Tax deferred retirement account (RRSP) for low-income Canadians?
If you are near retirement, quite likely using an RRSP is a wise choice, to defer paying tax, then probably pay at a lower rate.
If you have a spouse who's not employed for pay, or is an employee with no/low pension program, likely buying a spousal plan for such a spouse is a wise choice.
Your goal is to provide for more or less equal income for you and the spouse, after retirement, as all or most of the income in one person's hands will be taxed at a higher rate.
If you like to have a substantial portion of your asset in instruments where the number of dollars is "safe", then it would be useful to have such investments in an RRSP.
If you have a company pension plan, it will provide you with some pension (unless the co. goes broke - in which case you'd better hope that the pension plan was carried by an outside carrier, so that the company couldn't raid it).
In that case, you might be wise to do some careful figuring, especially if you have a moderate tolerance for risk.
As you know, many financial agencies offer to lend you the money for your RRSP, if you don't have enough. The interest that you pay is not deductible.
However, should you choose to buy stocks or equity mutual funds outside of an RRSP, the interest on such a loan is deductible.
If you buy Canadian stocks that pay a dividend, such income outside of an RRSP is taxed at a low rate. If you own Canadian stocks inside of an RRSP, there is no tax now - but every dollar is added to taxable income when you withdraw it.
If you own stocks outside of an RRSP, when you sell them (or die) you deduct your cost of purchase, and the remainder is your capital gain. You must pay tax at regular rate on half of it - but you get half of that capital gain free of tax.
Not so if it was held in an RRSP - every dollar withdrawn is added to taxable income.
I bought a Canadian stock 40 years ago for slightly over $4.00 per share. I thought it valuable 40 years ago - and still thought so, 30 years ago, and 20 years ago, and 10 years ago. It's worth about $100.00 now, so I still think it valuable and am not about to sell it. As long as I hold it, I do not have to talk to the Canada Revenue Agency about that increased value, so I avoid paying tax on that asset, so long as I hold it - which is much of the advantage that you gain by using RRSPs.
If I sold it now, I'd get $100. When I deduct the $4.00 that I paid, my capital gain is $96.00, and I have to pay tax on half of that, $48.00 ... but I get $48.00 with no tax to pay on it. That's over 10 times the amount that I invested originally. Tax-free: nice.
If you have $1,000. to invest and put it into an RRSP, you have $1,000. working for you.
If I, in low tax bracket, pay 25% tax, I have $750. after-tax cash residue to invest.
Many financial advisors say that no matter what I do, I can never overcome the fact that you have 1/3 more than I do, working for you.
Suppose I buy a Canadian stock with my $750. cash, and borrow $400. to buy more Canadian stocks, giving all of the stock certificates to the bank as collateral - about $1,150.00.
When I have good credit, the bank will lend me 1/2 of the value of my securities that they hold, so they'd be willing to lend me up to $575.00, but I *never* would be willing to borrow up near that amount, in case the market went down.
Let's say the market goes down 25%, which it sometimes does, and my stocks went down the same amount - that $1,150. original value shrinks by $345., leaving me with $805.00 current value.
I borrowed $400.00, just barely less than half of that amount.
If the value of my asset goes any lower - the bank will be calling me, wanting a minimum $100., more likely nearly $200. cash, or about $400.00 worth of stock or mutual fund certificates. That's today -- tomorrow at the latest.
I have never had such a margin call, and always have some extra assets that I can use to cover, if need be.
The agreement on my loan was that I pay interest only (currently 6.25%) month by month and I use the dividends (about 3%) paid quarterly, on most of the stocks puchased to pay the interest on the loan.
At tax time, the tax rate on dividends on Canadian stocks is low, and the interest on my loan is deductible.
So the dividends on your stocks in RRSP were added, with no tax cost, and I lost a portion of my dividends - but the loan interest is deductible, so my reduction on value isn't as large as one might think.
The original price of the shares was $4.00 (and change) - and the bank would lend me up to $2.00 - no more.
But when the value per share grew to $40.00, the bank would be willing to lend me up to $20.00, if I chose.
Originally, you had $1,000. working, and I had $750. cash, but $1,150. total.
But if I choose to borrow double that amount, later , when the value of the asset has grown, I have the equivalent of original $1,500. working for me.
I wouldn't want to follow such a procedure with only one stock (suppose the one that I chose was NorTel, which fell from $120. to $0.69) - way too risky.
But you'll be investing in an RRSP next year, and the year after that.
And I'll be buying various stocks, so that if the value of one decreases substantially, I'm not sweating blood, unable to pay much of the loan back using my assets on hand.
And I've been playing these games for nearly 50 years, (though not accepting major risk) and have met monthly for the last 7 years with about 20 people of similar interests.
Some thoughts that you might want to consider, as an alternative method of investing, in place of part of your RRSP program.
Now, nearing 80, I was forced to take money out of my RRIF last year (about 8 - 9% of it, percentage rising annually), though I sold some stocks, developed capital gain, and would have liked to have avoided having that extra income last year, but had no choice.
I saved about 26% going into RRSP - now am paying about 38%, going out.
Good wishes for learning how to deal with your income, plus your assets, wisely.
P.S. From $4.00 to $100.00 is 4.5 doubles, more or less. Divide 40 by 4.5 gives about 8.5 years on average to double. Divide 72 by 8.5 is under 9 - about 8.5: the stock was growing at about 8.5%.
Divide 72 by your rate of growth and the answer is how many years it'll take your money to double.
That's just the growth in value of the underlying asset.
Dividend rate originally was about a nickel or a dime on $4.00 value of the stock. Now each stock pays me $2.80 dividend annually. That's in addition to the growth rate of the asset.
That's one of my better investments - I've had a number of major losers, as well.
Life isn't all peaches and cream.