From morningstar.ca – March 3, 2008
Last week's federal budget centrepiece was the Tax-Free Savings Account (TFSA), giving investors a new vehicle to save on taxes. As previously reported, the TFSA is scheduled to make its debut in 2009, allowing maximum contributions of up to $5,000 a year.
Although a TFSA is very different from an RRSP, each of these accounts holds an after-tax advantage in returns over a non-registered account. Everyone who is 18 years old and over will be able to contribute to a TFSA, and if you are eligible to make RRSP contributions it will generally be to your advantage to contribute to both.
That, of course, depends on having the money available. According to a national BMO Financial Group/Leger poll released on Feb. 27, more than half of Canadians are not making an RSP contribution this year.
Realistically, for a large number of Canadians who won't be able to contribute to both a TFSA and an RRSP, the question becomes: Which one of the two will leave me further ahead?
To illustrate the differences between the TFSA, RRSP and non-registered savings, the Finance Department created a table comparing the three according to one scenario. The example used a $1,000 one-time contribution, held for 20 years by an individual with a 40% marginal tax rate. The assumed return, implying a very conservatively managed portfolio, was a compound annual 5.5%.
The RRSP investor jumps out to an early lead, since there is a tax deduction that leaves this account with the full $1,000 to invest. The TFSA and non-registered accounts, by contrast, start out with only $600, since they must make their contributions with after-tax dollars.
Both the TFSA and the RRSP accounts enable income to accumulate tax free, while the holder of the non-registered account gets hit with income tax each year. The RRSP extends its lead, since it started out with a larger amount, while the TSFA ranks second and the non-registered account lags.
By the end of 20 years, the value of the net contribution plus investment income has reached $1,751 for the TFSA, $2,918 for the RRSP, and only $1,307 for the non-registered account. (The government's example for the non-registered account assumes a tax rate of 28% on investment income, based on portfolio returns that are assumed to be composed of 30% capital gains, 30% Canadian dividends and 40% interest.)
The great equalizer between the TSFA and the RRSP account occurs at the time of withdrawal. The value of the TSFA remains at $1,751, since no taxes are payable on withdrawal of either the original TFSA contribution or any capital gains, dividends or interest earned.
But the $2,918 RRSP is taxable at the highest marginal tax rate at the time of withdrawal, which works out to a tax hit of $1,167. This leaves the RRSP holder with after-tax proceeds of $1,751, thereby finishing in a dead heat with the TFSA holder. (The non-registered account finishes last with $1,307.)
The key variable is how the tax rate at the time of withdrawal compares to the tax rate at the time of the contribution. Here are the three scenarios, and how they may affect your choice of account:
• If the two rates are identical, as in the hypothetical example cited in this article, the TFSA and the RRSP are equally effective tax-savings alternatives.
• If the tax rate at the time of withdrawal is lower than at the time of contribution, the RRSP is the better choice.
• If the tax rate at the time of withdrawal is higher than at the time of contribution, the advantage goes to the TFSA.
In other personal-finance related developments in the budget, there were several changes affecting life-income funds (LIFs) and registered education savings plans (RESPs).
LIFs are locked-in pension accounts. They hold assets that are transferred from a registered pension plan to an individual who would prefer to manage his or her own account rather than remain in the pension plan. LIFs can be created, for instance, when individuals are laid off from an employer.
The budget provides much increased flexibility for LIF holders to gain access to their assets. Individuals who are 55 years or older, and with LIF holdings of up to $22,450, will be able to wind up their accounts and have the option of transferring the assets to an RRSP or a registered retirement income fund (RRIF).
Those 55 and older are also entitled to a one-time conversion of up to 50% of their LIF holdings into an RRSP or RRIF, with no maximum withdrawal limits.
In addition, all individuals facing financial hardship (such as low income, disabilities or medical costs), will be entitled to unlock up to $22,450 from their LIFs.
As for RESPs, the budget proposed changes in the time limits and age limits. The maximum number of contribution years will be increased to 31 years, up from 21 years. The lifetime contribution limit remains at $50,000.
The deadline for terminating an RESP will be extended to the year that includes the 35th anniversary of the plan, up from the current 25th anniversary. If the beneficiary qualifies for the disability tax credit, the deadline is extended to the 40th anniversary year, up from the 30th year.
In terms of age limits, no contributions can currently be made in family plans for beneficiaries who are 21 or older. The budget calls for raising this age threshold to 31 years old.
Monday, March 3, 2008
Do You Want Insurance With That?
Recently, CBC’s Marketplace ran a story on the pitfalls of purchasing mortgage and creditor insurance and we thought this would be a perfect opportunity to highlight the benefits of arranging your own life and health insurance plans in order to protect yourself and your loved ones.
When you are approved for a mortgage, credit card or line of credit, your lender will offer to sell you insurance to pay off these debts in case of a death or disability. This offer may seem convenient, but you should be aware of many factors before saying ‘yes’ to these coverages.
Most of us will agree that it is important not to leave your loved ones with outstanding debts in the case of a premature death or disability, but mortgage or creditor insurance plans offered by the banks and lenders are not always the best option.
When you purchase mortgage insurance you are actually joining a group insurance policy owned by the lender. Though this may seem like the easiest way to get the coverage that you want, but there are many disadvantages.
With mortgage insurance, the lender is beneficiary on the plan there are no further provision to protect your family. There is very little flexibility with the coverage. Your lender will insure you only for the amount of your debts. You cannot alter, renew or convert the plan.
Should you happen to move to another lender in the future, or sometimes even renegotiate with your current lender, the policy is not transferable. This means you will have to reapply for the insurance coverage and pay premiums based on a higher age, or you may not qualify for coverage at all should your health change.
Also, since creditor insurance is provided through a group plan, you pay the same rate for the coverage as everybody else. You are not rewarded for looking after your health or with some plans, even being a non-smoker.
Another important fact is that your premiums and benefits are not guaranteed. Your lender can change or cancel the policy at any time. Also, your premiums remain the same while your benefit will be reduced as you pay-off your mortgage.
There have also been many documented cases where mortgage insurance claims have been denied due to non-discloser by the clients, even after years of paying premiums for coverage mortgage clients thought were in place the whole time.
With so many gaps in creditor insurance polices, most Canadians will want better guarantees and greater choice. It should also be noted that most lending officers and mortgage brokers don’t even hold an insurance license. Quite frankly it makes sense to speak with an insurance professional about mortgage insurance.
Financial advisors that hold an insurance license have a process in place to help you purchase the right amount and right type of insurance.
Their recommendations will put you in control of your insurance plan. You will own the policy, you can make changes to the plan when necessary, and your loved ones are the beneficiaries—not the bank. If circumstance change, the beneficiary can choose to use the money for other needs instead of paying the mortgage off automatically.
Term life insurance is more affordable and will meet most people’s needs. But you also have the option of choosing permanent insurance like whole life or universal life plans, as well as personal disability or critical illness insurance as well.
A personally plan will have important guarantees and cannot be canceled. If you decide to shop around for better mortgage rates, your insurance plan is portable and will stay in force even if your move to another lender. Also, the insurance benefit will not decrease like mortgage insurance.
You should be aware that when you arrange a mortgage, the lender may ask you to purchase insurance, but you have the right to shop for the plan that meets your needs.
So before you say ‘yes’ to creditor insurance talk with an insurance professional to find out how you can better insure your debts.
When you are approved for a mortgage, credit card or line of credit, your lender will offer to sell you insurance to pay off these debts in case of a death or disability. This offer may seem convenient, but you should be aware of many factors before saying ‘yes’ to these coverages.
Most of us will agree that it is important not to leave your loved ones with outstanding debts in the case of a premature death or disability, but mortgage or creditor insurance plans offered by the banks and lenders are not always the best option.
When you purchase mortgage insurance you are actually joining a group insurance policy owned by the lender. Though this may seem like the easiest way to get the coverage that you want, but there are many disadvantages.
With mortgage insurance, the lender is beneficiary on the plan there are no further provision to protect your family. There is very little flexibility with the coverage. Your lender will insure you only for the amount of your debts. You cannot alter, renew or convert the plan.
Should you happen to move to another lender in the future, or sometimes even renegotiate with your current lender, the policy is not transferable. This means you will have to reapply for the insurance coverage and pay premiums based on a higher age, or you may not qualify for coverage at all should your health change.
Also, since creditor insurance is provided through a group plan, you pay the same rate for the coverage as everybody else. You are not rewarded for looking after your health or with some plans, even being a non-smoker.
Another important fact is that your premiums and benefits are not guaranteed. Your lender can change or cancel the policy at any time. Also, your premiums remain the same while your benefit will be reduced as you pay-off your mortgage.
There have also been many documented cases where mortgage insurance claims have been denied due to non-discloser by the clients, even after years of paying premiums for coverage mortgage clients thought were in place the whole time.
With so many gaps in creditor insurance polices, most Canadians will want better guarantees and greater choice. It should also be noted that most lending officers and mortgage brokers don’t even hold an insurance license. Quite frankly it makes sense to speak with an insurance professional about mortgage insurance.
Financial advisors that hold an insurance license have a process in place to help you purchase the right amount and right type of insurance.
Their recommendations will put you in control of your insurance plan. You will own the policy, you can make changes to the plan when necessary, and your loved ones are the beneficiaries—not the bank. If circumstance change, the beneficiary can choose to use the money for other needs instead of paying the mortgage off automatically.
Term life insurance is more affordable and will meet most people’s needs. But you also have the option of choosing permanent insurance like whole life or universal life plans, as well as personal disability or critical illness insurance as well.
A personally plan will have important guarantees and cannot be canceled. If you decide to shop around for better mortgage rates, your insurance plan is portable and will stay in force even if your move to another lender. Also, the insurance benefit will not decrease like mortgage insurance.
You should be aware that when you arrange a mortgage, the lender may ask you to purchase insurance, but you have the right to shop for the plan that meets your needs.
So before you say ‘yes’ to creditor insurance talk with an insurance professional to find out how you can better insure your debts.
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