Pay down your mortgage or invest in your RRSP?

In response to my RRSP week, there have been quite a few questions regarding the effective use of the homebuyers plan; again I approached Aaron Theilade from Investors Group for some guidance.

 

Does it make more sense to pay off your mortgage or to invest in a Registered Retirement Savings Plan? Perhaps you’re expecting to receive some extra money from an inheritance or an employment bonus, and you’re not sure which route to take. The truth is, there is no easy answer. There are many variables that must be taken into account. Concentrating on paying down a mortgage may be the best route for one person, while focusing on an RRSP may benefit another. Here are some factors to consider:

♦ Your age. When you’re young, it is wise to make your RRSP a priority. The sooner you get money into a sheltered retirement plan, the longer it will grow on a tax deferred basis. But don’t overlook the need to build home equity. It can give you a head start on the expenses of moving to a larger home as your family grows.

 

♦ Your income. The more you earn, the higher the rate of tax you’ll pay. That means you must earn more in before-tax dollars to make mortgage payments. If you’re a high income earner you may want to quickly reduce this expensive debt.

 

♦ Investment returns. Pay attention to the general rate of investment returns you could reasonably expect to earn when you make your decision. Astute investors could be further ahead by investing their money than paying down the mortgage. The benefits of investing are magnified by an RRSP, with tax-deferred growth within the plan and the tax deductions on contributions.

 

♦ Your mortgage rate. If your current mortgage rate is low, it may make more sense to invest in an RRSP. In times of good returns for financial markets, low borrowing costs make a compelling case for contributing to your RRSP.

RRSP Home Buyers Plan (HBP)

Continuing with this weeks topic the RRSP Home Buyers Plan (HBP) today we are going to talk about how to participate in the plan and what specific conditions that need to be met.

For the T1036 form please visit my website at www.tddave.com under useful forms.

Participating in the Home Buyers’ Plan

After you meet all of the conditions for participating in the HBP:

1. Complete Form T1036, Home Buyers’ Plan (HBP) – Request to Withdraw Funds from an RRSP.

You have to fill out Form T1036, for each RRSP withdrawal you make. After completing Area 1, give the form to your RRSP issuer, who will complete Area 2.

Your RRSP issuer will not withhold tax from the funds you withdraw if you meet the HBP conditions.

You can withdraw a single amount or make a series of withdrawals throughout the same year and January of the following year, as long as the total of your withdrawals is not more than $20,000.

If you buy the home with your spouse or common-law partner, or other individuals, each individual can withdraw up to $20,000 from his or her RRSP, provided each of you meet the HBP conditions.

Example
On October 15, 2006, Charles withdrew $7,500 from his RRSP under the HBP. Before the withdrawal, Charles had entered into a written agreement to buy a qualifying home. In March 2007, he withdrew an additional $1,500 to pay expenses he had not anticipated.

Because Charles’ second withdrawal was received after January 2007, it is not considered an eligible withdrawal and must be included in his income for 2007.

Your RRSP issuer will send you a T4RSP, Statement of Registered Retirement Savings Plan Income, showing the amount you withdrew under the HBP in box 27. You have to attach this slip to you income tax return.

Note
If the total of your RRSP withdrawals under the HBP is more than $20,000, you will have to include any excess withdrawn as income on your return for the year you receive it. In addition, your RRSP issuer has to withhold tax on the excess amount at the time of the withdrawal.

2. File an income tax return.

Starting in the year you make your first HBP withdrawal and for each following year, you have to send us a completed income tax return until you have repaid all HBP withdrawals or included them in your income. You have to file a return even if you do not owe any taxes. Attach the T4RSP slips your RRSP issuer sends you for your HBP withdrawals to your return.

Complete Schedule 7, RRSP Unused Contributions, Transfers, and HBP or LLP Activities, to show your total HBP withdrawals on line 15 or to enter the amount you repaid for the year on line 6. Attach Schedule 7 to your return.

Do not include any RRSP contributions designated as an HBP repayment on line 208 of your return.

Home Buyers’ Plan (HBP) RRSP Withdraw for First Time Home Buyers

Lately I have come across a higher number of clients who are interested in the RRSP early withdraw plan for first time home buyers. This week I will focus on Home Buyers Plan, and some tips that clients have found useful.

The Home Buying Plan is a great way to help you acquire the necessary down payment to afford a home, the benefit is that you are really borrowing from yourself  interest free!  The loan from your RRSP’s must be repaid within 15 years and can be set at varying lengths of amortization depending on the institution who is providing the loan. Do not attempt to pay the loan off in 1-2 years,  we have all been taught to be adverse with debt but opting to pay off the loan in 1-2 years can lead to serious cash flow problems, and financial upset.

Because the loans are on the total principle withdraw from the RRSP they can easily add up. Understand that you are not paying any interest on this loan but if you take a $15,000 RRSP loan out and take a two year repayment the monthly payment will be $625 high enough to seriously disrupt your cash flow, but if you take a 5 year repayment it becomes a more manageable $250 per month

Today’s topic is the conditions for the HBP, one of the most important things to ensure is that you must be a first-time home buyer. Several files that have crossed my desk recently I have had a number of folks who whish to use the program but have obviously purchased quite a number of homes before, this will not fly with CRA.

Below are the conditions that the CRA presents for participation

Conditions for participating in the HBP

Only the individual who is entitled to receive payments from the RRSP (the annuitant) can withdraw funds from an RRSP. You can make withdrawals from more than one RRSP as long as you are the annuitant (plan owner) of each RRSP. Your RRSP issuer will not withhold tax on these amounts.

Generally, you will not be allowed to withdraw funds from a locked-in RRSP.

To participate in the HBP, ONE of the following conditions must apply:

* You are withdrawing funds to buy or build a home for yourself as a first-time home buyer.

or

•    You are withdrawing funds to buy or build a home for a related person with a disability .
•
In addition, ALL of the following conditions must apply:

* You must enter into a written agreement (Offer of purchase) to buy or build a qualifying home. The agreement may be with a builder or contractor, or with a realtor or private seller. Obtaining a pre-approved mortgage does not satisfy this condition.
* You intend to occupy the qualifying home as your principal place of residence.
* Your repayable HBP balance on January 1 of the year of the withdrawal is zero.
* Neither you nor your spouse or common-law partner owns the qualifying home more than 30 days before the withdrawal.
* You are a resident of Canada.
* You buy or build the qualifying home before October 1 of the year after the year of withdrawal.

You are responsible for making sure that all HBP conditions that apply to your situation are met.

If a condition is not met while you are participating in the plan, your RRSP withdrawal will not be considered eligible. You will have to include the RRSP withdrawal as income on your income tax return for the year you received the funds.

If you do not meet the conditions to participate in the HBP in the current year, you may be able to participate at a later date.

RRSP Transfers – Tax Benifical Tactics

Interesting article on RRSP transfer, although Mr. Drache admits that none of these planning tips are new or unique they can be quite helpful when properly executed, and in Canada where we already pay a large amount of tax every little tip can help.

The only thing to note is that although Mr. Drache recommends that the RRSP loans be repaid as timely as possible (as the interest is not tax deductible ) I have found that clients should select the full 15 years to repay and simply pay double the amount of the monthly payment. If a one or two year term is selected that I have found that clients become burdened with heavy payments that erode household cash flow.

Transfers a useful RRSP move

Get expert advice to be sure your moves are OK

Arthur Drache, Financial Post Published: Tuesday, February 19, 2008

As the contribution limit to RRSPs has crept up over the years ($19,000 for 2007), many individuals have found it more and more difficult to get the funds to make annual contributions.

One approach is to borrow the funds to make the contribution and pay down at least a portion of the loan out of the associated tax refund.

While there is nothing wrong with this strategy, it does take a certain amount of self-discipline to ensure the loan is repaid as quickly as possible. This is important because the interest on the loan is not deductible.

Another possibility is to make a transfer of capital property held personally to the RRSP. Where such a transfer is made, the RRSP contribution is equal to the fair market value of the property in question. And while this may be an attractive proposition for many, there are a number of key points to bear in mind.

The property must be such as to be eligible to be held by RRSPs. This is seldom a problem, but if what you are considering contributing is not a “normal” investment, check that it is OK. For example, some foreign bonds will qualify while others will not.

If the property has appreciated since you acquired it, there will be a capital gain on the transfer.

If the property has dropped in value since you acquired it, there will be no deduction for the capital loss.

Of course, when you are making such a transfer, you also have to keep in mind overall tax and investment strategy. While there is no tax on an RRSP, when payments comes out, they are added to income, even if they might otherwise have been subject to preferential tax treatment if the investment were personally held.

As a general rule, you may want to limit capital contributions to an RRSP to assets that do not pay dividends (as you will lose the value of the dividend tax credit), assets that are likely to produce capital gains (as the full gain will ultimately be taxed) and assets that have flow-through tax credits that will be wasted in the RRSP.

Thus, when you do make a transfer of assets to an RRSP, you should carefully assess the investment attractions of the asset to determine whether they are better off being held outside the plan.

We might note that for those who may be flush with tax, you can legally buy assets from your RRSP. Let’s say you feel that a particular asset that is held in the plan has significant new capital gains potential. You can buy the asset for fair market value, thus taking it out of the plan and putting it into your personal portfolio, where the tax-associated benefits may be maximized.

Given that the RRSP is tax-free, the fact that the asset may have appreciated significantly since the RRSP acquired it will not trigger a taxable gain within the plan.

None of these planning tips is new or unique, but given the pitfalls that might apply depending on the particulars of the case, it would be best to get some expert advice to make certain there are no unpleasant surprises down the line.

— – Arthur Drache, CM, QC, is an Ottawa-based lawyer at Drache Associates LLP and is associate counsel to Miller Thomson LLP.