The Information You Need
TFSA stands for Tax-Free Savings Account. It is a type of savings account that allows individuals to earn tax-free investment income on their contributions. Unlike traditional savings accounts, the money that you put into a TFSA can be invested in a variety of different investment vehicles, including stocks, bonds, mutual funds, and GICs. Any income earned on these investments, including interest, dividends, and capital gains, is tax-free.
The amount of contribution room in a TFSA is determined by the government and is indexed to inflation. For 2023, the contribution limit is $6,500, bringing the total contribution room to $89,000 for those who have been eligible to contribute since the inception of the TFSA in 2009.
The tax treatment of a TFSA is straightforward. Unlike contributions to a Registered Retirement Savings Plan (RRSP), contributions to a TFSA are not tax-deductible. However, any income earned on investments held within the account, as well as any withdrawals made from the account, are tax-free.
It is important to start investing early in a TFSA, or any other type of investment account, because the longer your money is invested, the more time it has to compound and grow. Compound interest is the interest earned on both the initial principal and any accumulated interest, which can significantly increase the value of your investments over time. By starting early, even with small contributions, you can take advantage of the power of compound interest and potentially build a substantial nest egg for your future. Additionally, because of the tax-free nature of TFSA contributions and earnings, investing early in a TFSA can help you maximize your returns and minimize your tax burden.
RRSP stands for Registered Retirement Savings Plan. It is a type of investment account that is designed to help Canadians save for their retirement. Contributions to an RRSP are tax-deductible, meaning that they can reduce your taxable income for the year in which they are made. Any income earned on investments held within the account is tax-deferred, meaning that it is not taxed until it is withdrawn from the account.
The amount of contribution room in an RRSP is determined by your income and is calculated as a percentage of your earned income, up to a maximum amount set by the government. For 2022, the maximum contribution limit is 18% of earned income up to a maximum of $29,210, plus any unused contribution room from previous years. The maximum contribution room for 2022 is $29,210 + unused contribution room from previous years.
When you put money into an RRSP, you receive a tax deduction for the amount of your contribution, which reduces your taxable income for the year. For example, if you earn $50,000 per year and contribute $5,000 to your RRSP, your taxable income for the year will be reduced to $45,000. Any income earned on investments held within the account is not taxed until it is withdrawn from the account, which allows your investments to grow tax-free until retirement.
When you take money out of an RRSP, the withdrawals are considered taxable income and are subject to income tax. The goal is to withdraw from the RRSP at a lower tax rate than you contributed at. There are certain circumstances when you can withdraw funds from your RRSP without paying tax, such as for the Home Buyer’s Plan or the Lifelong Learning Plan, but these must be repaid to the RRSP in the future.
In summary, an RRSP is a tax-advantaged investment account that allows you to save for retirement by contributing pre-tax income and deferring taxes on investment income. While contributions to an RRSP are tax-deductible, withdrawals are subject to income tax. It is important to carefully consider your retirement goals and tax situation when deciding how much to contribute to your RRSP.
A Spousal RRSP is an RRSP account that is opened and owned by one spouse or common-law partner, but the contributions can be made by either spouse. The idea behind a Spousal RRSP is to help couples with a significant income gap maximize their retirement savings and reduce their overall tax burden.
The mechanism of a Spousal RRSP works like this: the spouse with the higher income contributes to a Spousal RRSP in the name of their lower-earning spouse. The contribution is tax-deductible for the higher-income spouse, but the account belongs to the lower-income spouse. This can be particularly beneficial when one spouse earns significantly more than the other, as it allows the higher-income spouse to transfer some of their wealth to the lower-income spouse for tax-advantaged growth and withdrawal in retirement.
For example, if a dentist earning $250,000 per year is married to a spouse who is an at-home caregiver with no income, the dentist can contribute to a Spousal RRSP in their spouse’s name. This will reduce the dentist's taxable income, while allowing the couple to save for retirement with a tax advantage. In retirement, when the withdrawals are made, they will be taxed at the lower-income-earning spouse's tax rate, which can result in significant tax savings.
It is important to note that there are attribution rules in place that apply to Spousal RRSPs. These rules require that any withdrawals made from the Spousal RRSP within three calendar years of the last contribution be attributed back to the higher-income spouse and taxed accordingly. This means that if the dentist in the example above were to make a contribution to their spouse’s Spousal RRSP and then withdraw the funds within three years, the withdrawals would be taxed at the dentist's tax rate, not the lower-income-earning spouse's tax rate.
Working with an experienced financial planner is important to fully understand the tax implications and avoid any pitfalls when setting up a Spousal RRSP. A financial planner can help to determine the optimal contribution amounts and timing, as well as provide guidance on other retirement planning strategies to maximize your savings and reduce your overall tax burden.
RRSP Alternative – IPP
An Individual Pension Plan (IPP) is a defined benefit pension plan that is designed for an individual or a small group of executives or business owners. It is a registered retirement savings plan that allows for a larger retirement savings contribution than what is possible with an RRSP or a defined contribution pension plan.
The IPP is similar to a traditional pension plan offered by large corporations. It provides a guaranteed retirement income based on a formula that takes into account the participant's years of service and salary history. The contributions to an IPP are made by the employer and the employee, with the maximum contributions based on the participant's age, years of service, and income.
For business owners like a principal dentist, an IPP can be an attractive retirement savings vehicle because it allows for significant tax-deductible contributions, potentially reducing the amount of tax paid on current income. Additionally, an IPP can provide a higher guaranteed retirement income than other retirement savings plans, which can be especially important for those who are self-employed and may not have access to other retirement benefits.
Another advantage of an IPP for business owners is that it can be structured to provide creditor protection for the business and its owners. This is important for those in professions with a higher risk of litigation or those who may face financial challenges in their business.
However, an IPP is a complex and expensive pension plan that requires ongoing administration and actuarial calculations. It is important to work with a knowledgeable financial planner and pension expert to ensure that an IPP is the right retirement savings vehicle for your needs and to help you navigate the complex regulatory requirements associated with these plans.
In summary, an Individual Pension Plan (IPP) is a defined benefit pension plan designed for an individual or a small group of executives or business owners. It can provide significant tax-deductible contributions and a higher guaranteed retirement income than other retirement savings plans, making it an attractive option for business owners like a principal dentist. However, the complexity and cost of an IPP require careful consideration and expert guidance to ensure that it is the right choice for your retirement savings goals.
A Registered Education Savings Plan (RESP) is a tax-sheltered investment account that is designed to help families save for their children's post-secondary education. The RESP is an investment vehicle that is available to Canadian residents, and it comes with various grants and benefits to help families save for their children's education.
The Canada Education Savings Grant (CESG) is a grant that is available to families who contribute to an RESP. The CESG provides a matching contribution of 20% of the contributions made, up to a maximum of $500 per year, per child. In addition to the CESG, there are also provincial grants available in some provinces, such as the British Columbia Training and Education Savings Grant (BCTESG), which provides a one-time grant of $1,200 to eligible children born in BC after January 1, 2007.
An RESP provides several benefits to families who use it to save for their children's education. First, the investment income earned in an RESP is tax-sheltered until it is withdrawn to pay for education expenses. This means that families can earn investment income without having to pay taxes on it until the funds are withdrawn. Second, when the funds are withdrawn from an RESP to pay for education expenses, the income is taxed in the hands of the student, who is likely to be in a lower tax bracket than the parents.
For young dentists who are starting their families, working with a financial planner at DEC can be an excellent way to ensure that they are setting up their RESP correctly from the start. A financial planner can help young dentists choose the right investment options for their RESP, ensure that they are contributing enough to maximize the available grants and benefits, and provide ongoing support to help them stay on track to reach their education savings goals.
In summary, an RESP is a tax-sheltered investment account designed to help families save for their children's post-secondary education. The RESP comes with various grants and benefits, such as the Canada Education Savings Grant (CESG) and provincial grants like the British Columbia Training and Education Savings Grant (BCTESG). A financial planner at DEC can help young dentists set up an RESP right away when a new baby comes home and provide ongoing support to ensure that they are on track to reach their education savings goals.
The First Home Savings Account (FHSA) is a savings plan that combines the tax advantages of both the Tax-Free Savings Account (TFSA) and the Registered Retirement Savings Plan (RRSP). The FHSA is designed to help Canadians save for their first home purchase by providing them with a tax-advantaged savings vehicle.
The FHSA works in a similar way to the TFSA in that contributions are made with after-tax dollars, and investment income earned within the account is tax-free. However, unlike the TFSA, contributions made to an FHSA are tax-deductible, similar to contributions made to an RRSP. This means that contributions can be used to reduce taxable income in the year they are made, providing an immediate tax benefit to the account holder.
Similar to the RRSP Home Buyers' Plan (HBP), the FHSA can also be used to fund a first-time home purchase. However, unlike the HBP, there is no requirement to repay the funds withdrawn from the FHSA. This means that the FHSA can be a more flexible option for those looking to save for their first home purchase.
It is important to note that while the FHSA has been approved, it is not yet in force, and it is unclear when it will be available to Canadians. As a result, young dentists who are planning to buy a new home should stay tuned and work with experienced planners like us at DEC to determine the best savings strategy for their unique situation, whether it be through the RRSP HBP or other available options. A financial planner can help dentists understand the tax implications of each strategy and create a customized plan to help them achieve their homeownership goals.
Borrow to Invest
Borrowing to invest is a strategy where an individual borrows money, typically from a financial institution, to invest in financial markets or other investment vehicles. The idea behind this strategy is that the return on the investment should be higher than the cost of borrowing, resulting in a net gain for the investor.
In Canada, the interest paid on borrowed funds used to invest may be tax-deductible if certain conditions are met. The interest expense can be deducted against investment income, such as dividends or capital gains, to reduce the overall tax liability. This tax benefit can increase the net return on the investment, making borrowing to invest an attractive strategy for some investors.
However, borrowing to invest comes with a significant risk. If the investment does not perform as expected, the investor may not only lose their investment but also be left with a debt that must be repaid. This can lead to financial hardship and stress.
For dental students who have been approved with a $350k line of credit, borrowing to invest can be a tempting strategy. However, it is important to work with an experienced financial planner to determine whether this strategy is appropriate for their unique situation. A financial planner can assist in selecting suitable investment instruments and manage the investment to make sure the leverage strategy works well. They can also help to monitor the investment performance and make adjustments as needed to ensure that the investment is meeting the desired goals.
Overall, while borrowing to invest can be a powerful strategy to build wealth, it comes with significant risks and requires careful planning and management. Working with an experienced financial planner can help to minimize these risks and ensure that the strategy is appropriate for the investor's unique situation.
Investment Line of Credit V.S. HELOC
Both investment lines of credit and home equity lines of credit (HELOCs) can be used to execute a borrow-to-invest strategy, but they work in slightly different ways.
An investment line of credit is a loan that is secured by the assets held in an investment account, such as a brokerage account. The loan is typically provided by the brokerage firm or another financial institution, and the interest rate is based on the prime rate. The borrower can use the funds to purchase additional investments, and the investment account serves as collateral for the loan. If the investments lose value, the borrower may be required to provide additional collateral or sell the investments to repay the loan.
On the other hand, a HELOC is a loan that is secured by the equity in a home. The borrower can access the funds by using a line of credit, and the interest rate is usually lower than an investment line of credit. The borrower can use the funds for any purpose, including investing. However, if the borrower defaults on the loan, the lender can seize the home to repay the debt.
The main difference between the two is that an investment line of credit is secured by the investment assets themselves, whereas a HELOC is secured by the equity in a home. This means that with an investment line of credit, the borrower doesn't need to provide additional collateral other than the investments themselves. This can be an advantage for investors who don't want to put their home at risk. However, investment lines of credit may have higher interest rates compared to HELOCs, and the borrower must be careful to only invest in securities with a potential for a higher return than the interest rate on the loan.
In summary, both investment lines of credit and HELOCs can be used to execute a borrow-to-invest strategy, but they have different advantages and risks. It's important to work with an experienced financial planner to determine which option is best for your unique financial situation and investment goals.
As a dental professional, it's not uncommon to have a significant income gap between spouses, which can lead to higher tax bills on investment income. However, there is a prescribed loan strategy that can be utilized to help reduce taxes and maximize investment growth.
The prescribed loan strategy involves loaning funds to your lower-income spouse, who then invests the funds in a non-registered account. The loan is structured in a specific way, with an interest rate that is equal to or greater than the Canada Revenue Agency's (CRA) prescribed rate, which is currently 1%. The interest on the loan is paid annually by January 30th of the following year.
The prescribed loan strategy allows the investment income to be attributed to your lower-income spouse, who is likely in a lower tax bracket than you are. This can help reduce the overall tax bill on investment income. The strategy also allows you to retain ownership of the funds, which can be important in certain situations.
It's important to note that this strategy requires careful planning and attention to detail, as there are specific rules and deadlines that must be followed. For example, the interest on the loan must be paid by January 30th, not January 31st, and there are other rules related to the loan amount and repayment terms.
To ensure that the prescribed loan strategy is implemented correctly, it's important to work with an experienced financial planner who understands the rules and can help structure the loan in a way that is beneficial for both you and your spouse. They can also help you select appropriate investment vehicles and manage the investments to ensure that they are aligned with your financial goals and risk tolerance.