Q. I am a new Canadian (27 years old) and started working in Canada about 1.5 years ago. It took me a while to figure out how things work in this country and a few months ago, after ditching a financial advisor who was also a family friend, I started investing on my own.
Currently, I have a TFSA with $11,000, an RRSP with about $9,000 as well as my employer’s matching pension plan. Both my TFSA and RRSP are invested in ETFs and so far, I am satisfied with it. We also have our son’s RESP savings plan that we contribute $2,500 to every year and currently, it is still with the advisor, but we are planning to transfer it into a self-directed account in the near future.
My wife and I also have a mortgage and, unfortunately, we put only 5% down because the house was being sold by an owner well below its actual value and it was short notice (We also own a townhouse but it is rented out and makes a small amount of money every month).
Here is my question. I am a pretty good saver and manage to save at least $600 to $800 every month (my after-tax pay is about $33,000/year). Plus, at the end of the year, I receive a very decent bonus which is being fully invested. Currently, I’ve maxed out my RRSP and invest $600 in my TFSA every month and I want to continue investing at least that amount but I also have some surpluses and cash reserves that I would like to invest. Would it make more sense to add those surpluses to the TFSA or add lump sums to pay down the mortgage? I don’t feel very comfortable having such a large mortgage (it is about $210,000) and would prefer to pay it off as soon as possible but I would like to hear someone else’s opinion regarding my options. Thanks a lot.
A. Adam, I’ll quickly address your question, and then explain how to use the Canadian tax system combined with your rental property, to save even more money. I bet you’ll like this one!
Here’s the simple stuff:
- Continue maximum investments into the RESP. It’s either pay now or pay later. If you pay now you’ll get the 20% education grant. So pay now!
- Continue with the RRSP contributions as they will also help you to maximize the Canada Child Benefit.
- Mathematically, paying down your mortgage and contributing to a TFSA are the same thing if the interest rate on each one is the same. So if you think you can earn more interest on your TFSA do the TFSA. If you’re not sure, pay down your mortgage.
Ok, now the exciting stuff – “The Cash Flow Dam”.
You have a non-incorporated business in the form of a rental property.
Did you know that you don’t have to pay business expenses with business income? You can keep all of your business income and borrow money to pay business expenses.
Why would you do that? Because money borrowed to earn an income is tax deductible.
Picture this: take the rental income you’d normally use to pay your rental expenses and pay down your mortgage. Then borrow money from a dedicated line of credit to pay your rental expenses.
Are you still with me? You still have the same amount of debt. Except instead of all of the debt in the mortgage it is now in the combination of your mortgage as well as a line of credit.
You made an extra payment to your personal mortgage equal to the total amount of your rental expenses. The interest on the borrowed amount from the dedicated line of credit is now tax deductible.
When you file your taxes and get your tax refund, use that money to pay down your mortgage. In the first few years, the tax refund may not be much, but it will add up over time.
Once your personal mortgage is paid off you can start to pay off the tax-deductible line of credit.
Here is a more detailed explanation:
- Each month (pay period) add up all of the expenses related to your rental.
- Write a cheque, “Company Expenses”, against a dedicated line of credit for the amount of your expenses, payable to your business.
- Write a cheque from the account you deposit the rental income, “Draw-re: expenses”, payable to yourself for the total amount of the expenses.
- Deposit your cheque into your bank account and pay down your mortgage.
The other possible benefits of this strategy, which reduces your net family income, means you may:
- Receive more of the Canadian Child Benefit, and
- Qualify for some of the other RESP grants or bond
Keep going Adam, you’re doing really well.
Allan Norman is a Certified Financial Planner and Chartered Investment Manager for Atlantis Financial Inc in Barrie, Ont.
This commentary is provided as a general source of information and is intended for Canadian residents only. Allan offers financial planning services through Atlantis Financial Inc. and can be reached at [email protected]
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