Quick financial update

So just a summary from the last post...it's a girl! My daughter Ava was born on March 15th, 2011 and that has been a wonderful blessing to our family. She has received her SIN number so we are heading to the bank on Friday to begin her RESP for schooling!

Financially, I took out a $5100 RRSP loan and ended up getting back over $3000 from the government, so all of that $3000 will go towards paying back loans (both the RRSP loan and my student loans). My priority for paying back loans will be
1) smallest student loan (done)
2) RRSP loan (I have about $3200 left)
3) last student loan (I have about $9800 left)
4) house mortgage (I have about $120,000 left)

We'll see if I do another RRSP loan for next year...chances are that I will. The net worth increase is tremendous and the regular payments aren't a strain on me financially.

As far as investing, once the TSX gets to 15000 I will take 20% of my Dividend holdings and turn them into bonds. After that, it will be once the TSX gets to 16500. All of my contributions are going into the Dividend Fund at this time.

RRSP Loan

So this weekend I took out a loan from the bank for RRSPs. Generally I think it makes more sense to save ahead (which I do anyway), but I had some extra cash floating around (paycheque to paycheque) and some RRSP contribution room so I decided to take a loan. I ended up borrowing a little over $5100 (which turns into me paying back $200 per paycheque). The total cost of borrowing is about $70. Considering that I'll get at least 30% of that back through my income tax, it sounds like a pretty good investment to me! The interest rate they gave me as well is below prime, so it will be my lowest priority to pay off.

When I get my income tax back, I will split the return three ways: 1/3 going towards an RRSP re-contribution (for next year), 1/3 going towards my mortgage, and 1/3 going to a student loan. Once my student loan is paid off, then I will concentrate my energy towards the RRSP loan, and then finally to my bigger students loan. All in all, this will really help our next worth and things are moving in a perfect direction before the baby is born!

What To Do With Your Tax Return...

So tax season is pretty much over now and people are starting to get some money back from the government (if you have been reading this blog and have put some money into RRSPs and donations and education anyway). So the question is, what are the best options to do with your tax return?

Option 1: Get a lower tax return next year

Remember that when you receive a return from the government it means that the government has overtaxed you in the previous year. They have hung onto an extra chunk of each pay, with you getting no benefit. So next year, get less taxes taken off each paycheque, so your cash flow improves.

Option 2: Reinvest in RRSPs (or an RRSP loan)

The next best option is to re-invest in RRSPs any money that you get back from the government. So if you get back $1000, immediately contribute that into your RRSP for next year. If you do your taxes (or estimate them) and find out that you will be getting $1000 back, take out an RRSP loan from your bank for $1000 and pay them this back with your return. The advantage to doing this is that you will get an extra $350 back on your return (depending on what your marginal rate is) so you have extra money regardless. I haven't tried this yet, but "fatcatc" has this planned for the future. Don't just pick a random amount though: make sure that you only borrow what your previous potential tax return was, so that this loan can be repaid immediately, rather than linger over the year.

Option 3: Pay off bills

If you have credit card debt, that is another option for your tax return (although still less preferable than options 1 and 2).

Option 4: Build an emergency fund/planned spending

What can also be done is to build an emergency fund with your return or planned spending. What planned spending means is if you know that you spend $500 for Christmas each year, rather than putting it on your credit card this upcoming year, pocket aside $500 from your return so that money is available to you at this time.

Option 5: Upgrades on your house

I rate this a little higher than my last option because this is something that is building value. Although I always think of "Christmas Vacation" where Chevy Chase is counting on his Christmas bonus to put in a pool. You can't really plan "in 2011 I will spend my return on a new deck and in 2012 I will spend my return on hardwood floors", etc. in case things don't happen as expected.

Option 6: Random spending

Some people decide to buy a big screen television or new furniture with their tax return...they treat it like a lottery winning each year. If all of your bills are paid, your TFSA is maxed and your RRSPs are maxed out, then I say "go ahead", but for the other 99.999% of Canadians (at least that I know), there are better fiscal ways for this.

As far as what I did with my tax return, most of mine went to bill payments, although about 10% of my return went to emergency fund contributions and 10% went to "random spending". "frugala" is planning to take her money and "throw it on the pile", which is her way of saying that she will keep it in her emergency fund.

I'm Not Such An Accountant After All...

I forgot a piece of paperwork (my 2008 taxes to get my RRSP contribution limit and how much I need to re-pay for the home buyers plan) so I was unable to finish the calculations for my income tax, but the software worked extremely well (I was able to save what I was doing). Frugala and I worked together (her organizing the paperwork and me doing the computer part) and it took about half an hour for each of our taxes. It was a great system because we didn't need to flip between pages and all that. The software was Quick Tax software and I would recommend it, as you can make changes on the fly and there is no chance for calculation errors. Additionally, you can submit your taxes automatically electronically and allows you to save your tax forms as .PDFs or print them for future reference. I will finish my taxes up on Friday when I go with frugala to work, but it seems like I will still be getting significant money back, encouraging me to deduct less tax at the source again for the remainder of 2010.

Taxes...this afternoon!

This afternoon, frugala and I are going to her parents place to do our taxes. Both of us are confident that we are getting money back (because of RRSPs and education and donations) but we still have put it off for two weeks. The reason for this is that frugala's parents have tax software that we want to try out. We have all seen the advertisements (or the packages themselves) in the supermarket, or store and said "I don't know if thats a good deal or not" (to pay $20 for software to do your taxes). Frugala's parents already bought it and there are extra licenses to do taxes, so we will try it out and I will post either this evening or tomorrow with a recommendation or not.

For myself, I am curious to see how much money I will be getting this year, because I dropped my taxes at the end of last year. I am expecting about half of what I got last year, but we'll see how it turns out.

Spousal RRSP

As I am getting married soon, we were talking about taxes the other day, and my fiance joked that "I had better be able to get her below the tax bracket so she gets her GST cheques this year". Then I started thinking, I am taxed at a higher bracket than she is, so deductions above the amounts to get her to that tax level are better given to me.

The option that I am thinking about is Spousal RRSPs. Because I am getting taxed at a higher marginal rate, the contributions will still be whatever we individually do, but the deductions would go to the higher income earner.

Here are some links (for myself for further reading)

Spousal RRSPs from TD
How Spousal RRSPs Work (from Million Dollar Journey)
Can RRSPs and Spousal RRSPs be rolled into one?"

Legally Deferring My Taxes

Just an update on my tax situation. A few months ago, I filled out a T1105 form from the Ontario government that would allow me to pay less income tax off of each paycheque. The idea is simply this: rather than get a large cheque back come income tax time, to get a little more for each paycheque throughout the year. Over the course of the year, I will still earn the same amount and pay the same amount, but rather than have the government hang onto my extra taxes paid, I would pay less for each paycheque. The math behind this is that I can use this extra money immediately to either invest, or to pay loans or whatever. It is a better use of my money to have it now rather than to have the government hang onto it for the better part of a year.

So my plan was to have half of my RRSP deductions taken off each paycheque. So if I contribute $200 per paycheque to RRSPs, I would have the government tax me on $100 less of my salary. In this way, I will still get some money back come tax time, but also get a benefit now.

It works perfectly so far (we'll see what happens come income tax time). I went to the bank and got a letter saying what my RRSP contributions were and then the government agreed to reduce my taxes each paycheque. If I want to do this for 2010 (which I do) it was recommended that I get all my paperwork in by November 1st of 2009 (which I will immediately do).

Some people like getting a big cheque back at tax time. It's almost like a Christmas bonus or a lottery winning. I would much rather have more disposable income throughout the year and have more control of my money, so I will continue to do it this way.

Taxes Now or Later

I just received a letter from the government approving my request to have my taxes reduced at the source. My theory is that since taxes are earning no interest anyway, that if I take half of what my last year tax return was and reduce it from my taxes this year, then I will get the money back sooner.

An example to clarify: If I got back $2600 last year on my tax return (for ease of calculation), I would want to get back this year an extra $1300 over the year on my paycheque and still get $1300 back on my return.

The way I calculated this was to use my tax bracket (38%), and divide the $1300 by 0.38 to get $3421.05. I tell the government that I want to be taxed at a level$3421.05 lower than I am actually getting paid (over the year), giving me an extra $1300/26 = $50 per paycheque. In theory this is good, but my brother discussed two potential problems with this.

First is the timing. My claim is to be taxed at a level $1950 lower. What the government did is approved this, but asked the $1950 to be taken off my last six pays of the year. I anticipated this over the entire year (giving me an extra $28.50 per pay using the 38% above), instead of $123.50 that it will work out this way. Money is money I guess, but it is a nice luxury for the rest of the year.

Second is the wording. My brother thinks that instead of my taxable income dropping (which is what I want) that my taxes will drop $1950 for the rest of the year. Divide this by 6 and you get an extra $325 cash each paycheque and the likelyhood that I will have to pay into taxes in March. I still don't think this is the case, but the seeds of doubt have now been planted.

I will post two weeks from now (when my paycheque has been changed) and let you know how it worked out from me. If it works the way I think it will, I will do this every year, as a few extra bucks during each pay make the cash flow (and loan payments/etc.) nicer and I don't think I need that huge cheque from the tax office each spring.

Less Taxes

I have finally filled out my Form T1213, Request to Reduce Tax Deductions at Source, where the government will tax me less each pay cheque because of my RRSP deductions. The math behind this is because they are over taxing me I get back several thousand dollars at income tax time. If I get a little bit more each paycheque, they will hold onto less tax on my behalf, and I will be able to earn interest on this money (or pay off loans...which is what I plan to do with it).

I have thought about this a bit, and am only having them deduct half of my RRSP deductions, leaving the other half for myself at income tax time. The reason for this is threefold: first, I like getting a little bit of money back at tax time, second, I wouldn't want to try to plan it to the nearest cent and then owe money in March and third, because I took advantage of the Home Buyers Plan, I will start repaying it this year, so I need some of my RRSPs to do so.

I will know in 2-4 weeks if this actually goes through, but I expect that it would. All I needed to send them was a copy from my bank (you can get it from your work if they take RRSPs from you) of my regular payment plan. Once it goes through, the government sends notification to your work and your taxes get lowered. It’s as easy as that! I'll repost on here when it actually goes through.

RRSPs vs. TFSA

This post will help me to organize my ideas about whether it is better to invest in a Registered Retirement Savings Plan or a Tax Free Savings Account. Of course, it is best to maximize them both, but this post is for those (like myself) who are unable to do so).

RRSPs
- can hold any investment (within reason) within your RRSP
- get an immediate tax rebate from your deposits (so if your marginal tax rate is 40% and you invest $1000 into your RRSP, you get $400 back from the government)
- interest grows tax free inside your RRSP
- you must begin withdrawing at age 65
- you get taxed on any amount that you withdraw (you are deferring your taxes on this money...instead of paying them now (when you probably have less money), you will pay them later (when you probably have more money)
- maximum contribution rate is 18% of your previous year's income up to a maximum of $21000 less the Pension Adjustment on your T4 slip

TFSAs
- even though it is called a "Savings Account" you can still hold most investments within your Tax Free Savings Account (I have a bond index fund for mine)
- interest grows tax free inside your TFSA
- you have already paid taxes on your money now, so no immediate tax benefits, but when you withdraw the money, you do not have to pay taxes on it
- maximum contribution is $5000 (although this is expected to go up slightly as time continues)

From a mathematics standpoint, lets show what is the best deal for people to do, and then the reality:

My example will be a single $5000 deposit, earning 5% per year, at a tax rate of 35%, grown over 10 years.

RRSP:
- $5000 invested, $1750 credit now,
- if you reinvest this $1750, you will end up with $10,995.04 at the end of ten years
- assuming the tax rate is still 35% when you withdraw, you will have $7146.78

TFSA
- $5000 invested, $0 credit now
- valuation after ten years is $8144.47

So what is the better option? It is different for everyone, but this is how I see it:

RRSP - great having a tax break now! Even though it ends up as a little less money in the long term, most adults are in a worse current financial situation than they are in the future. The other sad reality is that the $1750 credit I don't think is always reinvested, making the TFSA a much better plan. The final benefit to an RRSP is that the money is locked away (at least until you buy a house), so that you don't have access to it.

TFSA - financially this makes the most sense, but there is the human factor to consider. This money is not locked in. There is never a penalty to withdraw, so if you need money you can go into this fund. As long as you consider this money in your TFSA to be retirement money that you cannot touch, this is the better option.

Taxes

We all want to pay the least taxes possible. With RRSP contributions, and taking courses, and donations I always get back several thousand dollars in income tax in the spring. Starting this year, I will have to re-pay my Home Buyers Plan, which will only be a few hundred dollars from my RRSPs deducted.

The question that I am asking is this: "Is it better to receive several thousand dollars at income tax time" or "Is it better to have your employer reduce the taxes withheld on each paycheque giving you more money every paycheque" or "Is a balance better (a slight drop is taxes and a smaller income tax cheque in March)". I will analyze the three options as best as possible.

Option 1: Receiving money at income tax time - Up until now I really liked this option. Getting an extra paycheque (or two) in March would always do wonders for my net worth spreadsheet and it was nice to put some savings and pay off some loans with that money. The problem is that this is not the most efficient way.

Option 2: Is it better to have your employer reduce the taxes - For ease of calculation, lets assume that I get back $2600 at income tax time. This averages out to $100 per paycheque that the government has taken from me. Mathematically, it makes much more sense (both for my cash flow and total net worth) to have my employer drop by taxes by $100 per paycheque and then get back no money in March. Remember that the government isn't paying you interest on the money it holds, so whether you pay it on credit card bills, or on your mortgage, or invest it, you will be way ahead.

Option 3: Have taxes reduced now and get some back in March - Unfortunately, we really have little idea how much money we will be getting back at income tax time. My biggest fear is always to have to write any cheque, and a cheque to the government in March would not be pleasant. This third option (the one that I will go with) will be to take whatever your income tax credit was last year, and divide it in 2 (and then by 26) and have your taxes cut by that amount each paycheque. In my above example, I got back $2600. I will cut this in half to $1300, and then divide it by 26, giving me an extra $50 per paycheque. In this way, I will also get $1300 back at income tax time. Even if there is a slight change in taxes (positive or negative), there is a guarantee that my paycheque will be larger and I will still get money back at tax time.

Does this make sense? I will go with Option 3, but Option 2 is much more optimized. Leave a comment with your opinion.