Saving and Taxes, Part 2
This week, we review the third type of savings- long-term savings. In the last blog post we looked at emergency and short-term savings.
Long-term savings are intended for use usually in retirement or as an estate asset. Their purpose is fairly broad, unlike short-term savings. Short-term savings often have a defined purpose and timeline, and are depleted, then possibly re-built. Think of car purchases, home renovations. Long-term savings are intended to be built and used over decades. Their purpose tends to have some fuzziness around the edges- for example, during retirement, you may or may not need money for health expenses. If you own a cottage and are planning to pass it to your children, you may want to have money available in your estate to pay the taxes owing on your death. The purpose of the savings may change, however, if you sell the cottage before estate settlement.
Long-term, and broad purpose, necessitates a different return on these savings than your emergency or short-term savings. Inflation erodes our spending power over time; a dollar today can’t buy a dollar’s worth of stuff 15 years from now. When your plan is developed, it’s important that your money continues to be able to buy what you need. Achieving a return that keeps up with the rate of inflation involves taking on risk; you will see your investments decline some of the time. If you achieve a rate of return less than the rate of inflation (which is guaranteed if you keep the money in your bank account or invest in a GIC), then you will need to save more dollars to meet your goals. If you achieve a rate of return above inflation you have real growth in your investments. Some of the money that you will spend in the future will be money that you made on your money.
Long-term investments are often made by purchasing mutual funds, stock, bonds or by using a discretionary management service (where your investments are chosen for you in respect to your risk tolerance, risk capacity and goals). It is important that your investment advisor understands your risk tolerance- how comfortable you are when the value of your investments goes up or down; your risk capacity- how much can you afford to lose and still meet most of your goals; and your goals- what do you want/need this money to do for you.
Some long-term savings can benefit from tax-deferral through vehicles such as a Retirement Savings Plan (RSP), an Individual Pension Plan or deposits to permanent life insurance policies. More on tax consequences for savings next week.
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