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TAXFlash News from IncomeTaxCanada.net
:: Retirement savings depend on tough choices: Pay down mortgage or contribute to RRSP?
:: The unfortunate reality for most people is that there is only so much cash available to do the things that should be done. Were this not the case then any article addressing the issue of retirement saving would be redundant. But, alas, the supply of money is limited and this means decisions must be made on where best to direct our hard-earned loonies. This being RRSP season, you may find yourself faced with one or both of the following choices. Should I pay down my mortgage or contribute to my RRSP? This is a perennial issue faced by people carrying a mortgage on their home who see the need to set aside funds for retirement. Forests have been clear-cut dealing with this issue and, yet, despite it all, there appears to be no definitive answer. In fact, the Vancouver Sun ran an article in its Special Report RRSP Extra a week or so ago and the conclusion was that not even the experts could agree on the correct course of action. Drawing on the poor performance of equity markets since the year 2000, some experts expound the mortgage first-RRSP later approach and it’s certainly hard to argue against their case. On the other hand, others consider market performance over a longer period of time, concluding that a focus on retirement rather than debt repayment will produce the optimum result. None of this is really surprising to me. The different conclusions are really functions of the historical data used and the assumptions made about future events. Reaching a definitive conclusion on paying down a mortgage versus contributing to an RRSP suggests that someone has a crystal ball and I’ve yet to meet such a person. There are so many variables involved in dealing with this issue making any conclusion, one way or the other, suspect. If the Bank of Canada struggles to accurately predict interest rates over the next year or two, then who among us can say where rates will be ten or twenty years hence? And that’s simply one variable – what about future investment returns and personal tax rates and so on? So what’s my take on the matter? How does who gives a hoot sound? My position on this issue is to forego doing one or the other and instead do both – use the funds at your disposal to contribute to your RRSP and apply the resulting income tax refund against your mortgage. Following this approach, at the end of the day, you won’t have made the entirely correct decision; but then you won’t have made the worst decision either. When you retire, with all of the time at your disposal, you can run the figures based on actual historical data and figure out which option would have been best. Another choice RRSP investors frequently grapple with is whether or not to borrow for their RRSP contribution. Banks and other RRSP vendors will lead you to believe that this decision is a no-brainer. No surprise there. If you think about it for a moment, why would they think otherwise, when the bank can lend you money, charge you interest on the loan, have you turn around and give the money back to them in the form of an RRSP contribution and then possibly pay you a lower rate of return on your invested loan? Did I say no-brainer? I sure did but I was referring to the bank’s decision not yours. Like the mortgage vs. RRSP issue, the decision to borrow money for an RRSP contribution involves a number of variables including the interest rate on the loan, the rate of return on the RRSP investment and your marginal tax rate to name a few. Logically it makes sense to borrow for an RRSP investment if the rate of return on the invested funds exceeds the rate of interest charged on the loan – nothing profound there. Having said that, financial planners generally recommend that any funds so borrowed be repaid within one year to avoid the potential cash-flow crunch that can happen if you pile one RRSP loan on top of another. So that’s the rule of thumb, but before you rush off to the bank to borrow the full amount of your available RRSP contribution limit, you’d be wise to check out your marginal tax rate first. Does it make sense, for example, to borrow $30,000 for your RRSP contribution when your taxable income is only $40,000? I’d say no based on the potential tax saving that can be achieved by the RRSP deduction. The lowest rate of tax (about 22 per cent) applies to roughly the first $31,000 of taxable income; the middle rate of tax (about 31 per cent) applies to taxable income between $31,000 and $62,000. In this example, $9,000 of the $30,000 RRSP deduction would be claimed against income taxed at the middle rate with the remaining $21,000 deducted at the lowest tax rate – that’s a pretty poor return on an RRSP deduction. This situation becomes even worse when you consider that a future withdrawal of RRSP funds could push the taxpayer into a higher tax bracket – low tax saving on the way in and high tax cost on the way out – that’s not the hallmark of sound financial planning. The answer in this example is to borrow $9,000 and no more. The deadline for 2002 RRSP contributions is slightly more than two weeks away. The time to turn your mind to the decision at hand is now, not two weeks from now while standing in a long, slow-moving line at the eleventh hour.
Free Tax Advice Article Submitted to Income Tax Canada.net exclusively by Jim Maroney Official details about this and other topics on income taxes can be found in English & Francais at www.ccra-adrc.gc.ca Income tax information offered by www.IncomeTaxCanada.net is done so without endorsement by Canada Revenue Agency (CRA) - l'Agence du Revenu du Canada (ARC) (formerly Canada Customs and Revenue Agency - l'Agence des Douanes et du Revenu du Canada CCRA-ADRC and formerly Revenue Canada – Revenu du Canada) or any Canadian government agency. The free advice is of a general nature for Canadian taxpayers seeking legal ways to reduce their personal and small business income taxes payable to the federal and provincial (or territorial) governments in Alberta, British Columbia, Manitoba, New Brunswick Newfoundland-Labrador, Northwest Territories, Nova Scotia, Nunavut, Ontario, Prince Edward Island, Quebec, Saskatchewan or Yukon. Specific taxation situations vary from taxpayer to taxpayer, province to province, territory to territory. The free tax advice here is only a general guide. Canadians should always seek individual guidance on accounting rules and tax laws from knowledgeable accountants and lawyers. To prepare your income tax return online and NetFile your Canadian income taxes electronically in English or Francais, please visit www.ufile.ca or www.impotexpert.ca websites. Additional information on financial products and services for Canadians can be found at www.CanadianCreditCenter.com. |
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Jim Maroney