Deposit Insurance at Canadian Credit Unions

Nickel at Five Cent Nickel posted recently about protecting credit union deposits in the United States. Nickel points out that the NCUA is a federal agency that adminsters the NCUSIF, which insures deposits at credit unions in a way similar to the protection provided by the FDIC.

I've written before about the equivalent insurance available to Canadians and Americans for assets held at a bank (CDIC / CDIC) or brokerage (CIPF / SIPC). I was interested to see yet another kind of asset protection, and I immediately started wondering whether Canada had equivalent protection for credit union members.

It turns out that there is similar protection in Canada, but it is structured differently.

Canada's credit unions and caisses populaires (as they are known in Quebec) are provincially incorporated, whereas credit unions in the U.S. are federally chartered entities. As a result of this, regulation of Canadian credit unions is almost exclusively at the provincial level. The CUCC is federally chartered and regulated, and receives some liquidity support from the Bank of Canada and the CDIC, and several provinces (Alberta, British Columbia, Manitoba, Nova Scotia, Ontario and Saskatchewan) have credit union centrals that are registered under both federal and provincial legislation.

Each province provides its own insurance on deposits at credit unions. The details by province are as follows:

• Alberta - Unlimited deposits protected under Credit Union Deposit Guarantee Corporation (CUDGC)


• British Columbia - Deposits protected up to $100,000 under Credit Union Deposit Insurance Corporation (CUDIC)


• Manitoba - Unlimited deposits protected under Credit Union Deposit Guarantee Corporation of Manitoba (CUDGC)


• Newfoundland - Deposits protected up to $250,000 under Credit Union Deposit Guarantee Corporation (CUDGC)


• New Brunswick - Unlimited deposits protected under Credit Union Deposit Insurance Corporation (CUDIC)


• Nova Scotia - Deposits protected up to $250,000 under Credit Union Deposit Insurance Corporation (CUDIC)


• Ontario - Deposits protected up to $100,000 under Deposit Insurance Corporation of Ontario (DICO)


• Prince Edward Island - Deposits protected up to $60,000 under Credit Union Deposit Insurance Corporation (CUDIC)


• Quebec - Deposits protected under l'Autorité des marchés financiers (AMF - I couldn't find details on a limit to the coverage)


• Saskatchewan - Unlimited deposits protected under Credit Union Deposit Guarantee Corporation (CUDGC)

Note that, as with protection provided by CDIC, eligible deposits must be in Canadian currency. There are some intricacies that vary by province, but in general the protection is comparable to that provided by CDIC (with the exception of the $60,000 limit in P.E.I.).

Comparisons in the air

Over at Four Pillars, there have been a couple of great posts recently comparing Canadian and American investment accounts. So far, the following comparisons are available:

• Canadian RRSP Vs. U.S. 401(k) Retirement Account Comparison


• Education Investment Accounts: Canadian RESP Vs. American 529 Comparison


• Updated: Canadian TFSA Vs American Roth IRA

The next post will compare Canada's new TFSA to the American Roth IRA.

This sort of cross-border comparison is exactly the kind of content I was looking for when I decided to start this blog. In fact, I've posted similar comparisons in my own lexicon series, as well as a post dedicated to comparing retirement and education accounts. Although I didn't go into as much detail with specific rules on the accounts, it's nice to see that I at least got my general facts straight (not surprising, considering I pulled a number of my RESP facts from Four Pillars' series on RESPs).

I have to hand it to the folks at Four Pillars for posting the content in a more Google-friendly format than my own comparisons; I'm frankly a little embarrassed to see my "Loonies And Savings Plans" title next to the likes of "Canadian RRSP Vs. U.S. 401(k) Retirement Account Comparison" and "Education Investment Accounts: Canadian RESP Vs. American 529 Comparison". Which do you think is more likely to come up in a Google search?

It's great to see this sort of analysis being posted. I think it's useful for people on both sides of the border to see how the other side has structured things. Knowing the similarities and differences between the two systems helps to understand how to get the most benefit out of your own investments.

The P2P lending minefield

Social lending has been in the news a lot in the past few months. Canada's first P2P lending community launched in February, and was promptly shut down pending resolution of some regulatory issues. As of today, the IOU Central platform is still "operating with limited functionality".

This week has seen some more interesting news on the P2P lending front. On Monday, Lending Club announced that they would suspend the ability to invest using their site, while keeping the borrowing functionality intact. Yesterday, I received an e-mail from CommunityLend, stating that they are getting close to a launch, and are asking for input on forming "borrower groups", presumably to assess the demand for loans so they can attract sufficient investors when they launch.

I imagine that, given the issues that have hit IOU Central, CommunityLend is being extra cautious, trying to avoid any false starts. This seems to be a prudent approach to take, particularly in such a new and untested (at least in Canada) industry. I'll be keeping an eye on this site; I have a feeling that when they open their doors, things will get interesting.

Here's the text of CommunityLend's e-mail:

Hello and Good-day from CommunityLend

If you are new to the CommunityLend mailing list, welcome to the family and thank you! Your support means everything to us. If you have been around for a while, you will remember that about four months ago we sent out an email with a few major announcements, including our funding and expanded team. We have kept relatively quiet over the past ten months while we have been consulting with the Canadian regulators. At the beginning of April we decided it was time to begin the ramp up to our launch.

Today we want let you all know that our site has received a major overhaul. The new look and feel is based on our launch design and we would love to hear what everyone thinks!

As you may have guessed we are now getting close to launching our service. In the next few months we will be regularly posting on our newly launched blog and making important announcements in our press release section. Our most recent announcement is on the formation of our Board of Advisers. We are very excited to have so much active support from such a fantastic group of people.

We would also like to draw your attention to our expanded management team, which is constantly growing as we move closer to full operations.

Finally, we would like to request that anyone who is interested in setting up a borrower community on CommunityLend contact Dave Coleman, our Community Advocate. Communities can be a great way to connect with people who share similar interests and help each other out financially. Examples are ethnic groups, interest groups, or even industry groups that want to use CommunityLend as a way to help finance their clients; the list goes on. If anyone is interested in starting a community, please do not hesitate to contact us.

Please note however that at this time, we are looking for borrower groups only. We will hold off on the creation of lender groups until our regulatory applications are approved and we are closer to launch.

Once again thank you for your interest in CommunityLend. Your help and support is invaluable!

-The CommunityLend Team

Loonies And Lexicons: Part 2

It's been a while since I wrote my Loonies And Lexicons post. Since then, I've noticed that I'm using the <acronym> tag an awful lot to translate the acronyms and abbreviations that I use. While I plan to continue to define these abbreviations for clarity's sake, I thought it would be worth taking another look at the Canadian terms and short forms that I use on the blog, in order to spell out their meaning in a little more detail (and all in one place). So, to readers on both sides of the International Boundary, welcome to the second edition of my cross-border glossary:

TFSA

Tax Free Savings Account. Coming in 2009, this was one of the most exciting items in this year's federal budget. Similar to the American Roth IRA, the TFSA will allow Canadians to contribute after-tax money (up to $5,000 per year) and have that money grow tax-free. The money can be withdrawn at any time, and withdrawals free up contribution room, so you can "refund" your withdrawals over time. This account is basically the mirror image of the RRSP, which offers a tax break at the time of contribution; the TFSA instead offers a break at the time of withdrawal.

BoC

Bank of Canada. Equivalent to the Federal Reserve in the US, this is Canada's central bank. The BoC sets monetary policy, issues currency, and manages funds for government and banks. The BoC tends to make the news whenever it announces changes to the prescribed interest rate.

CIPF

Canada Investor Protection Fund. Where the CDIC (or FDIC in the USA) insures bank deposits against bank failure, some limited protection is provided to investors holding non-cash securities. This protection is provided by the CIPC in Canada, which is equivalent to the American SIPC.

CPP/QPP

Canada Pension Plan/Quebec Pension Plan. These pension plans are funded by contributions by employers and employees. Your pension at retirement is determined by the amount you contributed to the plan during your earning years, as well as how long you contributed to the plan, and this income is taxable. This is equivalent to Social Security in the United States. Employees working in the province of Quebec contribute to the QPP, while employees working outside Quebec contribute to CPP.

OAS/GIS

Old Age Security Pension/Guaranteed Income Supplement. The Old Age Security Pension is a monthly payment eligible to most Canadians 65 or older. This pension is not based on contributions to a fund, but is rather based on the number of years you have lived in Canada. OAS income is taxable, while GIS is not. If your income is above the maximum ($64,718 for OAS or $15,240 for GIS), then a portion of these benefits is subject to a "claw-back". For OAS, the claw-back is 15% of every dollar of income over $64,718, and for GIS, it is 50% of every dollar over $15,240.

EI

Employment Insurance. Formerly UI, this program provides income support to cover temporary loss of employment income. This covers people who are between jobs, or are unable to work for various reasons, including parental leave. Employees contribute to this program through payroll deductions, and benefits are determined based on premiums paid and employment history.

ULOC

Unsecured Line Of Credit. As far as I've been able to tell, this is a product that does not exist in the United States. This is essentially a middle ground between credit card and a HELOC. The product works exactly like a HELOC, but does not have any collateral against the loan. ULOCs often provide free cheques and unlimited free transactions, so for the financially savvy, a ULOC can actually serve as a no-fee chequing account.

CAA

Canadian Automobile Association. Exactly equivalent to the AAA, this is our roadside assist/travel planning club of choice. With a CAA membership, we get free AAA maps and tour books whenever we need them, as well as member discounts at select hotels and other merchants.

Claiming the tax credit for charitable donations

Canadians can generally receive a non-refundable tax credit for charitable donations up to 75% of their net income (i.e. income minus deductions). I wrote a long post last month on the calculation of Canadian income tax, and in this post I mentioned that, for couples filing jointly, charitable donations should be pooled onto a single tax return.

The reason for this is that the first $200 of donations that you claim generate a credit at the lowest marginal tax rate (21.05% in Ontario for 2007), while anything over $200 is credited at the highest rate (40.16% in Ontario for 2007). If a husband and wife each donated $300 to an eligible charity this year, and claimed the donations individually, then each person would receive a 21.05% credit on the first $200, and a 40.16% credit on the last $100, for a total credit of $42.10 + $40.16 = $82.26 each. If, on the other hand, the entire $600 were claimed on a single return, then the the total credit would be $42.10 + $160.64 = $202.74, or $101.37 each. That's $38.22 in extra tax savings for the couple, just for claiming the donations jointly.

Until recently, I was under the impression that it doesn't matter which return you claim the taxes on, provided both returns have taxes against which to apply the credit. However, as I discovered while going over our own taxes last week, it does make a difference. The main reason for this is the provincial surtax, which is added if your provincial taxes owing are over a certain amount. In Ontario, for 2007, the surtax is 20% on taxes between $4,101.01 and $5,172, and 56% on taxes over $5,172. Because the surtax is calculated after applying any credits, the benefit of a tax credit is greater for taxpayers in higher provincial income brackets.

If your Ontario taxes (before credits and surtax) come to $4,000, then a $1 provincial credit saves you $1 in taxes, since you are below the surtax limit. However, at $5,000, your $1 credit saves you $1.20, and at $6,000, it saves you $1.56. For the $600 donation example above, the $202.74 credit is made up of $146.00 federal and $56.74 provincial. This means that someone with $4,000 in provincial taxes would save $56.74, while someone paying $6,000 would save $88.51. Clearly, it makes sense for the donations to be claimed by the person with higher total taxes.

By claiming our $1,300 in 2007 donations on my own return instead of Ms. Loonie's return, we end up saving an extra $75 in taxes as a couple. That's $75 that we can divvy up between us however we want.

Who are we to turn down free money?

Making sense of income tax

With February out of the way, and the associated deluge of RRSP advertising put to rest for another year, it's time for the push to get your tax return filed. Canadians have until April 30 to file their tax return, and this is the time of year when we traditionally shove a pile of paperwork at our accountant, and hope for the best.

Although there can be a lot of number crunching involved, preparing a personal tax return can actually be pretty straightforward. I thought I'd post a general summary of the calculation of Canadian income tax.

The Basics - Marginal vs. Average Tax Rate

At its most basic, income tax represents a percentage of the income that you make in a year. If you divide your total income tax for the year by your total income for the year, you get your average tax rate. You will rarely see two people with the same average tax rate, unless they have exactly the same income. This is because income tax is actually calculated as a percentage of marginal income earned within tax brackets. For 2007, the federal tax brackets and marginal tax rates were as follows:

• $0.01 - $37,178.00 - 15% tax


• $37,178.01 - $74,357.00 - 22% tax


• $74,357.01 - $120,887.00 - 26% tax


• $120,887.01 and above - 29% tax

Therefore, if you had income of $40,000, you would pay 15% on the first $37,178 ($5,576.70), and 22% on the next $2,822 ($620.84), for a total of $6,197.54 in federal tax, giving an average federal tax rate of 15.5%.

Each province has its own marginal tax rates, which are calculated on top of federal taxes. In Ontario, for example, the 2007 provincial brackets were as follows:

• $0.01 - $35,488 - 6.05% tax


• $35,488.01 - $70,976.00 - 9.15% tax


• $70,976.01 and above - 11.16% tax

Therefore, if you had income of $40,000, you would pay 6.05% on the first $35,488 ($2,147.02), and 9.15% on the next $4,512 ($412.85), for a total of $2,559.87 in provincial tax, giving an average provincial tax rate of 6.4%.

That's the basic method of calculating income tax. Here is the CRA's list of 2007 tax rates.

Now we can get into some of the other factors that affect your income tax.

Income

Not all income is created equal. Employment income is fully taxable, while scholarship income for post-secondary students is entirely tax-free, and investment income has special tax rules. For a full breakdown of the treatment of various income sources, refer to the CRA's guide to total income for 2007.

Deductions

Deductions reduce the income on which you must pay taxes. You could say that tax deductions come off the "top" of your income, so you end up paying less tax in your top tax bracket. For example, if someone has $40,000 in income and claims a $1,000 deduction, then their taxable income drops from $40,000 to $39,000. This means that the amount of income taxed at a federal rate of 22% drops from $2,822 to $1,822, for a tax savings of $220. Compare this to someone earning $35,000, who also claims a $1,000 deduction: their federal tax savings will be only $150.

In general, tax deductions favour higher earners, since the tax savings happen in a higher tax bracket.

Examples of tax deductions are RRSP contributions, union dues, and job-related moving expenses. For a full list, refer to the CRA's list of 2007 federal deductions.

Non-refundable Tax Credits

Whereas tax deductions come off the "top" of your income, credits come off the "bottom", meaning they represent a tax savings in your lowest tax bracket. Take, for example, our $40,000 and $35,000 earners from above. If each of them claims a $1,000 federal tax credit, then they will each save $150 in federal taxes.

The "non-refundable" nature of the tax credits simply means that these credits can only be used to offset taxes owing; if you owe $100 in taxes without any credits, and claim a $1,000 credit, you will owe $0 in taxes, as opposed to being owed $50 by the government. In most cases this extra $50 can be carried over to the next tax year.

Tax credits are considered more equitable than deductions, since they do not favour high-income taxpayers over low-income individuals.

Examples of non-refundable tax credits are the Basic Personal Amount, the Canada Employment Amount, and CPP and EI contributions. For a full list, refer to the CRA's list of 2007 federal credits.

Charitable Donations

Charitable donations are treated as a tax credit, but there's a slight twist. The first $200 of donations in a given year generate a credit in your lowest bracket, and any amount above $200 generates a credit in the highest bracket (regardless of whether you have income in that bracket). This means that a donation of $300 would translate to a $200 federal credit at 15%, and a $100 credit at 29% regardless of your income.

If you are filing jointly with your spouse, you can (and should) pool your donations together on one return. If each spouse makes a $300 donation and claims it individually, then each spouse will have a federal tax savings of $59 (15% of $200 plus 29% of $100), for a household total of $118. Compare this to one spouse claiming $600 in donations, for a federal tax savings of $146 (15% of $200 plus 29% of $400). Similarly, if you plan to donate $300 this year and next year, it may be more beneficial to wait until next year to claim this year's donations. The idea is to minimize the number of "transactions" that are subject to the $200 threshold.

Other Taxes

Ontario residents pay a health premium, based on their income level, to subsidize health care. Several provinces, including Ontario, are also subject to a provincial surtax. For example, the 2007 Ontario surtax applies to provincial taxes as follows:

• $0.01 - $4,100.00 - 0% surtax


• $4,101.01 - $5,172 - 20% surtax


• $5,172.01 and over - 56% surtax

Note that the surtax is applied to the provincial taxes owing, not to taxable income. If an individual owes $6,000 in Ontario taxes, then their surtax will be 20% of $1,072 ($214.40) and 56% of $828 ($463.68) for a total surtax of $678.08.

A good rundown of all the provinces' applicable taxes is provided at Taxtips.ca.

Pulling It All Together

That's a lot of material to digest, so let's bring everything together with an example. I'm most familiar with Ontario taxation, living as I do in Toronto, so this will be an Ontario-centric example.

Particulars

• Employment income: $50,000.00


• RRSP contributions: $5,000.00


• Charitable donations: $500.00


• Income tax withheld by employer: $9,500.00


• CPP contributions paid: $1,989.90


• EI premiums paid: $720.00


• No "special" credits apply

First, let's calculate our friend's taxable income. The $5,000 RRSP deduction takes total taxable income down to $45,000. This is the amount that is subject to federal and provincial taxes. The taxes owing would be calculated as follows:

Federal Tax

• 15% of $37,178 = $5,576.70


• 22% of $7,822 = $1,720.84


• Total federal tax = $7,297.54

Ontario Tax

• 6.05% of $35,488 = $2,147.02


• 9.15% of $9,512 = $870.35


• Total Ontario tax = $3,017.37

This gives us the gross federal and provincial income tax amounts. Now, let's determine the non-refundable tax credits:

Federal Non-Refundable Tax Credits

• Basic Personal Amount = $9,600


• Canada Employment Amount = $1,000


• CPP Contributions = $1,989.90


• EI Premiums = $720.00


• Total federal credits = 15% of $13,309.90 = $1,996.49

Ontario Non-Refundable Tax Credits

• Basic Personal Amount = $8,553


• CPP Contributions = $1,989.90


• EI Premiums = $720.00


• Total Ontario credits = 6.05% of $11,262.90 = $681.41

Now factor in the charitable donations:

Federal Tax Credit

• 15% of $200 = $30


• 29% of $300 = $87


• Total federal credit = $117

Ontario Tax Credit

• 6.05% of $200 = $12.10


• 11.16% of $300 = $33.48


• Total Ontario credit = $45.58

Now determine the net taxes owing:

Federal Tax

• Gross income tax = $7,297.54


• Non-refundable tax credits = $1,996.49


• Charitable donation credit = $117.00


• Net federal tax = $5,184.06

Ontario Tax

• Gross income tax = $3,017.37


• Non-refundable tax credits = $681.41


• Charitable donation credit = $45.58


• Net Ontario tax = $2,290.39

Since the net Ontario tax is below $4,100, there is no applicable surtax. This individual's taxable income is $45,000, which translates to a $450 Ontario health premium. Therefore, the total taxes owing are as follows:

• Net federal tax = $5,184.06


• Net Ontario tax = $2,290.39


• Ontario health premium = $450.00


• Total tax payable = $7,924.44

This individual owes $7,924.44 in taxes for the year. However, because the employer has already withheld $9,500 in income taxes, there will be a tax refund of $1,575.56.

That's the basic nuts and bolts of how taxes are calculated in Canada. There are, of course, more complicated situations, for which a tax professional should be consulted. At the very least, however, this guide should help you to estimate your own return, so you know roughly what to expect.

Changes coming to RESPs?

This week, the House of Commons passed a bill that would provide a tax deduction for RESP contributions. The bill still needs to be approved by the senate, but it's an interesting idea.

Currently, RESP contributions are made with after-tax dollars, and compound tax-free until they are withdrawn by the beneficiary for post-secondary education purposes. At withdrawal, the investment income is taxed to the beneficiary, at their (usually low) marginal rate. Under the proposed bill, up to $5,000 in annual contributions would qualify for a tax deduction, similar to RRSP contributions. This would represent a fundamental change in the tax treatment of these plans, and potentially provide a much greater incentive for parents to contribute to their children's plans.

I've written before about the benefits of contributing to RESPs, essentially looking at this plan as a sort of "education insurance", but this new bill would significantly change some of the assumptions. Let's look at a simple example to determine what the impact of this change might be:

Assumptions

• One-time RESP contribution of $5,000


• CESG match of $500


• Contributor marginal tax rate = 43.41%


• Beneficiary marginal tax rate = 22.15%


• Investment growth = 8%


• Inflation = 3%


• 18 year investment period

The $5,000 contribution would generate an immediate tax savings of $2,170.50 for the contributor. In future dollars (i.e. after 18 years' inflation at 3%), this would be $3,695.13. The $5,500 (contribution plus CESG match) would grow to $21,978.11 after 18 years of 8% growth. Assuming that the beneficiary withdrew this entire amount for education purposes at the 18 year mark, they would pay $4,868.15 in taxes (since taxes would presumably be paid on both the contribution and the investment income). This represents $1,173.02 in net taxes paid (i.e. taxes paid by the beneficiary minus taxes saved by the contributor).

Compare this with the current rules, where the beneficiary would pay tax only on the $16,478.11 investment income, for a net taxation of $3,649.9 (since the contributor does not have any up-front tax savings). This is $2,476.88 more than the taxes paid under the proposed system.

Based on this example, it seems that the proposed tax deduction would result in a much more tax-efficient way to save for education, especially if the contributor were to put the $2,170.50 tax refund in a TFSA for some additional tax-free growth.

What do you think about this idea? Have I missed anything?

Another nice tax surprise

After last week's realization that Ms. Loonie would owe $2,500 less than expected on her 2007 tax return, I've been on the lookout for other hidden gems in the income tax rules.

Well, faithful reader, you will be delighted to learn that I've found another unexpected tax credit for which I (and many other Canadians) will qualify: the Canada employment amount. This is a federal non-refundable tax credit for taxpayers who received employment income for the year. You can claim the lesser of $1,000 or your total employment income (lines 101 and 104 of your tax return).

I earned just a smidge over $1,000 in 2007, so I'll be claiming the full $1,000 credit. At a tax rate of 15%, this translates to an additional $150 in my pocket.

Given that I stopped commuting to work just after the public transit amount came into effect, it's nice to have one of these new credits actually apply to me.

Who doesn't love finding $150?

If I don't roll up the rim, who will?!

This afternoon, I had a moment of weakness, and went down to the Tim Hortons in the food court to get a half-coffee/half-hot chocolate (a café mocha without the whipped cream). Much to my surprise, I was handed a Roll Up The Rim To Win cup. It turns out, this year's iteration of the annual promotion/sweepstakes has been running for over a week.

A year ago, I would have known about this within hours, not days. I guess I really have changed some habits in the past year. Without really noticing myself doing it, I've ditched my daily Tim Hortons habit, and turned their coffee into a once-in-a-while treat.

For those of you who just can't get enough of rolling those R's, you can track one blogger's adventures at this new website.

I haven't finished my coffee yet, but I'll let you know if I win the Bayliner bowrider or the Toyota Matrix.

Happy rrrolling...

RIP, Jeff Healey

Sad news for Canadian music fans: Jeff Healey passed away yesterday at the age of 41 after a lifelong battle with cancer.

Jeff is a Canadian music legend, well known for his signature "overhand" guitar playing style and his extensive body of work. In recent years, he had become extremely active in the Toronto jazz music scene, as both a performer and an afficionado.

We'll miss you, Jeff.

Early RRSP withdrawals

I seem to have savings and taxes on the brain. I'm not sure whether this is because of yesterday's budget announcement, or Friday's RRSP contribution deadline. Either way, if you've been conscious at any point this month, you've probably been urged by someone to throw those piles of extra cash you have lying around into your RRSP.

While everyone's talking about getting money into RRSPs, I thought I'd look at the ways it's possible to take out your RRSP savings before retirement. Specifically, the HBP and LLP offer a way to do this when buying your first home, or pursuing post-secondary education, respectively.

Home Buyer's Plan

If you are a first-time home buyer, you can withdraw up to $20,000 from your RRSP, with no tax penalty, provided this money goes toward the purchase of a home within a specified time frame. You then have fifteen years to pay this money back in annual instalments into your RRSP. If you miss a year of catch-up contributions, then the amount of missed contributions is added to your taxable income, and taxed at your marginal rate.

Example

Suppose you withdraw $15,000 for a down payment under the HBP. You will then be required to pay back $1,000 per year to make up for the withdrawal over the next 15 years. If you miss a year, then $1,000 will be added to that year's taxable income.

You can look at this withdrawal as a loan you make to yourself from your retirement savings. There is no interest on this loan, except for the lost compounding on the funds you withdrew. If you withdraw $20,000 and pay it back over 15 years, then the value of those funds will be less than $20,000 in today's dollars. Hopefully you will make up the difference in home equity, but this is far from guaranteed.

Read more details on the HBP here.

Lifelong Learning Plan

If you are (or your spouse is) enrolled in (or planning to enrol in) post-secondary education, then you can withdraw up to $10,000 per year (up to a plan limit of $20,000) from your RRSP to cover educational expenses. You then have 10 years to pay this money back into your RRSP. As with the HBP, any missed catch-up contributions will be added to your taxable income.

Read more details on the LLP here.

Repayment

To pay back a withdrawal under either of these plans, you must complete Schedule 7, and include this with your tax return. The Schedule 7 designates a portion of your annual RRSP contributions as repayments to the HBP or LLP. These designated contributions will then not be included as deductions on your tax return.

Example

Suppose you have withdrawn $15,000 under the HBP, and make two RRSP contributions, one for $1,000 and one for $5,000. You would use Schedule 7 to designate $1,000 as an HBP repayment, and only the $5,000 would be included as a deduction on your tax return, even though you technically contributed $6,000 to your RRSP.

Note that the net tax consequence of making the $1,000 repayment and another $5,000 in RRSP contributions is to reduce your taxable income for the year by $5,000. This could also be accomplished by claiming the entire $6,000 as a deduction, and "missing" the $1,000 repayment: you would reduce taxable income by $6,000 for the contribution, and then increase it by $1,000 for the missed repayment.

Unless it bothers you to be "in arrears" on your repayments (to yourself), there doesn't seem to be much reason to claim a formal repayment on your tax return. The key is to ensure that your total RRSP contributions each year of your repayment period are greater than your required repayment amount.

Tax Free Savings Account: a Roth account for Canadians?

Wow, a lot can change when you spend a week on the couch. The federal government released the 2008 budget yesterday, and the news on everyone's lips (well, maybe not everyone, but at least on most Canadian PF bloggers' lips) is the creation of a new tax-advantaged savings plan, the TFSA. I hate to be a day late and a dollar short, but I can't go without commenting on this.

I've written before about the savings plans available in Canada and the US, and where the RRSP has a close cousin in the IRA, and the RESP is analogous to the 529 plan, the one savings vehicle unique to the United States is the Roth IRA. While the IRA (like the RRSP) is funded with pre-tax dollars, and withdrawals at retirement are fully taxed at the marginal rate, the Roth IRA is funded with after-tax dollars, and withdrawals at retirement are not taxed.

Well, the Roth account seems to have a new cousin (by marriage) in the proposed TFSA. Although not designated as a retirement account, the workings of the TFSA seem comparable to those of the Roth IRA: you can contribute up to $5,000 per year to a TFSA, and the income you earn in the account is not taxed. You can withdraw from the account at any time without penalty, and doing so actually frees up your contribution room again, so you can "re-fill" the account.

I'm finding it very difficult to find a downside here. The TFSA seems to be the ideal place for Canadians to keep their Emergency Funds. There's obviously a lot to be worked out here. I'm not sure what investments can be held in a TFSA, and what sort of interest rates will be paid on "cash" investments, but it sounds like a fantastic idea.

And it's nice to tie up a loose end by finding a dancing partner for the Roth account.

Looking into RESPs

The Loonie clan has seen a number of new additions recently, with births and pregnancies abounding. As a result, I've been thinking about RESP options, and decided to learn a little more about the workings of this plan. I've written briefly about RESPs in my Loonies And Savings Plans post, and other Canadian bloggers have posted great guides to RESPs, so I won't be delving too deeply into the intricate workings of these accounts. Instead, I'll look at a few of the rules, and lay down my decision on participating in the plan.

The Basics

When you set up an RESP, you register two individuals under the plan:

• The contributor (you) is the subscriber


• The future student is the beneficiary

The subscriber can contribute after-tax money to the plan, up to a lifetime limit of $50,000 per beneficiary. In contrast with RRSP contributions, the subscriber does not receive a tax deductions for any RESP contributions. However, the plan does have a couple of tax advantages:

• Provided that the beneficiary attends a university or college, withdrawals from the plan are taxed at the marginal rate of the beneficiary, not the subscriber. Since the beneficiary, as a student, should be in a low tax bracket, they will pay very little tax on these withdrawals


• The subscriber has already paid tax on the contributions, so only the growth in the investments is taxable. Combined with the first point, this means that RESPs can provide over 20 years of nearly tax-free growth

In addition to being a fairly tax-efficient way to save for a child's post-secondary education, there is the additional benefit of the CESG, which matches 20% of subscriber contributions, up to an annual maximum of $500 and a lifetime limit of $7,200. The CESG matching contributions count as investment growth, and are not taxed when withdrawn by the beneficiary. This represents an immediate tax-free 20% return on the first $2,500 in annual contributions.

The Big "If"

The big question with RESPs is, what happens if the child doesn't pursue post-secondary education? In this case, you "collapse" the plan, meaning that you, as the subscriber, close the account and withdraw the funds. Since you can have over 20 years of investment growth in the plan, there will clearly be some taxes to be paid. Here's the rundown:

• Your contributions are not taxed, since you made them with after-tax dollars


• You must refund any CESG that you received, immediately knocking up to $7,200 off your investment growth


• You must pay a 20% penalty on your investment growth (excluding CESG)


• You must pay taxes on your investment growth (excluding CESG) at your marginal rate

That's a pretty big tax hit to look at, but there are many factors to consider.

An Example

Suppose you contribute the $50,000 maximum, receiving the $7,200 CESG maximum, and over the years your investments grow to a total of $100,000. If the beneficiary attends university or college, then they have access to $57,200 in tax-free money, plus $42,800 in investment returns that, if used for education, will be taxed at their (low) marginal tax rate.

If the beneficiary does not pursue post-secondary education, then the plan must be collapsed, and the funds revert to the subscriber. If the subscriber's marginal tax rate is 40%, then they will have to pay the following:

• 0% tax on $50,000 contributions = $0


• $7,200 in refunded CESG


• 20% penalty on $42,800 investment growth = $8,560


• 40% taxes on $42,800 investment growth = $17,120


• Total paid = $32,880

This leaves the subscriber with $67,120 ($50,000 contributions plus $17,120 growth) out of the $100,000 that was built up in the plan. The 20% penalty, combined with the loss of favourable tax treatment of investment income, result in a huge tax hit to the subscriber in the event of a collapsed plan. However, there is some rationale behind these penalties:

• The 20% penalty is meant to offset any investment growth that you realized based on the CESG matching. Since your contributions were topped up by 20% each year, 20% of your investment growth is essentially due to this grant. So, having to pay back the CESG plus 20% of your returns makes sense


• The RESP can be looked at as a sort of "education insurance", where you pay an annual premium so that you have "coverage" in the event that the beneficiary pursues post-secondary education. Unlike most insurance policies, however, you get back all of your contributions at the end, with interest, if the plan is collapsed


• The $17,120 in net investment returns in the example given above should still be better than inflation, so even though you paid a big chunk to taxes, your contributions have still more than kept their value over time


• You were essentially willing to "gift" all of your contributions to the beneficiary anyway, so getting back your nominal contributions is a pretty nice consolation prize

The Verdict

For me, it really comes down to this: an RESP is a way of saying to a child, "I'm willing to help you out if you decide to pursue post-secondary education." If the child takes you up on the offer, then they have a great resource to help them through their education. If not, you've passed up some potential investment opportunities, but you more than recoup your contributions, and you know that you were there to support the child. There's nothing to stop you from giving them some of this money anyway, if that's what you want to do.

I'll be looking into setting up RESPs for some of my young relatives over the next couple of years.

This month has 29 days

In addition to being an Olympic year, 2008 is a Leap Year. That means your savings accounts will earn an extra day's interest, but your debts will also accrue an extra day's interest. Most significantly, this year February has 29 days.

For those of you here in the Great White North, a Leap Year has a specific impact on tax planning. The deadline for RRSP contributions in a Leap Year is February 29, not March 1. This means that, if you make a contribution after February 29, it will be counted toward your 2008 (or later) taxes.

February 29 is a Friday, and will therefore be a very busy time in most bank branches you might choose to visit. Therefore, it's probably a good idea to set things in motion for any last-minute RRSP contributions before the 29^th, so that you don't find yourself late to the party.

Coping with the January pay-cut

For Ms. Loonie and me, tomorrow is the first payday of the new year. In Canada, the year's first paycheque is often substantially smaller than the last pay of the previous year, since it marks the return of our good friends CPP and EI. For those who haven't had the pleasure, these payroll deductions are used to fund government-provided pension and unemployment insurance, respectively. For 2008, the deductions are as follows:

• CPP - 4.95% of annual earnings in excess of $3,500, to an annual maximum of $2,049.30


• EI - 1.73% of annual earnings, to an annual maximum of $711.03

Once you've reached the annual maximum, the deductions stop, so you effectively get a pay raise around half-way through the year. The problem is that, if you get used to this increased income, it's a bit of a shock to the system when the deductions start again in January. Even if you have a year-end raise, unless it's an increase of 15% or more, your January paycheque will be smaller than its December predecessor.

How to deal with this "pay cut"? Ideally, you would base your spending around this diminished income, and have the discipline to save the extra that you earn after maxing out the deductions. Then, when January rolls around again, you're already spending less than you earn, and have built up a substantial cushion of savings. This takes a lot of discipline, but it puts you in great financial shape.

As for us, we have some room for reductions in several budget categories, so I'm making small cuts here and there to make up the difference. Since the Emergency Fund is already above $1,000, I'm reducing the bi-weekly contributions to $10. Our (modest) budget for eating out is also being cut. The good news is that, after having a cash-only Christmas, we don't need to spend January playing catch-up. I am also receiving my year-end bonus tomorrow, so that helps to ease the pain of a diminished paycheque.

UPDATE - The January "pay cut" only applies to Canadians who earn more than $41,100 per year. I completely overlooked this point when I originally wrote this post, and I should apologize for that. File this "pay cut" under "problems I'm fortunate to have".

A new credit report to check?

Today in the RedFlagDeals.com forums, I found a link to the Financial Consumer Agency of Canada website. This site has a number of useful interactive tools, including quizzes on credit reports and scores, credit cards and mortgages. There is also a mortgage calculator, and a "Cost Of Banking Guide" to help select the bank account that's right for you.

One interesting piece of information I found here is a link to a Canadian credit reporting agency that I didn't even know existed. Apparently the three credit agencies in Canada are Equifax, TransUnion, and Northern Credit Bureaus. As with Equifax and TransUnion, Northern Credit Bureaus provides a free copy of your credit report delivered by mail. The FCAC recommends obtaining a credit report from all three agencies at least once a year.

I've updated the "Free credit report" post linked in the sidebar to reflect this new information.

Another cross-border parallel

The recent rumblings about E-Trade's credit loss woes have a lot of investors (specifically, E-Trade's brokerage customers) worried about what might happen if E-Trade were actually to go bankrupt.

This is not the same thing as a bank failing, where cash deposits (up to the applicable limit) are insured under either the CDIC or FDIC (depending on which side of the Canada-US border you frequent). Investment assets (such as stocks and bonds) are not covered by CDIC/FDIC.

However, I was interested to read at My Money Blog that there is a corporation that protects investment assets. The SIPC provides protection of investment assets up to a limit.

Thanks to Canadian Capitalist for pointing out that, once again, we Canucks have a similar corporation, namely the CIPF.

So there's one more piece of cross-border financial arcana sorted out. Here are the links to the two corporations' websites:

CIPF
SIPC

Loonies And Savings Plans

Back in August, I wrote my Loonies And Lexicons post, which attempted to draw parallels between Canadian and American personal finance terminology. I wanted to follow up with an exploration of the different savings plans available in Canada and the US. Specifically, I'll be focusing on the education and retirement savings plans that offer a tax advantage.

Education

In Canada, parents can save for their children's education using an RESP, whereas the American equivalent is the 529 plan (named after section 529 of the Internal Revenue Code). The basic idea of the accounts is the same, but the details are different:

RESP

• Contributions are made with after-tax dollars


• Interest and other investment income in the account are taxed upon withdrawal, at the recipient's tax rate. Since the recipient is a student, their tax rate will typically be in the lowest bracket (if not zero), due to their low income and education tax credits. This means that the growth of the account is very tax-efficient


• There is a lifetime contribution limit of $50,000; any contributions over this limit will be subject to taxation


• Through the CESG, the government will match 20% of the first $2,000 in annual contributions to the account. Note that the CESG match is taxed as interest when it is withdrawn by the recipient

529 Plan

• Contributions are made with after-tax dollars


• Interest and other investment income in the account are not subject to federal tax upon withdrawal


• Two types of plans are available:
  
  • Prepaid Plan - Tuition "credits" are purchased, at today's rates, to be used in the future. Think of this as a defined-benefit plan, with performance based on tuition inflation
  
  
  • Savings Plan - Contributions to the plan are invested, and their future value is based on investment growth. Think of this as a defined-contribution plan


• Specific plan details vary from state to state, but investors can choose to join an out-of-state plan. Several states, however, offer state tax advantages, as well as matching grants, for investors who participate in their own state plan

Note that the tax treatment of 529 withdrawals can be much more favorable than that of RESP withdrawals. Canadian Capitalist, Quest For Four Pillars and Million Dollar Journey have written extensively on how to navigate RESPs.

Retirement

In Canada, the only tax-advantaged retirement plan is the RRSP, while the US offers a variety of IRA options.

RRSP

• Contributions are made with pre-tax dollars, and withdrawals at retirement are fully taxed as income


• Employers will often offer employee savings plans, with contribution matching via a DPSP, which are treated as RRSP contributions when withdrawn at retirement. DPSP contributions are typically subject to a vesting period


• Annual contribution limit is 18% of previous year's earnings, up to a maximum ($19,000 for 2007)


• If an individual participates in an employer's pension or DPSP, then they receive a pension adjustment which reduces their contribution limit for the next year

IRA

• Two flavours of IRA are available:
  
  • Traditional IRA - Contributions are made with pre-tax dollars, and withdrawals at retirement are fully taxed as income
  
  
  • Roth IRA - Contributions are made with after-tax dollars, and withdrawals at retirement are not taxed


• Annual contribution limit for 2007 is $4,000 if under 50, and $5,000 if 50 or older. If an individual holds both a traditional and Roth IRA, then the limit applies to the combined total of contributions to both plans


• Employers often offer a 401(k) plan, which is also available in both traditional and Roth varieties. 401(k) plans often include an employer match on employee contributions. As with the 529 education savings plan above, the 401(k) is named for a section of the Internal Revenue Code. 401(k) contribution limits for 2007 are $15,500 if under 50, and $20,500 if 50 or older


• Certain kinds of employers may not be eligible to provide a 401(k) plan, but may be able to offer a 403(b) or 457 plan as alternatives

Canadians do not have an option equivalent to the Roth IRA; income from investments made with after-tax dollars is subject to applicable taxes (whether interest, dividend, or capital gain). Note that the 2007 contribution limits for Canadians and Americans under 50 are roughly equivalent ($19,000 and $19,500, respectively).

Check out that Loonie...

The Loonie opened above $1.10 US this morning. I have to admit that I'm completely lost when I try to keep track of all the factors at work here, but the net result is that we here in Canada have a very strong dollar heading into the holiday season. Mix this with some of yesterday's tips on holiday shopping, and Canadians could make out well this December.

I'm home fighting a bad cold, so this will be it for posts today. Hopefully I'll be up and about tomorrow.

Federal income tax cuts

There's been a lot of talk about whether we would be seeing tax cuts with the fall fiscal update, and it's now official.

The following personal tax measures are being introduced:

• The federal basic personal amount (the maximum income you can make without paying any federal income tax) is being raised from $8,929 to $9,600, retroactive to January 1, 2007, and continuing through 2008. The limit will increase to $10,100 for 2009.


• The lowest personal income tax rate (paid on income between $9,600 and $37,178) is being reduced from 15.50% to 15.00%.


• The GST is being knocked down another point to 5%.

I'm excited about the income tax measures. Basically, if you make over $37,178, the change will save you $241.90 in income tax for 2007. The GST reduction will also be handy, although I now have to learn to calculate 13% tax in my head, just when I had 14% figured out!