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Student Debt Repayment

Post secondary education is definitely an investment in ones’  future, but the costs are rising each and every year.  Statistics Canada reported that Canadian undergraduate tuition fees in the 2008/09 academic year rose 3.6% from the previous year, after a 2.8% increase in the 2007/08 year. Over the 10 year period from 1998/99 to 2008/08, undergrad tuition fees rose on average 4.4% per year, while inflation in comparison rose 2.3% per year over the same period.

Because of this, it’s not surprising that many students must go into debt to pursue their education.  In fact, the Canadian Federation of Students claims that as of this writing, that the level of Canada Student Loan debt is currently over $13 Billion.  This even excludes provincial and private loans to pursue education, and many students must borrow from multiple sources.

One advantage of a Canada Student Loan versus a bank student loan, is that any interest paid on your loan is tax-deductible (that is, you pay the interest in pre-tax dollars).  Every year, come tax season, the National Student Loan Service Centre (NSLSC) mails out a receipt for the total interest paid on your loans to claim on your tax return.

If you’re like me, and have loans through both the NSLSC and a bank, you may want to consider this strategy to see if it makes sense for you.

Because the interest on your bank loan is not tax deductible, it is likely to your benefit to pay off this loan as quickly as possible, in order to pay as little interest as you can.  However, many students in their first few years coming out of school, likely don’t have incredibly lucrative careers yet.  Hence, you may not have the cash flow to pay as much as you would like to your loans as quickly as you’d like.

Now, when it comes to repayment at your bank, you won’t really have a lot of options: they will likely dictate the term of your loan repayment, and assign an interest rate based on your credit history.  You may even have had a co-signer on your loan (like a parent, spouse, or other family member) whose credit this loan will affect.  The bank will determine what your periodic payments will be, and you’ll start paying!

With a Canada Student Loan, there is the possibility for a tad more flexibility.  If your income is not over a certain threshold, you could qualify for interest relief, where you do not have to make payments for a period of time.  Also, you get to choose either a fixed or variable rate (set by the NSLSC) for your repayment, and can negotiate the term.  If you’ve subscribed to the NSLSC’s Online Services, you can even log on to their website, and customize your repayment terms there.

Now to the strategy:

*Note: Evaluate whether this is right for you.  You may wish to seek outside professional financial advice.

  • Say, right now you’re paying $300 per month to the NSLSC, and an additional $300 to your bank each month, for $600 total.
  • By extending the term of your Canada Student Loan to the maximum they will allow, this will lower your monthly payments.  You will also end up paying more interest, of course, but as discussed previously it is tax deductible unlike the interest on your bank loan.  Say in our example, extending your term allows you to lower your NSLSC payment to $200.
  • This frees up $100 more cash flow each month!  Now, it’s not time to go out and party.  We’re going to turn around and pay this additional $100 on our bank loan, making our payment there $400 total.
  • We’ll continue to pay off the bank loan at an accelerated rate, getting rid of the non-interest deductible loan more quickly.
  • Once the bank loan has been eliminated, this doesn’t mean we have $400 per month to spend on clothes and beer: we go bank and adjust the NSLSC payment to the entire $600 per month, accelerating the repayment of that loan.

By employing this strategy, you could end up saving money spent on interest on your student loans!  Crunch the numbers yourself, or speak to a financial pro and see if this might work for you.…

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Debunking The RRSP Mystery

As you probably already know, Canadian taxpayers are eligible to contribute to their retirement savings through something called an RRSP.  Some of you might actually contribute too… for those who do: Good Job!; for those who don’t: START NOW!

If you’re a little confused by all the banking acronyms out there (RRSP, RSP, LIRA, LRSP, etc., etc…) I don’t blame you.

First:

  • RSP = Retirement Savings Plan
  • RRSP = Registered Retirement Savings Plan

In general: RSP = RRSP – when people say one, they mean exactly the same thing.  The “Registered” part has to do with the fact it is registered with the Federal Government, allowing you to take advantage of the benefits of holding an RRSP.

As for the other acronyms… we’ll worry about them later.

Now, the biggest part of the shroud of secrecy that surrounds RRSPs has everything to do with the last letter of the infamous acronym.

P = Plan

An RRSP isn’t an investment on it’s own, like a stock, mutual fund, a bond, or a Guaranteed Investment Certificate (GIC):  It’s a PLAN.  It’s a portfolio to hold investments inside.  If it helps, think of it as a manilla folder that you hold your investment statements inside.  Of course banks and investment brokers confound and confuse you by asking you “Have you bought RRSPs this year?”

You can have virtually any kind of investment in an RRSP:

  • stocks
  • bonds
  • GICs
  • mutual funds
  • cash (Yes, even plain old cash… sitting there earning little to no interest)

When you go to a bank or broker and “buy an RRSP”, you are getting some combination of the above.

The other part about the Plan is that you can hold multiple RRSPs.  For example, you could have:

  • A Mutual fund account from your Big-5 bank (RBC, TD, Scotia, BMO, CIBC)
  • Stocks through a discount brokerage
  • A high-interest savings account from an online bank (ING, PC, etc.)
  • Canada Savings Bond RRSP

There are no restrictions on the number of accounts you can hold, and only a few restrictions on the types on investments.  See the Canada Revenue Agency’s RRSP website if you’re more curious.…

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Early RRSP Withdrawls

As in life, too with RRSPs: there are always exceptions to the rule.

I mentioned yesterday that if you withdraw funds from your RRSP prior to retirement, you pay a hefty amount of tax on these funds.  However, the government has set up some programs to assist people in certain situations to temporarily withdraw these funds for use, and not have them taxed as income.  These programs include:

  • Home Buyers Plan (HBP)
  • Lifelong Learning Plan (LLP)

Home Buyers Plan

If you are a first time home buyer* the government will allow you to withdraw up to $25,000 from your RRSP when you purchase a home.  If you are part of a couple, each person may withdraw up to the full amount, for $50,000 total.  The intention is that you use this for your down payment, but it can be used for anything including, but not limited to: closing costs, renovations, furnishings, a trip to the Maldives, etc.

*Note: the government defines a first time home buyer as anyone who has not owned their residence in the last 4 years (approximately – see the CRA for exact conditions.)  So you may qualify even if you have owned a home previously, just not recently.

Two conditions to note:

  • You cannot withdraw funds you have contributed in the last 89 days
  • These funds have to be repaid to the RRSP within 15 years: the program is in effect a loan to yourself.

Lifelong Learning Plan

This is effectively the “Adult” version of the Registered Education Savings Plan (RESP).  A person can withdraw up to $20,000, with an annual limit of $10,000, from their RRSP in order to pursue full-time post-secondary studies.  Of course, there are conditions.  Check the CRA’s website to be sure.

There are similar conditions to the LLP:

  • Same as the HBP, you cannot withdraw funds you have contributed in the last 89 days
  • These funds have to be repaid to the RRSP within 10 years instead of 15 like the HBP.  However there is a grace period from repayment while you are studying full-time, and briefly following your studies.

Remember, if you’re interested in participating in these programs, they are a bit more complicated than the overview I’ve given here.  Consult the Canada Revenue Agency’s website, and speak to a financial professional.…

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Marginal Tax Rates

You’ve likely heard the term “Marginal Tax Rate” a number of times (I’ve even dropped it previously on this blog), and wondered what it meant.

By definition: your marginal tax rate is defined as “the rate of tax on your last dollar of income”.

Because in Canada, there’s no flat income tax rate across all ranges of incomes your marginal tax rate will vary depending on what your salary is, and what province you live in.

It’s a somewhat complicated calculation, but thankfully there’s many tools out there to help you.  Ernst & Young’s 2009 Personal tax calculator is a great resource (among many others on their site).

So why is knowing your marginal tax rate important?  Well, one applcation relates to my RRSP articles from last week:  If you withdraw funds from your RRSP without taking advantage of a program like the Homebuyer’s Plan, or the Lifelong Learning Plan, these funds are taxed as income at your marginal tax rate.

Now to an example!

Let’s say that I live in Quebec, earn $59,000 per year, and am considering withdrawing some money from my RRSP to buy a boat.  Before I do this, I should find out what my marginal tax rate is to see if this is really a good idea.

I visit the calculator, plug in my salary, hit Calculate and find that my marginal tax rate is a whopping 38.37%!

The boat I want to purchase costs $15,000. (It’s a nice boat)  Keeping in mind that I’ll have to pay 38.37% tax on my withdrawl, I calculate:

B = the amount I need to withdraw to buy my boat

B – 38.37% = $15,000

B – (B * 0.3837) = $15,000

0.6163 B = $15,000

B = $15,000 / 0.6163

B = $24,338.80

Note: Hopefully I didn’t lose anyone here, but I know that not everyone is mathematically inclined.  If you’d like a nice formula for doing this calculation it’s:

After Tax Cost = Price / (1 - marginal tax rate)

If I withdraw money from my RRSP to buy my $15,000 boat, it’s going to end up costing me $24,338.80!  This is likely a very bad idea, and I should probably just save the money and buy my boat next summer instead.

But now I know the implications of withdrawing funds from an RRSP!…