Glossary of Investment, Tax and Retirement Planning Terms
Adjusted Cost Base
Annual RRSP dollar maximum
Asset allocation fund
Canada Pension Plan
Capital gain calculation
Capital gain or loss
Capital gain tax
Cash surrender value
Consumer Price Index
CPP Death benefit
CPP Disability pension
CPP Retirement pension
CPP Surviving spouse's pension
Deferred Profit Sharing Plan
Defined benefit pension plan
Defined contribution pension plan
Dividend income fund
Dollar cost averaging
Exempt capital gains
Foreign content restrictions
Foreign investment income
Government pension programs
Guaranteed Income Supplement
Guaranteed investment certificate
H - I
Interest rate risk
Life income fund
Locked-In retirement account
Locked-in retirement income fund
Marginal tax rate
Money market fund
Mortgage vs. RRSP
Net asset value
Notice of Assessment
O - P
Old Age Security
Past service pension adjustment
Pension adjustment reversal
Permanent life insurance
Profit sharing plan
Rate of inflation
Rate of interest
Rate of return
Registered Education Savings Plan
Registered pension plans
Registered retirement income fund
Registered retirement savings plan
Reinvestment of distributions
Canada Revenue Agency Notice of Assessment
RRSP and death
RRSP deduction limit
Single-premium deferred annuity
Standard of living
Taxation of a mutual fund
Term to 100 investors,
Unclaimed RRSP contribution
Unused RRSP deduction limit
Whole life insurance
Year's Maximum Pensionable Earnings
The adjusted cost base is the cost of acquiring an asset and is used to calculate a capital gain or loss on the purchase of a stock, mutual fund or other type of property. It is equal to the sum of the:
Original purchase price of an investment
PLUS the amount of reinvested distributions
PLUS the amount of any additional purchases
Capital losses can only be used to reduce or offset capital gains. When losses exceed gains in a year, they can be carried back to be applied against gains in any of the previous three years, or carried forward indefinitely.
The amortization is the number of years during which a loan is repaid.
A taxpayer may contribute an amount up to the RRSP deduction limit. Each year, the RRSP deduction limit increases by 18% of the previous year's earned income, up to a dollar limit. This dollar limit is called the annual RRSP dollar maximum.
The annual RRSP dollar maximum is currently set at $19,000 in 2007, $20,000 in 2008, $21,000 in 2009, $22,000 in 2010, and increase in line with annual changes in the Average Wage (a measure compiled by Statistics Canada) beginning in 2011.
An annuity is a contract entered upon with a life insurance company to provide periodic income for life. The purchase price of the annuity contract depends on the age of the annuitant, the benefit or survivor pension payable upon death to a beneficiary or spouse, and market rates of interest. The purchase price is lower when interest rates are high, because the amount of money paid to the insurer earns more interest, which is used to pay the monthly income.
There are several types of annuities. Life annuities provide income for life and cease on death. A joint and last survivor annuity provides income for the lifetime of the primary annuitant, and upon death a percentage of the pension (such as 50%, 60% or 100%) continues to be paid to the spouse for the remainder of his or her lifetime.
Sometimes annuities are payable for a guaranteed period such as 5, 10 or 15 years. In such cases, the pension is paid for the first 5, 10 or 15 years, whether or not the annuitant is alive. After the expiry of the guarantee period, the pension is paid as long as the annuitant is alive and ceases upon his or her death.
An indexed annuity is an annuity under which payments increase gradually every year to keep up with inflation.
An asset is anything that has a monetary value, such as an investment, real estate, a business or a consumer durable good.
The asset allocation is the proportion of a portfolio invested in each of the three main types of investments – cash or short-term equivalents (e.g., Treasury bills), longer-term interest-bearing securities (e.g., bonds), and stocks or equities. An investor's asset allocation strategy depends on investment objectives, age and time horizon, tolerance to risk, and market outlook.
An asset allocation fund is a type of mutual fund that invests a mix of stocks and bonds based on a sophisticated computer investment model.
A balanced fund is a type of mutual fund that invests in a mix of stocks and bonds. Typically, the mix is between 40 and 60 per cent of either type of assets. The objective is to have less variability than equity funds.
A beneficiary is a person who receives proceeds or benefits from an insurance policy, annuity, trust, will, RRSP or other registered plan.
A bond is an investment certificate that promises to repay the purchaser at a later date the purchase price plus interest at a pre-determined rate. Interest-bearing bonds pay interest periodically. A bond will specify a maturity date, and a coupon or interest rate. The rate for bonds is usually fixed. Governments, utilities, mortgage holders and many other types of institutions and corporations issue bonds to raise capital.
The market value of a bond fluctuates based on changes in interest rates. If interest rates go up after a bond has been issued, its value goes down. This is because new bonds issued at that time will have a higher return. The market price of a bond must reflect the fact that a rational investor would pay no more than the amount that will accumulate at the prevailing interest rate over the remainder of the duration of the investment. Similarly, when interest rates are falling, bonds purchased at a higher yield will increase in value.
A bond fund is a type of mutual fund that invests primarily in a mix of government and corporate bonds. This type of fund generates interest income and also capital gains or losses as the market value of bonds increase or decrease with changes to interest rates.
A callable bond is a bond in which the issuer can decide to pay back the principal earlier than the stated maturity date. Callable bonds trade at a small premium over regular bonds.
The Canada Pension Plan or CPP is a contributory, earnings-related social insurance program. It provides benefits to contributors on retirement, disability and death. The CPP applies throughout Canada except in Québec where a similar program, the Québec Pension Plan (or QPP), is in force. The two programs are coordinated under agreements between the two governments.
The program covers virtually all employed and self-employed persons in Canada (except in Québec where the QPP applies) who are between the ages of 18 and 70 and who earn more than a minimum level of earnings in a calendar year.
The CPP is financed through contributions from employees, employers and self-employed persons, as well as investment earnings from the Canada Pension Plan Fund. Starting in 1998, a new CPP Investment Board will invest all new contributions in capital markets to achieve a better return. Human Resources Development Canada administers the Canada Pension Plan through a network of Human Resource Centers of Canada located in principal cities and towns across the country.
CPP death benefit
CPP disability pension
CPP retirement pension
CPP surviving spouse's pension
This example shows the calculation of a capital gain taking into account reinvested distributions and the adjusted cost base:
|| +$ 750
|| + $8,000
|Adjusted Cost Base
If the 1550 units are sold for $23,000, the capital gain is:
- Proceeds from Sale: $23,000
- Adjusted Cost Base: -$18,750
- Capital Gain: $4,250
The sale of a stock or a mutual fund triggers a capital gain or a capital loss. A capital gain is the difference between the selling price of a stock or other equity and its adjusted cost base. If a stock is sold below the adjusted cost base, the difference is a capital loss. Amounts previously reported are added to increase or adjust the price paid for the investment. See example of a capital gain calculation.
A capital gain is defined as:
- Proceeds from sale
- LESS investment charges
- LESS Adjusted Cost Base
Only 50% of a net capital gain is taxable. In other words, only 50% of the net capital gain enter into income on the tax return. The net capital gain is the difference between capital gains and capital losses in a particular year.
Cash are short-term assets and generally include bank accounts, term deposits, money market funds and Treasury bills. Cash assets are liquid as they can easily be redeemed. Cash assets have generally kept pace with inflation, but have not outperformed it.
The cash surrender value is the amount that the insurance company will pay if the policyholder terminates a life insurance policy.
Compound interest is the effect of interest being earned on previously earned interest.
The Consumer Price Index or CPI is an index published by Statistics Canada each month measuring changes in the cost of living. The change in this index is called the rate of inflation. The CPI is based on the average cost of a typical basket of goods and services.
Contributions to the CPP are made on the portion of an individual's annual earnings which is between the Year's Basic Exemption (YBE) and the Year's Maximum Pensionable Earnings or YMPE.
From 1966 to 1986, employees contributed 1.8 percent of covered earnings and their employer paid a matching contribution. Self-employed persons contributed at the rate of 3.6 percent of covered earnings. Since 1987, the contribution rate has increased gradually each year.
For 2003 and future years, the contribution rate is 4.95 percent of covered earnings from the employee and a matching contribution of 4.95 percent from the employer. A self-employed person must contribute 9.9 percent.
A contributor may request, once per year, a record of earnings, which is an account of an individual's earnings and contributions to the Canada Pension Plan. Human Resources Canada issue statements of earnings for the Canada Pension Plan upon request by calling the Government of Canada Income Security Programs Information Service at 1-800-277-9914 (for service in English) or 1-800-277-9915 (for service in French). You must call this number and request an application for a statement of earnings under the Canada Pension Plan. Human Resources Canada will issue a statement only if they receive a written application.
Persons who have contributed to both the CPP and QPP are said to be "dual contributors". A dual contributor who, at the time of applying for a benefit, lives in Canada but outside Québec receives the benefit from the CPP. In turn, the CPP assesses the Québec Pension Plan for its share of the cost of the benefit. Similar provisions apply to the reverse situation.
The death benefit payable under the CPP is a lump-sum payment equal to $2,500.
The CPP disability pension is a monthly benefit consisting of a flat rate component and an earnings-related component. The flat rate component is a basic amount unrelated to previous earnings and paid to all persons who are eligible. The earnings-related component is equal to 75 percent of a retirement pension, calculated as if the contributor was age 65 at the time of payment of the disability pension. The disability is payable until age 65, recovery or death.
Any person who has made contributions to the CPP is eligible to receive a monthly retirement pension at any time after the contributor's 60th birthday. However, for a retirement pension to be paid prior to age 65, the contributor must have substantially ceased to be engaged in paid employment or self-employment.
The retirement pension payable to a person at age 65 is a monthly benefit equal to 25 percent of a contributor's average monthly pensionable earnings during the contributory period.
An individual's contributory period is defined as the period starting on January 1, 1966, or when the contributor reaches age 18, whichever is later, and ending when the individual begins to receive a retirement pension from the CPP or QPP or reaches age 70.
In calculating average monthly pensionable earnings, actual pensionable earnings from past years are adjusted to reflect current values.
However, any month of disability is excluded from the contributory period. Also, periods of low or zero earnings (up to 15 percent of an individual's contributory period) may be excluded in calculating average monthly pensionable earnings. The intent is to compensate for periods of unemployment, illness or schooling. Months of low or zero earnings while caring for a child under the age of seven may be excluded from the contributory period, if the contributor received Family Allowances or was eligible for the Child Tax Benefit. This is called the "child-rearing drop-out provision".
Persons who continue to work and make contributions to the CPP after age 65 may substitute periods of pensionable earnings after 65 for periods before age 65 when they had low or zero earnings.
The amount of a retirement pension starting before age 65 reduces by 0.5 percent for each month between the date the pension commences and the date of the contributor's 65th birthday. Similarly, a pension beginning after age 65 increases by 0.5 percent for each month between the 65th birthday and the month for which the first payment is made. The maximum upward or downward adjustment is 30 percent.
All CPP benefits are adjusted in January of each year to reflect increases in the cost of living, as measured by the Consumer Price Index. The CPP pension must be included in taxable income.
The pension under the CPP payable to a surviving spouse aged 65 or over is equal to 60 percent of the retirement pension which the deceased contributor could have received at age 65. The pension payable to a surviving spouse under age 65 is composed of two parts, a flat rate component and an earnings-related component. The earnings-related portion is equal to 37.5 percent of the actual or imputed retirement pension of the deceased contributor.
If a surviving spouse is between the ages of 35 and 45, has no dependent children and is not disabled, the survivor's pension is reduced by 1/120th of the amount described above for each month his or her age is less than 45 at the time the contributor died.
If a surviving spouse ceases to be disabled or to have a dependent child in his or her care and is between 35 and 45 years of age, the pension is reduced, as described in the preceding paragraph. If the surviving spouse is under 35 years of age and ceases to be disabled or to have a dependent child, the pension is suspended until age 65.
Debt is a type of investment that includes Government and corporate bonds, debentures and mortgages. They usually are low risk and have a higher return than cash.
A deferred profit sharing plan or DPSP is a profit sharing plan, in which the employer deposits annually contributions based on company profits to individual employee accounts. Both employer contributions and investment income remain tax-sheltered until withdrawn. At retirement or termination of employment, employees transfer the value of their account to an RRSP, a RRIF, or purchase an annuity from a life insurance company. Employers often use this arrangement to provide a source of retirement income to their employees.
A defined benefit pension plan is a registered pension plan that guarantees the employee a certain income at retirement, based on a formula that usually takes into account earnings and years of service with the employer. The employer pays the amount required to provide the promised benefits, as recommended by an actuary who assesses the pension fund's assets and liabilities. Some plans require that employees contribute a percentage of their earnings toward the cost of benefits.
A defined contribution, or money purchase, pension plan is an a registered pension plan in which each employee holds an account where employee contributions, employer contribution made on behalf of the employee, and investment income accumulate without tax until retirement. Employer and employee contributions are usually based on a percentage of the employee's earnings. At retirement, the balance of the account is used to purchase an annuity or transferred to a life income fund. The level of income provided during retirement depends on the performance of the investments held in the account.
Depreciation is the loss in value of an asset.
A distribution is the amount credited to the unit holder of a mutual fund in respect of any capital gain or dividend realized by the fund.
Diversification is the process of spreading the number of investments across various types of investments to reduce the amount of risk in a portfolio. Diversification applies to the type of investment, industry, geographical location and currency.
A dividend is a portion of a company's profit paid to common and preferred shareholders. A stock selling for $20 per share with an annual dividend of $1 per share has a dividend yield of 5%. Dividends are usually paid quarterly.
A dividend income fund is a type of mutual fund that invests primarily in shares of corporations that pay regularly high dividends.
Dividends received from stocks of Canadian corporations or from mutual funds that invest in Canadian corporations are taxed at a rate lower than income or interest. The amount of dividends grossed-up by 25% is entered into income on the tax return, but an offsetting dividend tax credit of 13.33% directly reduces the amount of provincial and federal taxes.
The dividend yield is the total amount of dividends paid over the past year per share divided by the current price of the stock.
Dollar cost averaging is a strategy to minimize risk and maximize return. By investing the same amount to purchase a stock or units of a mutual fund on a regular basis, one reduces the average cost per unit, whether the unit price goes up or down. When the unit price is low, more units are purchased. If the unit value increases, more units increase in value. If the unit value decreases, fewer units decrease in value.
Earned Income is income eligible for consideration when calculating the RRSP deduction limit. It includes employment (T4) earnings (i.e., salary or wages), rental income, alimony received, net business income and disability benefits paid by the Canada Pension Plan or Québec Pension Plan. Earned income excludes investment income, retiring allowances, severance pay, taxable capital gains and pension income.
Equities refer to preferred and common shares, any other equity instruments of public or private corporations, and mutual funds in which assets are primarily invested in stocks or marketable securities which does not provide a guaranteed return. Equities are assets that increase or decrease in value based on the demand of a market in which they are bought and sold.
Equity in a real estate property is the difference between the market value of the property and the balance of any outstanding mortgages.
An equity fund is a type of mutual fund in which funds are primarily invested in stocks. There are different types of equity funds, some that invest in large companies, and others that invest in companies with a small capitalization base.
Estate planning is the process of developing and maintaining a plan to preserve wealth and provide an orderly transfer of assets upon death to beneficiaries. There are several objectives to estate planning, such as minimizing or deferring taxes; providing liquidity to cover taxes and other liabilities; providing income to dependents; dividing the after-tax value of the estate; and minimizing probate fees and other costs related to settling the estate. An important issue is to implement various strategies while alive with a person's assets in order to minimize taxes at death.
These various objectives are accomplished by maintaining a valid up-to-date will, which sets out the disposition of assets in accordance with the intentions of the deceased. Without a will, a person is said to die intestate, and assets are distributed in accordance with the laws of the province of residence, without regard to tax effectiveness.
The estate is responsible for covering liabilities, including taxes, in the year of death. If cash is not available, property may have to be sold. The value of a RRSP or RRIF will generally be fully taxable in the final tax return, unless the spouse is named as beneficiary.
On the date of death, any property is deemed sold at its market value. Thus, 75% of the deemed capital gain must be included in the deceased final tax return. To minimize such adverse consequences, one strategy is to ensure that the principal residence, bank accounts and other assets are jointly owned with the spouse. When one spouse dies, those assets pass to the surviving spouse without triggering a capital gains tax.
When other capital assets, such as life insurance policies or an RRSP have a idd beneficiary, this result in a direct transfer of these assets to the beneficiary, bypassing the estate and avoiding probate fees on these assets.
There are several common tax-effective strategies. One is leaving the proceeds of the RRSP to the spouse to allow a tax-free rollover of the proceeds into the spouse's RRSP and continue deferring taxes. Another consists in leaving capital assets such as stocks or mutual funds to the spouse, so there is no deemed disposition. Giving money during the lifetime will reduce probate fees payable at death, which are based on the size of the estate. Purchasing life insurance to cover taxes payable at death is another technique used to preserve the value of the estate.
Other related considerations: Upon marriage, an existing will become invalid and must be rewritten. Legislation restricts investments by executors of money held in an estate, unless the will specifically provides for it.
The Canada Revenue Agency eliminated in 1994 the $100,000 capital gains exemption. Investors were allowed at the time to file a capital gains election creating a tax credit pool for each investment. The unused balance can be used to offset capital gains from sales of these stocks or mutual funds.
A financial planner is an investment advisor who assists clients in assessing investment objectives and developing both short and long-term financial plans. Financial planners typically receive remuneration from commissions on the sale of mutual funds.
Fixed income refer to any short or long term investment which earns interest at an agreed upon rate of interest. This includes cash, checking or savings accounts, guaranteed investment certificates, term deposits, Canada savings bonds, bonds issued by the Federal, provincial or municipal government, or a corporation, Government of Canada Treasury Bills, money market or other similar investments, such as Provincial Notes, Bankers' Acceptances and high quality commercial paper. Also included are mutual funds in which most or all assets are invested in bonds or other types of securities mentioned above.
In the past, the Income Tax Act imposed a limitation on the amount of foreign investments that an RRSP or RRIF could hold. This limitation has been removed in 2006.
Foreign investment income is income from an investment outside Canada or a mutual fund that invests in foreign securities. Foreign interest and dividends are fully taxed in Canada, and are not eligible for dividend tax credits. However, there are foreign tax credits when tax is withheld on dividends or capital gains.
Government pension programs in Canada are the Canada Pension Plan, Old Age Security, and Guaranteed Income Supplement and other provincial schemes for lower income earners. The Québec Pension Plan is an arrangement parallel to the Canada Pension Plan for residents of Quebec.
A Group RRSP is a registered retirement savings plan sponsored by an employer or association. A financial institution administers the Group RRSP, and sets up an individual account for each participating employee. The Group RRSP offers the convenience of making RRSP contributions directly through payroll. Contributions to a Group RRSP are made before deductions for income taxes. In other words, the tax benefit is immediate, there is no need to wait until the following year to receive the tax refund.
The Guaranteed Income Supplement is a program of the Government of Canada designed to provide income to older persons with little or no income other than Old Age Security. The amount paid is based on the person's total income in the previous year. Eligible persons must apply to Health and Welfare Canada in order to receive benefits. The Guaranteed Income Supplement is not subject to income tax. The amount payable depends on marital status and income received in the previous calendar year.
A guaranteed investment certificate or GIC is an interest-bearing deposit with a term usually from one to five years. Interest on a GIC may be paid periodically (monthly, quarterly, semi-annually, annually), or paid at maturity along with the initial investment. The interest income is taxable every year whether or not it is actually received.
Home equity is the amount of money invested in a principal residence.
An income fund is a type of mutual fund in which funds are primarily invested in fixed-term securities such as bonds, Treasury bills, mortgages and shares of preferred and high-quality stocks. These funds provide a steady stream of interest as well as capital gains.
Income splitting is a tax-planning technique of transferring income between a spouse in a higher tax bracket to a spouse or family members who are in lower tax brackets, thus reducing overall income taxes of the family. The Canada Revenue Agency set out attribution rules to limit income splitting, but contributions to a spousal RRSP are still an effective tax-saving strategy.
$1 in two years will not purchase the same goods as $1 today. This is because of the presence of inflation in the economy. If the purchase of a good costs $1 today and the rate of inflation is 3%, the same good in two years will be $1.06 (i.e., $1x1.03x1.03). Inflation-adjusted dollars is a way of expressing future dollar values in terms of today's value. This is accomplished by removing the inflation component from dollar values in the future. For example, an amount of $100,000 payable in 20 years is the same as $55,368 today, if we assume an annual rate of inflation of 3%. In other words, $100,000 in 20 years will have the same buying power as $55,368 today.
The inflation risk is the risk that the real return of an investment will be negative.
Interest is the amount of money paid by a borrower to a lender in exchange of a loan. The interest on a loan is at an agreed rate and for a specified period of time. Interest is usually expressed as an annual percentage.
The interest rate risk is the risk that proceeds from an investment received in the future will have to be reinvested at a lower interest rate.
Intestate is the condition of a person dying without a will. If a person dies intestate, the succession laws of the province in which the deceased resided determine how the assets will be distributed. Ontario provides that the spouse receives the first $200,000 of assets, and any excess is split with one third going to the spouse, and the remaining two thirds to the children. Where there is only one child, assets in excess of $200,000 are split equally between the surviving spouse and the child.
Investment income is a general term referring to any type of revenue earned from a single investment or a portfolio of invested assets.
Investment risk is the potential for loss when making an investment. There are four common types of investment risks: liquidity, volatility, inflation and interest rate risk. Generally, stocks have high volatility, but have offered historically the best protection over the long term from the inflation risk. On the other hand guaranteed investments have no volatility, but carry a significant interest rate risk.
Life expectancy is the average number of years that a person can expect to live based on statistics.
A life income fund or LIF is a RRIF for funds originating from a locked-in RRSP or a registered pension plan. The Canada Revenue Agency prescribes an annual minimum withdrawal, which is based on age and the market value of the LIF at the beginning of the year. Provincial legislation requires that the annual withdrawal do not exceed a maximum based on age, the value of the LIF and long term interest rates.
A LIF under the Newfoundland and Labrador jurisdiction continues to maintain control on the investments until the end of the year of the 80th birthday, at which time the balance held in the fund must be used to purchase an annuity from a life insurance company. A LIF subject to other pension legislation does not have to be converted to an annuity.
The minimum age at which a LIF may be set up depends on the provincial legislation that applies to the member of the pension plan who is transferring funds to a LIF. The person holding a LIF has control over all investment decisions. As with an RRSP, funds in a LIF are tax-sheltered until withdrawn. See also locked-in retirement income fund.
Life insurance is a contract that pays a specified amount upon death to a designated beneficiary, in exchange for the payment of periodic premiums.
The liquidity risk is the risk of not being able to sell an asset.
A living trust, or inter vivo trust, is an arrangement whereas a person gives full control of their assets to a trust while living. Assets in a living trust pass directly to the trust's beneficiaries, upon the person's death, avoiding probate fees.
A locked-in RRSP is an RRSP with funds that have been transferred from a registered pension plan. Provincial legislation requires that these funds be locked-in, which means that no withdrawal is allowed other than for the purpose of paying retirement income. At the time of retirement, funds in a locked-in RRSP are used to purchase an annuity or converted to a life income fund. A locked-in RRSP is also referred to as a locked-in retirement account or LIRA in certain provinces.
A locked-in retirement income fund or LRIF is similar to a life income fund, except that it does not require the purchase of an annuity when the holder of the LRIF reaches age 80. Persons whose locked-in RRSP is subject to Ontario, Alberta or Saskatchewan legislation have a choice to select either a life income fund or an LRIF at the time of retirement.
The marginal tax rate is rate of tax paid on the highest band of earnings of a taxpayer. The federal income tax rates in Canada for the four tax brackets are currently in 2003 of 16% of the first $32,183 of earnings, 22% of earnings between $32,183 and $64,368, 26% of earnings between $64,368 and $104,648, and 29% of earnings in excess of $104,648. In addition, each province has its own tax brackets and tax rates. These rates are reviewed annually and brackets are indexed in line with inflation in most provinces
A market index is a sampling of different holdings in the asset class it represents. For example, the S&P/TSX Composite Index measures the performance of 300 different stocks of stocks of publicly traded Canadian companies representing different sectors of the economy. Its intent is to show trends in the market and provide a benchmark to measure the performance of a portfolio.
The Scotia McLeod Universe Bond Index reflects the performance of corporate and government bonds.
Money market is debt with a term of three years or less. Investments include government bonds, Treasury bills and commercial paper from banks and corporations.
A money market fund is a type of mutual fund that invests only in short term securities, such as bankers' acceptances, commercial paper and short-term government bonds or Treasury bills. The emphasis for these funds is on safety and liquidity.
A mortgage is a loan secured by the collateral of a real estate property. The loan is usually payable over a fixed term during which the principal and interest are paid in regular installments.
Making RRSP contributions before paying down a mortgage is usually the best strategy according to many financial experts. This is because the tax-sheltered investment growth of RRSP contributions plus the tax refund applied to reduce a mortgage may exceed slightly principal and interest charges saved from applying the same amount to the mortgage. However, this depends on the investment return on the RRSP and the mortgage rate that will apply over time.
Similarly, borrowing from an RRSP for a down payment may or may not be preferable depending on the investment rates of return and mortgage rates over time. The federal government's Home Buyers Plan allows first-time buyers to borrow up to $20,000 from their RRSP on an interest and tax free basis. The amount withdrawn must be repaid within 15 years.
One must look at the impact of the following two scenarios to determine whether one option is better than the other:
Keep Money in RRSP: Amount accumulated in the RRSP plus investment earnings less taxes on withdrawal, less extra capital and interest payments.
Borrow from RRSP: the after-tax accumulation of amounts repaid to the RRSP plus investment earnings, but none of the extra mortgage costs.
A mutual fund is a pool of securities, usually stocks and bonds, held in a trust. An investment manager decides which individual securities are bought and sold. Ownership is acquired by purchasing units of the trust based on the market value of investment held in the pool on the day of purchase.
Some funds assess a sales charge, or load, on the purchase or sale of units, while other funds have no sales charge. The value of the unit fluctuates daily, based on the net asset value of the fund.
The trust receives interest and dividends from the pool of securities, and realizes capital gains or losses when the manager sells securities. The trust avoids taxation by distributing income net of expenses to unit holders. Interest, dividends and capital gains are taxable every year based on the number of units held and are reported on a T3 slip, and must be declared on the tax return.
Each mutual fund has its own investment objectives, depending on the type of fund and its investment charter. Some funds seek to generate income on a regular basis. Others seek aggressive growth by investing in young companies with a low level of capitalization.
The net asset value or NAV is the current fair market value of each unit of a mutual fund. The NAV is the total value of the fund's investments plus other assets less liabilities, divided by the number of units outstanding.
The net worth is a person's total assets minus total liabilities. Lending institutions require this information to approve credit. Net worth also is a measure of a person's financial well being.
From the balance of all assets and investments is deducted any amount of debt payable, such as unpaid income or property taxes, car loan, credit card balances, personal lines of credit, unpaid bills, or other loans, debt or obligations.
The Notice of Assessment is the summary that the Canada Revenue Agency sends after filing to confirm the income, credits and other information stated in the personal income tax return. It also states any errors made on the return, and the amount of tax or refund owing.
The notice includes a Registered Retirement Savings Plan (RRSP) Deduction Limit Statement for the current year which provides a reconciliation of the RRSP deduction limit between the previous year and current year.
Old Age Security or OAS is a social insurance program that provides a basic level of pension income, on application, to anyone age 65 or over who meets residence requirements. OAS is financed from the general tax revenues of the Federal Government. All benefits under OAS are adjusted quarterly each year in line with rises in the cost of living as measured by the Consumer Price Index. The monthly OAS pension effective January 2003 is $453.36 per month.
Persons who are Canadian residents must include the basic Old Age Security pension in their taxable income. Persons who reside outside Canada are subject to tax withholding on their basic Old Age Security pension. The usual rate of withholding tax is 25%. However, persons who live in countries with which Canada has concluded a tax treaty that specifies a rate of withholding lower than 25% are only subject to that lower rate.
A minimum of 10 years of Canadian residency after reaching age 18 is required to receive an Old Age Security pension in Canada. To receive OAS outside the country, a person must have lived in Canada for a minimum of 20 years.
The amount of a person's pension is determined by how long he or she has lived in Canada. A person who has lived in Canada, after reaching age 18, for periods that total at least 40 years will qualify for a full OAS pension. A person who cannot meet the requirements for the full OAS pension may qualify for a partial pension. A partial pension is earned at the rate of 1/40th of the full monthly pension for each complete year of residence in Canada after reaching age 18.
The amount of Old Age Security pension paid to persons with high incomes is reduced through a recovery provision of the Income Tax Act. For 2003, the tax recovery applies to persons whose total income exceeds $57,879. For every dollar of income above this limit, the amount of basic Old Age Security pension reduces by 15¢.
A past service pension adjustment or PSPA is an adjustment to previously reported pension adjustments in respect of pensionable service after 1989 to reflect an improvement in the pension benefits provided under a registered pension plan.
For each year of participation since 1990, there has been a pension adjustment reported for the pension benefits earned under the plan. If the pension is improved for some or all these years of service, the employee should have had higher pension adjustments. The PSPA is the difference between the pension adjustments after the improvement and the pension adjustments before the improvement.
A pension adjustment or PA is an amount that reduces the RRSP deduction limit of persons who are in a company-sponsored registered pension plan. This is an attempt to equalize the various tax deferred savings programs in Canada and ensure that persons who participate in a company pension plan do not have the same level of RRSP contributions as those who do not.
Thus, persons who are not in a pension plan do not have a pension adjustment. Those who participate in a registered pension plan or a deferred profit sharing plan have a pension adjustment reported for each year of participation on their T4 slip (Statement of Remuneration Paid). The pension adjustment reported in a calendar year reduces allowable contributions to an RRSP for the next calendar year.
The PA is the amount contributed by an employee and/or employer to an employee account in a defined contribution pension plan or deferred profit sharing plan, or the deemed value of pension benefits accrued during the year in a defined benefit pension plan.
If a person is a member of a defined benefit pension plan, the PA is calculated as 9 times the benefit accrued during the year less $600. For example, a person who earned $40,000 would be able to contribute $7,200 or18% of earnings to the RRSP in the following year if there were no company pension. However, if the person earned a pension of, say, $500 last year in a company pension plan, then there would be a PA of $3,900 (9 times $500 less $600). The PA reduces the maximum allowable RRSP contribution to $3,300 ($7,200 less $3,900).
A pension adjustment reversal or PAR is an amount that cancels a portion or all previous pension adjustments and increases the RRSP deduction limit. This applies to a member of a registered pension plan or deferred profit sharing plan who terminates employment after 1996 and transfers benefits out of the plan.
The PAR is equal to the sum of the pension adjustments for each year of participation since 1990 in the registered pension plan, less lump sum payments in respect of pension benefits earned since 1990 that are transferred to a locked-in RRSP.
Permanent life insurance, also called whole life insurance, is a life insurance policy with level premiums that provide coverage for the entire duration of life, and pay the stated amount upon death of the insured. This type of policy has an investment component, a cash surrender value, that increases in value over time. The policyholder can borrow against the policy or redeem it. However, redeeming the full cash surrender value will usually cause a cancellation of the policy.
Portability is an option to transfer the value of a terminating employee's pension from a registered pension plan to a locked-in RRSP, to the pension plan of another employer, or to an insurance company for the purchase of an annuity.
Probate fees are an amount charged by the province upon death to certify a will. Fees vary by province, but are generally of 0.5% of the first $50,000 of the deceased person's assets, and 1.5% of the excess.
A profit sharing plan is a compensation arrangement that distributes annually to employees a specified percentage of a company's profits in addition to their income. Each employee's share of the overall distribution usually depends on seniority and income level.
The rate of inflation is the annual rate of increase in the general price level of goods and services. Year after year, each dollar buys less as the prices of goods and services sold in the market increase. This is how inflation erodes the purchasing power of someone who receives a fixed income. Inflation is measured as the increase over time in the Consumer Price Index. (See Inflation-adjusted dollars.)
The rate of return is the percentage change in the value of an investment over a period of time.
The real return is the rate of return on an investment after adjusting for inflation. For example, if the rate of return is 8% and the rate of inflation is 3%, the real rate of return is 4.85% (1.08 / 1.03 – 1).
A Registered Education Savings Plan or RESP is a government-sponsored plan that allows parents to contribute each year in an account that appreciates tax free for up to 21 years.
Contributions are not tax deductible, but investment income is not subject to income tax. There is no limit on the amount of contribution per year for each beneficiary, as long as the cumulative amount does not exceed a lifetime maximum of $50,000 per beneficiary. The government provides a grant of 20% of contributions, up to a maximum of $500 per year for each beneficiary.
When the child starts post-secondary education, the RESP provides income to pay for tuition and related expenses, taxable at the rate applicable to the child's income, not the contributor. If the child does not pursue a post-secondary education, accumulated earnings can be transferred to the contributor's RRSP, if there is sufficient contribution room available. The maximum amount that can be transferred is $50,000. If RRSP contribution room is not available, income tax must be paid plus an additional 20% penalty tax. The RESP may only be tax sheltered for 26 years.
A registered pension plan or RPP is an arrangement sponsored by an employer for the purpose of providing income to their employees after retirement. RPPs are registered with the Canada Revenue Agency to obtain tax-deductibility of employee and employer contributions and accrued investment income. Money accumulates in a fund held in a trust that is separate from the company's assets. RPPs are also subject to provincial pension legislation that sets out minimum standards to ensure equitable treatment, prudence and due diligence.
There are two main types of RPPs: defined benefit pension plans and defined contribution pension plans.
Registered plans is a general term referring to registered retirement savings plans, deferred profit sharing plans and locked-in RRSPs. (Company pension plans - either a defined benefit or a defined contribution pension plan - are registered pension plans.)
A registered retirement income fund or RRIF is a withdrawal plan registered with the Canada Revenue Agency in which proceeds accumulated in an RRSP are used to provide an annual income. Investment earnings continue to accumulate on a tax-sheltered basis, but withdrawals are taxed as income.
The Canada Revenue Agency prescribes an annual minimum withdrawal, which depends on the age and market value of the RRIF at the beginning of the year. Once a RRIF is opened, payments must commence in the following year.
There is no minimum age to set up a RRIF. An individual may hold several RRIFs with different financial institutions. The RRIF holder maintains controls of the investments. Funds held in a RRIF may also be used to purchase an annuity from a life insurance company.
A registered retirement savings plan or RRSP is a personal savings plan registered with the Canada Revenue Agency in which contributions and investment earnings accumulate on a tax-deferred basis. Withdrawals from an RRSP account are taxed as income. By the end of the year in which the RRSP holder reaches age 71, the RRSP must be closed, converted to a registered retirement income fund, or used to purchase an annuity from a life insurance company.
An RRSP holder may make contributions during the taxation year, or 60 days after the end of that year. Contributors who become age 71 during the year may contribute until December 31 of that year, but not beyond.
Annual RRSP dollar maximum
Foreign content restrictions
Notice of Assessment
Past service pension adjustment
Pension adjustment reversal
RRSP deduction limit
Registered retirement income fund
Unclaimed RRSP contribution
Unused RRSP deduction limit
Distributions from a mutual fund are usually reinvested, and more units are credited to each unit holder's account. The tax treatment is the same as if each unit holder received the money and used it to purchase more units of the fund.
A retiring allowance is an amount of money paid to a terminating or retiring employee in recognition of service, accumulated sick leave or loss of employment. A portion of funds payable as a retiring allowance may be transferred directly to an RRSP without being subject to income tax. This is in addition to the normal limits for RRSP contributions.
An individual may transfer up to $2,000 for each year of service before 1996 plus up to $1,500 for each year of service before 1989 in which no pension or deferred profit-sharing plan benefits were earned.
The return is the percentage change in the value of an investment over a period of time. This may or may not include any distributions, such as dividends or capital gains.
A reverse mortgage is a loan taken by a homeowner using as collateral a real estate property. It is called a "reverse mortgage" because rather than making payments on the property, the homeowner receives income from the property, based on the amount of the loan. The person who takes a reverse mortgage continues to own and occupy the home, and benefits from any increase in the equity of the property. The principal and interest are repaid by the estate, or upon sale of the property.
A reverse mortgage allows persons with significant equity in their homes to use it as a source of income. It provides immediate access to cash, investment or annuity income or a combination thereof. Initial funds received through the program are tax-free and annuity income does not impact any senior income supplements currently available.
The amount of home equity that can be unlocked ranges between 10% and 45%, and depends on the age, gender and marital status of the applicant. An older person can access a higher percentage.
TD Bank and Royal Bank currently sponsor the Canada Home Income Plan reverse mortgage program.
Eligible persons must be 62 or over (for couples, both spouses must be age 62 or over) and be a resident of British Columbia or Ontario in a geographic location that meets underwriting requirements. Certain types of properties, such as leasehold, co-ops and properties with larger acreage are not eligible.
For more information, call the Canadian Home Income Plan at 1-888-641-5256.
Risk tolerance is a term describing the degree of investment risk an investor is willing to accept.
On death, the proceeds of an RRSP are distributed to a idd beneficiary, or to the estate, as designated in the RRSP or will. If a spouse is the designated beneficiary, the RRSP is transferred tax-free to the spouse's RRSP or RRIF. Proceeds can also be transferred tax-free to provide a term annuity to dependent children or grandchildren until adulthood. If dependent children or grandchildren are physically or mentally handicapped, the RRSP can be transferred to an RRSP in their name.
The RRSP deduction limit is the maximum amount that a taxpayer can deduct in the tax return of a given year for contributions made to an RRSP after 1990 and before the first 60 days of the following year. This deduction limit applies to RRSP contributions to the taxpayer's RRSP, or to a spousal RRSP, for which the taxpayer did not previously obtain a deduction.
The RRSP deduction limit for the current year is equal to:
The unused RRSP deduction limit at the end of the previous year
Plus: 18% of previous year's earned income up to the annual RRSP dollar maximum
Minus: previous year's pension adjustment, if any
Plus: pension adjustment reversal, if any
Minus: net past service pension adjustment, if any
Each year, the Canada Revenue Agency provides a statement of this amount in the Notice of Assessment. This information is also available from the Canada Revenue Agency's Tax Information Phone System (TIPS) listed in the blue pages of the phone book.
The Canada Revenue Agency allows an indefinite carry-forward of the unused RRSP deduction limit. This means that contributors can make up in the future for years during which they were unable to make maximum RRSP contributions.
Experts give the following advice in order to maximize accumulation of savings at retirement: start saving at the earliest possible age, save each and every year, and contribute the maximum allowable amount to an RRSP. The keys to maximizing wealth are time, deferring taxes, savvy shopping and having expenses that are lower than income.
Time is an essential ingredient because of the leveraging effect of compounding. Also, investment fluctuations tend to smooth out over time, especially with dollar cost averaging.
Deferring taxes means paying taxes later, but before that day arrives, the money can grow completely tax-free. With compounding, tax-free growth of investments is even more leveraged.
Savvy shopping is the ability to pay less than the full price for purchases big and small. Spending less than what is coming in means that there is always money left to invest.
A share is a certificate representing ownership in a corporation or similar entity. Stock is also used interchangeably.
A single-premium deferred annuity is an annuity purchased for a lump sum from a life insurance company by the sponsor of a registered pension plan. In return, the insurer will pay a lifetime pension when the policyholder retires.
A spousal RRSP is an RRSP to which a spouse makes contributions on behalf of the other spouse. Spousal RRSP contributions are useful for couples who want to save taxes during retirement. It allows drawing smaller amounts from the spouses' respective plans, instead of one spouse drawing a larger amount – and paying more income tax. This strategy is called income splitting.
All or part of an RRSP contribution can be directed to the RRSP of a spouse, while maintaining the deductibility of the full amount in the hands of the contributor. The spouse's maximum RRSP deduction is unaffected by such contributions. However, the Canada Revenue Agency requires that withdrawals from the spousal RRSP during the current taxation year or preceding two years, be added to the contributing spouse's income in the year of withdrawal.
Contributions to the spouse's RRSP may be deposited until December 31 of the year in which the spouse becomes age 71, without regard to the age of the contributing spouse.
A spouse is defined as a person of the opposite sex who lives with and is engaged in a conjugal relationship for 12 or more months, or is the parent of natural or jointly adopted children.
The standard of living is an expression that refers to the degree of wealth and luxury that a person experiences in everyday life. One objective for building net worth during income-earning years is to maintain one's standard of living during retirement.
Stock is ownership of a corporation, represented by shares of capital in the corporation.
A tax bracket is a specific range of income to which a particular tax rate applies. The federal income tax rates in Canada for the
four tax brackets are currently 15.5% of the first $36,000 of earnings, 22% of earnings between $36,000 and $72,000, 26% of earnings between $72,000 and $118,000, and 29% of earnings in excess of $118,000 (Note: amounts are rounded to nearest thousand). See also marginal tax rate.
A tax credit is an amount that can be claimed in the income tax return by all taxpayers that reside in Canada.
Tax on a mutual fund only occurs when a mutual fund makes a distribution, or when units are sold or transferred. There is tax on the interest, dividend and capital gains realized by fund in proportion to the number of units held. There is no tax if the mutual fund is held in an RRSP.
Term insurance is a type of life insurance that does not have a savings component or cash surrender value. The premium remains constant only for a specified term of years. Term policies are renewable, in periods of one to 20 years, and are usually not available to persons age 75 or older. Premiums rise significantly with each renewal.
Term to 100 is a type of life insurance that is permanent, but unlike whole life insurance, does not have a cash accumulation or cash surrender value. This life insurance is usually cheaper than permanent insurance but more expensive than term insurance. Premiums are fixed and guaranteed to age 100, whereas term insurance premiums rise with each renewal.
A testamentary trust is a trust that takes effect upon death. A trust is a pool of assets managed by a trustee according to the terms set out by the person who created the trust. Professional trustees charge an annual fee for their services based on a percentage of the assets in the trust. Testamentary trusts are subject to probate fees, but have the same tax status as individuals. Accordingly, they have attractive income-splitting opportunities, because the trust pays tax on amounts distributed, not the beneficiary receiving payments. The main purpose of a testamentary trust is to ensure that assets are distributed in accordance with the deceased person's intentions.
A Treasury bill or T-bill is a short-term security issued by a government, with a maturity generally between 30 to 364 days. T-bills have a face value and sell at a discount based on current interest rates. The difference between the discounted price and the face value is the yield of the Treasury bill.
An RRSP over-contribution is the amount of RRSP contributions in excess of the RRSP deduction limit. Such amounts are not tax deductible and could be of up to $8,000 in the past. This buffer was put in place to provide leeway for taxpayers who contributed unintentionally above their limit.
The Canada Revenue Agency reduced this buffer to $2,000 in 1996. Taxpayers who over-contributed by more than $2,000 must claim the difference between their over-contributions and $2,000 before claiming any tax deduction for RRSP contributions. This difference is called the unclaimed RRSP contribution.
Schedule 7 of the Income Tax Return contains the amount of Unclaimed RRSP contributions, if any.
Universal life is life insurance that has an investment component in addition to a death benefit. The policyholder has the flexibility to change the death benefit and amount or timing of premium payments, and this increases or decreases the investment component.
The unused RRSP deduction limit is the maximum amount which, at the beginning of the year, can be contributed to an RRSP.
The unused RRSP deduction limit is equal to:
RRSP deduction limit for the previous year
Minus: allowable RRSP contributions deducted in previous year
The Canada Revenue Agency shows this amount in the Notice of Assessment. A taxpayer may choose to make RRSP contributions in a given year up to the maximum allowable amount, or carry forward indefinitely in the future any amount below the RRSP deduction limit.
Variable life is whole life insurance that provides a death benefit dependent on the market value of the portfolio of invested premiums of the policyholder at the time of death. The insurer invests premiums in common stocks. Variable life insurance is sometimes referred to as equity-linked insurance.
Volatility is the risk of market price fluctuations, or the potential for a loss when an investment is sold at a market price that is lower than the purchase price. It is a measure of the fluctuation in the market price of the security.
Withholding tax is the amount a financial institution must withhold by law and remit to the Canada Revenue Agency on funds withdrawn from an RRSP. The table below sets out the withholding tax:
A will is a legal document detailing the distribution of a person's assets upon death. A will may address other arrangements, such as the naming of a guardian for the children. A person who dies without a will is said to die intestate.
The process of setting up a will begins with an inventory of all assets of the person making the will. This includes real estate, bank accounts, registered plans and any other investments. The next step is to decide who will be the children's guardian if both spouses die at the same time. Experts recommend retaining the services of a lawyer to help draft a will. Another option is using software packages available on the market. A valid will must be signed by the person who makes the will and by two witnesses who are present at the time of signing. It is important to maintain current the will as life circumstances change over time.
The yield is the annual rate of return of an investment, expressed as a percentage.
For stocks, yield refers to the rate of return on dividends, and for bonds or other fixed income investments, it is the interest paid on the invested amount.
The Years Maximum Pensionable Earnings or YMPE are eligible earnings used in determining maximum benefits and contributions under the Canada or Québec Pension Plan. For 2007, the YMPE is $43,700. The employee and employer contribution rate is currently set at 4.95% of earnings between the YBE and the YMPE. The Government set the contribution rate to meet future funding requirements.
The YBE or Years Basic Exemption is $3,500. The Canada Pension Plan does not cover earnings below the YBE. The YMPE is linked directly with the average Canadian wage, and the Year's Basic Exemption is equal to $3,500. which represents approximately 10 percent of the YMPE for year 1997.