Category Archives: Saving

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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Filed under Estate Planning, Estates, Finance, How It Works, inheritance, pre-nuptial agreement, Saving, Wills

How to Get a Bigger Paycheque

Have you ever heard of a Source Deduction Waiver?

Every payday your employer deducts the amount of  tax set by the Canada Revenue Agency. This money is applied against your annual tax bill.

But not everyone has the same income tax circumstances. There are people who have significant deductions, like monthly RSP contributions, child care expenses, or even deductible investment loan interest, which often result in a sizable tax refund each year.

If this describes your situation, you might be eligible for a Source Deduction Waiver. A source deduction waiver means that your employer could deduct less tax from your paycheque each month. If that’s the case, it will mean that you won’t receive a huge refund at the end of the year, however you will get more money every payday.

While it does feel nice to get a big refund every spring, you have to remember that this refund is your own money, which you have given to the government as an interest free loan for the past twelve months. I am sure you could come up with better ideas than of what to do with a little more money every month than the government does.

For the proper forms, go to the Canada Revenue Agency website, www.cra-arc.gc.ca, and search for form T1213.

If you are up to date on your taxes, the government will calculate the proper amount, and authorize your employer to reduce the tax withheld. Please remember that this is not automatically renewed, you do have to reapply each year.

Put a little more money in your own pocket next year.

 

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Filed under Employment, Saving, Taxes

Flaherty’s Changes to Mortgage Rules

What will the changes to Canadian mortgage rules announced on January 17 mean to you?

If you already have a mortgage – not much. If you buy a house within the next 60 days (before the changes take effect) – not much. If you plan on buying a house during the next few years – not much.

If you are ass deep in debt, and looking to refinance to the hilt with a nice low interest rate, flexible payment, Home Equity Line of Credit in order to bail yourself out – lots.

New rules will restrict the number of years you can stretch out a normal mortgage to 30 years. No more 35 year mortgages with CMHC. You will also need to come up with a minimum down payment. No more “no-money-down” mortgages.

But that’s not the big news. The big news is that the Government through CMHC will no longer insure Home Equity Lines of Credit – called HELOCs.

For the last number of years home owners have been flocking to the banks (and others) to refinance their homes with Helocs. This allows them to use the equity they have built up in their homes to refinance debts like credit cards, or buy things like fancy cars, boats and cottages, or heck, just pay for a trip to Aruba.

These Helocs are sold to people by highlighting the flexibility of the payments, the low interest rates and your ability to pay off as much as you want. In reality most people only pay the minimum interest payment, never reduce their principal, and will get killed if the interest rates go up by more than a percentage or two.

Helocs are a form of never-never plan. Most of them allow you to make minimum or interest only payments, and never actually pay down the principal. I  can’t tell you how many of these things I helped people convert into real mortgages during the last few years I was advising clients.

You could live in your house forever and never succeed in paying it off. These lines of credit are as bad as credit cards, they’re a guaranteed source of monthly income for the banks that you never escape.

And with their floating interest rates on a principal that never declines, they are a time bomb waiting to happen in a world where interest rates have no-where to go but up.

As soon as CMHC insurance for these Home Equity Lines of Credit dries up, expect to the see the banks pull back their helping hands, and tighten up their credit granting procedures.

With any luck Mr. Flaherty will have prevented the banks from letting a few unlucky people from getting in over their heads in the future. If these rules work as intended, uninhibited, intemperate consumer spending will be marginally reduced, and those least able to cope will be protected from the bank’s grasping fingers.

What can you do?

If you have one of these never-never plans, talk to your mortgage lender. You have two options, set up a declining balance payment, which will pay off both principal and interest – or – convert to a regular mortgage with a defined amortization and a fixed interest rate on regular monthly payments.

As soon as you can, stop giving your life away to the banks, and get your house in order.

 

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Filed under CMHC, Economy, Finance, HELOC, Home Equity Line of Credit, interest rates, mortgages, Saving

Get Ready for Inflation

Ben Bernanke’s comments today underline my hunch that the US would try to inflate their way out of their fiscal mess.

Don’t take the Fed’s low interest rates policy at face value. In the long term this kind of policy causes inflation, and eventually we will see that higher interest rates will be necessary to bring the inflation it creates under control.

If you are a saver you will be penalized, as your savings and investments become devalued. People invested in Bonds and Bond funds, and GICs are especially in the firing line. It appears that the best strategy for the next little while will be to think short term. Don’t lock your investments in to contracts longer than 12 months.

Mortgages should be treated the opposite way. If you are not planning on selling, lock in for as long as you can. If inflation gets out of control, it isn’t unreasonable to expect mortgage rates to pass the 10% mark some time in the next 2 to 5 years.

Right now interest rates and mortgage rates are being held down by the lasting dregs of the recession and the appalling housing market in the US. But this will not last.

In Canada the housing market is relatively healthy, prices have not dropped, and anyone with a large mortgage at the high end of carrying capacity will be vulnerable to large jumps in interest rates.

http://www.reuters.com/article/idUSTRE69D5XW20101014

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Filed under Economy, Inflation, interest rates, mortgages, Saving, Uncategorized, US Debt

Rising Mortgage Rates

I have to admit I was a bit shocked today when someone asked me if they should lock in the interest rate on their mortgage .

Shocked mainly that they hadn’t already done it.

Historically mortgage rates have run in the 6% range, I’m talking 100 year averages here. So I consider it a general rule of thumb, that if mortgage rates are below 6% you are in bonus territory, and should lock in for as long as possible.

We are now just beginning the process of making a transition from a period of falling interest rates into what I think will be a fairly protracted period of gradually rising interest rates.

Now, I am not saying that I see rates rising to the levels we saw in the mid-eighties (god forbid) unless some unforseen financial crisis hits (of course that’ll never happen, right). But it is not unreasonable to expect to see mortgage rates climb into the 6-8% range in the next few years.

It is possible that there will be a political imperative which keeps rates lower than this, but honestly, with the mess the deficit mess the US is in, and the bumpy ride the Euro zone is going through, I can’t see the current low rate environment continuing indefinately.

So what to do?

Generally, in a rising interest rate environment you want to be locking in the low rates as long as you can, for as long as they exist.

In the opposite case, in a falling interest rate environment you want to be in short term, variable rate mortgages so that you can take advantage of savings as they occur.

But both scenarios have end points. This is where you must make a personal judgement call based on your own comfort zone. For myself, I called 5% the bottom, and considered anything offered less than 5% as bonus territory. This is probably true of many of us who struggled with 14 and 16% mortgages years ago.

But when mortgages are rising, when do I want to stop locking in, and go short term in hopes that rates will begin to fall again? This is tougher. What happens if you go variable and the rate shoots up to 16%? What a killer that would be. But do I take the chance on a variable if rates are 12% and I think they will fall?

I can only fall back on historical averages again. Personally I would probably only lock in for a year at a time once rates get higher than 8%. If rates go over 10% I am going to be looking to a variable mortgage, knowing that I am going to have to ride the rollercoaster until the rates fall again.

But you can be sure that once they fall, and eventually they will, I will again lock in for as long as I possibly can. Because I know, that one day interest rates will rise again.

And if you ever needed an argument for paying off your mortgage as quickly as possible – this is it.

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Filed under Economy, How It Works, Inflation, interest rates, mortgages, Saving, Uncategorized, US Debt

Spousal RRSPs, How it Works

If you are not familiar with all the mechanisms of RRSPs, Spousal RRSPs, TFSAs and some of the other types of accounts which are offered at Banks, Investment Dealers and Insurance Companies in Canada, it can be very easy to misunderstand how they work and how they differ. This is very common with Spousal RRSPs.

Often when the account is being set up the advisor gives a quick verbal explanation of how the account works and what the benefit will be to you. Sometimes you get the details in writing, but let’s face it, how many people ever bother to read the fine print?

On more than one occasion I have run across people who misunderstood how their Spousal RRSP works.

To cover the basics – It is a retirement savings account which allows one spouse (husband or wife) to make deposits into the retirement fund of the other spouse. They can be married or common-law. This is most useful in cases where one spouse earns a higher income than the other, or one spouse will have a higher retirement income from a fully funded defined benefit pension plan, and the other will not.

The main things to remember are

  • the account is set up in the name of the receiving spouse
  • the spouse who makes the contribution is the one who gets the tax deduction
  • the receiving spouse, who’s name is on the account, is the owner of the account
  • the owner of the account makes all the decisions about how and where the money is invested
  • the contributor has no say in how the account is operated, or how or when money is withdrawn
  • in the event of marital breakdown the money in this account will be included in the marital assets calculations and apportioned according to the divorce agreement, the contributor does not have a right to ask for the return of the money
  • tax attribution rules mean that if money is deposited by the first spouse and withdrawn within the first three years by the receiving spouse, it will be taxed back to the original contributor
  • exceptions to the three year rule occur in case of marital breakdown or death of the account owner

So are Spousal RRSPs a good idea? Yes. Although new pension splitting rules have reduced the income splitting benefit slightly, it is still good financial planning to equalize income as much as possible and ensure the both spouses have fully funded retirements.

 

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Filed under How It Works, Investing, Pensions, Retirement, Saving, Spousal RRSP, Taxes

RRSP or TFSA?

It’s alphabet soup time out there. Ads everywhere telling you to top up your TFSA overriding the usual February cacophony of RRSP season.

What are you supposed to do? Either ? Both? If you have limited funds which one gets priority?

Many of us are sitting here today looking at RRSP accounts that are still slightly battered from all the recent upheavals, although I think most of us can see the light at the end of the tunnel. But disillusioned by the past year and a half, we ask if we are ready to go down that path again.

At the same time, those near to retirement look at the measly $5,000 annual limit on a TFSA and laugh. There isn’t enough useable space to make a realistic difference in anyone’s immediate plans.

What to choose actually depends on a number of factors; What is your current tax rate? What is the tax rate are you likely to pay in retirement? How old are you? Do you have a pension? What are your current savings? Do you have an emergency fund?

As guidance, I’ll lay out a couple scenarios.

1) 50 year old management type with a good pension and current RRSP holdings, with the house almost paid off.

a) This person is currently in a high tax bracket, and likely to be in a fairly high tax bracket in retirement. Pension income splitting will reduce a couple’s tax burden, and allow them full benefit of their retirement income. Advice – concentrate on the debt, and funnel extra savings to a TFSA which can provide the “fun money” which will make retirement more enjoyable.

b) If you are single or have a spouse who will also have substantial post retirement income, income splitting isn’t likely to help you very much. Advice – forget the RRSPs entirely, they will just create a bigger future tax burden. Pay off the debt, max out TFSAs and if there is still ability to increase savings, investigate unregistered corporate class mutual funds which have a number of tax deferral advantages. Don’t forget the preferential tax status given to Dividend income.

2) 35 years old,with an annual income less than $35,000, no current savings. 20 years left to pay on a 25 year mortgage amortization. A few bucks in an RRSP, no other current savings, no emergency fund.

a) An annual income less than $35,000 is sort of the cut off tax bracket where RRSP contributions are of questionable value. The tax refund you get today, will be pretty well entirely eaten up by the tax you will pay when you start withdrawing the money in retirement. The lower your income the less efficient the RRSP becomes. Advice – get a TFSA to do double duty. Immediate savings can function as an emergency fund because withdrawals will not be penalized. Long term, the TFSA will replace the RRSP for this person, and all income withdrawn from it will be tax free in retirement, which will not affect the person’s eligibility for programs such as OAS. For this person the focus should be on saving, build that nest egg, protect against emergencies. The mortgage, which will pay itself off over time, will be done well before retirement, I wouldn’t worry about it. The trick here is avoiding further debt.

3) Young person, just starting out, lower income, good prospects for the future, no savings, renting. Advice – no question, max out the TFSAs. When the time comes to buy a home, the down payment can be withdrawn from the TFSA without all the headaches of the RSP Homeownership plan. Not only does it not have to be repaid, but you get the available room back the following year, so you are not penalized. During the growing and accumulating years the TFSA can act as an emergency fund, and in the long term will provide tax free income in retirement exactly as above. If this young person does move up in income and tax brackets there may come a day when the tax deduction of an RRSP contribution would be beneficial, however I would continue to advise maxing out the TFSA first.

What to avoid – Tax Free Savings Accounts which are set up like a plain jane savings account, paying pitiful daily or monthly interest. Forget it. At current (and foreseeable likely future) interest rates, these accounts are pointless. The amount of income which could possibly be generated isn’t worth the effort of protecting. We are talking pennies in tax savings here folks. Most of us alive today aren’t likely to live long enough for this to do us any good at all.

What to do – Get a Tax Free Savings Account which is set up like a regular investment account at your local bank, brokerage or investment dealer. Then treat it exactly like you would an RRSP. Same type of investments. GICs, mutual funds, ETFs, stocks, bonds – whatever sets your little heart afire. Think long term, but always keep a little short term money in there on the side in a money market fund or short term GIC, just in case.

 

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Filed under Finance, Investing, Mutual funds, Pensions, Recovery, Saving, Tax Free Savings Accounts

Cashing out Your Pension

I hear it all the time. A person comes to see me, and tells me how someone (perhaps a friend or a so called investment advisor) suggested they cash in their pension when they retire. Oy vey. Please people, stop it already.

I have heard all the arguments why this is such a terrific idea. And I have seen all the tears when things don’t work out according to somebody’s overly optimistic plan. So lets recap.

Yes, when you leave a job, either quitting or retiring, you are often offered the opportunity to convert (or commute) your pension. This is where the first misunderstandings come into play. Yes, you can commute a pension. You can take the money in your company pension account, and put it into a Locked In Retirement Account (LIRA). A LIRA works similar to a RSP, except (1) it is locked in until you turn 55, (2) there are minimums and maximums that you can withdraw each year.

However, there are pitfalls which these so called friends and advisors neglect to either mention or give proper emphasis. Firstly, like an RRSP, your investments will be subject to market forces. So yes, you get to decide how it is invested, in stocks, mutual funds or GICs as you wish. And if they go down in value, like most investments did in 2008, you alone suffer the consequences.

Secondly, in Alberta, BC, Saskatchewan and Quebec, additional voluntary contributions you might have made in the past are not subject to creditor protection, and could be seized if you were ever sued. In Ontario, Quebec, New Brunswick, Manitoba and Saskatchewan locked in accounts are subject to garnishment for child support.

Thirdly, it is possible that not all of the money in your pension plan account will be eligible to be transferred directly to a LIRA. You may find that there will be a cash portion which will be paid directly to you, and you get walloped by income tax deducted from this amount at your top marginal rate. Peachy eh? Especially if you weren’t warned.

One of the things that really has people excited are rule changes in some provinces which will allow you to take up to 50% of your pension money in cash after January 1, 2010. Hooray! The government will then grab taxes from this amount at your top marginal rate. So if you live in Ontario you could lose up to 46.4% right off the top to the government. Dalton McGuinty  and Jim Flaherty will thank you.

My concerns with this whole process are many.

1. Canadian pension plans are generally well funded and regulated, and unless your company goes bankrupt, you will get all the money you are entitled to.

2. Canadian pension plan managers have shown better long term investment returns than the average RRSP investor. Especially Teachers, HHOOP, Hydro and many of the Union plans. Do you really think that you, as an amateur, can do better than the professionals who work in the business all day every day, who are able to utilize economies of scale and instant preferential access to the most up to date information when making their investment decisions?

3. In a defined benefit pension if there is a shortfall, the employer is on the hook to make up the difference. If your LIRA has a bad year, guess who makes up the difference?

4. If you take out 50% of your pension as a lump sum, what are you planning to live on when you retire?

Now, I know that you can never say never, and there are a few people for whom commuting a pension might actually be a good idea. However, they usually fit into certain limited categories.

A. You have multiple tiny pensions which individually will pay very small amounts every month. In this instance you may not suffer any great penalty by combining them and investing them as a unit.

B. You have a diminished life expectancy, no spouse, and wish your pension assets to go to your heirs. If you can make the argument that you will not live long enough, because of a pre-existing illness, to collect the bulk of your pension, then it might make sense to roll it over into a LIRA so that it can become part of your estate. However – big however – this will expose the entire pension to estate and probate taxes.

So exactly why are some people so quick to advise you to commute your pension?

First, is often the friend who read something someplace, and in whose hands a little knowledge is a dangerous thing.

Secondly, and most egregiously, is the so called advisor who assures you that he can put you into investments that will outperform the “pitiful” returns attained by pension plan managers. This guy is solely driven by commissions. Really, really big commissions. Thousands of dollars in commissions. Big, big, fat, juicy, buy a new Cadillac commissions.

Please don’t listen to these people. By the time you come to see me, I can’t fix it. I can’t correct the mess they have made. I can’t restore the long term value that they destroyed.

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Filed under Estate Planning, Investing, Locked in Retirement Accounts, Mutual funds, Pensions, Saving

Getting Paid to Sit and Wait

Many of you have heard me talk about Dividend funds over the past couple years. I am obviously a fan. I can think of nothing better than getting paid to just sit and wait.

There are a few different types of Dividend funds, the tradition Large Cap fund, and the Dividend Growth fund. These can then be broken down into Canadian, US, Global or sector funds. Although they generally hold different types of investments, they basically operate in the same way.

A Large Cap Dividend fund, formerly known as a “Blue Chip” fund, is made up of the big boys of the stock market. Banks, Insurance Companies, Utilities, Pipelines. These companies have a large enough capitalization (number of stocks outstanding) that their price usually doesn’t move a great deal on a daily basis. Their stock price just grows at a rather slow and steady pace over a longer period of time. Boring! And for a long term investor, boring is fabulous.

A Dividend Growth fund is usually made up of a mix of larger and smaller companies, who may have more potential for year over year corporate growth than the big guys. This can provide more capital apreciation than you might get from a Large Cap fund, but because of this, can introduce more volatility, and the price swings of the individual stocks in the fund can be greater. They still pay a dividend every three months, just like the big guys. Not as boring, but it’s still not exciting enough to be a conversational topic at your next dinner party.

So why is boring good? We are interested in the main underlying feature of any Dividend fund, The Dividend. Every three months these companies pay out their corporate profits in a quarterly dividend of cash to their shareholders. In this case, the fund, and and fund holders, you and me.

This is the good part –

At the end of each year, the fund manager takes all those dividends they have collected during the year, and pays them out to the unit holders of the fund (you) in the form of more shares (units) of the fund. So now, not only have the basic underlying stocks in the fund increased in value, and thereby the fund itself has gone up (we hope), but you now have extra units of the fund. So next year your fund will get dividends on the original units you owned, but also on the new ones you just recieved. Which will in turn be used to buy you more units next year.

And the shares go up, and cash rolls in, and you get more units…

And so on, and so on…..

 

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