Saving Strategies

Small businesses should look at Group RRSPs as an alternative to costly traditional pension plans, while individuals can’t go wrong with a TFSA.

Canadians are falling behind in their retirement planning. Statistics Canada reports that unused RRSP contribution room continues to grow, and as the annual deadline, which is 60 days after December 31, fast approaches, many people find themselves unable to come up with sufficient funds to maximize their yearly contribution.
Banks and other lending institutions bend over backward offering low-rate loans to fund RRSP contributions, but the interest on the loan isn’t tax-deductible and must be paid back with after-tax dollars. Savvy savers use any RRSP refunds to immediately pay back as much of the loan as possible.
However, in reality, investors are still one year behind in their contributions. The maximum contribution for 2011 is 18 per cent of your previous year’s annual income to a maximum of $22,450. For 2012, it’s $22,970, up to and including the year in which the contributor turns 71. In addition, check with the Canada Revenue Agency to determine whether you have any unused RRSP contribution room.
Large corporations are opting out of traditional defined-benefits pension plans because funding shortfalls paid to retirees become liabilities to the corporation. However, with money-purchase pension plans, the onus of funding retirement assets is on the employee.
Furthermore, a rising unemployment rate has led workers to become more mobile in their career paths, and that means higher turnover. And that, in turn, means small- and medium-size businesses operating without some sort of pension-type benefit are at a disadvantage to their larger corporate counterparts.
{advertisement} One solution for SMEs is to look at creating a Group RRSP for employees. These have several advantages for both company and staff. A Group RRSP contribution becomes a taxable benefit and can be paid with pre-tax dollars to the employee, but unlike a pension plan, the contributions aren’t mandatory.
In this respect, some large corporations offer existing money-purchase pension plans as well as a Group RRSP. The administrative costs of the Group RRSP are generally lower than pension plans, and the provider carries out the bulk of the administrative work. Most Group RRSPs are administered by life insurance companies or mutual fund companies, and as an added benefit, the adviser overseeing the plan can advise owners and employees with other personal financial questions or problems.
In the case of Group RRSPs administered by life insurance companies, there’s another financial planning benefit: with a designated beneficiary, the assets are creditor-protected. Keep in mind that this type of Group RRSP often carries additional fees and conditions.
For employees, contributions to a Group RRSP are made with pre-tax dollars because they are deducted at source. This means the employee receives an immediate tax deduction. Contributions are generally made each month, allowing the employee to dollar cost average their investments.
Many responsible employers strongly encourage workers to make contributions by choosing to match contributions to a fixed rate such as five or 10 per cent. Matching contributions become a benefit to both parties because they encourage staff retention and attract new employees as the business grows.
Some Group RRSPs also allow the employee to make spousal contributions, which is very beneficial for single-income families. At retirement, built-up retirement assets can be converted to income for both spouses, thus tailoring retirement income. Finally, Group RRSP assets are portable, so if an employee chooses to leave the company, he or she can transfer or redeem the funds within the plan. However, in some instances, the employer contributions may be subject to lock-up provisions similar to pension plans.
Tax-Free Savings Accounts
This year marks the fourth year in which Canadians can make annual $5,000 contributions to a tax-free savings account (TFSA). I routinely receive calls from both clients and potential clients asking whether they should consider a TFSA, and I have to practically shout, “YES!”
Canadians over age 19 are allowed to contribute up to $5,000 each year to a TFSA. Contributions are made with after-tax dollars, so investors don’t receive a tax deduction for income tax purposes, but all income from investments held within the plan grows tax-free. In addition, investors can withdraw a portion or all of the assets within the TFSA at any time without penalty, which makes it a great savings vehicle. More importantly, in the year after any withdrawal, the investor can re-contribute all of the withdrawn funds without affecting future contributions.
For high-income investors near retirement, the TFSA becomes even more attractive than RRSP contributions if we remove the tax-deduction aspect. For retirees in the highest marginal tax bracket, the idea of making an RRSP contribution today and removing it in future years has limited appeal. All assets removed from an RRSP or registered retirement income fund are subject to full taxation at a graduated rate at the time of de-registration. With a TFSA, all original contributions and any gains are completely tax-free when removed from the plan.
Contributions do not need to be cash. Investors with existing investment portfolios that are fully invested can opt to contribute shares of stocks, bonds, or mutual funds in lieu of cash. However, investors must know that contributing non-cash assets to a TFSA will trigger a taxable event that favours the Canada Revenue Agency and not the investor.
Just like non-cash RRSP contributions, if the resulting transfer generates a taxable capital gain in either the RRSP or TFSA, the investor must report the taxable gain for that taxation year. Unfortunately, if the contribution of non-cash assets results in a capital loss, the individual cannot use it to generate a capital loss for tax purposes.
Investors with limited financial resources should consult with a financial adviser or their accountant to determine the ratio of RRSP contributions and TFSA contributions that will best suit their individual financial situation.
Steve Bokor, CFA, is a portfolio manager with PI Financial Corp., a member of CIPF.