When it’s time to decide which mix of savings/investment vehicles is right for you, your options can start looking like a hearty bowl of alphabet soup. There are registered retirement savings plans (RRSPs), Tax-Free Savings Accounts (TFSAs), registered education savings plans (RESPs) and – less well known – participating whole life insurance (PWLI). Determining which savings/investing plan or combination of plans is best, depends on your personal situation and your objectives. The debate over whether to invest in an RRSP, TFSA, or another financial vehicle comes up every year. There are tools that allow you to shelter investments from taxes, and all could have their place in a financial plan. Here are some factors to consider as you decide which type of account to ‘save’ in. What are the most optimum vehicles to use for what purpose?
Until 2009, most Canadians held their retirement savings in an RRSP, where they could claim a deduction for their contributions and then defer tax until withdrawals were made, which generally occurred at retirement. The introduction of TFSAs in 2009 has provided another “savings” vehicle that allows investment growth to accumulate and be withdrawn at any time, tax-free. Unlike an RRSP, you can’t claim a tax deduction for the contributions you make to a TFSA (after-tax dollars are used). On the plus side, if you need to withdraw money from your TFSA, you can do so tax-free and you have an opportunity to replace that money, because all TFSA withdrawals are added back to your unused contribution room, but not until the following year. ¹
If you have children or grandchildren, RESPs are another popular option. The subscriber (or contributor) makes contributions on behalf of a beneficiary (the child). The contributions are not deductible or taxable on withdrawal. The growth is tax-deferred until withdrawals are made; at which time it can be taxed in the beneficiary’s hands if the beneficiary enrolls in a qualifying post-secondary educational program. Contributions to a child’s RESP may qualify for the Canada Education Savings Grant (CESG), and if your family’s income is below certain amounts, you may also qualify for the Canada Learning Bond (CLB).
You can invest or save using any of the financial vehicles available to you inside of a non-registered plan. In this case, after-tax dollars are used, and the growth is taxed on an annual basis, but no tax is charged upon withdrawal. This is generally not the best option for tax planning purposes since your potential compounding growth is reduced due to taxes.
*** There is an option that takes all the best attributes of the registered plans and minimizes the negatives – stay tuned. ***
Since 1847, 20 years before Canada was officially a country, participating whole life insurance (PWLI) has been a staple of savings in North America. It grew out of favour over the years as new and ‘sexy’ investments became more popular. People began to chase the big returns and moved away from slow and steady. As we have learned, often the hard way, ‘steady and steady’ wins the race in the long run. Life is a marathon, not a sprint, and how you finish is what matters, not how you start. PWLI provides guarantees and tax advantages that are not available anywhere else. As financial professionals we are taught never to even say “guarantee” or “tax-free”. But these are possible and available. Where can you get guarantees in life? Only death and taxes come to mind. 😊
Life insurance is not normally seen as a savings tool, but if designed and implemented correctly, it can produce safe, secure, and predictable returns that are many times greater than any typical guaranteed savings vehicles (these include savings accounts and guaranteed investment certificates (GIC)). The only way to actually make money in a savings account or a GIC is if you lock your money away and don’t touch it. Wait a minute, that’s the case with all investment and savings vehicles, isn’t it?
Not so. A properly designed PWLI, and working with an experienced and knowledgeable advisor, will allow you to save money at a very competitive rate and have access to that money when you want, without penalty or any questions asked, AND your money continues to grow, AND you will create and provide a lasting legacy for your family. Sound too good to be true, read on.
If you’re “saving” for retirement, then you are typically torn between an RRSP and a TFSA. Whether the best choice is to save in an RRSP, or a TFSA depends on your savings needs, as well as your current and expected future financial situation and income level. But are these the best vehicles to meet your retirement goals? Here are some thoughts to consider.
RESPs are used exclusively for investing for post-secondary education – Government grants and incentives may be available to enhance returns. A RESP has but one purpose and when the money is spent it is gone forever, never to earn for you again. This option will be discussed further in a separate article.
RRSPs are generally used for investing for retirement. Contributions are tax-deductible and investments grow tax-free within the account. Both the contributions and investment earnings are 100% taxable upon withdrawal, but the idea is that these withdrawals will happen after retirement when your income and tax rate are expected to be lower than when you contributed. Withdrawals are included in income and affect eligibility for federal income-tested benefits and tax credits, such as the Canada child benefit, GST/HST rebates, and Old Age Security (OAS). Once you withdraw funds from your RRSP, the contribution room is gone for good, unless you do so through a program such as the Home Buyers’ Plan or Lifelong Learning Plan – note that these come with limitations and must be paid back over time.
TFSAs can be used to save for both retirement and shorter-term needs. Contributions are not tax-deductible, but investments grow tax-free inside the account. Amounts withdrawn from a TFSA are not subject to tax and will not affect eligibility for federal income-tested benefits and tax credits. Withdrawals are added back to your available TFSA contribution room in the following calendar year, so there is very little downside to using TFSA savings for mid-sized to large purchases.
PWLI allows you to save for any purpose you desire, and for multiple purposes, with one plan – meaning you can use your savings while it still grows for the next time you want to use it. Use it to pay for post-secondary education, autos, real estate, vacations, business ownership, AND retirement. PWLI is a tax-exempt product, which is included in the tax code, it is not an exception to the tax code. Your growth is tax-advantaged and can be tax-free. AND you will create and pass on a legacy – 100% tax-free!
*** What the government and your bank likely haven’t told you about registered options. ***
First, let us look behind the curtain of the RRSP.
Registered – this means that whatever account you use, it is registered with the federal government. This is a government-created and controlled program. They determine the rules and can change them anytime – which they do on a regular basis. Since this program was created by the government, who benefits from it? You and me, or the government? If the government wanted us to pay less taxes, they would reduce the tax rates. Instead, they created an exception to the income tax act, to “help us save taxes”. Are you not a little bit suspicious of this? The fox is guarding the hen house! No government survives without tax revenue!
Retirement – Few Canadians can rely on a defined benefit retirement plan from their employer, so the government incentivises us to contribute to our own defined contribution plan, the RRSP. The Canada Revenue Agency (CRA) then becomes your silent business partner – your business of preparing for your retirement years. This is the business partnership…
Savings – the program is called a “savings” plan. Firstly, it is important to make decisions, especially financial decisions, from a place of knowledge and understanding. Secondly, we must correctly categorize and define terminology. Savings means that your capital is protected, your money will be there when you need it. Investing comes with the risk of loss. Your money will go up and will go down – this is almost certain. The question is… will it be up or down at the time you need it? Calling it a savings plan implies that we are saving our money and it will certainly be there when we need it. However, in fact, we are investing our money and we have no certainty what will be available when we need it. We hope, wish, and pray!
Plan – it is nothing more than a plan. A plan is an intention or decision about what one is going to do. Plans can and will change and many of life’s events can derail your plan. Assuming you stick to the plan, there are rules that you must follow. Once you retire, the money in your RRSP becomes retirement income. To make these withdrawals, you’ll need to convert your account into a Registered Retirement Income Fund (RRIF). You must do this by the end of the year that you turn 71, but you have the option to do so sooner. Starting in the year you turn 72 you are forced to withdraw income from your RRIF. The government dictates the minimum amount per year that you must withdraw (they want their portion, that they have been waiting for all these years). All money you take out at this stage will be taxed as income when you withdraw it.
When you pass away, your spouse can inherit your RRSP on a tax-deferred basis. If you don’t have a spouse, any beneficiaries you name receive it as cash, but the value of the RRSP is subject to tax in your final tax return. Note that this will happen when your spouse passes away – it is always a deferral of tax. Your executor must ensure that the tax gets paid from the proceeds of your estate. Also, if you haven’t named beneficiaries, it gets rolled into your estate and would be subject to probate and other fees, so it’s important to name a beneficiary. Nevertheless, the tax gets paid as though the RSP was sold on the day of your death. It becomes a part of your income for that year, along with every other asset that is deemed disposed of on the same day. It is very likely that the tax rate will be at the highest level – your marginal tax rate. This is near or above 50%, depending on your province! Are you doing all this planning, only to give the government half of the wealth you have created in your lifetime? The tax will get paid! What’s the best way to do that? What’s in your best interest and not the government’s?
Think about this for a minute. You have deferred paying tax, but you have also deferred the enjoyment your money could bring you and your loved ones by locking it away in jail for most of your life. If you don’t outlive your retirement savings and you pass away before it is all spent (also applies to your spouse) you will then “give” a very large portion of the remainder to the government. All the sacrifice over the years has not benefitted you and your family the way you planned. Those left behind must pay the tax bill. How will they do it? There is a better way! You can have a better plan!
Your RRSP contributions are tax deductible. So, when you contribute to an RRSP, you pay less in income taxes than you would otherwise. And while the money is in the account, it grows tax-free. Later, when you withdraw that money again — typically in retirement — you pay taxes on 100% of it, as though it is income.
This is the typical conventional wisdom… You will see the benefits of contributing to your RRSP in the form of tax savings in the year of contribution. When people talk about RRSP contributions being “tax-deferred,” they mean that you save on taxes now, and pay them later.
You can expect to save 20 to 40 cents on the dollar in tax when you make contributions to your RRSP. The exact amount depends on your marginal tax rate, which is determined by income level and differs by province. When you withdraw that money in the future, you will pay taxes on it equivalent to your tax bracket at that time. The general thinking is that you can expect your income in retirement to be lower and you will be in a lower tax bracket, so you will pay less taxes.
What is wrong with this strategy? Do you want to have less income in retirement? Do you want this to be your plan? What do you want to do in retirement? Stay home and not spend money? Perhaps you will need less income in retirement. But do you want this to be your actual strategy – what you are hoping, wishing, and praying for? Would you rather have options and choices – and not be limited?
Are we really going to pay less tax in retirement? Do we think that tax rates, tax brackets, or deductions will be higher or lower in the future? Will all levels of government need more or less revenue, considering the enormous deficits and debts they have accumulated? When we defer the payment of tax on our income, we are also deferring the tax calculation. How can we possibly know what that calculation will look like in 20 to 50 years? Do you want this to be your strategy? Do you want to take that risk?
When we contribute to an RRSP, we are investing seeds, in the hope that they will grow into a harvest. This is the best scenario – we are investing so that our money grows, and we can use it in retirement. So, we are saving tax on the seeds that we are sowing and paying tax on the harvest in the future. Will we really pay less tax? Where is the tax “savings”?
With a TFSA, you don’t benefit from any income tax savings upfront, but when it comes time to withdraw the money from your account, you won’t pay any taxes, even on interest and investment growth. If you think your income will be higher in retirement than it is now, or if you want to ensure that the money’s available for any purpose, not locked away until retirement, then a TFSA might be a good option. If you’re in a low tax bracket, saving in a TFSA may be more advantageous than saving in an RRSP since TFSA withdrawals have no impact on credits and federal income-tested benefits such as the child benefit, GST/HST credit, and OAS.
Having money in your TFSA can help you avoid taxes on large expenses during retirement. It can even help you avoid OAS claw back if you’re income level is high enough.
The downsides of the TFSA are two-fold. First, it is a government created and controlled program that is subject to change. For instance, the annual contribution limits have been changed many times over the years. That leads us to the second problem – the annual contribution limits. Why are we limited in the amount of money we can put into a TFSA? Because the government is not getting the money they want and need, from the likes of the RRSP. Currently, we are limited to $6000/year per person in contributions. If you have not contributed in any given year, the limit is carried forward into future years.
The idea of saving or investing for retirement is a good one. We should plan ahead and prepare for the time we choose not to work full time. The question is… what is the best vehicle to use to achieve that goal?
Participating Whole Life Insurance (PWLI) is an asset purchase that builds equity (cash value) and provides a guaranteed death benefit. This asset allows the owner to benefit while alive and you do NOT have to die to win. It is true LIFE insurance and not death insurance. Due to the level fixed premium, guaranteed growth in cash value, and a death benefit guaranteed for the lifetime of the contract, PWLI becomes a financial tool that can be used wisely to build wealth, provide needed liquidity, and legally avoid certain income and estate taxes. The coverage provided in PWLI is slowly converted to paid-up insurance, which the policy holder owns rather than the insurance company. This allows greater liquidity and control over the cash values of the policy. The faster paid-up insurance is established in the policy, the faster the cash value in a PWLI policy will accrue.
PWLI policies offer dividends to policy holders. Dividends are paid to policy holders based on the profits, which the insurance company has earned over the past year. Dividends are classified as a “return of premium paid” by the CRA and are therefore not taxable if they are used to purchase more paid-up insurance. The fully paid-up insurance in turn earns dividends and adds to the uninterrupted compound growth of the cash value and the death benefit.
There is no other product that can provide the living and death benefits that PWLI can provide. Life insurance by design, is not an investment, but rather a binding contractual agreement, which keeps your money safe and liquid so that you can use other people’s money without losing the growth on your own money. It is the financial tool that successful people have used for centuries to keep more of the money they make and stop losing money to taxes, interest, market volatility, management fees, and opportunity costs.
PWLI works because the insurance company assumes the risk of managing the premium dollars collected from the policy holder in exchange for providing a legally binding contract that provides a death benefit for the beneficiaries of the policy. That binding contract lasts for the entire lifetime of the insured. That is why it is called Whole Life Insurance, because it provides life insurance coverage for an entire lifetime, even if the insured lives past the policy maturity date. Instead of an ever-increasing premium as is found in term and universal life Insurance contracts, premiums for PWLI are based on a fixed level premium that is contractually ensured never to go up for the entire lifetime of the insured. Premiums can be reduced, or even stopped, in the future, but the premiums can never be increased.
PWLI is an excellent tool for saving for retirement. But it has multiple purposes – it is an AND asset that can be used for any and all purposes you choose. It is the golden goose that lays golden eggs for your lifetime and for every generation that comes after you. How powerful is that?
A properly designed participating whole life policy, or several policies, can provide a means to fund your retirement in the most tax-efficient way – even tax-free – AND leave a tax-free benefit to your beneficiaries! But this vehicle provides so much more…
PWLI is a solid and secure financial tool used by individuals, families, business owners and companies to keep more of the money they make. Your wealth must reside somewhere – why not in an entity that you own and control and that grows your wealth while you are able to access it and use it? We all would do well to discover these truths before we lose the opportunity to purchase the life insurance that will provide us with the guarantee that we will have enough money when we retire; instead of risking money in investments that get destroyed by taxes, management expense ratios, and volatility – all out of our control!
Below is a table with the attributes and features of all three retirement savings options. Consider the attributes that you want in your savings and investments and compare the two typical financial vehicles with the traditional one. You decide from there.
Whether to save in a TFSA, a RRSP, a PWLI policy, or a combination of all of them depends on your savings needs, your priorities and objectives, your tolerance to risk, your eligibility for income-tested benefits (now or in the future), and your current and expected future financial situation and income level. We are happy to help you determine the best tax-advantaged savings and investment strategy to help you achieve your goals. Reach out and get your questions answered.
Click on: GRoth Financial Services. Serving BC, AB, SK and ON
1 Overcontributions in a year will be subject to tax consequences assessed by the Canada Revenue Agency. 2 The annual contribution limit is currently $6,000 per year. Increases rounded to the nearest $500, will be applied as warranted by the Consumer Price Index. The annual contribution limit was $5,000 for years 2009 to 2012, $5,500 for years 2013 and 2014, $10,000 for 2015, $5,500 for 2016 to 2018, and $6,000 for 2019 to 2022. 3 Any income from deliberate overcontributions will be taxed at 100 per cent. 4 Successor holder means a spouse or common-law partner as these terms are defined in the Income Tax Act (Canada). Certain contracts may provide that if a spouse is named as the sole beneficiary, the spouse will automatically continue the contract as the successor holder and the applicable successor holder rules would apply. In these situations, the investor’s spouse may have the option to be treated as a beneficiary of the contract, and beneficiary rules would apply. 5 The withdrawal of amounts in respect of deliberate overcontributions, prohibited investments, non-qualified investments, asset transfer transactions, and income related to those amounts don’t create additional TFSA contribution room.
Disclaimer The commentary in this publication is for general information only and should not be considered investment or tax advice to any party. Individuals should seek the advice of professionals to ensure that any action taken with respect to this information is appropriate to their specific situation. Commissions, trailing commissions, management fees and expenses all may be associated with purchases. Please read the prospectus before investing. Investments are not guaranteed, their values change frequently, and past performance may not be repeated.
Your email address will not be published. Required fields are marked *
Comment *
Name *
Email *
Website
Save my name, email, and website in this browser for the next time I comment.
Post Comment