Maximizing Value from Pandemic Savings
April 9, 2021 by David Christianson
In 2018, Canadians were saving less than 2% of their collective incomes, according to Statistics Canada. In the previous 10 years, the savings rate had never exceeded 5%.
The pandemic changed all that. The national savings rate briefly jumped to 28% in May/June of 2020, before settling down to 12.7% in the fourth quarter of 2020.
With limited options for spending on entertainment or travel, many people who used to spend 10% or 20% of their income on such things suddenly have large amounts of savings on hand.
It’s a good problem to have… So, if you’re in that situation, what should be your priorities?
Obviously, number one is to pay off high interest, non-deductible debt, starting with any outstanding credit cards and finishing up with lines of credit. If you can avoid paying non-deductible interest, do that.
(Deductible interest – sometimes known as “good debt” – can help you build wealth, if used prudently. This is interest paid on loans used to purchase income-producing investments (stocks, mutual funds, ETFs), rental real estate and business assets.)
The next step would be to decide how much can be committed to long-term investments, and in what type of account those investment should be made.
For people in the medium and high tax brackets, an RRSP contribution should be considered. Every $1,000 into an RRSP will reduce taxes by $332 to $504 for people with taxable incomes above $49,000.
For people with lower taxable incomes or those who have maximized RRSPs, consider placing the money into a TFSA account to invest. This does not provide an immediate tax deduction, but years of tax-free growth and no tax on withdrawals.
But “invest” is the key. Savings in a bank or credit union are currently earning virtually nothing. That’s fine for money you will be using in the next couple of years, but to make your money grow in excess of inflation requires committing some of that money to equity investments. This means either equity mutual funds, ETFs or direct ownership of shares of good companies.
If you’re new to this, focus on investments in mature company, dividend-paying shares, not the speculative ones you read about in webpage ads. The key is to have a durable investment strategy with which you will stick long term.
If you take big risks, you might end up like someone who starts on an exercise program with four hours in the gym, can’t walk the next day and then never goes back. Slow and steady wins the investment race over the long term.
Prescribed rate loans
For families with one high-income earner and one low-income earner, a loan might be in order. The tax laws require the taxpayer who earns the money to invest it and claim the investment income on his or her tax return in the future.
However, the rules also allow the high-income earner to loan the money to a spouse or partner at a 1% interest rate. The loaned money is invested in the name of the lower tax bracket person, who can then legitimately claim the investment income going forward.
The 1% interest must be paid each year within 30 days of year-end, deductible to the borrower and taxable to the lender.
In the long run, this can pay off enormously by accumulating retirement capital in the name of the low-income earner, always taxed at a lower rate on his or her tax return. Once set, the current 1% interest rate can stay forever.
Next week we will have some last-minute tax tips and important information for people who sold real estate in 2020.
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Dollars and Sense is meant as an introduction to this topic and should not in any way be construed as a replacement for personalized professional advice.
Please consult legal, tax, insurance and investment experts for advice on your unique situation.
David Christianson, BA, CFP, R.F.P., TEP, CIM is recipient of the FP Canada™ Fellow (FCFP) Distinction, and repeatedly named a Top 50 Financial Advisor in Canada. He is a Senior Wealth Advisor & Portfolio Manager with Christianson Wealth Advisors at National Bank Financial Wealth Management, and author of the book Managing the Bull, A No-Nonsense Guide to Personal Finance.
