With the increased market volatility that people have experienced this year, more and more investors are looking to the security of Guaranteed Interest Certificates (GICs) to protect their savings. However, what many people do not realize is that while most GICs are not subject to market risk, there are other types of risk that can affect a GIC.

 

To understand this, let’s look at what GICs are. GICs and Term Deposits are debt instruments issued by banks, trust companies or other financial institutions that guarantee investors a fixed rate of interest for a set term.   The investment period for a term deposit/GIC can be measured in days, months or years. Depending upon the financial institution, these debt instruments can be purchased for short durations such as 30, 60 or 90 days. They may also be available for investment periods of 1 – 5 years and some institutions offer terms that extend well beyond the five years.

 

At the end of the investment term, the instrument matures and the financial institution returns the principal and any interest payments owing to the investor. The minimum amount of principal required for investment will differ by financial institution.

 

If a GIC is held outside of an RRSP, it is important to know that the income earned is treated as interest income. Also, an investor must report accrued interest annually even if the investment is for longer than one year and that investor won’t receive the funds for another 1 – 4 years.

 

So now that we understand what a GIC is, what are the risks? A GIC is subject to 3 types of risk, Inflation Risk, Reinvestment Risk and, to a much lesser extent, Default Risk.

 

Inflation risk is the probability that price increases will erode the value of an investment. A GIC provides a maximum or capped rate of return which means that it cannot adjust to increases in inflation. If the interest rate on a GIC is lower than the rate of inflation then, while your principle will remain the same, the purchasing power will continue to fall every year. For example; at the time this article was written the average 1 year GIC posted rate was 1.2%, the core CPI (rate of inflation) was 2.4%, therefore even if you are in the lowest marginal tax bracket of 24.2% your Real After Tax Rate Of Return on a GIC would be -1.49%.

 

Reinvestment risk refers to an investor’s ability to take future proceeds and reinvest them in securities that have similar risk/return profiles. It is the risk that, when the investment matures, if you purchased the same investment again it would be at a lower rate. There are mixed opinions on the risk this presents in the current market. Some people feel that interest rates are going to continue their downward trend while others feel they can’t go much lower and will start to climb. Whatever happens, it is a risk you should be aware of. 

 

Default risk is the risk that a company will not have the funds available to pay the principal owing on an outstanding debt at maturity. This risk is very minimal for a GIC. Most financial institutions that offer GIC investments are members of CDIC or Assuris which means that, if you qualify, your investment is protected up to $100,000 in the event of the financial institution failing. If your total investments in like accounts exceed $100,000, the excess is not protected. Splitting your money into separate accounts does not increase your protection amount. Also, your deposits are not protected if your financial institution is not a member of CDIC or Assuris (i.e. credit unions, caisse populaires, Canadian branches of foreign banks, and some Canadian chartered banks). You may want to check to make sure your deposits are protected through CDIC, Assuris or other provincial deposit insurance programs to assess your exposure to Default risk. You can get more information on CDIC and Assuris at their websites. www.CDIC.ca and www.Assuris.ca.

 

A GIC is much less volatile than securities held in the market but that does not mean they are risk free and the low rate of return may make them inappropriate for some investors. If you would like to learn more about GICs and how they can fit into your portfolio please contact a professional at Langlois Financial Services Inc.

Hopefully you'll never need to manage through such an unpleasant contingency but there is always a chance that you or someone you love might face a layoff in the future, particularly during this time of economic uncertainty.

 

You might already be acquainted or all too familiar with the vexations that come with being dismissed suddenly. When this happens, or at any other time you receive news that affects your financial plan, it is extremely important that you contact your financial advisor immediately. Not only is it your responsibility to let them know when there are "material changes" to your plan, it is usually imperative that they advise you on how to manage your cash flow, investments, benefit plans and the tax implications that usually accompany employee severance packages. 

 

Although receiving a large or modest severance package can help soften the blow of losing your employment, the sudden influx of cash can have serious tax consequences if not managed properly. In some cases, it might even be beneficial to negotiate with your employer and arrange to receive severance payments after January 1.

 

Retiring allowances can sometimes be transferred to your registered retirement savings plan (RRSP) without using up your existing contribution room. Retiring allowances, as defined by the Canada Revenue Agency, include payments an employee receives when his or her job is terminated, either to recognize long service or to compensate for the loss of employment. This includes money paid for unused sick leave or damages (in the case of wrongful dismissal, for example).

                                                                                                         

Retiring allowance does not include superannuation, pension benefits, funds given in lieu of termination notice or amounts paid for unused vacation time.

 

The amount eligible for transfer depends on the length of time you have been with the company. The amount is equal to $2,000 for each year or part year you worked with the company before 1996, plus another $1,500 for each year or part year you worked with the company before 1989, provided you did not earn (or have vested rights to) benefits in a registered pension plan or a deferred profit-sharing plan.

 

The amount of the retiring allowance eligible for transfer to your RRSP will be reported in box 26 of your T4A slip. Ineligible amounts will be shown in box 27. If the severance you receive does not qualify under these rules — if you're leaving an employer you joined in 1997 or later, for example — the amount of severance that can be tucked away inside your RRSP will depend on the contribution room you have available.

 

If your RRSP is full, that amount might need to be reported as income. If this is the case, it could make more sense to negotiate with your employer and arrange to receive this income after January 1.

 

Deciding whether to stay in your company pension plan (if you have one) or move your funds into a locked-in, self-directed retirement account requires that we do a calculation to determine which investment (your pension plan is an investment!) will generate better returns over time.

 

Thanks to recent pension regulation changes, locked-in accounts no longer need to be converted into a life annuity at age 80. This means pension payouts to a surviving spouse might not necessarily stop or be reduced when the pension plan member dies. Locked-in accounts might even be used to provide an inheritance to the member's family.

 

Finally, group life and health benefit plans can sometimes be converted into an individual policy without the need to provide medical evidence. This situation should be dealt with immediately.  In some cases, there might be only a short period of time — usually 30 or 60 days — to make these arrangements. Unless you are in excellent health, this could be your only chance to obtain sufficient insurance coverage at a standard rate.

 

Although you hopefully will never need to use it, this information may be important to your financial well-being. Do not hesitate to contact a professional at Langlois Financial Services if you find yourself in this situation or any other that could have an impact on your financial plans.

With the new Tax Free Savings Account available in January, many people are wondering where to save for their retirement. Should they look at RRSP or TFSA? Before getting into that, let’s first look at the similarities and differences between the two.

 

 TFSAs and RRSPs are directly comparable in four ways:

1.      They do not impose a tax on annual investment income.

2.      There are penalties of 1% per month for over-contributions.

3.      Carrying charges are not deductible (because they are not used to earn income in either case).

4.      Both require holders to include only eligible investments.

 

In all other respects, they are quite different financial vehicles, starting with age limitations. While TFSA holders have to be at least 18, there is no minimum age requirement for an RRSP (RRSP contribution room is based on earned income).

 

The ability for TFSA holders to carry forward contribution room indefinitely following withdrawals is not replicated with RRSPs. With a few exceptions (notably the Home Buyers' Plan and Lifelong Learning Plan), when a withdrawal is made from an RRSP, the contribution room it represents is lost forever. Another important difference is the upper age limit. TFSAs can last the holder's lifetime but an RRSP matures when the holder reaches age 71, at which time the proceeds are commonly rolled into annuities or Registered Retirement Income Funds (RRIFs).

 

The differences between the two accounts are more pronounced when it comes to taxes. Unlike TFSAs, RRSPs provide appealing tax deductions for contributions. It is difficult to overlook the instant gratification of the tax deduction from the RRSP contribution. But looking ahead, it helps to remember that, unlike with TFSAs, RRSP withdrawals are taxed as ordinary income, so the holder will not benefit from the reduced rates for capital gains or dividends from Canadian companies. Also, unlike with TFSAs, withdrawals from RRSPs may reduce the holder's income-tested benefits, including Old Age Security, the Guaranteed Income Supplement and the age credit.

 

TFSAs appear to have an advantage on the question of contributions from spouses or common-law partners. The taxation for this situation is best explained in the scenario where one spouse earns all the family income. Where the working spouse provides the funds to contribute to a TFSA in the name of the non-working spouse, the income earned in and/or withdrawals from the TFSA are not subject to tax. Therefore, attribution rules would not require the working spouse to report any income or gains from the TFSA.

In comparison, with an RRSP it is unlikely that the non-working spouse would have RRSP contribution room; however, the working spouse could make RRSP contributions to a spousal RRSP.  In this case, the working spouse gets the RRSP deduction, but when the funds are withdrawn, the withdrawal is included in the non-working spouse's taxable income. This is a good income splitting technique (albeit the benefits are somewhat diminished by the new pension splitting rules). In certain situations, the attribution rules could apply and require that a withdrawal be included in the working spouse's income (note that RRSP attribution rules can be complex). It should also be pointed out that, in the first year this couple could contribute $5,000 each to a TFSA, whereas the RRSP contribution is limited to the working spouse's RRSP contribution limit.

 

Both accounts face a deemed disposition on death but, while TFSAs have no tax on the disposition, the fair market value of an RRSP balance will be subject to tax. Both types of accounts allow for transfers to surviving spouses. A transfer of a TFSA to a surviving spouse is on a tax-free basis.  A transfer of an RRSP to a surviving spouse is on a tax-deferred basis which means that, on the death of a surviving RRSP holder, there will be a tax bill on the remaining RRSP balance.

 

Given the similarities and differences, how do you choose where to put your money to create the right balance? For most clients the key choices will be made between TFSAs and RRSPs. Using one or the other or both, depends on your goals. TFSAs are flexible and can be used to meet either short-term savings objectives or long-term objectives like retirement savings. RRSPs are clearly designed for retirement savings with limited exceptions — allowable tax-free withdrawals (and subsequent repayment) for the Home Buyer's Plan or the Lifelong Learning Plan.

 

Your incomes levels — now and expected in the future — are also important in choosing between TFSAs and RRSPs.  If your marginal tax rate is higher at the time of contribution than it's likely to be when withdrawals are made (i.e. working income is higher than expected retirement income) an RRSP is preferable for its tax-saving qualities. If the reverse is true, and retirement income (and hence marginal tax rate) is expected to be greater than during your working life, then a TFSA will be the better choice because of those tax-free withdrawals.

 

For most people, it won't necessarily be an either/or situation. Those who consistently save and invest throughout their working lives may well be in higher income brackets at retirement. Over the course of their working lives, they may juggle the utility of both types of accounts.  RRSPs can be used to build savings that will generate retirement income (but hopefully not so much that OAS/GIS and age credit benefits are depleted) while TFSAs can be used to top up savings.

 

It sounds complicated but it isn't. The important thing to remember is that the TFSA is another weapon in your savings arsenal. And depending on your circumstances, it can be used alone or in concert with other savings and investment vehicles to save tax and leave more money in your hands. Contact one of the professionals at Langlois Financial Services to review the options that are right for you.