The article “FP Answers: My income has doubled and I need to learn how to invest it better. Help?” was originally published by Julie Cazzin with Brenda Hiscock on August 20, 2021 in Financial Post. PHOTO BY GETTY IMAGES/ISTOCKPHOTO.
Suddenly more than doubling your salary is exciting. But it can also bring more investment choices. Here’s how Rita can put her big raise to work
FP Answers puts your investing questions to the experts. This week our expert is Brenda Hiscock, fee-only, advice-only certified financial planner. Whatever your investment question, ask us, because FP Answers.
Q: I am 35 years old and my income has more than doubled in the last year from $40,000 annually to $100,000. I thought the best thing to do with the extra money was to contribute to both my tax-free savings account (TFSA) and my husband’s TFSA. We have no kids. I’m just not sure this is the right thing to do. My husband Jim has a six-figure registered retirement savings plan (RRSP) and I have none, mainly because I never had enough income to make it worthwhile for me.
I figure I can max out both of our TFSAs over the next five years. We have no debt, but still have a manageable mortgage. We are also very active in our church and give about $10,000 annually to charity. We’d like to continue doing this. I was also going to start contributing to my own RRSP after I top up the TFSAs. Does this plan sound OK? And how should I invest the money within the TFSAs? I want to keep it simple. I’ve never had much money and am new to investing. — Rita T.
FP Answers: Congratulations on your income increase, Rita. It should provide you an additional $40,000 of after-tax income. Some of this could and probably should be allocated to charitable donations, since philanthropy is important to you. You will get a tax refund for nearly half of what you give to charity after your first $200 of donations based on your income.
You are correct that your previous income level probably did not justify making RRSP contributions, given you were in a relatively low tax bracket. With a wage increase to $100,000 from $40,000, you now have a relatively high income, and RRSP contributions could be beneficial from a tax perspective.
At your new income, your marginal tax rate will be 35 to 46 per cent, depending on your province or territory of residence. RRSP contributions can be used to reduce your taxable income, and, in turn, generate a tax refund.
RRSP contributions may be better than TFSA contributions if you are choosing between the two at your income level. If your income is higher than your husband’s, you may want to consider focusing on your RRSPs to generate the most tax savings you can as a family.
You have not indicated if either of you have a company pension with your employer or a group RRSP. If so, you will want to maximize the opportunity for company matching contributions from those plans as a priority.
Rita, you indicate that you are still carrying a mortgage. RRSP and TFSA contributions may be better financially in the long run compared to paying down low-interest-rate debt such as a mortgage. This is especially true if you have a moderate- to high-risk tolerance and are paying low investment fees. On the other hand, if your risk tolerance is low, then the case for paying down your mortgage becomes stronger.
If you and your husband are able to max out your RRSP contributions based on your available RRSP room, you may want to invest additional savings into a TFSA. You may even want to consider some TFSA contributions even if you have not maxed out your RRSPs. TFSA contributions can be more flexible than RRSPs and can be used to save for short- and medium-term expenses, as well as for retirement. All investment income and growth within a TFSA is tax free, as are withdrawals. If you withdraw from your TFSA, this increases your TFSA room, but not until the next calendar year.
An important consideration, Rita, is that if you keep your TFSA in a savings account or invested relatively conservatively, you may be better off just putting that money against your mortgage to save the mortgage interest. Interest rates may be low, but if you make a lump sum mortgage payment, each future payment will go more towards your mortgage principal before interest rates eventually rise.
Another item to consider is that when people have significant income jumps, it often leads to lifestyle creep and an increase in spending. To the extent you can save a salary increase, or at least part of it, try to avoid simply spending more. If you want to determine how much of the increase you can afford to spend and how much you should save, developing a long-term retirement plan on your own or with a professional could help set parameters.
You also asked about how to invest within your RRSP and TFSA. That depends on several factors including your risk tolerance, time horizon, financial goals, etc. In many cases, spouses have different risk profiles. If that is the case, it is important to have a discussion and to develop an investment strategy that will work for both of you. Keeping your investment fees low will help you keep more of your net investment returns. Many retail mutual fund fees may have embedded fees of two per cent or more and there are plenty of lower-cost options available.
You may also want to consider setting up automatic monthly deposits to your RRSP or TFSA to take advantage of dollar-cost averaging. You will buy more when stocks are down, and less when stocks are up, but, most importantly, your savings will just become part of your monthly budget. This strategy removes much of the guesswork of attempting to time the stock market by saving first, and spending second.
In summary, at your level of income, the tax reduction and deferral of RRSP contributions may be better than the tax savings from a TFSA. Consider whether you should be contributing to your RRSP or your husband’s account.
You should consider how much you can and need to save each year, and then invest those savings as aggressively as you can given your risk tolerance, while trying to keep your investment fees relatively low.
If you decide to repay your mortgage instead, both investing and debt repayment are good choices that will help increase your net worth and help you achieve financial independence.
Brenda Hiscock is a fee-only, advice-only certified financial planner at Objective Financial Partners Inc. in Toronto