Insurance Made SimpleFor when things get complicated
Segregated funds (set funds) are an investment product. Insurance companies sell these individual insurance contracts that invest in one or more underlying assets, such as a mutual fund.
Unlike mutual funds, segregated funds provide a guarantee to protect part of the money you invest (75% to 100%). You are guaranteed to get some or all of your principal investment back, even when the underlying fund loses money. But, you have to hold your investment for a certain length of time (usually 10 years) to benefit from the guarantee. And you pay an additional fee for this insurance protection.
If you cash out before the maturity date, the guarantee won’t apply. You’ll get the current market value of your investment, less any fees. This may be more or less than what you originally invested.
3 advantages of segregated funds
- The Principal is guaranteed – 75% to 100% of your principal investment is guaranteed, depending on the contract, when you hold your fund for a certain length of time (usually 10 years). If the fund value rises, some segregated funds also let you “reset” the guaranteed amount to this higher value – but this will also reset the length of time that you must hold the fund (usually 10 years from date of reset).
- Guaranteed death benefit – Depending on the contract, your beneficiaries will receive 75% to 100% of your contributions tax free when you die. This amount is free from probate fees when your beneficiaries are named in the contract.
- Potential creditor protection – This is a key feature for business owners in particular.
3 disadvantages of segregated funds
- Your money is locked in – You have to keep your money in the fund until the maturity date, in order to get the guarantee (usually 10 years). If you cash out before that, you’ll get the current market value of your investment, which may be more or less than what you originally invested. Additionally, you may be charged a penalty.
- Higher fees – Segregated funds usually have higher management expense ratios (MERs) than mutual funds. This is to cover the cost of the insurance features.
- Penalties for early withdrawals – You may have to pay a penalty if you cash out your investment before the maturity date.
You will pay higher fees for a retail segregated fund because of the insurance protection it provides. Carefully consider your need for these features before you buy.
3 KEY POINTS
- 75% to 100% of principal is guaranteed upon death or maturity
- Investment must be held until the maturity date (or until death if earlier) to get the guarantee
- Higher fees to cover the cost of the insurance protection
Tax Free Savings Account
A tax Free Savings Account (TFSA) is an account in which Canadian residents 18 years and older can save or invest. Income earned on contributions is not taxed. The TFSA account-holder may withdraw money from the account at any time, free of taxes. The Canada Revenue Agency (CRA) describes the difference between a TFSA and an RRSP as follows: “An RRSP is primarily intended for retirement. The TFSA is like an RRSP for everything else in your life.”
Contributions to a TFSA are not deductible for income tax purposes; contributions to a RRSP are deductible.
A TFSA does not have to be a cash savings account. Like an RRSP, a TFSA may contain cash and other investments such as mutual funds, certain stocks, bonds, or GICs.
Annually, the maximum annual contribution room for each year prior to 2013 was $5,000. Beginning in 2013 it was increased to $5,500 per year. The 2015 federal budget raised the contribution limit to $10,000, however, in December 2015 a newly elected government proposed to restore the pre-2015 contribution limit of $5,500 for 2016. For 2019, the annual contribution maximum has been increased to $6000.
As of January 1, 2019, the total cumulative contribution room for a TFSA is $63,500 for those who have been 18 years or older and residents of Canada for all eligible years.
|Years||TFSA Annual Limit||Cumulative Total|
Any unused contribution room under the cap can be carried forward to subsequent years. If you only put in $2000 this year (2019), you could contribute the regular $6000 in the next year(2020), plus the $4000 ($4000 – $2000) you didn’t contribute in 2019. Those same rules apply to unused ‘cap room’ in previous years.
A tax free savings account can hold any investments that are RRSP-eligible. A TFSA can be self-directed, in that the person themselves determines the investments held, or it can be part of a directed plan that is offered by an investment company or bank. Investments can include; publicly traded shares on eligible exchanges, eligible shares of private corporations, certain debt obligations, instalment receipts, money denominated in any currency, trust interests including mutual funds and real estate investment trusts, annuity contracts, warrants, rights and options, registered investments, royalty units, partnership units, and depository receipts.
Assets within a TFSA are not protected from creditors in the event of bankruptcy or a financial judgement that results from legal proceedings against the account-holder, whereas those within an RRSP are protected.
If an account-holder withdraws funds from a tax free savings account, his or her contribution room is increased by that amount in the tax year after the withdrawal. An over-contribution, may occur when an individual (who has already maximized his TFSA contributions) might have the mistaken belief that a withdrawal from the TFSA will immediately create contribution room and ‘re-contribute’ the withdrawn funds later in the same calendar year.
Fast points summary
- The contribution room is carried forward. If you don’t use it all this year, you can carry it forward and include it in next year’s contribution.
- No taxes on any earnings.
- No taxes on any withdrawals.
- When you withdraw money from the account, the contribution room available gets increased by the amount of the withdrawal, but in the following year. That is so you can’t keep withdrawing and contributing during the same year.
- You can transfer the TFSA between financial institutions – this will work the same way as transferring your RRSP – there will be no effect on your contribution room.
- Like an RRSP, you can have multiple TFSA accounts, but the yearly maximums apply to all accounts added together. So you can’t put $6000 in each TFSA, but rather all the contributions to the different TFSA accounts can’t add up to more than $6000 total.
- If you borrowed money to contribute to your TFSA or RRSP, the interest on that loan is not tax deductible.
- You can withdraw money from the TFSA and transfer it to a non-registered account or RRSP.
Build a future for your children.
Congratulations! You are a proud parent! This might be the most exciting time of your life, and quite frankly, it’s probably one of the scariest times too! This precious life that you have created is looking to you for the teaching, guidance and love that will take them to adulthood. Oh, and provide the financial support to make their dreams come true. It’s time to start thinking about how you might build a future for your children.
Here’s the dilemna
You have no idea where their dreams will take them! How can you plan for something that is 15, 20 or more years in the future? What will they need help with? Education? Their first home? Starting a business? How much will they need? What will stuff cost in that unknown future?
The truth is
You can only do as much as you are able. That might sound simplistic, however it is true. The saving that you do for your child is based on many different factors. The most important of which is staying within your abilities, and making the most of that. Too many families have taken an overambitious approach to saving for their children, only to realize that it becomes beyond their reach at some point.
Whatever approach you take towards building a future for your children, and creating future financial wealth for them, please remember that you can always increase the amount you are saving in the future. It’s a wiser choice to start with a plan that you can truly afford. If your financial situation changes down the road, you can always increase the amount of saving you are doing. Certain investment plans won’t allow you to decrease the amount that you are setting aside, and missing payments is not acceptable. Some prudent planning is necessary.
What do you really want to save for?
If it’s for education, and you are fairly positive that a post-secondary education is what you want to prepare for, then the RESP is a viable option. Please remember that is it a federal government regulated plan. That means that there are rules as to how, where, and when the money that you saved is utilized. However, there are grants available which help to make your investment grow faster. That means that you not only your own contribution, but also what the government will add to that.
Like any investment, there are risks involved.
In 2008 when the stock market fell over 30%, there were many families counting on the RESP to fund their children’s schooling. They came to the realization that not only was their growth gone, but a good part of their initial investment was gone as well.
The RESP does have an overall investment cap that states you can never put in more than $50,000. The government grant is limited to a max of $7,200 over the life of the plan. Even with amazing investment returns, there are real limits as to how much growth there can be in this plan.
I work with insurance investments, namely segregated funds. There are guarantees built into these plans to safeguard against losing all of the investment contributions in your RESP plan.
Whole life insurance
A great option for creating future wealth for your child is a participating whole life insurance plan. Your plan will receive an annual tax free dividend from the insurance company for life. The growth within the plan can be used for absolutely anything, anywhere, anytime. This type of insurance plan grows not only in the usable equity in the plan, but also in the amount of life insurance. This might be the only life insurance plan that your child will ever need. Ever. For life. You can put basically as much into this plan as you wish. Therefore, you can see some pretty incredible growth over your child’s lifetime, and the dividends grow tax free every year.
So what is the best choice? This is where we have a conversation. What do you really want to save for? How much time is there before your child may need these savings? What will your budget allow you to contribute? Do you know about/ understand about investing? What is your risk tolerance for investments? Do you like rules, or do you prefer a plan that has no limitations as to how it’s used?
Build a future for your children
The bottom line is this; Choose an approach you feel comfortable with. Invest an amount that works for your situation, over a length of time that allows your it to grow for it’s intended purpose. Then commit to making the plan work to it’s full potential. Your child is dreaming about their future, and you can help them get there.