What are the pros and cons of loaning yourself a mortgage from your RRSP or LIRA? Read on for the details.
Growing up, I never had sufficient exposure and education to personal finance. My grandparents lived in a decent home, which was bought at a very reasonable price in an incredibly valuable neighbourhood that benefited from 40 years of real estate growth, all while living more modestly than they needed to.
My parents also bought their home in the booming 1980s when prices and wages were decent, but interest rates were punitive. They eventually moved up the property ladder and into their dream home. All along I was kept in the dark about all this and, as I grew into adulthood, eventually found myself reading more books and blogs around personal finance to learn the context of their history.
First Time Home Buyers in Toronto
Back in 2012, my wife and I bought a house in a family-friendly neighbourhood near a subway station in Toronto. We had both saved up since before we met and knew we wanted something we could start our family in without feeling too crowded for space.
We were lucky and grateful to have saved more than a 20 percent down payment, and we locked-in to a mortgage at 2.99 percent for five years. We have been told how lucky we were to have bought when we did, especially by friends and family who have been left on the sidelines of homeownership.
Fast forward to 2019, after we renewed early at 2.49 percent in 2016 and added two kids and a whole lot of daycare costs to the family, we were looking to renew once more while rates are still considered historically low. Unfortunately, we were not able to get a renewal rate as low as even our initial mortgage. We needed to determine the best option for our renewal considering we may want to move up the property ladder and still have access to an emergency fund.
I became more interested and engaged in personal finance, drawn to the likes of Boomer & Echo for the practical advice and relatable stories of Robb and his contributors. As our family grew, and our situation demanded more personal and financial attention, I knew I had to make sure the money we brought in was being utilized to its best potential.
The Best Laid Plans
Then in 2018, while waiting for our second child to join our family, I experienced a major shock and life setback: I was laid off. This was a double hurt as we knew the impact would be felt both in the short-term – going on EI and utilizing severance pay – and long-term that I was no longer enrolled in a defined-benefit pension plan.
At the time, I decided to take the pension money and manage it myself inside a LIRA, or Locked-In Retirement Account, in case I found myself in another workplace pension and could use it to buyback service. However, my new job only has a defined-contribution pension, so I’m left to manage my LIRA on my own, with no ability to contribute to it and no early access.
I knew I’d have to be a prudent investor to carefully grow this retirement fund in the age of rock bottom interest rates, low fixed income yields, and the tail-end of a long-running bull market. How can I get this to grow enough to meet my retirement goals?
My Mortgage Gambit: How To Set Up an RRSP or LIRA Mortgage
Here’s where our mortgage and my LIRA will come together, and I embark on what I jokingly call the “Mortgage Gambit” (in honour of Norbert’s Gambit): I’m going to stop worrying about my retirement fund and raid my LIRA as an RRSP mortgage!
Starting this process early in 2019 allowed us to do the research and take stock of what was needed to have in place to be able to raid my LIRA at mortgage renewal time in mid-2020.
First, I needed to have a LIRA with an institution that can hold a Non-Arm’s Length Mortgage. Fortunately, I happen to already be a customer with the brokerage arm of a big bank that can hold a mortgage in an RRSP.
Second, we needed enough money in said LIRA to cover the balance of the mortgage. Since I could not add funds to the LIRA, it meant having to knock down the remaining principal of our mortgage debt.
After many years of diligent TFSA contributions, and the severance from my lay off, we planned to use our savings to pay down the balance over two calendar years using the mortgage’s prepayment options.
My wife and I began to slowly exit our investment positions and hold cash or short-term GICs to ensure we would not compromise our plan. We would track and control our spending for the year, limiting purchases to necessities and travel to a minimum. By the end of 2019, we would maximize the annual mortgage prepayment and then, in the beginning of 2020 before our renewal, we would make another prepayment to bring our balance down to below the amount available to hold the mortgage in the LIRA.
Third, we had to visit the bank and ensure they would allow us specifically to engage in this plan and that we met all the requirements. Thankfully, we would qualify and got a rough idea of the costs and what our interest rate might be. We would have to pay a set-up fee, an annual maintenance fee, a CMHC premium (as a requirement for Non-Arm’s Length Mortgage), and some legal fees.
The eligible interest rate was the bank’s posted 1-year open rate. After crunching those costs, and considering those factors, we still decided to pursue this endeavour.
Why I Took This Approach With My LIRA
Now you might be asking, “why would someone go to this hassle when he could just renew with a “vanilla” mortgage and invest aggressively in his LIRA to get the returns needed to grow it over 20 years?”
I thought about this, as a Couch Potato or Four-Minute Portfolio seemed appealing for the LIRA. It all came down to the one thing most Canadians, especially our dual-income, kids in daycare, contemporaries struggle with: cash flow.
While we are grateful to no longer be living paycheque-to-paycheque, we wanted our kids to have a standard of living that would allow us to have fun and feel comfortable without going into debt or dipping into our savings.
When my wife went back to work in mid-2019, after being on parental leave, we started paying for full-time infant daycare while already covering before & aftercare for a kindergartener and started feeling the pinch. When we felt short on both time and money, we resorted to dipping into our savings more regularly than we were comfortable with.
As I alluded to earlier, we bought the house knowing we’d have enough room for our family, but we knew we’d feel cramped when our kids got older. We wanted to move up the property ladder in the near future, and if we were dipping into savings every month and watching the housing market jump in value every year, we were concerned we would not be able to move up to a bigger and/or better property when we wanted to.
As the stock market went up, so did my concerns that it could run out of steam and come crashing down. We could not comfortably stomach any more loss of invested savings, especially the funds earmarked for our next down payment.
After enduring some past investment mistakes from my time before I learned to simply my portfolio, I had hurt some of my TFSA with unrealized losses and learned that not everyone should be invested heavily in equities without knowing the risks. Lesson learned.
With these three above concerns, we wanted to stop worrying about our mortgage, the inevitable rise of interest rates, free up cash flow to allow us to save for our next home, put ourselves in a better position to move up the property ladder in the next few years as house prices continue to climb, and have a guaranteed income to grow my LIRA without the ability to contribute. With an RRSP mortgage, I could have it all, with a small fee and a few caveats.
RRSP / LIRA Mortgage Benefits
The benefits of an RRSP or LIRA mortgage well outweigh the drawbacks:
- The money we would have given the bank in interest is now coming back to us. While we will still pay a small portion towards one-time and annual fees, the majority of our mortgage payments come back to us as repayments to the LIRA;
- We benefit from our already low remaining amortization, after previous prepayments, and are putting more towards the mortgage. This equates to a guaranteed return on investment equal to the savings in mortgage costs (in our case 2.49 percent tax-free with no capital gains on our primary residence);
- The money we pay as a mortgage has a guaranteed return on investment as we pay back the LIRA in the form of our mortgage payments at the posted 1-year open rate of 4.5 percent (as of this writing), plus when the cash goes back into my retirement savings account where I can pursue a Couch Potato or Four-Minute Portfolio with monthly dollar-cost averaging. Should the rate go up then I end up paying myself more, and should rates fall I can adjust the amortization and keep the same payment;
- The inability to contribute to a LIRA is superseded as holding a mortgage, allowing us to put back more than we take out in the form of loan payments that include an interest premium to myself and not the bank;
- Reducing our monthly mortgage payment by 80 percent to allow for improved free cash flow to cover our fixed expenses and have money left over to save up for our next house down payment;
- Allowing us to add to the overall amortization of the loan from eight to 25 years without adding to our indebtedness to a bank, as we want to be mortgage free before retirement, since I cannot access the money before retirement anyway.
Risks and Alternatives
We understand the risks involved, that’s why I nicknamed this a “gambit” move. We are putting a large amount of our cash savings towards a debt, albeit a manageable one secured against a valuable (and currently growing) asset, instead of investing it.
We could keep the cash and put it back into our TFSAs and invest it with a risk-appropriate plan. With that in mind, consider that in the past decade while the S&P/TSX has doubled in value, the Toronto housing market has tripled. Can either of these be sustained? I don’t know and I would like to believe that neither do the bulls or bears who have been arguing about either of these markets for as long as I can remember.
What I do know is the simple fact that my family needs to live somewhere, and we love our home, our friends & neighbours, our neighbourhood, and the memories we have made. We want to ensure that we take care of it and can afford to stay as long as we want to. We also want the ability to be able to (in the near future) find the right property to call our next home without too much sacrifice to our lifestyle.
I am not as worried about my retirement (no more than I was since my lay off) because if the bull market finally loses steam and my LIRA takes a hit in value I know that I’m not going to retire in the next 20 years – but we still need to live in our house.
I was more worried about eating away at our savings and if either my wife or I lost our jobs that we’d be able to keep the mortgage payments in check. If the bull market and economy keep roaring ahead, we’ll ideally both keep our jobs. If interest payments go up, the extra money will go back to my retirement and not the bank’s bottom line.
I am looking forward to sleeping a little more soundly and reconciling the loss of a rewarding career with its rare and coveted guaranteed DB pension and take advantage of my circumstances to benefit my family’s security. What do they say about life and lemons?
Thanks to Robb for letting me share my story. While I am not endorsing this move (in fact I asked Robb about it back in March 2019) as one needs to be in the right circumstances personally, professionally, and financially, I wanted to share with my fellow Boomer & Echo readers our story to promote to all those interested and engaged in their personal finance situations to take stock of your overall financial situation and determine what is best for you, your family, and future, and to find ways to keep (legally) as much of your own money in your pocket and still live a life you’re happy and comfortable with.
The two main ways to reduce taxes owing are through tax deductions and tax credits. What’s the difference between a tax deduction and a tax credit? Let’s explore:
A tax deduction reduces your taxable income. The value of a deduction depends on your marginal tax rate. So, if your income is more than $210,371, you’d be taxed at the federal rate of 33 percent and a $1,000 tax deduction would save you $330 in federal tax. On the other hand, if you earn less than $47,630, you’d be taxed at the federal rate of only 15 percent and a $1,000 tax deduction would only save you $150 in federal tax.
Two of the most valuable tax deductions are:
Your RRSP contribution is an example of a tax deduction, and is likely the best tax saving strategy available to the majority of Canadian taxpayers. The contribution reduces your net income, which in turn reduces your taxes owing. An added bonus for families who contribute to RRSPs is that the resulting lower net income will likely increase their Canada Child Benefit.
You have until 60 days of the current year to make a contribution to your RRSP and apply the deduction towards last year’s taxes. One tip for those who know in advance how much they’ll be contributing to their RRSP is to fill out the form T1213 – Request to Reduce Tax Deductions at Source.
You can contribute 18 percent of your income, up to a limit of $26,500 (2019). Watch out for RRSP over contributions – there’s a built-in safeguard where you can over contribute by $2,000. Excess contributions are taxed at 1 percent per month.
Day care is likely one of the largest expenses for young families today. Child-care expenses can be used as an eligible tax deduction on your tax return.
Typically, child-care expenses must be claimed by the lower income spouse. One exception is if the lower income spouse is enrolled in school and cannot provide child-care, the higher income spouse can claim the child-care costs.
The basic limit for child-care expenses are $8,000 for children born in 2012 or later, and $5,000 for children born between 2002 and 2011. Parents can also claim $11,000 for a child who qualifies for the disability tax credit.
Note that most overnight camps and summer day camps are also eligible for the child-care deduction.
Tax Deductions checklist:
- RRSP contributions
- Union or professional dues
- Child-care expenses
- Moving expenses
- Support payments
- Employment expenses (w/ T2200)
- Carrying charges or interest expense to earn business or investment income
There are two types of tax credits – refundable and non-refundable. A non-refundable tax credit is applied directly against your tax payable. So if you have tax owing of $500 and get a tax credit of $100, you now owe just $400. If you don’t owe any tax, non-refundable credits are of no benefit.
For refundable tax credits such as the GST/HST credit, you will receive the credit even if you have no tax owing.
Three of the most valuable tax credits are:
Basic Personal Amount
The best example of a non-refundable tax credit is the basic personal amount, which every Canadian resident is entitled to claim on his or her tax return. The basic personal amount for 2019 is $12,069.
Instead of paying taxes on your entire income, you only pay taxes on the remaining income once the basic personal amount has been applied.
You can claim all or a portion of the spousal amount ($12,069) if you support your spouse or common-law partner, as long as his or her net income is less than $12,069. The amount is reduced by any net income earned by the spouse, and it can only be claimed by one person for their spouse or common-law partner.
The Age Amount tax credit is available to Canadians aged 65 or older (at the end of the tax year). The federal age amount for 2019 is $7,494. This amount is reduced by 15 percent of income exceeding a threshold amount of $37,790, and is eliminated when income exceeds $87,750.
The Age Amount tax credit is calculated using the lowest tax rate (15 percent federally), so the maximum federal tax credit is $1,124 for 2019 ($7,494 x 0.15).
Note that the age amount can be transferred to the spouse if the individual claiming this credit cannot utilize the entire amount before reducing his or her taxes to zero.
Tax Credits checklist:
- Volunteer firefighter or Search & Rescue details
- Adoption expenses
- Interest paid on student loans
- Tuition and education amounts
- (T2202, TL11A), and exam fees
- Medical expenses (including details of insurance reimbursements)
- Donations or political contributions
The Verdict on Tax Deductions and Tax Credits:
Tax deductions are straightforward – if you earned $60,000 and made a $5,000 RRSP contribution your taxable income will be reduced to $55,000. Deductions typically result in bigger tax savings than credits as long as your marginal tax rate is higher than 15 percent.
A non-refundable tax credit, on the other hand, must be applied to any taxes owing and is first multiplied by 15 percent. That means a $5,000 non-refundable tax credit would only result in about $750 in tax savings.
The most overlooked tax credits and tax deductions (the ones most likely to go unclaimed) are medical expenses, union dues, moving expenses, student loan interest, childcare expenses, and employment expenses.
That’s why it’s important that Canadian tax filers make a checklist of every tax deduction and tax credit available to them at tax-time and take advantage of all that apply to their situation.
A recent discussion on Twitter teased out more answers from investors and advisors alike. Here are some financial planning fears keeping people up at night:
- Future tax laws. We’re planning for retirement with today’s tax rates in mind. Who knows what future tax rates will be, but the general consensus is that they’ll need to go up to meet the scale of entitlements that lie ahead.
- Elder financial abuse. Financial fraud against seniors is a multi-billion dollar problem. Sadly, the losses are worse when seniors are ripped off by their own friends and relatives.
- Sandwich generation. Saving for your own retirement while at the same time caring for aging parents and adult children.
- Consumption smoothing. Balancing the needs of your present and future self.
- Investing behaviour. Not adhering to an investment strategy during difficult times and bailing.
- Unforeseen health issues. The unknown demands of future healthcare.
- Wrong assumptions. When future spending and expected rates of return don’t match up with reality.
- Too conservative with investments. Old rules of thumb about investing in retirement don’t align with 30+ year long retirements.
- Another 2008-style market crash. No one wants to see their portfolio cut in half, especially the soon-to-be or recently retired.
- Loss or reduction of human capital. The ability to earn an income is our most important wealth building factor (why disability insurance is a must).
- Inflation. Often overlooked in this era of low interest rates and stable 2% inflation, but annual rising costs eat into retirement spending and pose a significant risk to our retirement plans.
- Pension risk. Underfunded pensions and increasing lifespans put enormous pressure on both public and private sector defined benefit pension plans.
Obviously we cannot plan for every scenario. But this is why financial planning is so important. We take the variables we know today and then use our best assumptions to project them into the future. Each year gives us more “actual” data to apply to the model and that gets us closer to our desired future goals.
It’s not perfect. Your financial plan is a compass. It’s pointing you in the direction you want to go. Unknown variables might take you a few degrees off course, so it’s important to recalibrate every year or so.
Have you thought about any of these issues and how they apply to your own financial plan? What are some of your worst financial planning fears? Let me know in the comments.
This Week’s Recap:
I’ve had a flood of financial planning inquiries since Christmas and I’ve spent the last week getting caught up. That’s why I was incredibly grateful to have a couple of guest posts to entertain you this past week.
First up we had travel expert Barry Choi stop by to explain the best credit card travel insurance for seniors.
Next we had a post from Late Cycle Nick, who shared his terrifying tale of betting the farm (and winning) on weed stocks before watching his portfolio crash and burn.
Over on Young & Thrifty I wrote a comprehensive comparison of low cost discount brokers – Questrade vs. Wealthsimple Trade.
Promo of the Week – Wealthsimple Trade
Speaking of Wealthsimple Trade, in my research I discovered that this new investing platform ranks a very close second to Questrade for self-directed investing – and, in some case, comes out ahead. Here’s why:
- Wealthsimple Trade is the only trading platform in Canada that offers zero-commission trades for ETFs and stocks. With Questrade, you get free ETF purchases but pay $4.95 to sell ETFs and to buy and sell stocks.
- Wealthsimple Trade started out with only non-registered accounts available, but have since added RRSPs and TFSAs to their platform. There’s no cost to open an account, no minimum to start investing, and no inactivity fees.
So, if you’re the type of investor who has basic trading needs inside of an RRSP / TFSA / Non-registered account, you might consider opening a Wealthsimple Trade account. It’s also ideal for investors who are contributing small, frequent amounts to their accounts and don’t want to get dinged for trading fees each time they do so.
One caveat is that Wealthsimple Trade is completely mobile and so it’s only accessible from a mobile device or tablet. There is no desktop access.
Try Wealthsimple Trade today and enjoy zero-commission stock and ETF trading.
The good news: Canada is no longer dead last in a global ranking of how much mutual fund investors pay in fees. The bad news: We’re still below average in the global rankings.
In another slap in the face to investors, most of Canada will ban Deferred Sales Charges in 2020 – except for Ontario.
Here’s advice on how to improve your finances from people who have heard all your excuses.
The hidden mental toll of overwhelming debt: How a payday loan spiral almost ended in disaster.
Why the best way to manage your money isn’t what you’ve been told:
“Precarious employment and changing values are why the old financial playbook needs a refresh. We have a sharing and a gig economy now—meaning there are a lot of people that don’t have full-time employment.”
Jason Heath explains how income from a rental property creates RRSP contribution room.
Our friends at Credit Card Genius share 9 easy ways to score free Amazon gift cards.
A Wealth of Common Sense blogger Ben Carlson has a new book out exploring a short history of financial scams (which I hope to review here soon). Here are some crazy tales of financial fraud that didn’t make it into his book.
Carlson’s latest in Fortune Magazine explains why you actually may want to buy ‘bears’ in a bull market.
Preet Banerjee uses the movie Interstellar to explain the concept of hyperbolic discounting and why it’s so hard to save for the future:
Millionaire Teacher Andrew Hallam shares the best and worst college majors for future income and employment.
Belief doesn’t have to be black or white. It lives on a spectrum, filled with asterisks. Morgan Housel explains what he believes least.
Finally, Rob Carrick says sorry snowbirds, but provincial health plans should not help Canadians cover their out-of-country medical costs.
Have a great weekend, everyone!