of 4.5% per year for balance period of mortgage)? RRSP contribution limit on the other hand never expires and keeps growing, so can be used anytime. And in general, a person's income 10 years hense would be larger than today, so therefore the marginal rate of tax would be higher 10 years hense, than today, so the RRSP limit utilisation 10 years later would give a larger tax benefit.

Is my thinking wrong somewhere?

Chandresh

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Quote:
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Orginally posted by chandresh

One thing I have not been able to understand is why would/should a person who has a mortage liability invest in RRSP? While RRSP would give ONE TIME tax benefit to a person depending on their marginal rate of interest (anywhere between 23 and say 45), that money not utilised for payment of mortgage would result in a compounding interest burden for balance of mortgage period.

If I have a mortgage of 250k and a yearly RRSP limit of 10k, wouldn't it be better to use that money (in addition to the regular mortgage payments) to repay the mortgage and reduce principal and therefore be debt free sooner, which in turn would also save a huge amount in interest payment (at today's rate an average of 4.5% per year for balance period of mortgage)? RRSP contribution limit on the other hand never expires and keeps growing, so can be used anytime. And in general, a person's income 10 years hense would be larger than today, so therefore the marginal rate of tax would be higher 10 years hense, than today, so the RRSP limit utilisation 10 years later would give a larger tax benefit.

Is my thinking wrong somewhere?

Chandresh
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I knew it was coming.

It really depends on lot of factors some of which are mortgage rates, mortgage amount remaining, income level, age of the person (time horizon for investment) risk tolerance and wheather the person is employed or self employed, company pension plan etc.


I would like to post ( cut and paste) opinions of a couple of financial planners comparing RRSP vs MORTGAGE to help people make an informed choice as per their situation.



First Opinion :

Financial Planning: RRSP or Mortgage Pay-Down?
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Which is better, contributing to your RRSP or paying down your mortgage? The RRSP-versus-mortgage question is a source of ongoing debate among many investors and financial professionals. The question is complex, and there is no definitive answer. The challenge is to determine what is more appropriate for you, given your current situation and long-term goals.

Three possible options are:

Option 1: Pay off your mortgage first and then contribute to an RRSP. With this strategy, you get a guaranteed after-tax return through your mortgage interest savings, which is important to many conservative investors.

Option 2: Contribute to an RRSP and use tax refunds to pay down the mortgage. When various personal situations are assessed, many investors decide to build two types of assets -- home equity and RRSP savings. Here you achieve mortgage interest savings by paying off your mortgage earlier and building a retirement savings base. This also provides further diversification of your investment strategy.

Option 3: Contribute to an RRSP and use tax refunds to contribute more to your RRSP. This strategy maximizes long-term tax-free compounding of RRSP assets, and gives the psychological benefit of knowing you are building a capital base to fund your retirement. Should you decide to stay in your home during retirement, it's the RRSP capital base that will help give you financial security.

The major factors influencing the choice of options are the mortgage interest rate versus the expected return in the RRSP, the investment time horizon, the availability of RRSP contribution room, and the ability to capitalize on mortgage prepayment privileges.

Given an expected RRSP return equal to the mortgage interest rate, and an investment time horizon of over 30 years, maximizing RRSP contributions generally maximizes net worth because the tax-sheltering advantages of the RRSP last for a lifetime, while the advantages of the mortgage prepayment end when the mortgage is discharged.

As the mortgage interest increases, or the investment time horizon decreases, it becomes more attractive to prepay the mortgage.

However, the answer comes back to your investment objectives and what is most appropriate for your personal circumstances. The best step to take is to assess each of the options available to you and decide which fits best with your current situation, risk tolerance, and goals for the future.



Second Opinion:

1. Should I pay down the mortgage or contribute to the RRSP?
Generally speaking, either financial strategy is a good choice. It is better than spending the money on things that have no inherent financial value. It is also better than \"investing\" (I use that term loosely) in depreciable assets like cars.

Let's compare the financial benefit of the two alternatives. First, let's look at the mortgage. Let's assume that mortgage rates are 7%. You might think that paying down the mortgage means you forego paying 7% in the future, and therefore, the mortgage pay-down has a financial benefit of 7%.

Most mortgages are not tax-deductible, thus you must earn more than a dollar to pay down a dollar of debt. In fact, you probably need to earn about $1.50 to pay down a dollar of debt.

Thus, paying down the mortgage has an after-tax benefit of over 10%. Remember, the higher the interest rate on the mortgage, the more attractive it is to pay down the mortgage.

Now let's look at the RRSP. Even if you are in the lowest marginal tax rate, you will save around 25% in tax (combined federal and provincial; note: rates vary from province to province). In a higher tax bracket, the RRSP might save you as much as 46% in tax savings.

The bottom line is that, when you compare the two, a dollar put toward the mortgage saves you 10% in interest while the RRSP saves you at least 25% in tax. Given the choice, I would take a 25% saving over a 10% saving.

The final point in favor of the RRSP is that making the RRSP contribution may give you the opportunity to both invest in RRSPs and pay down the mortgage.

For example, let's assume I have $10,000 and I am in a 40% marginal tax rate. By contributing to the RRSP, I should save $4,000 in taxes and potentially get that in a refund. Once I get the refund, I should then take the $4,000 and pay down the mortgage. I have created $14,000 out of $10,000, $10,000 went to the RRSP and instead of paying the government $4,000, I put it to the loan.

2. Is it better to invest outside or inside the RRSP?

In 2000, the capital gains inclusion rate was reduced to 50% from 75%, making investing outside the RRSP more attractive. But is it attractive enough to ignore the benefits of the RRSP?

The two key advantages to the RRSP are (a) the tax deduction and (b) the tax-deferred growth. These two benefits make the RRSP one of the most attractive financial planning tools available to Canadians.

But when you pull the money out of the RRSP, you will get taxed. Every dollar you pull out of an RRSP — regardless of whether it is capital gains, interest, dividends or your original invested capital — gets taxed at your current marginal tax rate.

On the other hand, the non-RRSP is taxed only on growth, dividends and interest. Withdrawing your capital is not subject to taxation. Astute investors will look for investments that generate capital gains because of the preferred tax treatment.

What's the best solution? It depends on your personal situation, but most people will still benefit from the RRSP. Let's take a look at some key factors:

Investing behavior.

If you are a really active investor and you like to buy and sell, trade or rebalance a portfolio frequently, you may be better off with the RRSP. Outside the RRSP, every time you trade, you create a potential tax disposition. The tax-deferred growth in the RRSP may be in your best interest.

Time horizon.

Generally speaking, it is rare to see investors hold the same investment for 20 to 30 years (or even 10 years). The longer the time horizon, the more you will benefit from tax-deferred compounding in the RRSP. Some say compound interest is the eighth wonder of the world.

Marginal tax rates.

It is important to understand what tax rate you are in at the time of the deposit, but also know your tax rate at the time of the withdrawal. This will be easier to estimate the closer you are to retirement. The worst situation to be in is if you take the money out in a higher tax bracket than when you put the money in.

Investment flexibility and freedom.

RRSPs have some investment restrictions, especially in terms of the foreign content limits. Outside the RRSP, there are few restrictions on what you can do. While there is still lots of investment flexibility inside the RRSP, there is more outside the RRSP.

Overall financial picture.

There is such a thing as having too much in your RRSP. In some cases, your RRSP may be so significant that income from it pushes you into a higher tax bracket.


All that said, remember that everyone's situation is different. You must take the time to assess your personal situation to see what path is best for you.




Third Opinion:

RRSPs are popular among Canadians as a retirement 'nest egg,' because they offer tax breaks as they increase in value. Many Canadians have also taken advantage of the federal government's Home Buyer's Plan, which allows buyers to withdraw up to $20,000 from their RRSP to help pay for a home. The money is tax-free as long as it is repaid within 15 years. More than a million people have taken advantage of this feature since the plan was introduced in 1992.

This is the time of year when companies that sell RRSPs are bombarding consumers with reminders that time is running out to 'top up' their RRSP contributions for the 2004 tax year. Homeowners with a little extra money are faced with the question of whether it's better to contribute to their RRSP, thus adding to their savings and reducing their tax load, or paying down their mortgage, which is never a bad thing because it increases the equity in your home.

Some financial planners say it's best to contribute to an RRSP and use your tax refund to pay down the mortgage. Mortgage interest rates, while not as good as last year, are still very low by historic standards so you may be able to get a better return within your RRSP than what you'll save on mortgage interest payments.

Others say that depending on the size of the mortgage and your age, you may be better off to put all the money toward the mortgage to reduce the amount you pay in the long term. Toronto real estate lawyer Bob Aaron took at look at almost 200 Canadian websites to get opinions on the matter, and he concluded that many of the sites had misleading or incorrect information. Most are sponsored by companies that earn commissions on RRSP contributions, while no one earns a fee when a homeowner pays down his mortgage.

The best advice is to take a close look at your own financial situation, taking into account the mortgage interest rates versus the expected return of the RRSP; your age and the length of time in the mortgage or RRSP; the availability of RRSP contribution room; your income; whether you are self-employed and/or have a company pension plan; and whether you can capitalize on mortgage prepayment privileges.

Generally speaking, if it's a long-term investment, you may be better off going with the RRSP. But if you are in a low-income tax bracket and are struggling to meet mortgage payments, it makes more sense to put as much as you can toward the mortgage and leave the RRSP contributions for later. Get some unbiased financial advice

http://www.senioryears.com/rrspoptions.html

http://www.moneysense.ca/planning/rrsp/article.jsp?content=932690

http://realtytimes.com/rtcpages/20050113_cadilemma.htm

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Pramod Chopra
Senior Mortgage Consultant
Mortgage Alliance Company of Canada

Mr. Chopra,

Excellent material ! Thank you for posting it.

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Dimple2001

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Orginally posted by dimple2001

Mr. Chopra,

Excellent material ! Thank you for posting it.

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Pramod Chopra
Senior Mortgage Consultant
Mortgage Alliance Company of Canada

Quote:

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Orginally posted by dimple2001

Mr. Chopra,

Excellent material ! Thank you for posting it.

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Chandresh

Advice is free – lessons I charge for!!