Tell me More About my Options: Financial Pop Quiz
November marks “Financial Literacy Month”, and represents a great opportunity to bone up on all things personal finance. The key to achieving your goals is to understand the steps you need to take to get you there.
Like baking a cake, driving a car or doing long division, financial literacy is a skill like any other, and requires practice, teaching and learning. Embrace financial literacy and the role it can play in keeping your financial picture healthy.
Although your eyes may glaze over when conversation turns to all things financial, knowledge is power. Power gives you control, and the momentum to achieve financial goals, beyond simply paying down debt.
To give you a crash course, here are two types of tax-sheltered investments that are commonly used by Canadians- but are at times misunderstood.
RRSP (Registered Retirement Savings Plan)
A common misunderstanding surrounding this one is that an RRSP is an investment in and of itself- it’s not. It’s a tax sheltered collection of investments of your choice (including stocks, GIC’s, mutual funds and a host of others). Taxes that you would pay on the growth of these investments is deferred until you are retired, and you draw from these savings like income (assumedly are in a lower tax bracket than you are currently). Additionally, the government sweetens the deal by offering tax deductions on contributions. Think of an RRSP like a basket, in which you place investments to be used later.
There are a number of other rules surrounding RRSP contributions (including a maximum annual contribution amount). There are numerous resources available, but here are all the “rules” http://www.cra-arc.gc.ca/tx/rgstrd/rrsprrif-reerferr/bt-eng.html.
Although retirement may seem a long ways off, RRSPs serve other uses too- including for first time homebuyers. The government permits first time homebuyers to draw on their RRSP savings to fund a down payment, without tax consequences (up to $25,000 in a calendar year). The deal is that you have to agree to repay what you’ve taken out back into your RRSP over a 15 year period.
RESP (Registered Education Savings Plan)
Again, this investment vehicle is tax sheltered. Instead of encouraging you to save for your retirement though, this option is geared towards helping you save for your child’s education.
Simply, a subscriber (the person who opens the plan and makes contributions), opens a RESP plan on behalf of a beneficiary (this is not limited to a parent-child relationship either. An adult can open a plan on behalf of nieces, nephews, grandchildren or even family friends).
After high school, the child withdraws money from the RESP to pay for education at an apprenticeship program, CEGEP, trade school, college or university.
Contributions are matched by the government through the CESG (Canadian Education Savings Grant) – which essentially matches 20 cents on every dollar you contribute, up to a maximum of $500 on an annual contribution of $2,500. There are options to carry forward, as well as for potentially larger CESG contributions, depending on family income. This grant continues until the child turns 17.
Like an RRSP, an RESP can hold a variety of investments, and also like an RRSP, income is pulled out when in a lower tax bracket (your child is receiving the income as a student and is in a low tax bracket).
Like RRSPs, RESPs come with their own set of rules (including how and where the funds can be used when withdrawn). Here is a good resource for those: http://www.hrsdc.gc.ca/eng/jobs/student/savings/index.shtml