RRSP basics

As tax season is around the corner, a lot of “experts” urge us to contribute to our RRSP. But what is an RRSP?

RRSP stands for Registered Retirement Savings Plan. It is the most popular way to save for retirement in Canada. It was introduced in 1957.

As indicated in its name, the plan is registered with Canada Revenue Agency. It works on a tax-deferred basis, i.e. money is only taxed when withdrawn. The interest earned is tax-free and re-invested into the plan.

Any type of investment is possible, such as cash, bonds, mutual funds, term-deposits, GIC’s…

In order to open an account, you need to have earned an income in the previous year. The contribution limit is 18% of your income for the previous year, to a maximum amount set by CRA – $ 24 930.00 for 2015-. If you do not contribute the maximum amount, unused contributions can be carried over for the lifetime of the plan. You can find the exact amount on your Notice of Assessment.

The main advantage of an RRSP is that contributions are tax deductible. They reduce your taxable income and potentially lower your tax payable. You don’t have to use your contributions as a tax-deduction if you haven’t earned a lot of money in a given year. You can defer the amount to a future year.

Be careful not to over-contribute. If you do so, you will have to pay 1% per month on any contribution exceeding $ 2 000.00.

The purpose of an RRSP is to supplement your government benefits during retirement. Ideally, you should never withdraw money from it until that time. If you take money out, you will have to pay taxes and report the amount on your next tax return. The current federal tax rates are:

  • 10% on the first $ 5 000.00
  • 20% up to $ 15 000.00
  • 30% on amounts over $ 15 000.00

You may have to pay additional fees and taxes, depending on your province of residence and the type of plan.

Two programs allow you to withdraw money from your RRSP without the tax implications: the HomeBuyer Plan, for first-time home-buyers, and the Lifelong Learning Plan to finance education.

It is also possible to have a Spousal RRSP. This plan is only interesting if one partner makes more money than the other or has a pension plan. The partner who earns more contributes to the RRSP of the other and takes the tax deduction. When the partner who earns less withdraws the money, it will be less taxed. It is the basis of income-splitting.

Some companies also offer Group RRSPs. Usually, contributions are taken out of your paycheque. Your employers may or may not match them. Since your employer manages the plan, you may have a limited choice of investments. There may also be other requirements. A group RRSP only makes sense if your employer also contributes.

TFSA basics

The Tax-Free Savings Account or TFSA was created in 2009 to help Canadians save more and potentially earn more interests as well.

The major advantage of a TFSA is that any contribution or withdrawal is tax free. Any gain and interest also are, and they do not affect the contribution room. You do not have to report your TFSA’s activities on your income tax return. It also does not have any impact on amounts from Old Age Security or Guaranteed Income Supplement.

From 2009 to 2012, the maximum contribution was $ 5 000.00 per year. Since 2013, it has increased to $ 5 500.00. If you don’t contribute the maximum amount, you can carry forward the unused contribution amount. Let’s say you opened a TFSA last year. You contributed $ 500 and did not make any withdrawal. Your contribution room for 2014 is $ 10 500.00.

You can have pretty much any type of financial products within your account such as bonds, stocks, cash…. You can also open several TFSAs. However, the annual contribution room is for all accounts.

You need to be 18 and have a Social Insurance Number –SIN- to open a TFSA. You also need to be a resident of Canada. You don’t need an income. Contributions are not tax deductible.

It is important to know your contribution room to avoid over-contributing. It is even more important if you make withdrawals.

Let’s get back to our example above. Let’s say this year you contributed to the maximum $ 10 500.00. You decide to withdraw the full amount to help your child pay for university. Your child decides not to go to university. Unfortunately, you cannot put the $ 10 500.00 back into your TFSA in 2014, as you have no contribution room left. You have to wait for January 2015 to do so.

If you put this amount back in 2014, you will be over-contributing and charged 1% on the highest excess amount for each month the excess remains in the account. You will also have to fill-in plenty of paperwork!

You can check your yearly contribution room with Canada Revenue Agency –CRA-.

A TFSA is definitely an interesting financial tool. Depending on your financial situation, it may actually be the best place to invest your money.

Competing financial priorities

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It is not always easy to know what you should do first, financially speaking. Debt, mortgage, children, retirement planning and saving are extremely taxing on your hard-earned dollars.

Obviously, your first priority is to pay your monthly bills. It is pointless to contribute to your RRSP if you are in arrears on your hydro bill. If you can’t pay your bills, you need to review both your expenses and income. Most likely, you will have to decrease your expenses and/or increase your income.

Once the bills are taken care of, you need to allocate money to service your debt; usually 15% of your net income. Any dollar towards your debt is a form of saving, as it is as much you won’t have to pay in interests.

While paying down debt, you also need a solid emergency fund. As previously stated, lines of credit and credit cards are not emergency funds; they are debt in the making! You need to build this fund with your own money.

For many people, this is as far as their dollars stretch….and it is OK for the time being. These are the three top financial priorities. As long as you don’t have them in order, you will probably have to delay on the two following ones:

  • Contributing to an RRSP/retirement planning. Government pensions won’t get you far in your senior years. The average monthly amount from the Canada Pension Plan is $ 600.00. You definitely need to save. If you can’t, start doing so when your emergency fund is built. Once your debt is paid off, you will also be able to save even more.
  • Contributing to your children’s RESP/saving for their education. This is a heated debate. A lot of “experts” make it mandatory for parents to pay for their kids ‘education, sometimes to the point of shaming them or making them feel guilty if they don’t do so.

Personally, I am a firm believer of “paying yourself first”. You are better off being debt free and able to retire comfortably than being able to pay for tuition fees. Not to mention your children will probably not be able to take care of your retirement pension or living expenses. Don’t feel bad if you can’t save for your children’s education. You are already providing a lot for them.

Financial set-backs and debt fatigue

I have been hit in the pocketbook a couple of times recently, just when I thought I finally had my debt under control.

Three months ago, our strata had a special general meeting to review the condition of our building envelope. Some repairs are definitely necessary. The -heated- debate was on how much owners should be paying. We had the “choice” between $ 5 000 and $ 10 000 per unit. “Luckily”, $ 5 000 was chosen.

Nevertheless, I do not have that money on hand, as I am still paying off around 12K of debt.

Then, in September, I got involved in a minor car collision for which I was found 100% at fault. In British Columbia, the Provincial Government administers vehicle insurance and the premiums are pretty hefty, as there is no competition.

To protect my premium and driver’s record, I was given the option to pay for all repairs on the 2 cars. Otherwise, I will face a $ 5 000 increase in my premium over the next three years. I haven’t been communicated the total cost of the repairs yet, but either way I have to pay!

The measly $ 2 000 I have in my emergency fund are just not going to cut it….If I had been able to put the amount allocated to my debt repayment over the last 3 years into a savings account, I would be more than able to pay for both.

I definitely feel trapped by my debt right now. I have also been suffering from debt fatigue. It feels endless and like I will never get out of it.

I also realized my debt is preventing me from doing many other things now, such as renovating my condo, taking classes and traveling.

Lately, I have been considering a change of career. It would take me back to self-employment but might also mean a pay-cut, at least at the beginning. It would also require me to take classes.

The issue is that paying for my bills and servicing my debt both require a solid paycheque. I simply don’t have enough savings to make-up for a pay-cut, or for no pay.

I will have to proceed step-by-step with my goals and it will probably take me more time to reach some of them.

Emergency Fund basics

If you are battling with a huge debt load, chances are you probably don’t have any savings to your name. It can seem like a really daunting and potentially impossible task, but you need an emergency fund.

As I have written before, life happens; accidents happen. If you don’t have any savings to face these, you will create more debt. By the way, a line of credit is not an emergency fund; it is debt in the making!  Let’s also define what an “emergency” is. An emergency is a serious, unexpected situation requiring immediate action. Buying a plane ticket to Mexico to care for your mother on her death bed is an emergency. Buying a plane ticket to go to Mexico on vacation is not.

Before starting your fund, you need to have a budget in place, just like for debt repayment. The rule of thumb says you should allocate 10% of your net income toward savings. Depending on your debt level, income and expenses, it may not be possible for you to save this amount. Start with what you can, even if it is “only” $ 50.00 per month.

Your emergency fund should be liquid and quickly accessible. By definition, you won’t be earning high-interest on this money. Park it in a savings account or a TFSA.

There are lots of debates on “how much” one should have in an emergency fund. A lot of “experts” suggest 3 months of living expenses. Others say 6 months, or even a year. This represents a significant amount of money and will take some time to accomplish. It can actually be discouraging. I would suggest starting with a goal of $ 1 000.00. The point is to get started. Once you have reached this goal, aim for one month of living expenses, and so on.

To keep on track, set-up an automatic transfer between your accounts. Use any financial “boosters” you may receive such as a tax refund or a bonus from work. You may be tempted to put these towards your debt. Don’t, unless you have a collector harassing you or one of your debts carries a ridiculously high interest rate.

The leading cause of debt is not reckless spending, but lack of adequate savings to face situations like a job loss, an illness or a divorce. I know this first hand, as it was the result of my own personal debt; debt I am still paying off to this day….

A lot of “experts” also suggest you pay off your debt first, and then start saving. Based on my own experience, I (respectfully) disagree. You need to save, even if you have debt. That’s what I am doing. My debt is under control and in repayment, but my emergency fund is pretty low, about $ 1 600.00. I am also saving for retirement, but my main goal is to replenish my E.F. I am working on the first month of living expenses, i.e. $ 2 500.00.

The cost of eating-out

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Maybe you don’t like to cook; or you don’t know how to cook; or you just don’t have time after a long day at work to cook; or you don’t have time to make a lunch box before going to work in the morning. Whatever your reason is, you end-up eating out a lot. Have you ever wondered how much your eating-out habit is actually costing you? Time to stop wondering and time to start crunching numbers!

Before doing this, I have to confess I used to eat-out a lot. Coffees, pastries, doughnuts, lunches, dinners, take-out, order-in…you name it, I have done it and spent on it. Until that one month I decided to track how much exactly I was spending on all of this and almost had a heart attack when seeing the number!

I have improved since….but here it goes. Let’s start with breakfast. Sure it is very tempting to sleep-in an extra 15 minutes then get a coffee with a pastry at one of the many coffee shops around. Depending on where you are going, it will cost you around $3 to $5 each time. Let’s assume you buy 5 mornings a week at an average of $4, that’s $20 a week, or $80 a month or $1 040 if it is a year-round habit.

Who brings lunch to work? I think not! Depending on what you are eating and where, you will most likely spend around $10 to $12. Assuming you buy lunch 5 times a week at an average of $11, that’s $55 a week, $220 a month or $2 860 a year.

Let’s finish with dinner. Prices can greatly vary depending on what you eat, where, and whether you drink booze or not. The cost is around $25 to $35 per person.  Let’s assume you dine-out 3 times a week at an average of $30, that’s $90 a week, $360 a month or $4 680 a year.

If you were to do this, or are actually doing it, you are spending $ 8 580 a year on “just food”! And that does not include the occasional pizza delivery or the afternoon snack.

Staggering, isn’t it? Imagine what you could do with all this money. Maybe you could finally pay-off that 25% interest credit card. Maybe you could have a solid emergency fund. Maybe you could contribute more to your RRSP. Maybe you could afford that trip to Hawaii.

I don’t suggest you stop eating-out altogether, as this is unrealistic. However, I suggest that you start making your own breakfast and your own coffee. Buying an Americano at a coffee shop is really money down the drain.  Buy your lunch once or twice a week. Dine-out once a week or better, every other week.

But most importantly, track down your spending on these. You probably won’t believe the number until you actually see it.

80% of my meals are now home-cooked. My monthly cash flow is more balanced and I can still indulge in restaurants and lattes from time to time.