FINANCIAL PLANNING FOR CANADIANS: STARTING EARLY, STARTING SMART

WHY CANADIANS SHOULD START PLANNING THEIR FINANCES

As Canadians, many of us may know the importance of preparing our finances for the future. However, it is a topic that is most dreaded. The idea of financial planning may get pushed into the back of our minds and forgotten about, only appearing around tax season. When we do think about the topic, we may find that we do not have the knowledge and wisdom to make informed decisions. As a result, we may make mistakes or avoid the issue completely. Like many things in life, managing your finances is best done early. Being smart about your finances ahead of time can help you save money, which in turn can help you accomplish your goals. The following article will give you the tools you need to start your financial future.

When starting your financial management journey, the first thing to ask is “how much do I need to retire?” The answer to this question depends on your intended standard of living (how much you will be drawing out), and when you intend to retire. An article for Canadian Business How much do you need to retire well estimates that the average cost of a middle-class retirement is $250,000 to $750,000 for a couple, and $325,000 to $675,000 for a single person. Those who intend to have a higher standard of living or retire earlier will need more money. For more information on Canadian tax planning for retirees, please visit our link tax planning for retirees.

THE WAR OF ACRONYMS: RRSP VS. TFSA

Once you’ve determined your individual needs, the next issue is which route to choose. When doing so, consider your intended purpose and the length of the plan. You may have heard the acronyms “RRSP” and “TFSA”; each of these has its an intended use with unique pros and cons. Before you choose one, let’s go through some of the basics.

ALL ABOUT RRSP’S

A Registered Retirement Savings Plan (RRSP) is a Canadian financial management tool established by the individual and registered with the CRA. Though it has the word “retirement” in it, RRSP’s can be used for a variety of purposes (i.e. financing your first home, starting your post-secondary education, etc.) The idea behind it is that should you agree to put some of your income away and not access it immediately, and then the system will tax you when it is received (along with any interest and income it earns) rather than when you earn it.

Contributions to an RRSP are deductible so long as you add them within the year or 60 days after the end of the year. Therefore, supposing you contribute by March 1, 2015, you can get a deduction for your 2014 return. There are limits to how much you can contribute to, however. As long as you are 18 and do not contribute more than $2000 over your limit, a penalty tax of 1% will not be assessed. If you do go over, your contribution must be removed to avoid a penalty. There are three factors that limit contributions: a dollar amount, a percentage, and a pension adjustment. Although the dollar amount for 2014 is $24,270, you may carry forward unused deduction limits on the condition that you didn’t use them from 1991-2014. Therefore, your actual dollar limit may vary depending on how much you used previously.

As for the percentage, the annual deduction (subject to the dollar amount and pension adjustment) is limited to 18% of the previous year’s earned income. Therefore, 18% of your earned income in 2014 will be used to calculate your deduction in 2015. For most people, “earned income” is the same as “salary” – gross salary before deductions. It also includes net business income in the event that you are self-employed or an active partner in a business. It also includes:

• Research grants, net of deductible related expenses
• Royalties from works or inventions that you wrote or invented
• Taxable spousal and child support received
• Net rental income from real estate
• Disability pension that you received under CPP/QPP

Earned income is reduced by:

• Deductible alimony, maintenance, and child support you pay
• Most deductible employment-related expenses and travelling expenses (but not pension contributions)
• Net businesses losses
• Rental losses from real estate

DOING IT YOURSELF

If you would like to have more investment choices and take a little more risk, there is also the self-directed RRSP. Although financial plans in Canada are normally done through a consultant with a brokerage or financial institution, self-directed plans allow you to decide what to invest in. While there is more risk this way, the system tries to ensure that your money is invested in reasonable places (to learn more, please visit the CRA website on self-directed RRSP’s).

TFSA’S AND YOU

A TFSA (Tax-Free Savings Account) allows for Canadians age 18 and over to set money aside throughout their lifetime. Although these contributions are not deductible, you can withdraw contributions at any time, tax-free. In terms of limits, you can now (as of 2013) withdraw $5,500. From 2009 -2012, the annual dollar amount was $5000. If you have not made any contributions to date, you can carry the unused room forward starting from 2009 (when TFSA’s were introduced). If you were to open a TFSA in 2014, you could, therefore, contribute $30,000 ($5,000 for each of the years since 2009).

Unlike an RRSP, there is no cushion for over-contribution with a TFSA. If you go over your limit at any time in a calendar month, you are liable for a tax penalty of 1% of that month’s highest excess amount. Because this test applies to any time during the month, removing the excess amount will only stop the penalty from applying in the month after the withdrawal.

If you would like more information, please visit the CRA’s websites on TFSA’s and RRSP‘s. As for how to choose between them, please visit our resource on should I contribute to an RRSP or TFSA?

SPECIAL CONSIDERATIONS

There are also some special considerations to consider when choosing a financial plan in Canada. Although an RRSP does have penalties for withdrawing your funds early, it does have special provisions for withdrawals given you meet certain conditions. If you are a couple, you may want to contribute to a spousal RRSP (please visit our resource on .contributing to a spousal RRSP for more information).

FIRST TIME HOME BUYERS

If you intend to buy a home, there is the Home Buyers’ Plan. It allows you to withdraw funds (up to $25,000) to build a qualifying home (more information on what is a qualifying home) for either you or a related person with a disability. This withdrawal does not count as income, so it is withdrawn tax-free. The funds must then be repaid over 15 years without interest, starting from the second year the withdrawal is made. This tool may only be used by “first-time buyers,” that is someone who has not owned and lived in a home as a primary place of residence at any time during the five calendar years up to and including the current year. If your spouse has owned and lived in a home during that period and you have lived there, you also do not qualify.

RETURNING TO SCHOOL

In case you intend to return to school, there is the Lifelong Learning Plan (for more information visit the CRA’s website on the Lifelong Learning Plan). This plan allows you to withdraw funds to finance full-time education for either you or your partner. Under this, you are allowed to withdraw up to $10,000 per year for a four-year period as long as you do not exceed $20,000. You must repay your loan in equal installments over ten years, or they will be included in the income of the person who made the withdrawal. The first repayment is due five years plus 60 days from the first withdrawal. A year after you repay the loan, you can again participate in the plan.

FOR THE CHILDREN

Should you have children, you may be interested in a Registered Education Savings Plan (RESP). This allows you to earn investment income in a tax-deferred environment. Though contributions are not deductible, the income in this plan grows tax-free. When the child withdraws the funds, the income will be taxable to the child. As a student, the child will not only benefit from tax and education credits but will also not have much taxable income. For more information, please visit the CRA’s website on RESP’s.

SAVING FOR TOMORROW, TODAY

So far, most of what we have talked with regards to financial planning is strictly long-term. However, there are several things that you can do in the short term to begin your savings journey. From a tax perspective, the best thing to do is search for applicable deductions. The following info graphic explains some of the possible deductions to look for.

I hope you found this article about Financial Planning for Canadians useful. For more related information, tips and tricks, please have a look at our other articles.

ABOUT THE AUTHOR

ALLAN MADAN

CPA, CA

Allan Madan is a CPA, CA and the founder of Madan Chartered Accountant Professional Corporation. Allan provides valuable tax planning, accounting and income tax preparation services in the Greater Toronto Area.

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