Despite Widespread Belief, TFSAs Can Stay Liquid

A few weeks back, we were kind of stunned when we discovered someone in the family (Ray not to name her) had a lot of money in a savings account but did not register it as a Tax-Free Savings Account (TFSA). Interests gained in that account resulted in a juicy tax bill for her. Unnecessary because she still had plenty of TFSA contribution room available.

The money was not put in a TFSA because it was primarily used for emergencies and to pay for imminent renovations and Ray thought funds in a TFSA were not easily accessible. We checked with other members of the family and again, to our surprise, a lot of them believed TFSA money was not liquid at all. For many, TFSAs and RRSPs are all the same…money stashed there won’t be accessible till…far away retirement. So, many folks have the impression that TFSA money is tied up in some way that would prevent immediate access to their funds. But in fact, this is not true.

It’s sad because despite our financial knowledge and a lot of effort, money remains a taboo subject for many in the family. It seems like the more you are successful with money, the more people get shy and the less they are willing to talk about it. We try to remain humble about all of it, but it appears our glow still scares quite a few. These poor folks (no pun intended) prefer to keep things as anonymous as possible and give their trust to alleged advisors.    

So, another one greatly handled by so-called expert advisors. In this case, with no commission in play, the «expert» simply did not bother.

 

The Frozen TFSA Asset Misconception

Somehow, many people think TFSA funds are frozen and not easily accessible. And, despite the fact we love Disney, we are not talking about Frozen starring Anna & Elsa. And in reality, your TFSA might be more like Olaf, the chill snowman that loves and dreams about summer.

Exploring Better Alternatives to RRSPs

Lately, a lot of our analysis and writing hovers around retirement and RRSPs. We started with a brief post about Not Blindly Contributing to your RRSP a few months back and continued in March with more elaborate one explaining how we were Dealing with Complex Retirement Considerations. Today we persist with some profound thoughts on the never-ending RRSP versus non-registered debate. You’ll still note our research is not exhaustive as it particularly refers to our personal situation.

Some people feel RRSPs are a government scam to take more of their money thru taxes. Many angry retirees almost consider RRSPs as evil when they realize how much tax they owe at withdrawal. They just forgot all about the juicy tax refunds they received when they deducted their RRSP contributions in the first place. Over the years, these RRSP deductions helped fund a great portion of their retirement stash.

We can view RRSP tax refunds as a loan the government allows you to make to yourself. You only have to remember that you’ll have to reimburse it with interest some day (at withdrawal). If you are in the same tax bracket, the interest rate of that artificial loan will be equivalent to your investment return. If you now fall in a lower tax bracket, good for you, you’ll pay less «interest». Similarly, if your tax bracket is higher, tough luck, you’ll end up paying more «interest» via income taxes.

Dealing with Complex Retirement Considerations

As eluded to in our latest Portfolio Update, Boy! is the Canadian retirement system complex. We recently have been doing some research on retirement planning and will now report our findings here. We won’t cover every possibility as we concentrated on our own situation. It should still give you hints on major points to consider. We’ll remain thorough but try not to lose you in all the details. We suggest you pick up all that applies to your retirement situation and refine other pertinent details on your own from there. At least, our exploration should give you a decent head start.

Our main objectives in all those proceedings in to retire comfortably and to try to provide as much money for our kids and grand kids while we’re alive and not only after we die. From the beginning, we thought that minimizing taxes along the way would be one of the best ways to achieve this. As we discovered, it may not be that simple.

Still Preparing to Invest Big Money

For some years now, I’ve been gradually working less and swiftly heading to semi-retirement. Technically, it’s even better than that as in 2020, I should be working no more than 2 days a week! Full retirement will come just a couple more years afterwards! Hence, the accumulation stage of our investing plan is almost over and, mainly for fiscal reasons, we also started to phase out of RRSPs.

Despite all those facts, we are still preparing to manage and invest an extra 15-30K$ annually for the next 6 years. How could this be?

It’s true we will soon stop putting new money in. Yet, old money indirectly put aside years ago will start pouring in our investment accounts. A big chunk of our preretirement plan, currently tied up in other investment vehicles, will be released soon and we will have a chance to manage it ourselves. Some of our earliest RESP contributions are also similarly locked out. Since Lady C will (already!) start her post-secondary education, some portions of those RRSP funds will also become available for us to control.

We kind of just recently realized it, but all this means a lot of money, probably even more than in most typical accumulation years, will become available for us to invest and acquire stocks.

To some extent, let’s see how we intend to go about all this.

Think Twice Before Committing to The Home Buyers’ Plan

Today, we’re going to talk about one of our biggest financial mistakes over the years. It relates to the appealing Home Buyers’ Plan (HBP). Our young selves happily lunged into it acquiring our present house more than 15 years ago. At the time, it seemed like a very wise decision and the strategy provided us with a substantial chunk of change that greatly helped us in the short term. With retrospect, it now looks more and more like a very poor financial choice that considerably cost us in the long haul.

Everybody would love to, one day, have a nice home. For many, owning a big house is synonymous with financial success.

For most young folks, becoming a homeowner seems like a steep financial achievement and many may think it will remain only a distant dream. Then, they hear about the Home Buyers’ Plan (HBP) and their dream suddenly becomes more accessible. They see no-hassle free money that potentially can boost their house down payment (maybe a mistake). For some, the HBP may even provide the only cash to finance their once unattainable dream (definitively a mistake).

Fiscal Debt That Can Have Significant Long-Term Repercussions

The HBP allows you to avoid paying taxes on some RRSP withdrawals if you use those funds to buy your first house. After a two-year grace period, you have 15 years to repay your RRSP. The problem is that for most participants, the resulting tax bill will end up costing them much more in the future. The long-term implications and financial impact of that heftier tax bill cannot be ignored.

It makes no sense to withdraw from your RRSP avoiding only a 25-30% tax bill and later, to repay your RRSP with an ensuing 45-50% tax cost.

Maximizing RRSP vs Minimizing Taxes

Contrary to popular belief, maximizing your RRSP may not always be synonymous with minimizing your taxes. Sure, your contributions will bring down your taxable income in the short run and you probably will get a refund soon, once you file your tax return. But after all is said and done, you may also end up paying more tax.

The good news is that, as far as RRSPs are concerned, fairly simple fiscal planning can go a long way. The key is to compare your present (or contribution) tax level with your probable withdrawal tax level.

Because taxes increase with your income level, ideally, you want to contribute when your income is high and withdraw when it is low. In the same fashion, you want to avoid unnecessary contributions when your income is abnormally lower and limit withdrawals in periods where your income is higher.  

Preparing to Take Assets Out of RRSP

Early in the year, we talked about taking time to think and analyze the possibilities surrounding future withdrawals from our investment accounts. In the initial stage, our reflection concentrated on questions like how? And how much? At this point, we will sadly report that our efforts have not significantly paid off. We have not demystified the 4% rule yet. Neither did we develop or stumble upon a better alternative.

All that analysis still eventually oriented us towards the when?

Too Much RRSP May Equal Too Much Tax

As a result, we recently discovered our RRSP value may be too high and are now considering withdrawing money from it sooner than expected. In that context, it looks like we will deregister an important portion of our RRSPs to avoid future tax problems. Essentially, we discovered that too much money in our RRSPs may result in paying a lot more tax later in life or having a big tax bill attached to our heritage, mostly destined to our lovely daughter.

We will admit having too much money is a good problem to have. But it’s important to start taking measures now to possibly avoid wasting an important chunk of it later. With retrospect, investing more in TFSAs instead of RRSPs would have been a better choice, from a fiscal standpoint at least. Fortunately, it’s not too late for some type of gradual rebalancing.

Our RRSPs grew up faster with larger contributions and higher returns than projected. In that regard, part of the credit can be attributed to our successful DIY investing approach.

Changes in our pension plan conditions also greatly impact our future financial situation. Unfortunately, planning for an early retirement kind of goes against the grain. Consequently, we made very conservative assumptions during the last round of negotiations as initial talks amputated pension benefits by almost half for early retirees like us.  

The final agreement was better or less bad than anticipated, we will only lose about 10% of our retirement payouts. Again, this will probably end up generating additional taxable income later.

With all those factors combined, the perspective of paying more tax during retirement than in active life unexpectedly becomes very probable.

As an example, you can see from the Leaving Money in RRSP Chart that, just a 100K$ portion accumulated in your RRSP today, at 45, could generate a nasty tax bill of more than a million bucks 40 years down the road. RRSPs can be a great tool to avoid paying taxes now as it differs your fiscal obligation. But if your ultimate tax rate is high like in this example at 50%, you might end up paying a big chunk of that deferred tax back.

Now that we know we are going to take money or stocks out of our RRSPs, it’s time to explore related technicalities.

Gradual Transfer to Tax-Friendly TFSA

Let’s briefly get back to how much? Projecting income and corresponding tax levels over an extended period is far from exact science. You can still have a general idea of fiscal implications and take actions that should improve the situation.

Exhilarating Tax Time

I take advantage of a brief intermission in my day to tell you that last week; I took some time to file our taxes. It was kind of exhilarating as we are getting a huge tax return this year because of our Special Extra RRSP Contribution for 2015.

My old college teacher wouldn’t be proud of me as for him, getting a juicy tax return meant you lent your money to the governments for nothing. It certainly would have been better to arrange for smaller payroll deductions and get a smaller tax return afterwards. But I’m sure he would be lenient with me for once as special circumstances justify my oversight. The bottom line is that, in the end, we will have more money in our pockets.

We will use that substantial return to save some more in 2016 as all our main family projects already have been planned for. This will generate some kind of snowball effect: special savings in 2015 result in special tax return in 2016 which leads to even more savings in 2016 and so on and so forth.

For many years now, I’ve made it a point to file our tax returns myself. That way, I can understand all the implications and save as much as possible on unnecessary taxes; for example, applying all our family’s medical expenses only on my own tax return made us recover a couple hundred bucks again this year. 

Special RRSP Tax Considerations for 2015

For our Canadian readers, after the joy of the holidays comes the joy of …RRSP season!!!

Many may think I’m wacky but I kind of like RRSP season as it often rhymes with investing money and reducing taxes. It’s always a delight for me to torture my brain and find the best way to save as much as possible on taxes.   

My passion for RRSP reasoning will be well served this year as matters are even more complicated due the transition between the conservative and liberal governments.

Doing a thorough analysis would still be a nightmare so let’s limit ourselves to my family’s situation to help grasp some of the implications. I hope it will inspire you to explore your own RRSP tax conditions afterwards and complete all relevant research.

Before we go into the thick of things, I’ll remind you that I am not an investment or tax professional of any kind. The intent of this blog is not to give specific tax-related or investing advice. Before investing yourself, we suggest you to do all necessary research and consult a licensed financial professional if need be.

 

One Major Change

Because of the unusual transition situation, should we increase or reduce RRSP contributions this year? That is the question!

Starting in 2016, the liberals will reduce the middle tax bracket from 22% to 20.5% (for taxable income between $45,282 and $90,563 in 2016). They will also introduce a new tax bracket of 33% for taxable income over $200,000 but this measure won’t affect us with our more modest revenue. 

Carefully Choose When to File Each Income Tax Return

Refunds Early, Payments Later

For each income tax return of your family, choose the most appropriate time to send it.

Thus, if a refund is expected: you should produce the corresponding income tax return as soon as possible. If you anticipate a payment: still prepare your tax return but only send it in a couple days before the deadline. Make sure to avoid late penalties.

All your family’s tax returns don’t have to be filed at the same time. Depending on your situation, maybe Mom’s can be sent in early to get her refund and Dad’s later to make his payment.

Boost Your RRSP Contribution With a Short-Term Loan

If you are not able to contribute sufficiently, is borrowing to invest in your RRSP a good strategy?

Repay your short-term RRSP loan with your tax refund

A short-term loan is usually a brilliant idea; you can make a larger contribution to your retirement plan while limiting interest charges.

Towards the end of RRSP season (in February), you can borrow and contribute. You have to make sure to FULLY repay your RRSP loan a few months later when you get your tax refund (in March, April or at worst in May).

This short-term strategy allows you to increase your RRSP contribution without paying too much interest.

File Your Income Tax Return Yourself

You Know All About Your Own Situation

Unless your situation is very complex, you should file your income tax return yourself. You are the best person to analyze your own tax situation and take into account all nuances and possibilities.

You are also more motivated to reduce your own taxes than the H&R Block clerk can be.

Just A Little Research and Reading 

By completing your tax return yourself, you are, among other things, less likely to forget deductions. You just have to play with some numbers and read a bit; a little arithmetic and reading has never killed anyone!

Avoid Preparing Your Tax Return at the Last Minute

Prepare and Plan a Little Ahead

You should not wait to the last minute to prepare your income tax return.

For most, filing income tax return in late February or early March is possible when employment slips arrive. It’s even possible to prepare the majority of your declaration in advance and to finalize it with last-minute details. There’s no use to wait until April or even worse, till the end of April to send your tax return, especially if you’re entitled to a refund.

If you are a do-it-yourself investor like me, you may have to wait a bit longer for some papers because brokerage firms have till the end of March to send them out. You can still make sure that your transaction records are in order for your non-registered accounts. After a quick check when you finally get all your documents, you’ll be to file your tax return with no undue delay.

Provide All Necessary Information to Tax Expert or Software

Tax Experts Need Detailed and Complete Information

If you decide to hire a tax expert, a knowledgeable friend or to use tax software: be sure to provide them with all related information. 

They won’t be able to make a good job and maximize your return if you forgive some receipts or omit relevant information.

Only You Can Know

You are the best person to know your particular situation. Indeed, if you don’t provide all the details of your situation, the expert or software cannot guess. You have to allow them to exploit all possibilities that apply to your tax situation.

So, be sure to provide all current year tax information. Some previous years’ information may also be useful.

Good tax experts will ask the right questions. But still will be more motivated to maximize your return when you provide them organized information and make their job a little easier.

Organize Your Tax Documents Throughout The Year

A Single File with All Tax Documents

Instead of running around at the last minute for all your income tax papers,  gather and file all necessary documents as you receive them in a single folder for the current year, for example, identified "2010 Taxes”.

Make Copies and File As You Go

Group receipts in order by category and date. If it’s possible for you and you know copies will be necessary, make them before you file.

For example, place all receipts for medical expenses together and organize originals on the top of the stack and copies on the bottom.

Focus on Quality Dividend-Paying Stocks

Dividends and Appreciation

Blue-chip dividend-paying stocks should occupy an important part of your investment portfolio. They can be acquired directly by buying shares of solid dividend-paying companies in at least three different sectors of the economy. Some mutual funds or ETFs also specialized in dividend stocks.

Indeed, in addition to often offering interesting capital gain, these stocks also provide regular dividends to their owners. Those dividends may be easily reinvested or provide regular income.

Apply Medical Expenses For The Whole Family On The Same Tax Return

Because your medical expenses deductions are reduced according to your income (3% of your income), rather than using them separately, it is permitted and advantageous to claim medical expenses on the same federal tax return for the entire family.

You may simply not reach your income reduction limit if you use these deductions on separate returns.

You can deduct medical expenses made for yourself, your spouse or your children if they were paid by you or your spouse.

Example

Let’s suppose both Mom and Dad have a $50 000 taxable income and that, medical expenses are $1000 for Mom, $800 for Dad and $400 for Baby.

Claimed separately, Mom (with Baby’s expenses included) would get no deduction
($1000+$400-$50000x3% = $1400-$1500 = -$100 < $0).
No deduction for Dad either
($800-$50000x3% = $800-$1500 = -$700 < $0)

But if Mom claimed all the family’s medical expenses on her return, she would deduct 700$.
($1000+$400+$800-$50000x3% = $2200-$1500 = $700)