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QUESTION: I've asked this several times to lay people and nobody seems to know the answer - so it may be beneficial for people other than me! I have about $10,000 plus available for either RRSP's or to pay down my mortgage (currently at $182,000) I earn approx $51,000 p.a. Which is the better option? - or should I buy RRSP's and then put the tax refund into my mortgage (I'm allowed to pay up to 15% p.a.) Thanks in advance for your help B XXXXXXXX --------------------------------------------------------------------------- david ingram replies: This is an easy answer. I will "always" say that you should pay down your mortgage first. I did my first calculation on this back in 1973 and then published it in 1976. CBC MARKETPLACE picked it up in 1976 and put it on air and 'NO ONE" managed to dispute it then at a time when mortgage rates were running about 11%, Royal Trust's "M" fund was rated as the best RRSP in Canada (on Marketplace) and the VANCITY Credit Union was matching the rates. Today, all sorts of financial consultants are suggesting that the best is to Buy the RRSP and then use the refund to pay down the mortgage. That is fine, but they are really telling you to put in one hell of a lot more money AND it is the extra money that makes it "look good", not the "principal" of buying the RRSP and using the refund to pay down the mortgage. I can think of several RRSP people who will NOT like my sending this out because they are all pushing the "buy your RRSP and use the refund to pay down the mortgage" concept. Even Bank managers are pushing that concept. None of them are doing it for your benefit. The RRSP salesperson makes nothing if you just pay down the mortgage. The banker's branch looks worse if you just pay down the mortgage. Look at what would happen to your local branch's financial statement if 1,000 people paid off $10,000 on their mortgage instead of buying a $10,000 RRSP. That would be a total of $10,000,000 per branch. Pretend that 1,200 branches of the Bank of Nova Scotia did the same thing. That would reduce their mortgage portfolio overnight in ONE TAX SEASON by $12,000,000,000. Let me repeat that figure. If only 1,000 people per branch reduced their mortgage by Ten Thousand Dollars, the Bank of Nova Scotia's mortgage portfolio would be reduced by TWELVE BILLION DOLLARS. Chairman, Peter Godsoe, would be tearing the rest of his hair out. The stock would drop like a stone, mortgage rates would drop, because the bank would suddenly be trying to get people to borrow TWELVE BILLION DOLLARS and that is only one bank. If the Five biggest banks all had 1,200 branches do the same thing, they would collectively be trying to put out SIXTY BILLION DOLLARS at the same time. For the above to happen, six million people would have to make the same decision at the same time. If I could assume that there was a cost of just $200.00 in commissions and fees per sale, then life insurance and mutual fund and other financial people would collectively receive $1,200,000,000 (ONE BILLION, TWO HUNDRED MILLION) less fees in a 60 day period. In other words, no matter how much sense it makes for your advisor to tell you to pay off the mortgage first, they will usually shuck and jive around the issue because it takes two hours to explain that you are better off to pay off the mortgage (with no resulting commission) and only thirty minutes to fill in the RRSP form and take your money. And of course, they get to salve their conscience by suggesting that you put the tax refund into the mortgage, which is really hard for anyone to do because they want the refund to live on and it is "NEW" money anyway. Let me prove it to you. In your case, if you took $10,000 off of $51,000, your tax refund would be $3,106.00 so "your" marginal tax rate is only 31.06%. CAN I pretend it is 30%? Thank you. Right now, you only need to earn $7,000 to buy a $10,000 RRSP. Why you ask? Well if you earned $7,000 and borrowed $3,000 you could buy a $10,000 RRSP. If you did that on Feb 15, you could file your tax return the same day and would likely get back your $3,000 refund in two to three weeks. You pay back the $3,000 (plus a couple of dollars interest) and all you needed to earn was $7,000 and a couple of dollars. However, for you to buy the $10,000 RRSP and then use the refund to pay down the mortgage, you have to earn another $4,285.71. for a total of $11,285.71 instead of just the $7,000 in the first example. Why? Well you have to earn $4,285.71 and pay 30% tax of $1, 285.71 to have $3,000 left if you are going to use the refund to pay down the mortgage. No wonder you seem to have a little more left over at the end, you put another $350.00 a month into the project. My suggestion is that you pay down the mortgage. $10,000 off your 5% mortgage saves you $500 a year in interest for ever. That means that you do not need to earn $750.00 and pay $250.00 in tax to have $500.00 left to pay the interest. That is true for this year, next year, the year after and so on. If you were going to put something into your RRSP that was going to make a profit, buy it OUTSIDE of the RRSP. HOW? you ask. Simple, you now have $10,000 more equity in your home. Borrow the money to make the investment. Let's assume that you were going to buy a mutual fund which was going to go from $10,000 to $110,000 in the next ten years. (Yeah, we all wish!). If the stock was inside the RRSP and you went to cash the whole thing in, you would owe tax on the whole $110,000 right now. Let's just use a 30% tax bracket. You saved $3,000 of tax when you put the $10,000 in and you now owe $33,000 of tax to take it out. If we assumed that the $100,000 profit was composed of $20,000 of dividend and $80,000 of capital gains, you would now have to pay the bank back $10,000. The tax on the $80,000 of Capital Gains would be $12,000 (30% of one half of $80,000) and there might have been another $2,000 tax on the dividends because the dividend tax credit would be mostly tax paid money. So in an RRSP you would take out $110,000 - $33,000 and have $77,000 left over of tax free money. OUTSIDE of the RRSP, you would have $110,000 - $10,000 - $2,000 - $12,000 left or $86,000 left over PLUS $16,386 ($10,000 at 5% compounded semi-annually not in advance) tax free more equity in your house for a total of $102,386 or $25,386 MORE than buying the RRSP. The problem with a financial planner's explaining this to you is that it will take three or four hours and the financial advisor will not make anything more and he or she could have sold five more people a $10,000 RRSP in the same time. Oh yes, if you wanted to take that extra $4,285 you would have had to earn to buy the RRSP and pay down the mortgage and buy an RRSP with it - well you get the idea - I could go on and on for ever. -------------------- Accolade ONE! I do a lot of appearances with Fred Snyder on his radio show on Saturdays on CFUN (2 to 3 PM - 1410 on your AM dial). Fred (604) 731-8900 and his associate George Hatton (604) 913-9137 (who hangs out in my office) are two of the few mutual fund people who will tell you to pay off your mortgage or more likely, pay off your non-deductible MasterCard, Amex, Visa or department store credit car debt before you buy an RRSP. (If I can make it good at a 5% interest rate, imagine what it is like at 18 or 20 or 24% non-deductible interest on a credit card). In addition, both of these individuals (using a technique I developed back in 1975/76) or I can/will also show you how you can use a business or rental real estate or a mutual fund portfolio to make the interest on your CANADIAN mortgage tax deductible. It is a credit to Fred Snyder that he will put me on the air consistently when I have contrary opinions to his at times. That's what makes a horse race. Fred has regularly made the point with me that a person's "COMFORT" level is just as important as the "best" deal. People are comfortable with RRSP's. If you try and talk them out of it when everyone else has one and they want one too, you just turn them off. Better to get them started now and gradually educate them over the years which is why Fred has spent a fortune giving his educational seminars to clients, potential clients and competitors alike. I was at one seminar when three SUN Life agents were there with their clients for instance and they were getting it free. I have never attended one of his monthly seminars (I have been at 50 or so) without learning something. You can get at least one and likely a couple free by calling Sandy Snyder at (604) 731-8900. Accolade TWO To make your CANADIAN mortgage tax deductible, you need a creative and understanding mortgage person. I am sure there are more, but in my 40 years in this business I have only met "three" bankers who truly understood the situation and would continuously advise clients in the technique. One retired to the Sunshine Coast, one is dead, and the third, Joan Marsh (604) 535-9981 is now working on her own under the auspices of a separate CIBC offshoot "HOME LOANS CANADA". I do not care who your mortgage is with (even another branch of the CIBC), BEFORE you renew, before you get a new mortgage, talk to Joan. She is a miracle with self-employed people for instance. She recognizes that a self employed person's net income usually includes all sorts of extras that mean that they have more disposable income than the tax return shows. She will also (without blinking an eye), get you two mortgages at the same rate so that the non-deductible one can be paid down first while the second one that is deductible gets paid last. And, if you liked my "pay down the mortgage and borrow the money to make the same investment you would have made in the RRSP technique,", Joan Marsh can arrange a "deductible" line of credit which increases as the non-deductible mortgage decreases. ---------------- Accolade THREE Ozzie Jurock, whose website forwarded this question to me, is also one of, if not "the most" knowledgeable real estate people I have ever met. His Two real estate newsletters are a MUST READ for a serious real estate investor. In the last month, I have had inquiries from such divers areas as Dana Point, California, London England and Berlin Germany because of mentions in Ozzie's newsletter. The business acumen of the enquirers was also astounding with everyone of them already owning multiple rentals and still looking fro more information. I have not asked him, but if you send him a request to ozzie@jurock.com, I am sure he will put you down for a free three months of his newsletter.
COMMERCIAL
Last, but not least, for my own commercial, our office can
advise on deductible mortgages, RRSP investments, Real Estate Investments and
US / Mexican Working Visas and US/ CANADA / MEXICO Income Tax Matters. No one
can deal with your Canadian or American or combined Tax return dealing with
real estate investments, stock market transactions, estates, or working in two
countries at the same time than the CEN-TA Group Associates.
Remember, every US citizen living in Canada has to file an
annual US income tax return even if they have no US income. It is not
unusual for a US citizen living in Canada to get a $180,000 retroactive tax
bill for US tax which would not exist if the person had filed his or her US tax
return and claimed exemptions on time.
You see, if you are a US citizen living in BC with a dependent
spouse and your company deducted $30,000 in tax, you do NOT have to file a
Canadian Tax Return. You do NOT owe Canadian Tax so unless the CCRA
requests or demands a tax return, you do not "have to" file a return. You
SHOULD file a tax return because it is the only way you will get back your
$2,000+ refund but if you do not want your refund, you do not have to file a
return.
However, that same $100,000 is taxable to you as a US citizen
no matter where it came from.
To be sure, there is an exemption which was $70,000 in 1993
and is $80,000 US today but you have to file the return within 2 years to claim
the exemption. If not filed on time and they catch you, the IRS can turn
down the exemption and limit your foreign tax credit resulting in hefty tax
bills. On the other hand, if you come forward voluntarily, you can ask
them to extend the election and it is my experience that they have done so
without fail for over 2,000 catch-up clients we have done in the last 30 years.
And, A US citizen living in Canada with over $10,000 US
combined in Canadian financial accounts (banks, trust companies, debit cards,
RRSP's, Securities dealers, etc., ) is liable for a fine of up to $500,000 PLUS
5 years in jail fro failure to file a form TDF-90 for each account. The
record in my office was a $10,000 fine for a 105 year old woman with $38,000 in
the Royal Bank of Canada in Edgemont Village in North Vancouver.
For more information of US /
Canadian income tax, go to www.centa.com
and click on "US/Canada taxation".
For more information on US
working visas, go to www.centa.com
and click on "Entering the US".
For more information on when
a Canadian needs to file a US income tax return, go to
www.centa.com, click on Newsletters
and read the first page of the November 2001 newsletter.
For more information on
making your Canadian mortgage tax deductible, goto
www.centa.com, click on Newsletters
and read the next 11 pages of the November 2001 newsletter.
You are welcome to pass this
on to anyone else who is about to buy an RRSP or get a mortgage, or works in
the US or has a US rental property or a Canadian rental property or, or, or.
david ingram
david ingram -
taxman@centa.com
108-100 Park Royal South
West Vancouver, BC, CANADA, V7T 1A2
(604) 913-9133 - (604) 913-9123
www.centa.com
Cell is (604) 657-8451 (10 AM to 10 PM seven
days a week)
US / CANADA / MEXICO
Working Visa and
Income Tax Specialists
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