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| Home / College Guide / Here’s what a $1,000 investment in Nvidia stock 10 years ago would be worth now |
| Posted on Monday, February 12 @ 00:00:04 PST |
News It seems like an obvious move when tax season rolls around: Contribute to your Registered Retirement Savings Plan (RRSP) and reap the benefits of a bigger tax return. Right? Is not necessarily. it’s a misconception that William Chan, Chartered Financial Planner and head of Modern Vision Planning, says is quite common. “Sometimes people’s deposits are for amounts that aren’t necessarily beneficial to them because they don’t consider the tax implications of what they’re doing, there’s just the concept of RRSPs and refunds,” Mr Chan said. If you’re not familiar, RRSPs are tax-sheltered investment accounts, and one of their incentives is that the money you invest is deducted from your income tax, which can lead to extra money on your tax refund. Your investments are also protected from capital gains taxes as they grow, but you’ll eventually pay income taxes when you withdraw money from the account in retirement. This differs from accounts such as a Tax Free Savings Account (TFSA) where there is no upfront tax benefit, but you will not be taxed on both capital gains and any future withdrawals. There have always been arguments that certain subsets of the population would prefer one of the two accounts, and things are now further complicated by the introduction of the First Home Savings Account (FHSA), a powerful new tool that combines income tax benefits.
RRSPs and full protection against withdrawals and TFSA earnings taxes. We’ll break down some of the arguments against contributing to an RRSP for certain segments of the population. Younger investors or investors with lower incomes in particular likely have many alternatives to consider first. 1. If you don’t already have an emergency fund or other liquid investments One of the biggest downsides to an RRSP is that the money is essentially locked away until you turn 71. If you withdraw earlier than this, there can be significant penalties (there are some exceptions, such as withdrawing some money to buy a home). Scheherazade Hasan, senior advisor at Wealthsimple, said you should make sure you have funds that can cover at least three to six months of living expenses saved in an account that isn’t tied to the stock market at all — ideally a high-interest savings account. Even after that, it might be a good idea to put some investments into a TFSA first—or FHSA if you’re planning to buy a home—especially if you anticipate needing to take out money for big expenses in the near future. 2. If you earn about $100,000 or less Ms. Hasan says anyone earning less than $50,000 should focus on their TFSA or FHSA, as the tax-deferral benefits of an RRSP are pretty small if you’re in a lower income bracket.
In addition, a TFSA has the added benefit of its flexibility and lack of any taxation upon withdrawal, which could be especially beneficial if your investments have decades to grow exponentially. Even for people approaching about $100,000 in income per year, the decision isn’t necessarily clear. If you expect your income to grow into higher tax brackets as your career progresses, Ms. Hasan says it might be worth saving room for RRSP contributions for future years, when larger contributions could save you extra money by lowering your tax bracket. The same is true if you expect a storm on the way. Since your RRSP contribution room is carried forward, it could protect you from a large tax bill if you sell an investment property or receive a large inheritance. 3. If you just plan to spend the extra money from your RRSP refund In a way, Mr. Chan says, you don’t necessarily save on income tax with an RRSP. You’re just delaying taxation until retirement, as your withdrawals will be taxed as income. That’s why it’s important to use your tax refund wisely. For example, using money to invest in a TFSA is one of the best ways to leverage your returns, especially if you’re young and have a long investment horizon.
However, if you intend to spend your tax refund on an unnecessary purchase, you probably did not make the best financial decision. “Ask yourself if you need this refund … because if you don’t, you’re just kicking the can down the road,” said Mr. Chan. 4. If you have unpaid debt This may seem obvious in today’s interest rate environment, but paying off debt first wasn’t always the right move when interest rates were low and investments could exceed debt service costs. Today, Mr. Chan says your priority should be paying off any debt you have, especially higher-interest loans like credit cards or even your line of credit balance. 5. If you have children and could be eligible for additional RESP subsidies The Registered Education Savings Plan is one of the best tools for Canadians to invest in their children’s post-secondary education. Capital gains are tax-free, and the government matches 20 percent of your contributions per year, up to a maximum of $500. But households with different income thresholds may be eligible for various additional grants from the provincial and federal governments just for participating in the program. Mr Chan says this can be better value for parents who want to ensure their children can afford to study.
There’s another bonus: when your kids are at university or college, money is actually quite liquid. If there turns out to be an excess of unnecessary money due to scholarships or other factors, you can take your contributions and use them while your child is in school. 6. If you have a good workplace pension, especially a defined benefit pension plan One of the key caveats about RRSPs is that withdrawals will count as income and will be taxed as such in retirement. Pensions are also considered income, so relying on an RRSP and pension in old age could put you in a higher tax bracket and pay more than necessary. For this reason, it may be a better option to max out your TFSA first if you’re confident you’ll have a good pension to fall back on, as these withdrawals are completely tax-free. Mr. Chan adds that defined benefit pension plans are a particularly robust and reliable form of retirement income. If your workplace offers one, that may be one more reason to max out other investment vehicles before contributing to an RRSP. 7. If you are planning to buy a home Launched in 2023, the FHSA is a very powerful investment tool. Your contributions are tax-deductible just like an RRSP, and your withdrawals are tax-free like a TFSA.
Another advantage is that if you don’t end up buying a home, you can roll the money into an RRSP without affecting your RRSP’s contribution room. So there’s no reason not to max out your FHSA first if there’s any chance you’ll buy a home. There are only two things to keep in mind. The first is that an FHSA can be open for a maximum of 15 years before it must be closed. If it is very likely that it will be more than 15 years before you buy a home, this may be a reason to pause. Finally, the deadline for receiving your income tax refund based on FHSA contributions is not the same as an RRSP. The FHSA deadline was December 31, which means you won’t get a refund this year for contributions you make now. But you’ll get them next year, and that’s still reason enough for advisors to recommend FHSA contributions in the first place. Are you a young Canadian with money on your mind? To set yourself up for success and avoid costly mistakes, listen to our award-winning Stress Test podcast. Adblock test (Why?) Link to source Connected
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