Should You Get an RRSP Loan?

March 1 is the RRSP deadline. Every year financial advisors send out metric tonnes of paper advising customers to buy-buy-buy.

And if you don’t have the cash they will be very happy to assist you with securing an RRSP loan.

But is an RRSP loan the best idea?

The arguments in favour tout the instant tax reduction, the benefits of kick starting long-term growth and the positives of a healthy retirement nest egg.

The downside of RRSP loans? First you are borrowing money. Most RRSP loans have a one year repayment schedule, although you can get 2 or 3 year terms. That means you are adding on a monthly payment you may or may not be able to afford. If you could afford it why aren’t you already depositing that amount in your RRSP account?

The lender doesn’t care. If you don’t make your payments the lender will just cash out the RRSPs to repay the loan. And Canada Revenue Agency will make sure that they get repaid any taxes they refunded you.

So why are financial advisors so hot to push RRSP loans? Two reasons. Two commission cheques. Most of them get one small bonus when you take out the loan, and then they get commissions on the sale of the stocks, bonds or mutual funds in your RRSP.

On a $20,000 RRSP loan the bonus may not be much more than $50, but the commissions on the sale of $20,000 worth of mutual funds at 4% will be $800.

“But my bank has no commissions,” you say.

Nonsense. Even if you work with one of the big banks who proudly claims to provide Fee Free services, the person sitting across the desk from you has quotas to make and annual bonus cheques riding on the outcome of this meeting. And you can bet that if they don’t make their numbers during RRSP season the manager is going to be asking a bunch of hard questions during their next quarterly review.

I recommend that you suck it up. If you decide that you absolutely must make an RRSP contribution this year, and you have already maxed out your TFSA, then I suggest setting up a monthly contribution plan and plan on getting that tax refund next year.

The sneaky little secret of the RRSP loan industry is once you head down that path it is very hard to get out of the rut. Kind of like getting in credit card debt.

Let’s say you took out that $20,000 RRSP loan. If you have a top marginal tax rate of 40% your tax refund would be in the range of $8,000 (all other things being equal). If you take that $8,000 and pay it down on the loan you will now have a monthly payment of $626.43 for the next 1 3/4 years. Ten years from now your $20,000 might have grown to $35,815.95.

The problem is that $626.43 monthly payment. Because next year, come RRSP season, you will still be paying that $626.43. I am going to guess that you won’t have saved up any money during the year to contribute. And I will also assume that you can’t afford to take out another loan and make another (bigger) payment.

If you can afford to pay more than $600 a month on a loan, why can’t you afford to make a $600 monthly contribution directly to your RRSP? If you did that for 10 years you should have around $103,851 in ten years. And all the way along you have kept your $2,800 annual tax refund in your own pocket instead of using it to pay down a bank loan.

If you can’t afford that $600 a month, it’s okay. First, always make sure you have maxed out your Tax Free Savings Account, then sign yourself up for whatever size RRSP contribution you think you can comfortably afford. Even $25 a payday is a place to start.

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Taxable Natural Persons

Taxpayers Beware

For the past couple years there have been stories circulating around the internet claiming that you don’t have to pay income taxes.

Most of these stories seem to have originated from American conspiracy theorist websites. Their basic argument is that you are in fact two people; first the “natural” person you were born as. Second; the “legal” person the government created when they issued you a social insurance number.

According to these theorists, a “natural” person does not have to pay income tax.

False.

Canada Revenue Agency (CRA) has sent out notices warning taxpayers against these schemes.

There is no such thing as a “natural” person. You need to know that Canada Revenue Agency has won every single one of their court cases against these people. As a Canadian, you do have to pay the income tax you owe.

You should also know that these “tax protesters” as they call themselves, are usually raking in the cash by inviting you to attend expensive seminars that pretend to teach you how to avoid paying taxes. They will try to sell you books, dvds and consulting services containing the same false information.

In 2012 Russell Porisky, the main Canadian proponent of this scheme, was sentenced to 4 1/2 years in jail for tax evasion and fraudulently counselling other people to do the same.

“It is difficult to set out his line of argument with cogency because it lacks logic, coherence and consistency,” the judge wrote. “Mr. Porisky’s theory not only does not bear any legal logic, but it also fails to accord with common sense. It is a failed attempt at word magic and has no validity.”

The Canadian Constitution allows the government to raise money by any “mode or system of taxation.” The penalties for tax evasion are up to 200% of the taxes owing plus up to 5 years in jail.

Even if you don’t owe any taxes, Canadians need to file a tax return in order to qualify for HST refunds and Trillium grants.

Can anyone explain our Politicians?

If you have ever been confused by how our illustrious leaders act, and the seemingly stupid decisions they occasionally make you might want to take a look at Daniel Ben-Ami’s excellent review of The Darwin Economy: Liberty, Competition and The Common Good by Robert H Frank. The Spiked Review of Books.

Economic Theory Run Amok

For economics buffs out there (is there really such a person?) and those of you who are really just trying to figure out why the world is so messed up, I have to recommend a paper by Dan Ciuriak and John Curtis called What if Everything We Know About Economic Policy is Wrong?

Ciuriak and Curtis take a look at the current global economic situation and examine how Economic Policy has failed. They contrast the promises of Trickle Down Theory with the actuality of recession, high unemployment and government debt.

Download the pdf here for free.

I recommend that you print off a copy and hand deliver it to your local member of parliament, congressman or other favourite member of the political beau monde.

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The Consequences of Debt

The US government is in the process of learning one of the key lessons of the debtor.

The Creditor calls the tune.

The Chinese who hold trillions of dollars in US are not happy, and they are not afraid to let the US know that they need to shape up and fly right. Let’s hope that this credit downgrade is treated as a wake-up call, and the US uses the opportunity to get their fiscal house in order.

But don’t count on it.

The disfunctional houses of congress are too busy stabbing each other in the back in a pointless and self defeating series of internecine battles.

If the US doesn’t sort this out, expect more dire consequences in the future.

In the meantime, use this dip in the Dow to snap up any high quality blue chips while they are on sale. Just make sure you go for quality, look for income in the form of dividends to  tide you over until the markets recover.

When You Inherit Money

What happens when you inherit money? or a house? or stuff?

It depends on how you treat the money when it first arrives. If you put an inheritance into a joint bank account, or into a joint trading account, in the future the money will be treated as a joint asset. This means if you get divorced down the road you could lose half of your inheritance. So as a general principle, inheritances should always go into a separate account.

Houses are treated specially. If you put a house you inherited from grandma in both names, then it will definitely be split in a divorce. Even if you don’t put both names on the house, your partner could claim that it was the primary marital residence and make a claim for a share.

Alberta operates under the dower act, which is designed to ensure that a spouse cannot be disenfranchised from their share of marital property. The western provinces also have the homestead act which ensures that a spouse can make a claim on the family farm.

This is especially important for someone who inherits a farm or a family business outright. It is very important to discuss the future of this asset with your lawyer and financial advisor before it is even transferred to you.

If you keep the money separate, the original inheritance will probably not be included in any future divorce settlement or separation agreement. However, it is possible that income produced by the asset or the increased value of the asset might be.

So what do you do? Pre-nup. Or co-habitation agreement. Or post-nup. Talk to your significant other, spousal equivalent or current bed-buddy about money, who owns what, who gets what, and how it could play out if things don’t work out.

Talk to your lawyer. A simple pre-nup/co-habitation agreement shouldn’t cost more than a couple hundred bucks, and can save you thousands of dollars and tons of heartbreak down the road. Define who gets what, and where the money goes if something happens.

Although it’s pretty common for someone to leave that inheritance to their own kids, or grandkids, nothing says that you can’t keep the asset separate, and subject to a pre-nup/co-hab agreement in the event of a couple separating, and yet leave the asset to your significant other in your will later.

 

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RRSPs & Divorce

I’ve been getting  a number of questions lately about how RRSPs are treated during a divorce.

Although every province has slightly different divorce laws, they all treat RRSPs in a similar way.

It doesn’t matter who the RRSP or Spousal RRSP belongs to, and it doesn’t matter who actually contributed the money in the RRSP or Spousal RRSP. All RRSP contributions made during the years you were married (but not before) are considered marital property, just like your house. So they can be divided up between the two of you, or traded off against another asset.

For instance, say one partner has both an RRSP and a company pension, while the other doesn’t. If the money is close to equal, the partner with the pension could offer to give up the RRSPs in order to keep the pension for themselves.

In my own situation, I traded my share of the RRSPs for his share of the house.

Spousal RRSPs can be contentious during divorces because they belong to the spouse who’s name is on the account, not the person who contributed the money. But! Because you are getting divorced, all the money has to be counted in the communal pot.

So the contributor may, or may not, get some of their contributions back. Although, in practice, the higher earning spouse who has contributed to their wife’s or husband’s RRSP usually has a lot of RRSPs and Pension credits in their own name, so the chances of that happening in real life are pretty slim.

 

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The Cost of Tax Phobia

A lot of people are so scared of the entire idea of tax season, that they rush right down to the tax preparer in the mall, and pay them to make it all go away. These guys charge anywhere from $40 and up.

Some people use tax preparation services that offer refunds right on the spot. This is where things can get costly.

If you file your return online, under normal circumstances you should have your refund in a week or two. If you get your tax return prepared by the instant refund people you get your money right away. The cost you pay for this convenience is ridiculous. You can pay up to 15% of your refund for this service.

You should also know that if you pay someone else to do your tax return, and they make a mistake, it’s not their problem. It’s yours. CRA will make you fix the mistake, and you will have to pay any penalties, interest, or late charges yourself. The guy in the mall has no responsibility.

Some of these tax preparation companies have also begun to encourage customers to accept their instant tax refund in the form of a preloaded debit card instead of a cheque. These debit cards are so loaded with fees and charges that they reduce the real cash available in your pocket.

My advice? If you decide to do things this way, ask for a cheque, avoid the debit card. Best advice? Get a simple tax preparation software program, and do it yourself.

 

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Financial Train Wreck

Stephen Roach, chief of Morgan Stanley’s Asia unit, says that Asian economies will not be able to withstand the “Tsunami” of American cash which Bernanke is flooding into the financial markets.  http://www.bbc.co.uk/news/business-11756677

American fiscal policy is a train wreck that is set to sideswipe the rest of the planet. The little guys are likely to get squashed.

I see inflation becoming a threat before the global economy has had time to fully recover from the recession. We could be facing a period of stagflation which would be as bad or worse than what we have seen so far. It would most certainly drag out the jobless recovery in the US for a very long time.

Computerized Mayhem on the Dow Jones

A thousand point drop in the Dow Jones is stomach wrenching enough to make the toughest investor queasy. A thousand point drop in moments is just mind numbingly inconceivable. How many of us just stood in front of our tv screens like we had just been smacked upside the head with a board?

Although it now seems likely that the excruciating market gyrations we watched today were probably as the result of human error and/or a technical glitch, it really begs the question, How could we not have systems in place to guard against this type of thing?

Our stock markets have become so globalized that any news in any part of the world impacts decisions at trading desks everywhere. We have reached the point where turmoil in Greece impacts the price of oil in Alberta, and the rising price of gold affects the softening Euro.

Then some guy wearing his tie too tight hits the wrong button, and the Dow Jones tanks in moments.

I have to admit it made for great visual theatre, but the whole fiasco does call into question the degree to which we now rely on automated computer algorithms, and how unstuck things can become before real humans can step in to reassert manual control over the system.

Perhaps we need a rethink about the glories of technology and it’s ability to run our lives. Or should that be “ruin our lives.”