Dealing With Savings, Death and the Tax Man
Learning is hungry work, which is why WealthBar hosts a weekly Lunch and Learn session for groups or individuals interested in learning the basics of saving, investing and planning for retirement — and lunch is on us!
Savings, death and the tax man. It sounds like a melodramatic script, but it’s actually the drama of your life savings. Like a basic storyline, your money will rise, hit a climax, fall, and end in denouement (not to be morbid, but that means death. Unless you’ve found the secret to immortality, which we hope you will share with us. We’re are of course, sharing valuable information with you).
To be the heroine or hero in your own financial story, you must know what to save, how to save, and where to save. Like all heros, success takes a little sacrifice, some practical knowledge and a reliable sidekick (i.e., WealthBar).
Thinking about the lifestyle you’ll have to give up in order to save money can be overwhelming. Saving does take some sacrifice, and life is expensive. But saving doesn’t have to be painful. Mostly, it requires you to flip the script on how you think about your monthly expenses.
Most people think of saving like this:
Essentially, this model encourages you to save whatever money you didn’t spend on lifestyle (coffee, dinners out, those fantastic pants). This makes the money you save a variable number that depends on the whims of that particular month.
Furthermore, it’s a mental buzzkill. No one wants to take away from their fun funds. If the options are to witness the full power of Beyonce in concert or put your money into savings, of course you’d rather spend the money on queen B. She’s amazing!
So at WealthBar, we propose a different model of saving:
This is the out-of-sight-out-of-mind approach to saving, or ‘paying yourself first’. When it’s not an option to spend, you won’t.
It sounds simple, but making small sacrifices to save is difficult in the moment, which is why it’s crucial to change your savings to a habit instead. We can all make poor choices in the moment, but habits will stick.
Every month, most of us earn a set income (with the exception of the self-employed), but when we retire, our savings becomes our income. In a sense, the ‘now you’ is paying the ‘future you’ a monthly salary (hence ‘paying yourself first’). For those who dream of self-employment, this means in retirement you will be your own boss — a lifelong dream realized!
The best way to accomplish this habit is to make it automatic. Literally. The day after you get paid, have the amount you want to save automatically withdrawn from your bank account to your investment account. You don’t have to decide every month how much to invest, and now you can leave those hard choices for the dessert aisle at the supermarket.
The Tax Man
The tax man is not always kind to our savings, which is why it’s important to know which saving tool works best for you to best keep the tax man at bay.
For simplicity’s sake, we break saving tools down into three options: Registered Retirement Savings Plans (RRSP), Tax-Free Savings Accounts (TFSA) and non-registered savings accounts.
An RRSP lets you contribute a certain amount each year depending on your income (see your notice of assessment from the CRA). When tax season comes around, the money you contributed to your RRSP will be deducted from your total taxable income. So, if you earned $40,000 and contributed $5,000 to your RRSP, your total taxable income will be $35,000.
The downside of the RRSP is that because they are taxed deferred–meaning taxes will have to be paid eventually–when you withdraw from the fund in your retirement, you have to pay taxes as if each withdrawal were your paycheque. So, if you take out $30,000 in a year, you’ll be taxed as if it is income. The goal then, is to withdraw it at a lower tax bracket in retirement.
A TFSA allows you to save up to $5,500 per year no matter what your income, but it does not grant you that same initial tax break as an RRSP. What it does offer you is access to your savings without the gains on your TFSA being taxed upon withdrawal. In other words, the taxman can’t touch the interest earned on your savings. It is tax-sheltered.
There is also a non-registered savings account, which has no contribution limit, but is not tax-deferred or tax-sheltered. Any money earned on your savings will be taxed as income, but at a lower rate.
Each of these savings tools has a different function and offers different benefits. To highlight how they differ, we have to talk about everyone’s least favourite subject: death.
“Nothing is certain but death and taxes.”
Daniel Defoe first wrote that proverb in The Political History of the Devil, and the saying is as true today as it was when he scribed it in 1726.
How you plan for retirement and eventual death–sorry, but you’re not immortal–will determine how your life savings will be passed on to those left behind.
An RRSP functions great in life, but in death, it can be terrible. When you die, your RRSP is passed to a beneficiary. When an RRSP is withdrawn, it is considered income, so it is taxed like income. When you’re alive, you can withdraw small amounts every year (after you turn 70 years old, the government insists you make yearly withdrawals), keeping you in a lower tax bracket.
When you die, the remaining amount in your RRSP is paid out in full to your beneficiary. The amount will be taxed on your post-mortem tax return because even in death, that money is considered your income. If there is a lot of money left in your fund, it will be taxed according to the income bracket, which can leave a major dent in the contribution you planned to pass on to your loved ones.
A TFSA can be passed on to your spouse or paid out to a beneficiary without being taxed. What can be taxed is any interest or dividends accrued after death. So if your TFSA is $50,000, and $3,000 was accrued between the time you died and the account was transferred, $3,000 is subject to being taxed.
A non-registered savings account functions after death much like a TFSA. The amount in the account is transferred to the beneficiary without being taxed, but any capital gains from growth will be taxed, because even in death, the tax man will be there.
An RRSP functions really well during your working years, but is prone to high tax rates in retirement and after death. The TFSA does not offer the same perk of being tax-deferred, but when drawn upon, the taxman can’t touch it. The non-registered account is great for those who can save extra, but offers no perks like being tax-deferred or sheltered.
Death is not the end of taxes and how you arrange your savings can make a major impact on the legacy you leave behind to your loved ones.
Understanding your money’s journey is essential to you taking the lead role in your financial story. At WealthBar, we can help you navigate the twists and turns life takes, while keeping you on the path to financial well being.
To learn more about saving, join us at a Lunch and Learn session or talk to one of our financial advisors. We go over these topics as well as what type of investments to put into these accounts, and more all in a single lunch.
If you’re ready to start saving and investing, it only takes a few minutes to get started.