Financial Health Blog

Back-to-Back Annuity

2010-09-15T22:37:00.015-04:00

In this post I'm going to discuss a strategy that is not very-well known, or even discussed about in the industry, especially by banks. This, of course, is not a strategy that makes sense for, or to be used by, the majority of clients, however, it does have its niche - the older client population. The concept of Back to Back Annuity, or "Insured Annuity" as it is otherwise known, is not a new one. Advisors have been doing this type of strategy for their clients for years, so why is it that the vast majority of people (and even most advisors) have never heard about this? The reason: Because it's a strategy that involves Insurance products, therefore cannot be offered by banks, or the average advisor with only a Mutual Fund Licence.

Often the dilemma for people who are in the later years of their life is that they want to leave money for their loved ones, or a charity or something else, but don't have the means to leave a lump sum because they need to use their retirement funds to have an income to live their life. Another challenge is that they want to preserve their capital and don't want to risk losing any money, so they don't want to be invested in the markets.

When the low-return and inflexibility of GICs and Bonds is not something that attracts many retirees, what other options do they have? In this type of situation, the often overlooked strategy of the back-to-back annuity or "insured annuity" might fit in nicely.

So, how does it work?

Using this strategy is actually using 2 products together, to take care of 2 or more needs. The first part of the strategy is covering the need of being able to leave a lump sum for your beneficiaries after you pass away, and this involves getting a form of permanent life insurance (usually a Term to 100). Remember, insurance is a privilege, not a right, so you must qualify for it. This might be a challenge if you're in the later years of your life, and maybe had some health challenges over the years. Getting approved for the insurance is always the first step in the process, because if you don't get approved, then the rest of the strategy will not work.

Once approved, the second part of the strategy is fairly simple - using your lump sum of funds to purchase an annuity. In one of my previous posts (Annuities), I already discussed what an annuity is, and what type of annuities there are, so I won't get into too much detail about that here, but essentially the annuity would work as a vehicle to give you regular period cash flow so that you can live and enjoy your life.

So, essentially, you're using 2 of these products "back to back", which is why its called the "back-to-back annuity". Now, by using this strategy, both of your needs have been covered. 1) leaving a lump-sum of funds for your beneficiary, and 2) having a steady cash flow so that you can live and enjoy your life.

To better understand this concept, let's use an example of 2 people - one who just uses a simple GIC offered by the bank, and the other who uses the strategy discussed above. Just so we have a fair comparison, both clients will be the same age, in good health, in the same tax bracket and have the same amount of funds in their retirement savings.

Client #1:

John is a 75 year old non-smoker, and has his $250,000 of retirement savings invested in the bank, in a 5 year locked-in GIC giving him 4% interest. This translates into an annual income of $10,000 from that source. He also has a pension, is getting government assistance, and has some rental income putting the tax rate for his total income from all sources at approximately 31% (his MTR). This means, that he will have to pay approximately $3100 to the government in taxes from his GIC alone. This means he will be left with an after tax income of approximately $6900

His dilemma is that he's not sure if his after-tax income will be sufficient to keep up with inflation and live the type of lifestyle he wants, and might have to start taking extra money from his GIC, which would erode his capital. Also, he wants to leave as much of this money as possible to his kids and grand-kids without them having to pay taxes or other estate fees.

Client #2

John's friend, Jason, is also a 75 year old non-smoker, has $250,000 in his retirement savings, but is dealing with an advisor who has showed him a different option for his situation, which is not offered by the banks. He is also in a 31% MTR, and also wants to make sure that he has enough after-tax income to life a comfortable life. Jason is very adamant about leaving his family the $250,000 when he passes away, but wants to have more after-tax income from his money than just a normal GIC. He wants to make sure the funds go directly to his beneficiaries so that they don't have to pay any fees or taxes on the money.

His advisor recommends doing an "Insured Annuity" or "Back-to-Back Annuity" strategy, which intrigues him very much. His advisor shows him an illustration of how that strategy would work, and shows him how is after-tax income would be significantly greater, and he would still be able to leave the money for his loved ones. The advisor showed him a comparison between using this strategy versus just a GIC strategy that his friend John is using. The comparison is as follows:

	Jason (Client #2)	John (Client #1)

Capital/Single Premium Into Annuity	$250,000	$250,000
Annual Income	$24,378	$10,000
Taxable Amount	$1,024	$10,000
Tax Payable	$317	$3,100
Cash Flow Before Insurance Premium	$24,060	$6,900
Annual Life Insurance Premium	$13,738	$0
Annual Net Cashflow	$10,322	$6,900
Amount Left to Estate at	$250,000	$250,000
Subject to Probate Fees/Taxes?	NO	POSSIBLY

Please see attached for better view (click image):

Using this Strategy, Jason would have 49.60% higher after-tax income than John every year, but will still be able to leave money behind for his family when he passes away. This also means his equivalent rate of return would be approximately 6%. The strategy meets all his needs to live his lifestyle, and at the same time gives him the peace of mind that his family will be taken care of financially when he is no longer here.

This strategy works best for those who are 65+, but that doesn't mean someone who is younger will not benefit from it either. Older clients will receive a larger cashflow, as the insurance company is betting against their mortality, and therefore will offer them higher cashflow for their remaining years. Another thing to note is that it also works best for those who are in a higher tax bracket, as they are the ones who see the biggest difference in after-tax income compared to using the GIC strategy.

By no means should someone be putting all their money into this strategy, but using this strategy as a means to supplement other income is a great way to keep up their standard of living and let them enjoy a nice lifestyle. This is a great way for someone to create their own personal 'pension' if they do not have one, or are not receive enough from their own.

This strategy does not work in all situations, so its always best to sit down with your advisor and crunch all the numbers. Remember, this strategy is using 2 products to achieve the same goal. Usually what will happen is that you will get the annuity from one life insurance company, and the life insurance from a different life insurance company. It's very rare that the same insurance company will have the best rate for both products, so it is key to have an advisor who is fully independent, and can shop the market for you.

I hope you have learned a few things from this post, and if you have any questions about this strategy, or even want to see if this strategy would be good for you, please do not hesitate to contact me!

Disability Insurance Protecion

2010-08-05T21:38:00.003-04:00

In one of my previous posts I discussed the concept of Living Benefits, more specifically Critical Illness Protection (CI)- that is, protecting you and your family in the event that you or someone in your family was to get a sickness/disease. I also went through some statistics and indicated how we are actually more likely to get sick/injured by age 65, then we are to die. In this post, I'll discuss the other Living Benefit that is offered in the industry, which is Disability Insurance (DI). I'll also go through some common questions people have and discuss some of the unique benefits of this product.

What is Disability Insurance Protection?

When people are asked "What is your most valuable asset?", they generally respond with "Home" or "Car" or something of cost/dollar value. The real answer actually is, your ability to earn an income - THAT is your most valuable asset. Where Critical Illness Protection will provide you with a lump-sum payment in the event of a sickness, Disability Insurance provides you with a monthly income in the event you are unable to work due to injury/disability. Disability Insurance, essentially, protects the ability of you to earn an income through your own efforts, and can protect your ability to pay bills, eat, have a home, etc...

Do You Need It?

As I said in the Critical Illness post, nobody plans to get sick, its actually the same with Disability - nobody plans to get injured/disabled. Below are some statistics that we all should be aware of and take into consideration when assessing our own needs. DI is especially critical for those who are self-employed or working on a contract basis where they are not receiving benefits from the employer.

Here's a quote from the book "The Wealthy Barber" that might help put things into perspective.

“Disability insurance is the most neglected of all forms of insurance, yet for many people, it’s the most critical insurance need…. A thirty year old has a one in four chance of becoming disabled for one year or more at some point in his or her life…When people are disabled, they don’t just cease to be an asset to their families…they become a liability.”

Here's a chart I got from the SunLife.ca website that will give you a general idea of the what the chances of us being disabled by age 55.

Chances of becoming disabled for 3 months or longer before age 65*
Percentage 58% 54% 50% 48% 40% 30% 23%
Age 25 30 35 40 45 50 55

Source: Sunlife.ca

1 in 3 people, on average, will be disabled for 90 days or longer at least once before age 65.
The average length of a disability that lasts over 90 days is 2.9 years.

Source: Canadalife.com

Think you are already covered?

Most people have some protection through their employer as a group plan or get covered by Workers Compensation, but are these plans really protecting you properly?

Workers Compensation: Only covers work related accidents/injuries and may contain some limitation on length of payments (often the first 5 years or so), the amount of coverage (usually cover only about 60% of the salary) and types of injuries covered. This is only for those who are working on an employer-employee relationship - not for self-employed individuals.

Unemployment Insurance: Only covers for 15 weeks

Group Plans offered through employment: May contain some limitation on length of payments (often the first 5 years or so), the amount of coverage (usually cover only about 60% of the salary) and types of injuries covered. You do not have full control of the plan and once you leave the company you are working for, you are no longer covered, and it can be cancelled by employer. Generally, there might also be several limitations or exclusions from the work sponsored plan (i.e. no 24 hour protection, only covers work-related injuries, etc..).

Canada Pension Plan: Offer limited coverage and can reduce the amount of benefit received from the other sources. Also, the definition for 'disability' is more strict then for having a stand-alone plan.

Benefits and Contract

When you have a stand-alone DI Policy, you will be paying from your pocket with after-tax income and there is no tax deduction, therefore you receive the benefits from the policy tax-free. On the flip side, the benefits you receive from a work-sponsored plan are actually taxable because you are paying with pre-tax income. The contract on a stand-alone policy is between you and the insurance company directly, and in most cases it is 'non-cancellable', which means as long as you are making your premium payment, the insurance company cannot cancel the policy.

Within the contract, there are generally 3 definitions used for disability, and that will determine how long and how much the insurance company has to pay you. Some policies will actually require you to go back to work even if it is not in the same field of work you were doing before or if it is at a reduced salary. The 3 main clauses within a DI policy are:

Any Occupation: Means you are unable to work for any occupation, regardless of what type of duties or income is involved.

Regular Occupation: Means that you are unable to work in any occupation that requires you to do the same duties you would have done in your own occupation, or field of work.

Own Occupation: Means that you are unable to perform the duties of your own occupation, HOWEVER, can still work in another field/occupation and continue to receive benefits.

There are also 2 other benefits that can go along with these clauses and I've actually found a good description from another website:

Level of Benefit
Residual Benefit: A residual benefit is payable if the person is able to work on a limited or reduced basis. For example, an individual with back pain may only be able to tolerate sitting at a desk for 2 hours per day. The level of payout is based on the proportion of lost income relative to the time lost. This provision is essential since most individuals make claims for partial rather than full disability.
Partial Benefit: A partial benefit is also payable if you are working at a reduce level. However, the payout is based on the amount of lost time and duties and there is no requirement to show a loss of income. This is an attractive clause for those who are newly employed and show limited prior earnings (e.g. a new graduate doctor).

(Source: Click Here)

The "Elimination Period" (i.e. Waiting Period) of the policy is generally the amount of time you have to wait for the company to start paying claims. To assess how long your elimination period should be, you should have a general idea of how long you can survive without having an income coming to you from this policy. In order to determine this, you must take into consideration the following:

- Do you have a group plan through work? If so, will it cover you? for how long? how much?

- CPP Benefits - will you qualify? how long will it cover you? how much will it give to you?

- WSIB - will you qualify? how long will it cover you? how much?

- Personal Savings - how much do you have in savings? how long will it last if you were to have no income coming in? is it accessible at moments notice?

Features

Many policies will offer different type of features or 'riders' to the policy to enhance the coverage that you get. Some of them include:

Waiver of Premium: This feature will actually result in the insurance company to take over the premiums that you were paying, while you receive the benefits from the policy itself. Some companies will also refund the premiums that you paid during your elimination period.

Future Increase Option: This rider will allow you to increase our benefit in the future with only proof of income. Different companies will have different rules to how much you can increase your benefit and how often you can increase. This can be important to those who expect to go from one job to a higher paying job later on, or those who expect their salaries to increase significantly over time.

Cost-of-Living Option: This rider actually will keep pace with inflation, so to make sure that the benefits you receive are not eroded by inflation and keeps your purchasing power in tact. Usually the increases will be every 6 to 12 months.

Making A Claim

Just as in CI, you need to be diagnosed by a medical professional who is Licensed in Canada, the same rule applies to DI. Once diagnosed with an injury/disability that will meet the criteria of your clause (any occupation, regular occupation, own occupation), you would submit the required documentation to the insurance company. After it has been approved and the waiting period has been completed, the benefits will start to and can be used in any way necessary.

Protecting yourself in case of illness/injury is very crucial and can be very detrimental to your situation if you are not covered and something were to happen to you. As you can see, there is somewhat of an inverse relationship between the risks of getting a Critical Illness and getting a Disability. Generally, you're more likely to get an injury/disability when your younger, and the percentage decreases gradually as you get older - this is generally because those who are younger usually have more physical activities they are involved in, will work harder labour jobs and will be more likely to get be involved in something like a car/truck accident. On the flip side, there is less likely to get an illness when your younger, however the likelihood gradually increases the older you get. This is why it is very important to have both these products together to properly protect your family in case of any unforeseen circumstances.

Having a product like this can be a great addition to securing your financial future and assuring some sort of protection for you and your family. If you are not sure whether this is something that would be beneficial to you, please consult your financial advisor before making any decisions. I hope you've learned something from this post, and if you would like to get more information on this type of protection and the choices available, please do not hesitate to contact me!

Annuities

2010-05-12T13:40:00.012-04:00

In this post I will talk about Annuities, something that many people have heard about, but don't really know how it works. Annuities aren't as popular today as they used to be, because of all the different types of investments we have today, but they can still be used as a key part in someones portfolio.

Annuities are considered an Insurance contract, and therefore can only be offered by Insurance companies - which could be one reason that they are not known or used as often as other products. There are several different types of annuities, and they can have a few different features added to them as well, so I will explain the details of each below. Before I get to that, I will give a brief definition of what an annuity is, in general.

What is an Annuity?

Here's a definition I got from the Manulife website, which I think is simple but gets the point across.

In exchange for a single lump sum investment, an insurer makes guaranteed regular income payments to an investor that contain both interest and a return of principal. Annuity payments can continue for the lifetime(s) of one or two people, or for a chosen period of time.

(Source: Manulife.ca)

Annuity is often used in retirement portfolios, to give the Annuitant a regular and known stream of income. The concept is similar to that of a pension - when you retire, you start to receive a regular income stream, however, it is not always known. With an annuity, you will know exactly how much income you're receiving on a regular basis. You can purchase an annuity with either registered or non-registered funds, and have your tax rate prescribed (where you know exactly how much taxable income you're going to receive every year) or non-prescribed (every year you pay different amount of tax on your income.

First I'll go through the pros and cons of annuities, and then I will go into the main different types of annuities.

Pros

- receive a regular income stream

- income stream is known

- minimizes taxation of income (because it is returned as principal and interest)

- there is no market risk (you continue to receive regular stream of income even if the markets tumble)

- payments can continue to a beneficiary even after death

- can know exactly how much taxes you're paying

- can be indexed for inflation

- can be set up as single or joint

- generally higher returns than other products (i.e. GICs)

Cons

- very little flexibility - once the money is given to the insurance company, usually, you no longer have any access to it

- if you want to add a cashable component to your annuity (where you can take some of your regular principal as a withdrawal), this will reduce your income stream

- adding features (i.e. payments continuing after death, or index inflation) will reduce the amount of income you receive

- income stream is lower for younger clients

- do not take advantage of market gains

As you can see, there are still drawbacks to using this type of product, and it is not seen as something that might fit into every persons portfolio.

Now that you get a general idea of what Annuities are and how they function, I will now go through the main different types of Annuities offered in the industry.

Single Life - This is fairly self-explanatory. The annuity is issued to a one person, and the annuity payments will continue until the annuitant dies, at which point, they will stop.

Single Life with Guarantee - With this, you can set up a guarantee period (usually 20 or 25 years, or up to age 90, whichever comes first), which means, if you die within this guarantee period, the payments will continue to a named beneficiary until the end of the guarantee period. The longer the guarantee period, the less your income stream will be.

Joint-Life - The payments will continue until the death of the surviving spouse. You can add a 'reduction' feature which will reduce the amount of income received by the surviving spouse upon the death of the first spouse (usually reduced to 40% or 50% of current income stream). By adding this feature, you can increase your current income stream until the death of the first spouse.

Joint-Life with Guarantee - Same as above, but can also add a guarantee period (usually 20 or 25 years, or up to age 90, whichever comes first), so the payments can continue to a named beneficiary (or estate) upon death of the second spouse.

Term Certain - This type of annuity will provide you with a guaranteed income stream for a set number of years (to a maximum of 25 years or age 90, whichever comes first). After this period is complete, the payments stop. If you pass away during this period, the payments will continue to a named beneficiary.

As you can see there are several different types of annuities offered, all with certain features and benefits. One or more of these can fit very nicely into a retirement portfolio to provide you with a regular stream of income, which can help you to maintain your current standard of living and lifestyle. That being said, by no means should you put your entire savings into this type of vehicle. This product should make up only a portion of your retirement plan, and should be used together with other strategies/products.

I hope you have learned some good things from this post, and please consult your financial advisor before making any decisions on how this product might fit into your portfolio. If you have any questions or comments, please do not hesitate to contact me!

Index Funds

2010-04-22T18:41:00.007-04:00

In this post I'm going to discuss a type of "mutual fund" that is fairly popular with more educated and sophisticated investors. Index funds are something that are being discussed more and more in todays investment world, especially by those who are not very fond of traditional mutual funds. In this post I'll compare index funds with traditional mutual funds, and try to give the main differences between the 2.

What are Index Funds?

Essentially, an Index Fund is just a Mutual Fund that tracks a specific Index, such as the S&P/TSX Composite Index (Toronto Stock Exchange). An index fund will try to emulate the returns of the index as much as possible, by holding the same stocks as the index itself, and holding the same weightings as each of the stocks in the index.

An index fund will invest in the largest, strongest, and the best known companies in the country/region (and sometimes sectors or commodities) they are invested in. This might offer investors some sort of 'security' in their investment, in the sense that investors will feel that larger companies are less likely to get into financial trouble or become bankrupt or the like.

Management Style

Whereas a regular Mutual Fund will have a mutual fund manager who will buy and sell securities and try to beat the index (known as either professional or active management - depending on the type of fund), an Index Fund will take on what is known as 'passive management'. This is because the Index Fund Manager does not have to do much buying/selling, and his/her job is just to mimic the index as best as possible. Therefore, this requires a lot less research; which will also reduce the overall cost of the fund.

Having 'passive management' means generally there will be no advice from advisors as you would get with traditional mutual funds (therefore no trailer fees paid to the advisor -- which keeps their cost lower). This is why generally Index Funds are used by more sophisticated and educated investors.

Many Index Funds will not be able to fully mimic the index because they will have a 'weighted cap'. This means the fund will not be allowed to have more than x% of one company. For example, at one point Nortel made up more than 35% of Toronto's Stock Exchange, but when it crashed, it took the S&P/TSX Composite down with it. So to reduce the market risk, most Index Funds will have a 'cap' on how much % they can have of one company.

Costs

Since the management of an Index Fund requires a lot less in the way of research, buying/selling, management etc..., this will greatly reduce the costs (MERs) associated with the fund. Where a regular mutual fund can range from about 1.5% to 2.5%, an average Index fund can go anywhere between about 0.4% to 1.4% (depending on the company and the index it is following).

Also, Index Funds are generally bought from on online trading platform or a discount brokerage. This means for every transaction (buy or sell), there would be a charge. Depending on how many transactions are done and how much each transaction is for, this could actually negate any savings from the lower MER. In some cases, the fees associated with trading online will be more than an MER on a regular mutual fund, and thus lowering the overall return of the fund, thus

Risk/Returns

Although an Index Fund will hold the strongest, largest and best known companies in the country/region, they still carry risk (as does any other fund). In fact, often, an Index Fund will have more risk than an average Mutual Fund Portfolio. This is because an Index Fund will track only the Index in a specific region, so it will not give as much diversification as many Mutual Fund Portfolios.

Some will say to balance out risk, to just buy several Index Funds from several different Regions/countries, so to reduce the risk, but that availability of Index Funds for other regions is not as much as for regular Mutual Funds. Regular Mutual Fund portfolios generally have the ability to diversify more than an Index Fund Portfolios, so to reduce the risk. Also, as mentioned above, often there will be a small percentage of companies making up a large percentage of the index, and therefore will make up a large percentage of the Index Fund. This will be more risky than most Mutual Funds, who will have more companies with less weighting, so to spread the risk out.

Generally, Index Funds will have higher returns over a longer period of time, as compared to the average Mutual Fund. Having said that, the volatility is still a lot higher than Mutual Fund portfolios. A Mutual Fund manager will try to match, or even beat the index, with using as little risk as possible. So, although the general returns for Index Funds are higher than the average Mutual Fund, this is not considering the risk involved. If we were to look at the "risk-adjusted returns" (the returns calculating the risk being taken) for Index Fund in comparison to average Mutual Funds, we would find the the returns would actually be fairly similar.

As mentioned before, there is no "one-size fits all" investment or strategy for everybody. Index Funds can be a great addition to an investment portfolio, but only if used properly. Please consult your financial advisor before making any decisions on using Index Funds in your portfolio, and also do your own homework.

I hope you have learned something from this post, and please don't hesitate to contact me if you have any questions!

Critical Illness Protection

2010-04-13T23:26:00.003-04:00

In this post I will discuss something that, I think, is not discussed nearly enough by advisors and the general public. We've all heard about and have been swamped by ads of Life Insurance, Auto Insurance, Home Insurance etc..., but I don't think we hear enough of something that may be as important (or if not more important) then the above mentioned. The 2 complimenting products to life insurance for a family 'protection plan' are Critical Illness Protection, and Disability Protection (which I will discuss in another post). In this post I will focus on Critical Illness protection and will help answer several questions about it, such as: What is it? Do you need it? How much is needed? What types of coverage are there? etc...

What is Critical Illness Protection?

Critical Illness Insurance is a type of 'Health Insurance' that provides a lump-sum payment if you were to become seriously ill. It is also given the name "Living Benefits", because you don't have to die to receive the payout. It is considered to be a type of an Insurance to protect your lifestyle, and to help you recover from a serious illness.

Although the illnesses that are covered vary from company to company, you can be covered for most (or all) of the following:

Do You Need It?

Of course, no one plans to get sick, however, if something were to happen to your health unexpectedly, you want to make sure that your financially prepared to take care of the situation at hand.

While healthy lifestyle choices can be your best defence against some health risks, a critical illness such as cancer, stroke or heart disease can strike anyone at any time. Consider the following:
One in three Canadians will develop a life-threatening cancer⁽¹⁾.
One in two heart attack victims are under 65 years old⁽²⁾.
Each year, 50,000 Canadians suffer a stroke. Of all stroke victims, 75% will be left with a disability⁽²⁾.
(http://www.rbcinsurance.com/healthinsurance/critical-illness-insurance.html)

There are many statistics around about different type of illnesses and the chances of getting them, but the bottom line is that you are far more likely to get a critical illness before age 65, then you are to die. Also, due to medical advances, people are living longer and longer, and are more likely to survive a critical illness then ever before.

To determine if Critical Illness protection is needed, and how much is need, you can do some basic calculations. Basically, what you should do is to determine what your financial hardships would be if you were to become seriously ill. Many things need to be taken into consideration, such as:

- income replacement

- hiring a home-care nurse

- hiring a nanny

- business needs

- debt payments

- medical treatments

- travel

etc...

There are many websites that can help you determine the approximate amount of coverage required, but here's one that I found helpful, from Canada life:

http://www.canadalife.com/003/Home/Products/CriticalIllnessInsurance/CriticalIllnessInsuranceCalculator/index.htm

Types of coverage

Most insurance companies will be able to offer Critical Illness insurance, either as a stand-alone policy, or as a rider (addition) to a regular Life Insurance Policy. Many group insurance policies from work will offer some sort of combo of life/disability/critical illness protection, but in order for you to know what is being offered, please carefully read your group plan package.

Although different companies will offer different products, generally the types of coverage offered would be a 10-year term, 20-year term, to age 65, to age 75, and in some cases to age 100 protection. Often, the 10 year and 20 year term policies are renewable (but be aware, the premium rates upon renewal will usually skyrocket!)

Making a Claim

Making a claim is not as difficult as some might think. What you need is a licensed medical physician (in Canada), who specializes in your illness, to diagnose you with that condition or an illness covered in your policy.

Once approved, the insurance company will pay out a lump-sum payment, usually 30 days after the claim has been put through. The great thing about having a lump-sum payment, is that there is no restriction on how the funds can be used. You can go on a vacation, go to another country for an operation, buy a car, etc...

Also note, once the policy has paid out, the policy is now considered to be ceased, and is no longer active. A bonus is that, even if you recover from the illness, you keep all the funds provided to you.

What if there is no claim made?

In some cases, someone will go their entire life (or most of it) without getting any critical illness (and therefore not making any claim). Depending on the insurance company, some will provide you with a 'premium rebate' addition to your policy, which means that if the policy expires, and you have not made a claim, you receive all your premiums paid into the policy back in full. Also, if a person were to die without making a claim, the premiums can also be returned back to the beneficiary designated on the policy. This is one thing that insurance companies use to to peak the interest of clients.

Critical Illness protection can be offered by any Life Insurance Agent/Representative or can be offered by most Life Insurance Companies directly. As mentioned before, it can be an addition to a regular Life Insurance policy, and if combined, will often be cheaper then getting a standalone policy.

If you are not sure whether this is something that would be beneficial to you, please consult your financial advisor before making any decisions. I hope you've learned something from this post, and if you would like to get more information on this type of protection and the choices available, please do not hesitate to contact me.

Using Insurance as a Charitable Donation

2010-04-09T01:00:00.004-04:00

Many of us want to help the less fortunate or want to give back to an organization that has helped us in our lives. I've discussed, in my earlier posts, about using insurance as a means of personal/family protection as well as briefly touching upon the ability to grow money tax-sheltered. In this post I will discuss one of the other uses of insurance, which is using it as a charitable donation.

There are many people in society who either don't have dependents or any person(s) that they want to leave money for after they pass away, but have a favourite charitable organization or religious group etc... that they would love to leave money for. Many are regular donors to these organizations or charities and want to continue their giving even after they pass on. Some people will include the organizations name(s) in their will to have their assets given to one or more of their chosen organizations, but some might not be able to give as much money as they want due to lack of savings or pre-mature death. In cases like this, using an insurance policy as a means of leaving money for a charity/organization can be a great way to do that!

A person can make a substantial contribution to any charity by naming the organization as a beneficiary. Most likely, the amount they leave behind will be larger then any amount they would be able to afford on their own, so it is an easy and affordable way to make a generous contribution at the time of death.

Tax Advantages

There are usually tax advantages when you donate/contribute to a registered charity, and this situation is no different. All proceeds will go directly to the beneficiary, since we know that life insurance policies will pay out tax-free.

Having the tax-free proceeds being paid to the charity is great, but that is something that happens after death, so, what other advantages are there during life? Well, the premiums that are paid can actually be deducted from the annual income as an itemized deduction. So in this way, there are tax advantages both before and after death!

In order for this to be official, the policy's rights actually have to be signed over to the organization, and all the documents be delivered to them. All this means is that, the organization must be consulted before any change to the policy itself.

Other Details

By signing over the policy to the organization (basically making them the owner), the proceeds are not included in estate of the person who has passed away. If the policy is not passed over to the organization, but just has the organization as the beneficiary, the proceeds will be included in the estate's worth, even though the funds will be going directly to the organization. This could result in much higher taxes for the estate and might leave less money for other beneficiaries from the estate (i.e. family).

Other Options

Getting a new insurance policy might be something that is not affordable by everybody, so what other ways can be used to leave money through a policy? One way is, if someone has an existing policy, to have the dividends paid out by the policy (if there are any) to be allocated to the organization itself, rather then re-invested back into the policy (or given as cash). This can be done by contacting the insurance broker or the company who provided the policy, and they can check to see if it is possible with the policy that is already in place.

Another option is to add the organization as a beneficiary to an existing policy, which will still allow to make a large contribution, but won't cause any extra taxes since the existing policy would have been added to the estate anyways -- the only thing that would be done is splitting up where the funds are allocated at the time of death. The amount of donation given can actually be deducted from the gross estate of the person who has passed away (there will be a charitable donation tax credit for the amount of contribution), which is something that would benefit the heirs of the estate. However, using this option, where the life insured is still the owner of the policy, the premiums cannot be deducted by the life insured from their annual taxes.

Using an RRSP/RRIF

Another way to leave money for a charity is to designate them as the beneficiary of an RRSP or RRIF, and then buy an insurance policy equivalent to the value of the RRSP/RRIF. At the time of death, the charity will issue a tax receipt which will offset the tax burdens, and then the estate will receive the life insurance proceeds tax-free.

Wealth Replacement Insurance

This is a very interesting way to use existing assets and insurance to donate money, lower your tax bill, and accumulate more wealth overall. This is something I actually got from http://lsminsurance.ca/tips/general/charity-life-insurance . I will just copy and paste it:

This is a creative option which allows you to donate a large asset or lump sum of money to charity. In return, you receive a charitable credit for the donation which results in tax savings for the year the donation is made. You can then invest these tax savings in an insurance policy that potentially results in enough proceeds to replace the value of the gifted property.
Let's look at an example of the last method.
Mrs. Jones own a piece of land that originally cost her $100,000. It is now worth $300,000. She donates the land to charity and receives a donation receipt for $300,000, which will equate to tax savings of approximately $138,000 (assuming a 46% marginal tax rate).
Mrs. Jones incurs a taxable capital gain on the disposition of the land of $100,000 (50% of $300,000-$100,000) resulting in tax payable of $46,000. However, the net tax savings of $92,000 could be used to fund a life insurance policy on Mrs. Jones producing a potential tax free death benefit for her heirs in excess of her original donation.

Annuities

A charitable gift annuity allows someone to give a lump sum contribution to a charity, but still receive guaranteed periodic income in return (usually monthly). Generally, the older the person is at the time of donation, the higher the returns will be.

Using this strategy, keep in mind that the donations are irrevocable, which means, once they are given, they cannot be taken back and the control of those funds is no longer there.

A tax receipt will be issued for the amount the gift exceeds the total annuity payments made to the donor (calculated by Canada Revenue Agency's life expectancy tables). Also note, that most (or all) of the income that is received is tax-free.

Using the life insurance strategy can be used with either term or permanent life insurance policies, so it can be used for short term and long term plans. If this is something that interests you, please consult an advisor to get more information on all the details.

I hope you have learned something from this post, and if you have any questions, please do not hesitate to contact me.

Socially Responsible Investing!

2010-03-12T00:40:00.005-05:00

In this post I'm going to touch upon a topic that I've been getting a lot questions and comments about, which is the topic of 'Socially Responsible Investing'. I'm just going to go through some general points about these types of investments, because it is not a different type of vehicle for investing, just another way OF investing.

We are seeing a big shift in todays world in regards to people becoming more socially and ethically responsible, which is something that is very much needed. As we know, there are a lot of companies out there who are doing an excessive amount of pollution, are not complying with human rights, or are just involved in things that we do not agree with. Traditionally, when we invested in things like mutual funds, we weren't really paying attention to the type of companies we invested in; generally, we were just interested in having our funds grow for our future. However, if we really did our research and looked at some of the companies we were investing in and the type of things they were involved in, we might find ourselves feeling a little 'guilty' or 'uncomfortable' with that. So, whats the solution?

Over the last few years, there's been a big push for the creation of Socially Responsible Investment Funds. These are funds that are focused on investing in companies who meet certain guidelines in regards to how they do business, what type of business they're in, how they affect the environment and so on. Whether its because of religion, personal or moral belief, or any other reason, many people do not want to invest in companies that are involved in certain activities, as it goes against their belief system. Thus, a need for something different!

In 'Socially Responsible Funds', there are strict investment guidelines, and they have exclusion lists. For example, they won't invest in tobacco, or alcohol related companies, or companies that have a poor human rights record, or companies that are involved in weapons manufacturing, etc... Most people invest for their future in things like stocks or mutual funds and the like, however, they also might have a certain belief system which they want to adhere to; so, naturally, this would be a great alternative for them.

As most people don't know that they have a choice, I thought I would share some brief information to let you know there are other options for investing in your future. Typically, these funds work in the same way as regular mutual funds (i.e. investing in companies around the world, expecting growth and income, etc...), but work on a different mandate that is in line with peoples moral/ethical/religious beliefs.

One thing to note is that, generally, the returns on these types of funds MIGHT (not in all cases) be a little lower then a traditional mutual fund. The reason for this is because of the companies that the traditional mutual funds invest in. The fact is, tobacco and alcohol companies (and other types of companies that might not be invested in, in a socially responsible fund), generally have good and more stable returns other companies. However, from the performances that I have seen, these Socially Responsible Funds generally have similar average returns as regular mutual funds.

I hope you've learned something from this post, and if you would like to get more information on these type of funds and the choices available, please do not hesitate to contact me.

Exchange Traded Funds (ETFs)

2010-01-30T19:36:00.021-05:00

These days there are so many new investments types coming into the market, its hard to keep track of everything. Over the last few years we've seen a huge surge in something called "Exchange Traded Funds" (ETFs). Although they aren't very new to the industry (have been around for more then a decade), it seems like only in the last 4 or 5 years they have started to make a name for themselves. In this post I will go over the basics of this type of investment, the types of ETFs, the pros and cons, and also the type of investor who I feel would benefit most from it.

What is an ETF?

An exchange Traded Fund is like a mixture between a stock and a mutual fund. It works similarly to a stock because you trade on the stock exchange through a broker. And, like a mutual fund, you can purchase a group or basket of stocks (or other investments) rather then purchasing one at a time.

ETFs are designed to mimic the index or a sector. For example, you can own an ETF that mimics the S&P/TSX index. This means it will hold pretty much the same things and same weightings as that index. Because they are just tracking the index or a sector, the fund manager doesn't really have to do the buying/selling or analyzing/researching that a normal mutual fund manager has to do - thus lowering the fees associated with this investment (the MER).

ETFs are bought/sold on the market and can be sold at any time of day, just as a regular stock can be done. However, unlike stocks, you don't really have to watch and track them everyday, since its following the overall index. Just as regular mutual funds, these should be used as a long-term, buy and hold, type strategy. Unlike mutual funds though, you have more flexibility of when/how you buy and sell.

Types of ETFs

There are a few different type of ETFs that can be invested in and here are just the main ones.

General Index ETFs - Similar to an index mutual fund, these funds track the broad indexes such as the S&P/TSX Composite Index. This will track the largest companies on the index, and will invest over different sectors/industries.
Sector ETFs - These funds basically just track a specific sector within the Index, such as technologies or financials, but can also go into commodities such as gold or silver.
International ETFs - These funds can track indexes in other countries, for example USA, and will give you exposure to them. You can also get an 'emerging markets' ETF that will give you access to multiple international markets.
Fixed Income ETFs - Similarly to a fixed income mutual fund, these funds will invest directly into fixed income investments. However, these ETFs will follow the actual bond index itself.

Pros and Cons of ETFs

Pros:

Cost: Generally, ETFs will have lower MERs (fees) then regular mutual funds. This is because there much research/analyzing and buying/selling that a regular mutual fund would have, thus less work for the fund manager.
Flexibility/Liquidity: Since ETFs trade on the stock market, you can buy/sell at any time of the day (as long is there is someone to buy/sell from you). This is in contrast to a mutual fund, where the trade cannot be done until the end of the day, at which point the market could have fluctuated a lot.
Performance: Rarely do I discuss performance, because that can always come back and bite you in the behind since no 1 fund will always outperform. However, when it is something more consistent, then it should at least be taken into consideration.
Taxation: Although inevitably you will have to pay taxes on your ETFs, you can often delay the taxation if you buy and hold. With an ETF, you will pay taxes on any annual dividends (whether received in cash or redistributed - same as a mutual fund), but other then that, you will pay taxes on gains only when you sell the ETF. In a mutual fund, capital gains taxes are incurred as the shares within the fund are bought/sold during the lifetime of the investment (since other people who are in the fund will be buying/selling over the time) AND there will be a capital gains tax when the fund is actually sold by you (if sold for more then you purchased for).
No Minimums: With ETFs, there are no minimums to start investing (are there are with SOME mutual funds). You can start off with a minimum amount (although its not recommended due to brokerage fees), or as large an amount as you want.
Short Selling: This, in my opinion, is something for more sophisticated investors. ETFs offer the ability to short-sell, or in other words, betting on a decline on the index that the fund is tracking. In a way, this is a little more of a gamble, but if an investor has taken the time and energy to do all the research and highly feels that the market will go one way or another, they can take advantage of an opportunity they feel is coming.

Cons

Costs: Although one of the pros was lower MER costs then a traditional mutual fund, brokerage fees are something that MAY negate (and then some) the savings in MER if there is a regular contribution (i.e. monthly, weekly, bi-monthly). For example, if a brokerage is charging $15 per transaction (either buy or sell), and there is a monthly contribution, this means the total annual charge in just brokerage fees will be $180 (and then another $15 when you sell) . Note, this does not include the MER.
Lack of Liquidity: Again, also listed as one of the benefits, this can also be a weak point of ETFs. Since they are traded on the exchange, in order for one ETF to be sold, there must be a buyer. In some cases, there might be a challenge when trying to sell with limited or no buyers on the market.
Lack of Professional Management: Mutual Funds have become famous because of the professional and active management they offer. Since ETFs mimic the index, there isn't much decisions that fund managers need to make. This can be a downfall where actively managed mutual funds can spot opportunities to buy/sell certain investments where they see fit, thereby in theory, reduce risk and/or enhance potential for higher returns. Essentially, the investor would pretty much have to do the bulk of the research/analysis on each of the ETFs to make sure they are keeping up with all the opportunities within the market. Most
Spreds: When you conduct a buy/sell order, you have to pay a "spred" - the price at which you can buy is slightly higher then the price at which you can sell. Whoever is executing the trade in the stock market for you is basically just pocketing the difference. Therefore, you are not getting the full benefit from your trade as part of the money is going into someone else's pocket.
Dividend Re-investment: Many ETFs will offer a dividend component which will give the investor dividends in cash. With Mutual Funds, you can directly invest the dividends back into the fund, however, ETFs do not do that. This might not allow an investor to take full advantage of purchasing additional shares/units of the ETF to maximize growth. Some brokerages are now starting to introduce a DRIP (dividend re=investment program), but not all do. Also, when re-investing the dividend, many brokerages are charging a fee for the transaction. This could further deteriorate/minimize the growth potential in the fund.
No Guarantees: There are no guarantees in what you will get as a return when you purchase ETFs. For an investor who is risk averse, this might not be the proper type of investment for them. As opposed to something like a Segregated Fund that offers a principal maturity and death guarantee, ETFs do not have any of those type of features, which could make it a more riskier investment for many investors.
Fund Switching: With ETFs, there cannot be any direct 'switching' from one fund to another, instead, there has to be a sell order of one fund, and then a buy order of another. Any time this is done outside an RRSP or TFSA, there is a chance of taxes (if there are any capital gains), which will hinder the growth of the portfolio, especially if there are several changes done throughout the lifetime of your portfolio. Whereas, with mutual funds, you can have fund switching without causing any taxation (if the fund is structured as corporate class). Over the lifetime of an investment portfolio, this can add up to a LOT of taxes which can drastically reduce the overall return of the portfolio. Also note that any time there is a 'fund switch' there will be buy/sell fees associated from the brokerage.

As stated many times before, there is no ONE strategy that is best for everybody. ETFs can be a great way to get returns and outperform many other mutual funds, but if used, they should be done so in a knowledgeable fashion. I would say, generally, that ETFs are more for sophisticated investors who have the time, patience, and understanding capability of the market and its trends. This would be more stressed if an investor was to invest into things like commodities, since they tend to be more risky. Also, this is not a strategy that should be used with a regular contribution plan (for example monthly contribution) because of the fees associated with brokerages.

If an investor can only do regular contributions, it would be recommended to put those smaller regular contributions into no-fee/no-load mutual fund until it reaches a larger lump sum (i.e. maybe $5,000 or $10,000), and then transfer that larger balance directly into an ETF. This way, the per transaction brokerage fees are avoided, and an investor can take full advantage of the lower MERs.

Although ETFs would be a great addition to an investment portfolio, please consult a knowledgeable financial advisor in regards to how it might fit into yours. Just as mutual funds, there are many different types of ETFs, and each should be analyzed carefully. One thing to also note is that many Mutual Funds do actually use ETFs within their portfolios (usually a small portion) to take advantage of certain opportunities, so as an investor, both can be used to compliment eachother.

I hope you have learned something from this post, and if you have any questions, please do not hesitate to contact me.

Mortgage Insurance: Stay away!

2009-12-09T11:31:00.006-05:00

I know in the original post I said I would try to keep as much of an unbiased view on my posts as possible, but for this topic I have no choice but to let loose. Mortgage insurance is one of the biggest frauds in Canada, even though most people don't realize this. One of the things that get 'stuffed' down our throats when getting a mortgage is the concept of 'insuring' our mortgage against any tragedy that might happen to us (whether it be death or illness) -- hence the name 'Mortgage Insurance'. The concept that we're sold is that if anything were to happen to us, the mortgage would be paid off in full, and that at least our surviving family wouldn't have to bear that financial stress; because we know they would have to bear emotional stress.

In this post I'm just going to be very straight forward and tell you to STAY AWAY from mortgage insurance offered by the mortgage providers. For some reason the banks and other companies have been able to get away with non-insurance licensed advisors selling 'mortgage insurance' to clients for years. The reason is they don't technically name the product 'mortgage insurance'; they name it something to the affect of 'liability protection'. But at the end of the day, we all know what the product is, since even the vast majority of bank advisors call it 'mortgage insurance'.

Here are some of the reasons you should think twice before signing those mortgage insurance papers:

- beneficiary is the bank (not your family) -- if anything were to happen to you, the money goes directly to the bank (or mortgage company) and they will pay off your mortgage. Your family will never see the money so they will not be able to decide now how to use those funds

- it works on a declining balance payout -- example: you buy a house with a $300,000 mortgage, so originally your mortgage insurance protection is $300,000. Lets say 5 years later your balance is now $275,000; this means the payout is now only $275,000 and not the original $300,000 EVEN THOUGH your premiums (payments) are the same. They don't lower your premium with the face amount of the mortgage insurance.

- the underwriting is not done at the time of application (THIS IS HUGE!!) -- underwriting pretty much will tell you if you would have qualified for the insurance protection at the time of applying for it. Yes, they ask you some health questions at the time of signing the papers, but the vast majority of the time, those questions are very confusing and clustered. Sometimes they will list 15-20 health conditions in one question and a person might look over one of the conditions. If any of the questions are answered incorrectly (even if you don't know they are incorrect), and the insurance company finds out, they will say you committed fraud and will not pay out anything. Oh, and they will keep all the premiums you paid to them as well!

- usually more expensive then regular term life insurance

Now, we've all heard about companies not 'paying out' insurance, and many of those times we hear about it, it is a case about mortgage insurance. The discussion on mortgage insurance can be a lengthy one, so to help you get a very clear picture of what I have posted, please take a look at the below link -- its a video. The link below is a video from CBC Marketplace on mortgage insurance and gives you in depth points on why to be careful of this. It is just under 30 minutes long, but it is time VERY well spent.

http://www.cbc.ca/marketplace/in_denial/

Other options?

We all need some sort of protection in our lives - some sort of peace of mind - so if not mortgage insurance, then what else? The answer is very simple; regular life insurance (term or permanent). Generally, when you get life insurance, it should already have taken into account all your debts, but if you got your mortgage after your initial life insurance policy or you decided to make up your mind about getting life insurance some time after you got your mortgage, you can add to your existing policies.

In situations where a person already has some life insurance - but doesn't have the mortgage calculated into the total coverage - and they need to cover only the mortgage, term insurance might be the best option for them. We assume that the mortgage will be paid of in x # of years (usually 25 or 30), so someone can get a 20 or 30 year term policy. They do this because they know (or expect) they will pay off the debt in that period of time, and after the debt is paid off, they will not need any additional coverage -- thus saving the monthly premium also.

Keep in mind, that many term insurance policies are actually less in cost then 'mortgage insurance' offered by the mortgage institution. At least with a general life insurance policy in your name, you get to decide who the beneficiary is, the face amount never decreases, and often you can get more coverage for the same amount you pay for mortgage insurance.

Obviously this sort of thing would have to be discussed with your financial advisor, and they would give you all the options and help you decide what is best for your situation. Bottom line, be VERY careful of so called 'mortgage insurance' and also how it is 'sold'. The advisors who sell these products are trained on how to sell and which words to use to 'sucker' you in. I hope this post has been informative and PLEASE watch the video that I posted above; it will only do you good! Please consult your financial advisor before making any decisions and if you have any questions, please do not hesitate to contact me.

Income Splitting

2009-11-07T18:29:00.012-05:00

This post we will discuss Income Splitting, and how it can benefit a lot of families out there in reducing taxes. This strategy is being used more and more these days, as more people are becoming educated on this topic.

What is Income Splitting?

Here is a definition that I found to be very straight forward and easy to understand.

Income splitting is a strategy of shifting income from a higher income taxpayer to a lower income tax payer in order to reduce the overall tax paid by the group. The Canadian tax system is progressive and the rate of tax increases as income increases. Therefore, tax payers in Canada are motivated to split income between one another.

(Source: http://blog.taxresource.ca/what-is-income-splitting-in-canada/)

The above paragraph pretty much says it all, but we will get into a little more detail on how it can be used and what some of the advantages are. There are several ways to split income (properly) and we will discuss them below. Remember, the goal for income-splitting is to ensure that both spouses will have the same (or almost the same) annual income when they retire.

TFSA - As of January 1, 2009, the Canadian Government introduced the new Tax Free Savings Accoung in Canada. This is now one of the easiest ways to reduce taxes for a couple. This account can be specifically used to split income. The higher income spouse can give funds to the lower income spouse (as a gift) to put into a TFSA. Any income earned is tax-free, as well as any redemptions made from the account.
Spousal RRSPs (which I will discuss in my next post) - The higher-income spouse can directly contribute into a Spousal RRSP in the name of the lower-income spouse. Essentially, the couple might want to aim for having close to equal value in both RRSPs at retirement, so that both income streams will be about the same. (However, this might reduce government assistance to the lower income spouse during retirement)
Lending Money To your Spouse - This kind of speaks for itself. The higher-income spouse can 'lend' money to the lower income spouse at a prescribed interest rate (stated by the CRA). The lower income spouse can then invest those funds, and will then pay taxes (at a lower rate) on the income earned from that investment. The lower-income spouse must pay back the interest to the other spouse before the end of the tax year.
Asset Shifting - This strategy is just a 'swapping' of assets between both of the spouses. For example, the lower-income spouse has an asset that is not generating him any income (like a cottage). He can then swap that asset with an asset owned by the spouse that is producing income (asset must be of equal value).
Paying household expenses - The higher-income spouse can just pay all the household expenses (such as gas, hydro, cable, phone etc...), as well as the lower income spouses taxes, directly from their pocket. This will then allow the lower income spouse to invest the available cashflow and pay a lower rate then the higher income spouse would if they invested the money themselves.
Pension Splitting - This can be done with a spouse or common-law partner. There are also several rules as to how this can be done, but the idea behind this is the same -- to lower the overall taxes paid. Also be aware of age restrictions on this strategy as well.
Having your own business - This one can get a little tricky, and it is best to consult a tax professional when doing this. Tax write-offs are a business owners best friend! Also, if you are self-employed, you can employ your spouse or children, and pay them a reasonable wage.

As you can see, there are several strategies that can be implemented. Each have their pros and cons (which I have not gone into) and should be thoroughly understood before they are implemented. I am not a tax professional, therefore I haven't given too much detail on these strategies. Please consult your tax professional before making any decisions on which strategy to use, and also make sure you understand the benefits and drawbacks (if any) for every strategy.

I hope you've learned something in this post. If you have any questions, please do not hesitate to contact me!

Spousal RRSPs

2009-11-07T18:29:00.011-05:00

In this post I'm going to go over the topic of Spousal RRSPs and how it can help you lower your overall tax rate. This is a strategy that I find is not being used enough and is something that all couples should at least take a look at. I will not go through in depth about RRSP, since I've already covered that in one of my earlier posts, however, I will just highlight another way to use RRSPs to lower the overall taxes in a household.

What is a Spousal RRSP?

Essentially, it's just an RRSP set up for one spouse (who owns the plan), where the other makes the contributions. This is a form of "income-splitting" (which I discussed in my previous post) by shifting income from a higher income earner, to a lower one, so that the total income between the two will be taxed at a lower rate overall.

Note: common-law partners are also able to take advantage of this plan.

How Does it work?

Basically, one spouse will contribute into the the RRSP of the other spouse, but will claim all tax deduction on their own tax return. There is a immediate benefit of the tax deduction for the contributing spouse, but also the long term overall benefit will lower the tax bill for the both of them as they will be able to withdraw more funds at a lower tax bracket in their later years.

Contribution Limits:

The total RRSP contribution for 1 spouse (for both the personal RRSP and the amount contributed into Spousal RRSP) cannot exceed the Personal RRSP deduction limit for the contributing spouse.

Example -- If the husband has a total contribution limit of $10,000 for the year, and he contributes $7000 to his own personal RRSP, that means he is only allowed to contribute up to $3000 into the Spousal RRSP (anything more then this would be subject to penalty). This $10,000 can be split up any way and there is no minimum that is required to be put into either the Personal or Spousal RRSP.

Perks:

A spousal RRSP is also a great way to defer taxes for someone who is not able to contribute into their own personal RRSP because of their age -- i.e. at age 71, the RRSP must be converted into a RRIF and there can't be any more contributions made. As long as the spouse is under the age of 71, there can still be contributions made into the Spousal RRSP, and the tax deductions can be claimed by the higher income spouse.

Withdrawal Restrictions:

When dealing with withdrawals from Spousal RRSPs, there is something that's called the '3 year attribution rule' that has to be considered. This is a rule that prevents the higher income spouse contributing into the Spousal RRSP, and then having the lower income spouse immediately (or soon after) withdraw the funds at a lower tax rate.

The 3 year attribution rule states that if the lower income spouse withdraws money from that Spousal RRSP within 3 calendar years of it being contributed by the higher income spouse, then it will be taxed in the hands of the higher income spouse. However, if it is more then 3 calendar years after the contribution, then it is taxed to the lower income spouse.

Example -- Husband contributes $3000 into the Spousal RRSP in June of 1998. If the wife were to withdraw the funds any time before January 2001, they would be taxed in the hands of the husband. However, any time after that, and they would be taxed in the hands of the wife.

Creditor Protection:

Since the (receiving) spouse actually owns the plan, the funds deposited by the contributor would be protected from any action taken against them. The only rule for this is, that there must be a consistent patter of the contributor making contributions into that Spousal RRSP which are motivated only for the tax advantages.

This strategy is also used for OAS (Old Age Security) Calculations. To avoid clawback, many couples do this in retirement in the case where one spouse's income is a lot higher then the others.

One thing to note that one spouse is still allowed to have a Personal RRSP even if the other is contributing into a Spousal RRSP. Also remember, this strategy makes most sense when there is one spouse that is earning significantly more income then the other, to balance it out to pay the lowest tax possible. If both spouses are earning around the same amount of income, then this strategy probably would not make that much sense.

I hope you've learned something from this post and if it makes sense for your situation, please use it, because it will keep more dollars in your pocket. Please also consult your financial advisor before making any decisions, and if you have any questions or require further information, please do not hesitate to contact me.

Five Pillars To Financial Security

2009-10-17T20:44:00.007-04:00

In this post we will discuss, very briefly, the "Five Pillars to Financial Security". Keep in mind, up until January 1, 2009, there were only 4 pillars; however, with the introduction of the TFSA on January 1, 2009, there are not 5 pillars that we can all work with. We are not going to get into specifics of each pillar, as we've already discussed each pillar in detail in my previous posts, but this will be more of a general summary on how each pillar can affect your financial foundation.

The 5 Pillars are:

1. Home

2. RRSPs

3. Open Money (Non-RSPs)

4. TFSA

5. Universal Life (Insurance Product)

As we've discussed over and over again, every strategy has its pros and cons, which is why all strategies should be used to compliment each other. There is no 1 strategy that is best for everybody, since everybody's circumstances are different, therefore, everybody should have their own independent financial plan made for them. Below, is a small, simple table with the basics of every type of vehicle.

VEHICLE	CHARACATERISTICS	RETIREMENT USE
HOME	- No Tax Write-off - Low Rate of Return - Equity (usually) is making 0% return for you - Steady value (usually appreciating over time) - Do not pay capital gains taxes for owner	- Generally, NO retirement funds
RRSPs	- - Tax Deduction on Contribution - - Tax Deferred Growth - - Tax Refund given - - There is Maximum Contribution limit	- - 100% Taxable on Withdrawal (but there are ways to minimize or even create net 0% taxation)
OPEN	- May create Tax write-off (if set up properly) - Tax Advantage growth (not tax-deferred growth) - Can set up tax-efficient withdrawals - No Maximum Contribution	- Taxed on 50% of growth, on Withdrawal
TFSA	- No Tax write-off - Tax-Deferred growth - Low Maximum Contribution space (starting at $5000/yr in 2009 – will be increasing gradually over time)	- 0% Tax on Withdrawal
UNIVERSAL LIFE	- No Tax Write-off - Tax Deferred Growth (on investment) - Must Qualify - Benefit of having insurance protection for entire life - Leave beneficiaries tax-free income upon death	- 0% Tax on withdrawal (if set up properly)

As you can see, each pillar has its pros and cons; and as you can also notice, the cons in each pillar is made up for by the pros of another pillar, which is why it would make sense to use as many of the pillars as possible to compliment each other, so the financial foundation is set!

This post is just meant to be a brief summary of some of the things that were discussed earlier, just to kind of simplify the main points for each vehicle. It is also meant to make people aware to not put 'all their eggs in one basket', as we've heard many times before. Diversify, understand (the concepts/strategies), and prosper!

I hope this post has helped, even though we didn't touch on anything new. Be sure to consult your financial advisor before making any decisions. Please do not hesitate to contact with me if you have any questions/comments.

Education Savings: Part 4 --> In-Trust Account

2009-10-13T15:27:00.014-04:00

The last topic we will discuss is opening an In-Trust account. There are a couple of different type of "In-Trust" accounts but I will just cover the basics of the Informal In-Trust accounts.

What is an In-Trust Account?

- investment account opened by an elder (usually parent or grandparent) naming child as beneficiary

- child does not have access to funds until he/she turns age of majority; determined by province (usually 18)

- once child turns age of majority, they have access to funds and can do whatever they choose with that money

- can contain several different types of investments, such as stocks, bonds, GICs, mutual funds etc...

- contributor (usually parent or grandparent) decides when they will contribute and how much they will contribute

- usually have someone named as trustee who will take care of where the funds are invested and manages the account

In-Trust accounts are a great way to save for a child's future, whether it be for education, buying a car or even something like down payment on their first home. However, just like all other strategies, it has its pros and cons.

Pros:

- There is no contribution limit

- Anybody can contribute to the plan

- There is no restriction on how the funds are to be used by beneficiary

- Tax benefits (capital gains taxed in hands of beneficiary)

- Income on income (second generation income -- i.e. re-invested dividends that produce dividends) get taxed in the hands of beneficiary**

- Contributor decides when to contribute and how much they want to contribute

**Note: In most cases the tax bracket of the beneficiary will be very low or even zero in some cases, once they reach the age of majority

Cons:

- No government grants

- Dividends/interest on funds invested by contributor are taxed in hands of contributor (first generation income) --> this can be minimized or avoided by investing into a fund with little/no distributions

- No tax deductions

- Once child reaches age of majority, they can do whatever they please with the money (even if it is against the wish of the parents)

- usually no guaranteed return (if invested in stocks/mutual funds)

- once the funds have been contributed, they cannot be taken back by the contributor

Any time the child gets birthday or holiday cash gifts, they can be invested directly into the account. Also keep in mind, the Child Tax Benefit can be deposited directly into the account as well. If the child has their own income (i.e. from chores, babysitting etc...), they can also deposit the funds into the account.

Although this strategy can be a great way to save for a child's future, it probably isn't the best choice for Education Savings. Some parents decide to use In-Trust because of the flexibility and unlimited contribution space, but not having the Government Grants is a huge con, and can drastically reduce the amount of funds that are available for the child.

However, if the parents/grandparents think there is a good chance that the child will not pursue post-secondary education, this might be something that would be beneficial for them. This strategy is often used when the contribution space in the RESP for the grant has been maxed out (i.e. $2500 already contributed to give maximum of $500 grant, in the year).

Please consult your financial advisor before making any decisions. Also, in case of more complicated trusts (formal trusts), it is also recommended to consult a lawyer so the account is set up properly and all the legalities are understood. Please do not hesitate to contact me if you have any questions or require further information.

Education Savings: Part 3 --> TFSA

2009-09-24T01:44:00.009-04:00

One other option that is not discussed often by advisors and that is not seen as popular as the other options is using a TFSA. Even though this strategy is not used often, I still feel I should discuss it as an option that can be used by parents. I'm not going to go through all the points of using the TFSA strategy, because that can be found in one of my earlier posts (http://financialhealthblog.blogspot.com/2009/05/investments-par-3-tfsa.html).

Essentially, using this strategy can be seen as using funds from your own plan to pay for your childrens education costs. Many people would ask "why even use this strategy" due to some of the drawbacks, but I thought I would still touch upon it as an option for investors.

Pros:

- account is in your (the parents) name, so you have all control of what goes in/out of it
- the funds grow tax sheltered
- if the child does not go to post-secondary education, there are no penalties or setbacks
- you (the parents) are in complete control of the money; in case there is a trust issue in regards to the child(ren)
- funds can easily be redeemed in case of any emergency prior to or during childs post-secondary schooling
- there is no limit to how much can be redeemed at one time
- you choose how much and when you contribute

- very flexible in what is invested within the TFSA

- no penalties for stopping contributions or redeeming funds before the child(ren) goes to school

Cons:

- there is no government grant - this can make up a big difference if the child DOES end up going to post-secondary schooling
- there is an annual maximum
- usually no guaranteed performance (if invested in stocks/mutual funds)
- no insurance protection on childs life

- must be 18+ to open this account - can be challenging using this strategy if there are multiple children or a single-parent home because of the low limits

One key difference between this strategy and that of using an In-Trust Account (which I will discuss next), is that the funds in this account will always stay in the parents name, and will not automatically be put in the name of the child once he/she turns 18. This might be beneficial if there is an issue of trust with the child, in the case where the parents are not sure if the child will withdraw the funds and spend it on other things that they don't approve of.

The main reasons this strategy is not used as often as some of the others is because:
a) there no government grants; the up to $500/yr grant can make a huge difference in the amount of funds that are saved for post-secondary education

b) the max contribution limits allowed for TFSA

However, this strategy is used sometimes, especially in cases where it is complimenting one of the other strategies. Sometimes parents don't feel very comfortable with giving their children access to the funds, or might not be sure if their children will pursue post-secondary education.

The effects of maximum contribution room in the TFSA and the fact that there is no grant from the government might greatly reduce the amount that is accumulated for savings, so if you are using this strategy, please make sure you take the time to consider all the pros and cons. Also, if using this strategy, it is recommended that it be used as a compliment to one of the other strategies as well.

One important thing to note. This same strategy can also be done using an Open (non-registered) Plan by the parents. It would only make sense to do this once the TFSA has been maxed out, as there is preferential tax treatment on the TFSA.

Please consult your financial advisor before making any sort of decisions. I hope you have learned something here and please do not hesitate to contact me if you require further information.

Education Savings: Part 2 --> Cash Value Insurance Policy

2009-08-31T11:52:00.012-04:00

As mentioned in my previous post, there are several ways to save for your child's education costs. In the last post we discussed RESPs and all of the pros/cons as well as most of the aspects of RESPs and how it works. In this post we will discuss how you can use an Insurance Policy (specifically Universal Life) as a way to fund your childs post-secondary costs. (Also referred to as a 'Juvenile Life Insurance Policy'). You can use the below strategy similarly with a Whole Life Policy as well.

In one of my original posts titled "Life Protection" (http://financialhealthblog.blogspot.com/2009/05/life-protection.html), I went through the UL strategy and listed all the different aspects, as well as all the pros and cons of using this strategy. Also, as I mentioned in that post, it is a great way to save and grow money tax-sheltered, and is often used as more of a 'investment' strategy rather then just an 'insurance' strategy.

How does it work?

Essentially it is just a regular Universal Life (permanent insurance) plan that is started in the childs name. The reason it is started in the child's name and not the parents name is because the cost of insurance would be much lower for the child then the parent. That means for the amount of premium that would be contributed, a larger portion of that would go towards the investment component of the policy. At the same time, that child would have and existing life insurance policy that could quite possibly stay with them for the rest of their life.

At the time the child enters post secondary, at age 18 for example, there would have been up to 18 years of tax-sheltered growth that can be accessed.

How to access funds:

1. The funds can be directly withdrawn from the cash value of the policy. The growth of the funds would be taxed in the hands of the child at his/her marginal tax rate, which in most cases would be low or 0. However, if the entire cash value is redeemed, and there is no more contribution to the policy, the policy would inevitably lapse (be terminated).

2. Instead of withdrawing the funds directly from the cash value, you can use the cash value as 'collateral' for getting a loan from the bank. The actual amount of the loan would be less then the cash value and the rate at which the funds are borrowed can be fairly low. Also, the interest can be capitalized -- meaning instead of paying it directly from the pocket, it will be paid out through the policy. This can be a beneficial strategy, since instead of depleting the cash value, that would continue to grow and there would be no direct payment out of the pocket.

Pros/Cons of this strategy

Pros:

- the funds grow tax-sheltered within the policy
- if the funds are withdrawn from the cash value directly, the tax rate would most likely be low or 0
- the child will have an insurance policy which would likely last them their lifetime
- the way the funds are invested can be chosen
- lifetime contribution limit would likely be higher then then that of an RESP
- if the child does not pursue post-secondary education, there is no penalty or setbacks
- funds within the policy can be used for any purpose, not only for education

Cons:

- there is no government grant or contribution
- there is usually an annual maximum that can be contributed
- there is no guarantee of investment performance
- might not be enough funds in portfolio to cover all educational costs

This strategy can be a beneficial strategy in more then one way, and would also give the child a headstart on insurance protection for when he/she is older. However, as any other strategy, it must be used wisely and funded properly for it to work efficiently. This would be a great strategy to use in unison with another form of planning.

Example:

Contributing $2500 into an RESP per year - this would give an annual grant of the maximum of $500 from the government. Any excess funds can be put into a UL strategy, which would start the child off with insurance from a young age, or the excess funds can be put into another form of investment, such as a non-registered (which will be discussed in the next post).

Before using this strategy, make sure to ask your advisor all questions that you feel need to be asked and know all the ins and outs of the product that your advisor is recommending (most insurance companies have similar products but might have minor differences in some aspects). This strategy is not for everybody and might not make sense in all situations, so consult your advisor before taking this route.

I hope you have picked up some good pointers from this post, and as always, please do not hesitate to contact me with any questions or comments.

Education Savings: Part 1 --> RESPs

2009-08-26T00:26:00.015-04:00

Post-Secondary education can be a very stressful and expensive experience for both children and parents alike. These days we're seeing tuition fees increasing year over year, and there doesn't seem to be any end in sight. On top of tuition fees, there are several other expenses which often determine who can, and cannot, afford to get the education they want. Rent, food, transportation, internet, books and phone bills are just some of the additional expenses that get added on top of tuition to make up the total cost of post-secondary education.

Planning for education costs is something that should start soon after the birth of the child, because it can be a very long process. As parents and guardians, we want to see our kids getting the best possible education, but at the same time don't want to have to get a 2nd mortgage on our homes to do so; or even worse, we don't want to have to choose which child goes to post-secondary and which doesn't. Often what we see is the student taking up a part-time job during the school year to help pay for costs; but this usually leads to added stress and also to lower grades due to less time committed for studying.

Just as there are several different options when saving for our own future, there are a few different strategies that can be used to fund the child's post-secondary education. I will discuss just the 4 main strategies that are most often used and discuss the pros and cons of each. The 4 main strategies used are: RESPs, Insurance (Universal Life or Whole Life Policy), Open (Non-Registered Savings) and Trusts. In this post I will discuss the first of the 4.

What is an RESPs?

An RESP is a Registered Education Savings Plan. Similar to the RRSP, it is 'Registered' with the government and there are certain limitations to how it is used and what it can be used for. An RESP is a government sponsored initiative to help families save for post-secondary education. The contributions are made be a subscriber and has one or more beneficiaries designated to it. Here are some of the pros and cons about RESPs:

Pros:

- income earned grows tax-sheltered and tax-deferred
- can designate more then one beneficiary
- can get government sponsored 'bonuses' --> Canada Education Savings Grant (CESG), Canada Learning Bond (CLB), Other provincial sponsored programs
- when funds are withdrawn, it gets taxed at beneficiaries tax rate (I see this as a 'pro', since, in most cases the child's tax rate is very low or even 0)
- You can transfer the RESP from one child to another
- You can carry forward the unused grant room (maximum of $1000 for the next year)
- RESP can be transferred into an RRSP (max of $50,000 -- given that you have room in your RRSP to transfer that much) if it is not used

- No annual contribution limit

Cons:

- Lose any growth and must return grants back to government if child does not go to post-secondary education
- If you invest in the market, there is no guarantee in the amount of return you get
- If you invest in something like a GIC, you might not earn enough return to meet the needs
- RESP plan fees might eat away at your savings and growth
- No tax deductions
- If RESP is not used and there is no room for contribution in your RRSP, then funds are to be withdrawn as INCOME --> 20% penalty and taxed at MTR (maginal tax rate) [only growth is taxed]
*note: principal invested can be withdrawn at any time without paying taxes because it is invested with after-tax dollars

Other Points:

- Beneficiary must be Canadian resident and have a SIN (Social Insurance Number)
- Maximum lifetime contribution limit of $50,000
- Maximum lifetime CESG of $7,200
- Maximum annual CESG of $500 (20% of contribution up to $2,500)
- RESP can only be used to fund education at a Qualifying Post-Secondary Institution that is approved by the Government of Canada
- CESG stops when child turns 18
- Maximum CLB of $500 initially, and $100/year up to the time child is 15 years of age
- Can only qualify for CLB (Canada Learning Bond) under certain circumstances [must be under National Child Benefit initiative -- i.e. for low-income families]

I know this probably must have confused some of you (although I tried very hard to keep it simple); RESPs do have a lot of rules and regulations about them.

What I would recommend is putting a maximum of $2,500/year into an RESP so you can get the maximum $500 (20% of contribution) grant, and any additional funds to be invested in some other instrument; such as a TFSA or UL policy.

When investing into an RESP, you have 2 main choices in how you go about doing that. You can get a scholarship plan or have a self-directed plan.

Scholarship Plan

Scholarship Trust Funds guarantees that your child will receive specific benefits once the funds are needed. Usually the money is put into GICs or Bonds or the like - the investment decision is completely up to the Company and you have no choice over where the investments are allocated. The benefit of this type of plan is that there is some sort of 'guarantee' as to approximately how much money there should be in the plan when it comes to start withdrawing, however, there is very strict contribution rules.

The disadvantage of a scholarship trust fund is it offers very little flexibility. The monthly investment is determined by the company, based on your child’s age. Once committed to a plan, you must meet all monthly payments until your child goes to post-secondary education. If the child decides not to attend a post-secondary school or if one monthly payment is missed, the plan is terminated and all (or most of the) previous contributions are lost.

One main thing to look out for is that some scholarship trust funds do not allow you to choose the university or college; instead they determine from a list of schools where your child can attend and in some cases what expenses will be covered. So, if you are considering to use this type of plan, please make sure you fully understand which schools/institutions your child will be allowed to attend.

Another issue of concern is the drastically high fees that are involved by being with these plans. Usually the first 2 to 2.5 years of your contributions are gone towards covering Membership and/or Administrative fees, and if you were to stop contributing or opt out of the plan, you lose all (or most of) those dollars put in for those fees.

These plans are known as "pooled" plans. What this means is that all the investors are pooling their money into this plan - however, if some of them leave (stop paying into the plan), they leave most (or all) of their money into that pool, and then the money gets split among the remaining clients. The entire basis of this type of plan is that they know between 40-60% of clients will not live out the full life-time of the plan, thus, being able to split more money among less people.

So, if you are considering to go into this plan, you must be 100% certain that there will be no interruptions in the amount you're contributing, and the frequency. Some companies will allow you to start contribution again after you stopped (within a certain timeline - maybe 6-12 months), but they require you to pay back all missed payments + interest.

The lack of flexibility and lack of success for most clients are a couple of reasons people might shy away from this type of plan. You have to ask yourself, if approximately 1 out of every 2 people don't make it all the way through, what are the chances of you making it all the way through?

Self-Directed Plan

In a Self-Directed RESP, the contributor has the flexibility to determine how much to invest and how often. They also have the control to determine how and where the funds are to be invested. If managed properly, the investment can enjoy substantial gains.

With this plan, the student has the option to choose which university or college to attend and has flexibility to determine how to spend the funds on educational related expenses, such as tuition, schoolbooks and even living expense. If the RESP is not used for post-secondary education by the intended child, then it can be used by another member in the family or rolled over into an RRSP (or spousal RRSP), after all grants have been returned back to the government.

The disadvantage to a self-directed plan is it does not guarantee that there would be enough funds available once it is needed. However, there is a potential to earn a lot more growth in a self-directed plan, if managed properly.

In contrast to the Scholarship plan, you can start and stop contributions and also increase/decrease contributions as you so choose. There is no penalty for doing these, and no fees attached. One major benefit of Self-Directed plans, is that there is no enrollment fees attached to it, as opposed to Scholarship Plans. This means, that all your money will be directly going towards your plan - the only "fee" associated with this plan is the MER (management expense ratio) of the fund that you put it in. This is nothing uncommon from any other mutual fund/seg fund/stock investment that you buy, as every investment you pay some sort of fee.

As you can see, RESPs can be very confusing and complicated. When thinking about opening an RESP make sure you ask all the necessary questions and have all the information you need to make the right choice for you and your family. The last thing you want is the stress of having a shortfall in your child's future dreams. Make sure you do your homework and be very careful of RESP agents. Many will push the scholarship plan because it pays a LOT more but usually the first 2 years of contribution go straight to fees.

I hope you have learned some good things from this post, and please consult your financial advisor before making any decisions on how to invest for the future of your children. If you have any questions, please do not hesitate to contact me!

Cost of Insurance and Death Benefit: Level vs Increasing

2009-07-21T19:01:00.004-04:00

As mentioned in one of my first few posts, insurance is a very critical part of solidifying your financial foundation. Using the UL (Universal Life -- Permanent Insurance) can be a very beneficial strategy for you, if used properly.

However, a couple of the things that usually don't get talked about much are, how the insurance cost is actually broken down, and how the death benefit is calculated.

Cost of Insurance

Essentially, there are 2 ways cost of insurance is calculated; you can have Level Cost of Insurance or Increasing Cost of Insurance.

Level - Pretty straight forward; means that the cost of insurance will remain the same over the entire life of the policy

Increasing - Also pretty straight forward; means that the cost of insurance will rise every year over the life of the policy. Originally, cost of insurance will be a lot lower during the earlier years, to allow for more money to go towards the investment portion of the policy. However, over time the cost of insurance will surpass that of "level cost of insurance" and the policy will cost more to maintain.

Both strategies have their pros and cons and you should crunch the numbers for both strategies to see which one works best for you for the amount that you are contributing to your policy.

Death Benefit

Just as there is Increasing and Level Cost of insurance, there is also Increasing and Level Death Benefit.

With an Increasing Death Benefit, your insured amount stays fixed, while your death benefit increases with the accumlated savings.

Using an example of $500,000 Insured amount, plus $100,000 in the savings component, with an Increasing Death Benefit, the total payout would be $600,000 upon death. This is advantageous because you can increase your tax-free benefit to your heirs.

With a Level Death Benefit, the death benefit stays fixed and the insured amount decreases as your savings increase (thus decreasing the cost of insurance). Using the above example, the death benefit would be a total of $500,000 ($400,000 that the insurance company is giving you, and $100,000 of your own investments).

The benefit is that the overall cost of insurance is going to be lower, because as your investment amount increase, proportionally that's how much less coverage you will be paying for; therefore allowing more of your premium to go towards the investment amount.

However, once the investment amount has surpassed the face amount, the death benefit paid to your beneficiaries increases. For example, if you originally bought a policy with a face amount of $500,000, and later on in life your investment portion grows to $750,000, your beneficiary would actually receive the full $750,000, not $500,000.

Here's a great visual example that I got from the sunlife.ca website:

Level death benefit

For fixed insurance needs, the level death benefit is the less expensive option.

With this option, the amount of the death benefit paid to your beneficiary remains level. Here’s how it works: as the policy fund grows through contributions and earned interest, the difference between the death benefit and the policy fund value decreases.

The difference is called the “net amount at risk.” The cost of insurance (COI) you must pay each month for the base insurance portion of your policy is based on the net amount at risk. By lowering the net amount at risk, you can lower the monthly COI withdrawal.

Death benefit plus policy fund

With the increasing death benefit option, any amount in the policy fund is added to the death benefit and paid tax-free to the beneficiary.

The policy fund is not used to reduce the net amount of risk. Because the net amount of risk stays constant, you will know at purchase exactly what the COI withdrawal for your base insurance will be over the lifetime of your policy.

(source: http://www.sunlife.ca/plan/v/index.jsp?vgnextoid=ea9775b5e1856110VgnVCM1000002dd2d09fRCRD&vgnextfmt=default&vgnLocale=en_CA)

Essentially, these graphs can also be used to show how increasing vs level cost of insurance works.

As mentioned before, both strategies have their pros and cons, and much of depends on time horizon and how much you will be contributing to the policy over that time. Make sure your advisor always crunches the numbers for both strategies and shows you how each one would work for you.

I hope this has helped! If you have any questions please do not hesitate to contact me. Please consult your financial advisor before making any decisions.

Mutual Funds vs Segregated Funds

2009-07-14T23:33:00.009-04:00

In an earlier post, I had discussed the main differences between Stocks and Mutual Funds, as well as the pros and cons of each strategy (http://financialhealthblog.blogspot.com/2009/06/stocks-vs-mutual-funds.html). In this post I will discuss another type of investment strategy called Segregated Funds (Seg Funds) and compare that strategy with Mutual Funds.

To restate what my explanation of Mutual Funds is I'll copy and paste what I wrote in my previous post:

Let's take a step back and examine what a mutual fund really is. Generally, this is how I explain to someone what a mutual fund is:

There are a group of people who all are investing into a pool of money, which is then invested into a company. That company has Professional Money Managers who then go and buy and sell certain investments (stocks, bonds, cash etc..). The sole purpose of these managers is to buy and sell investments and to get the best returns they can; they look over the balance sheets, income statements, research companies, look at executive statements etc... They are managing all the money that is invested with them, and the fund will earn a rate of return (either positive or negative -- hopefully positive). For doing this service, they charge an MER (Management Expense Ratio), which is like the 'service fee' so to speak for doing all that work.

And some of the points about mutual funds:

Mutual Funds:

- Professionally Managed
- Can get a diversified portfolio
- Can have up to 100+ stocks
- Also may contain some bonds/cash/t-bills etc...
- Lower risk then just stock picking
- Management Fee charged
- Less control then individual stock picking
- If a few of the companies within the mutual fund tank, it will not affect your investments as much as an individual stock portfolio

Now, I think most people are familiar with, or at least have heard of Mutual Funds. Seg Funds, however, are often foreign to the average investor and have not been explained by some advisors (usually because many advisors are not licensed to deal with them). Some investors, however, are already invested in Seg Funds, but they don't even know it. They think it is just a regular Mutual Funds and don't know the difference. That being said, it can be difficult for the average investor to always distinguish between the two.

When giving an explanation of Seg Funds, I start by giving the explanation of Mutual Funds, and then give the differences. To better illustrate the differences, I usually draw it/write it out on paper so it is easier to understand; something similar to whats below:

	Segregated Funds	Mutual Funds
Overview	Your net premiums are invested in the segregated funds of an insurer which, in turn, invests in securities such as stocks, bonds and money market investments. Segregated Funds are insurance products.	Money is pooled and invested on behalf of unit holders in securities such as stocks, bonds and money market investments.
Regulated by	Provincial Life Insurance Acts	Securities Legislation
Capital Growth Potential	Yes	Yes
Track unit value in the newspaper	Yes	Yes
Diversify investments	Yes	Yes
Financial Protection	At death and maturity, premiums minus withdrawals are usually guaranteed, between 75% and 100%.	No guarantees on investment performance. Theoretically, you could lose everything.
Death Benefit	Beneficiaries receive either the guaranteed death benefit or the market value depending on which is greater.	The estate or beneficiaries 2 will get the market value only – there are no guaranteed minimums.
Probate Protection	At death, proceeds can be paid directly to a named beneficiary, avoiding the estate administration process, and the cost of probate fees.	At death, proceeds are an asset of the estate and are subject to the estate, administration process and legal fees. It could be some time before the estate can distribute the mutual funds. Proceeds could bypass probe if held in an RRSP and has designated beneficiary.
Creditor Protection	Designations in favour of a parent, spouse, child or grandchild may result in the insurance money being exempt from seizure. This is sometimes referred to as "creditor protection". The money cannot have been deposited as: Part of a fraudulent conveyance (transferring money to keep it out of reach of existing creditors). Within a specific time period before bankruptcy	Potential of creditor protection if in an RRSP.
RRSP Eligible	Yes	Yes
RESP Eligible	Yes	Yes
Taxation Implications for non-registered investments	You are only taxed on the income you actually receive. Taxation is based on how long you own the Segregated Fund units within the income period. E.g. if you buy units one day before the fixed date, you are only assessed for one day's income. The unit seller is assessed for income made before the end date. You can use capital losses to offset capital gains from other sources. For accounting purposes, acquisition fees are excluded from the adjusted cost base and treated separately .	You could be taxed on income you never received. Taxation is based on who owns the mutual fund units on a given date at the end of the income period. E.g. if you buy units one day before the end date, you are assessed for all income earned in that period, even though you did not benefit from that income. Capital losses must be carried forward by the fund and are not allocated to you, the unit holders. Acquisition fees are included in the adjusted cost base.
Under what circumstances might these be more suitable?	Non-registered or registered funds. Investors approaching retirement. Investors who like the security of guarantees. Business owners who want creditor protection.	Non-registered and registered funds. Investors who want a wide variety of specialized fund choices in their investments. Investors willing to give up guarantees for potential increased returns.

(Source: http://www.segfundscanada.ca/seg_funds_comparison.asp)

Another thing to note, Seg Funds have the ability to 'Lock-In' market gains with a feature called "aut0-resets" (some also have Manual Resets). This can be very beneficial to your bottom line and can guarantee you a minimum return of more then what you started with (principal).

Please note, that since there are some added benefits to Segregated funds, they also charge higher fees (MER's) as well; usually about 1% more then a regular mutual fund. So before using the Seg Fund Strategy, you must determine if you really want to pay the extra for some added features.

Each strategy is only suitable for certain investors so there should always be a proper discussion between the advisor and client before one is chosen. As you can see, both strategies have their pros and cons and there must be careful considering before choosing either one.

I hope this has been helpful, and if you have any more questions, please do not hesitate to ask me. Please consult your financial advisor before making any decisions. If you require any more information please do not hesitate to contact me.

Withdrawing from your RRSP: The Meltdown

2009-06-30T20:47:00.007-04:00

There comes a point when time when everybody must retire. During that time we must supplement most (or all) of our income in order to live the type of lifestyles we want. When doing so, there are several types of investments that a person can have to sustain 'income' for the retirement years. That being said, during this time, many are in their highest earning years and are in higher tax brackets than then were in their younger years. This results in paying a lot more tax then they would have when they first started their careers.

One of the main vehicles that people use for retirement income is their RRSP. Now, there's no hiding the fact that it can be very 'expensive' to withdraw from your RRSP, so I'm going to discuss a strategy that might just be right for you. This strategy is known as the "RRSP Meltdown".

Essentially, what this strategy does, is helps you 'withdraw' from your RRSP with netting little or no tax to you. What you do is get an investment loan equal to about 50% of the amount you have in your RRSP (for the average investor; for those who can tolerate more risk, a larger amount might make sense) and make the loan payments (interest payments) from your RRSP. To explain this strategy, I will provide you with an example.

Example:

Let's say you have $100,000 in your RRSP and are 15 years away from retirement, and at a 35% MTR. If you were to withdraw the entire amount, you would have to pay full taxes on the amount withdrawn -- therefore you would have to pay $35,000 to the Maple Leaf Foundation (i.e. the tax man), and the remaining $65,000 you get to keep.

Using the meltdown strategy, what you would do is get an investment loan for 50% of the amount that you have in your RRSP (i.e. $50,000). Now let's just assume that you're paying 5% on your investment loan, which means $2500 in interest. Instead of paying for that interest directly from your pocket, you would withdraw that amount from your RRSP.

The results would be as follows: the interest that you pay on the loan is tax deductible (because it is borrowing money to invest), so you can deduct that off your income; however, the amount you withdraw from your RRSP will be taxable at your MTR. Therefore, if your income was $75,000, you would have to add $2500 for the RRSP withdrawal, making it $77,500, but then you would get a $2500 tax deduction from the interest paid on the investment loan.

--> $75,000 + $2,500 - $2,500 = $75,000.

Therefore, you end up paying NET 0 tax on the above example.

What this does is gradually reduces your RRSP and over time the expectation is that your investment loan will increase. So what you can actually end up doing is withdraw your entire RRSP by paying net 0 tax. But also remember, that your RRSP is still growing over time too, even as your withdrawing, so this can be a great strategy for you to have some extra income in retirement.

However, just like other strategies, there are also pros and cons of this strategy that must be looked at and considered before making this decision:

Pros:
- potentially withdraw entire amount of your RRSP with paying little or no taxes
- moving from a Registered to Non-Registered plan (will only pay taxes on 50% of capital gains or will get dividend tax credit)
- potentially will have a lot more money in retirement
- will not be paying loan directly out of your pocket
- you have 2 pots of money growing for you; RRSP and Investment Loan

Cons:
- no guarantee to market performance;
- if interest rates rise too much, your RRSP might deplete too fast
- if done too late, the full benefit will not be derived
- not everybody can qualify for the investment loan

One major thing that you should also consider. For the average investor, I would highly recommend the funds be invested into Segregated Funds (which I will discuss in the next post). These are similar to Mutual Funds in some ways, with a few key differences.

Also remember, this strategy should be started several years before retirement for it to work properly, but also shouldn't be started too early, so please consult your financial advisor before getting in to this strategy. Let your money work for you, rather then you working for your money! I hope you learned something from this post. If you have any questions, please do not hesitate to contact me.

The Rule of 72: Doubling of Money

2009-06-24T15:43:00.005-04:00

When investing or borrowing money, probably the most determining factor in our decision is the interest rate we are paying, or getting, on our money. As discussed before, there are 2 types of interest: Simple Interest and Compound Interest. Simple interest, as its name suggests, is very simple to calculate. Compound interesting, however, can be a little more difficult.

The great Albert Einstein had come up with a concept called the "Rule of 72". This shows, by the compounding effect, how long it will take your investment or debt to double. What you do is divide the interest rate you're getting on an investment, or the interest rate you're paying on you're debt, and divide that into 72. The resulting # will give you the approximate time it will take for the money to double.

For example: If you're receiving 4% return on your investment, that means that if you held that investment, then every 18 years your investment will double (72 divided by 4 = 18).

Let's take a look at at a few different numbers and see what the difference could be.

(Reference: Taken from 'WFG Financial Foundations Flipchart')

As you can see, the potential difference is in the outcomes is astounding. Now, you have to ask yourself, where can you get these type of potential returns? If you look at the above example, the first rate of return of 4% is something you can't really even expect from a GIC, but lets just assume the bank gave you that on your GIC. After 36 years the difference is $600,000, which is potentially what the bank made off of you.

The highest rate of return on the example is 12%; which is probably the average return the bank will get from the money you invest with them (thank bank doesn't just take your money and put it into a vault with your name in it, they take your money and re-invest it to make more money). Just think about your credit cards, what sort of rate do you pay? 18%-19%? So, think about it, they're giving you 4% on your investment, and they're charging you 18% on your credit card. Does that seem fair?

Why not do something smart with your money and invest yourself, rather then let someone else make money off of you. Now, there aren't many places you are likely to get average of 12% return, but over time, if you're invested in the market, the chances for getting better then 4% are a lot more likely.

The key is to do your homework, and let your money work for you. Let the compounding affect and rule of 72 work in your favour. If you have any questions, please do not hesitate to contact me. I hope you've learned something from this post!

Stocks vs Mutual Funds

2009-06-17T12:11:00.008-04:00

This is the age-old question! A lot of people ask me what should they invest in, stocks or mutual funds? That's kind of a difficult question to answer, since most mutual funds are comprised partly (or in some cases fully) of stocks anyways. There is no general right answer for the entire population, so we must look at the differences of investing in 'single stocks' over mutual funds.

Let's take a step back and examine what a mutual fund really is. Generally, this is how I explain to someone what a mutual fund is:

There are a group of people who all are investing into a pool of money, which is then invested into a company. That company has Professional Money Managers who then go and buy and sell certain investments (stocks, bonds, cash etc..). The sole purpose of these managers is to buy and sell investments and to get the best returns they can; they look over the balance sheets, income statements, research companies, look at executive statements etc... They are managing all the money that is invested with them, and the fund will earn a rate of return (either positive or negative -- hopefully positive). For doing this service, they charge an MER (Management Expense Ratio), which is like the 'service fee' so to speak for doing all that work.

In a nutshell, that is my very 'general' explanation of what a Mutual Fund is. Many mutual funds are comprised by a good percentage of stocks; usually ranging from about 20% to about 80% (there are some funds who have less then 20% stocks and some who have 100% stocks). Mutual Funds are designed for all types of investors, ranging from those with absolutely 0 level of market risk, to those who can stand a lot of market risk and go completely aggressive.

Now, both stocks and mutual fund investing CAN be profitable, however, both are risky as well. Let's take a look at some points on both types of investments.

Stocks:

- Investing in one company at a time
- If that company tanks, your investment tanks
- You have to use your time and energy to buy/sell, research etc...
- No Management fees
- Can be very expensive to buy each stock of a company
- Per transaction fees (buying and selling)
- More control over your investments
- More flexibility
- A lot more risk

Mutual Funds:

- Professionally Managed
- Can get a diversified portfolio
- Can have up to 100 stocks
- Also may contain some bonds/cash/t-bills etc...
- Lower risk
- Management Fee charged
- Less control
- If a few of the companies within the mutual fund tank, it will not affect your investments as much

Both of these types of investments have the potential for positive or negative growth, and both have some sort of degree of risk attached to them. Generally, stocks have a higher potential to get higher gains. We've all heard of stock prices doubling or tripling in a short period of time if that specific company has substantial growth or good news coming out of it.

That being said, stocks also have a higher potential for a lot more losses. From my experience, the average investor (not institutional or big money investors) who invests only in stocks has between 3-5 stocks in their portfolio. Now, if one of those companies goes down the drain, then potentially that can be 20% (or more) of your portfolio (depending on how much was invested in each company).

These days it can be hard to determine which companies will grow and which companies will fall. In recent times we've seen several HUGE companies go belly-up, so stocks require a lot of research and analysis in the market.

Some people try to 'time' the market, but this can be a HUGE challenge because in order to time the market properly you have to be right TWICE: first, when you buy, and second, when you sell. Even the most experienced traders and analysts have trouble timing the markets properly and many of them have lost a LOT of money when trying to do it.

Mutual Funds, in my opinion, are more seen as 'steady growth' over a longer period of time. They can be a better indicator of the performance of the broader market as a whole, rather then just one company. If, for example, a fund had 50 companies in it, and 5 of those went belly-up, that would not have as big an effect as if 1 out of 5 stocks went belly-up. So the risk is often spread out over different companies, sectors, and geographical regions, among other things.

Generally, for mutual funds, it is more of a long term investment. So, usually, you're not trying to 'time the market', because there should be the hope that in the long run the money will grown and compound anyways. It can be seen mostly has a 'buy and hold' type strategy (keeping in mind you're not in the same mutual fund for the entire period of your investment; I think it is key to be switching every now and again to make sure you're diversifying properly).

It is clear that each strategy has its advantages and drawbacks. I generally suggest that the average person should not invest in stocks, because of the time and energy that is required to be devoted to do it. Most people do not have neither the time, the energy, nor the patience to do stock-picking. Why would you gamble with your future with something you're not able to commit proper time to?

Remember, we are all responsible for our decisions, whether we decide to invest in stocks, mutual funds or any other form of investments. One of the biggest causes of a portfolio going downhill is that we rely on other people for our advice. Some of these outside sources include Magazines, T.V., Radio, Newspapers, our friends, family etc... If you solely rely on these for stock picks, then you really should re-consider going into stocks.

Generally, for an 'average investor' I would recommend that if they are to do stock purchasing, to do so only with money that they are 'able to lose'. Meaning that if they lost that money because of that one company they invested in going out of business, that it wouldn't put them in a tough financial position. Sort of like, 'gambling money'; if you win, great, if not, no sweat off your brow!

Also, whenever making any decision, please consult a financial professional (your financial advisor/planner). If you require any more information, please do not hesitate to contact me. I hope this has been helpful!

How Much Protection Do You Need?

2009-06-10T21:18:00.004-04:00

As I mentioned in one of my earlier posts (http://financialhealthblog.blogspot.com/2009/05/life-protection.html), Life Insurance is something that almost every family, if not every family, needs. In the earlier post I also described the 2 main types of insurance coverages (Term and Permanent). Now that you're educated about the types of insurance, you need to determine HOW MUCH coverage you need.

There are several different ways to come to this number, but I will show the method that I use, as a general 'rule of thumb' when calculating how much protection a person/family needs. The method that I use is called the "DIME Method". This stands for:

Debt (combined credit cards, loans, lines of credit etc...)
Income (Income replacement for 10 years)
Mortgage (Mortgage balance)
Education (Assuming 4 years per child @ $15,000 per year)

Remember, this is a general calculation which should give you a 'ballpark' figure of approximately how much protection you will need; sometimes there are other circumstances that will increase/decrease the amount of protection needed.

Let's use an example.

Debt: $50,000
Income: $400,000 ($40,000 annual income multiplied by 10)
Mortgage: $250,000
Education: $120,000 (2 kids each attending for 4 years @ $15,000 per year)

Total: $50,000 + $400,000 + $250,000 + $120,000 = $820,000

This is the amount that will PROPERLY protect the family in the unseen case something happens to this income generator.

If the client, for example, already had some insurance put into place, then you would subtract that amount from the amount remaining. Lets assume that the client was sold a Permanent Insurance policy several years ago for $250,000; this would mean that remaining coverage needed is $570,000.

Now comes the point of choosing which type of insurance the client should take; Term or Permanent (or a combination of both)? This is something that needs to be discussed with your planner. Every family situation is different and needs to be assessed individually.

A couple of things to remember:
- Insurance is a privilege, not a right, so you must qualify for it.
- YOU are your most important asset; your ability to generate an income

If you require more information, please do not hesitate to contact me. I hope you've learned something!

Why GICs are NOT what they're made out to be: The Effect of Taxes and Inflation

2009-06-05T07:08:00.008-04:00

A couple of things that are commonly overlooked when dealing with investments is the effects of taxes and inflation your overall purchasing power. Living in Canada, especially, we are taxed a fair bit (some would argue, more then fair!), but that is not the only point to consider when investing. Inflation also adds to the reduction in your purchasing power (i.e. $1 today will not necessarily be able to buy the same things a year from now, as it would today).

As I mentioned in one of my earlier posts, the cost of living has gradually been increasing over time. 10 years ago the gas prices were about 60 cents/litre, groceries were a lot cheaper, houses were a lot cheaper etc... One would assume that the income levels would be increasing at the same rate as cost of living, but that's not the case, which is why we must pay close attention to the effects of inflation and taxes on your investments.

One investment that many people like to get is a GIC. What is a GIC? It is what's called a "Guaranteed Investment Certificate". In English: the company you invest with will guarantee you a certain interest rate for a certain period of time (that is usually locked in). Why do people invest in GICs?

Pros

- principal guaranteed
- rate of return guaranteed
- liquid asset (can be easily converted into cash in case of emergency)
- people see it as a "safe" investment

Why should people be weary of GICs?

Cons

- interest is taxed fully at your marginal tax rate (MTR)
- very little flexibility
- long term returns are minimum
- inflation erodes purchasing power
- if you break the term of a locked-in GIC, you lose all the interest accumulated and just receive your principal back
- the money you invest is the same money the bank is lending back to you for credit cards and mortgages etc... (credit cards usually charging in the 18%/19% range)

People think GICs are "safe", but are they really? Let's take a look at an investor who has $100 to invest and gets 2 rates of return on his GIC.

Example 1:

Client getting 3% interest rate on a 1 year GIC; 31% MTR (Marginal Tax Rate)
*Note: I'm using Inflation at 3.5%. Most people would say inflation over a 15+ year time period should be calculated between 2.5% and 3.5%. I use the higher end of the scale as an example because, based on all the things that are going on in the world today, we might actually be looking at rates at this level or even higher.

Saving: $100.00
At 3% Interest: + 3.00
Pay Tax at 31%: - 0.93
___________
Net After Tax: $102.07

Inflation at 3.5%: - 3.50
Actual Return: $ 98.57

As you can see, you actually end up LOSING money with this rate. Remember, at this point in time, you'd be pretty lucky to get 3.00% from a bank on your GIC.

Example 2:

Client getting 5.25% interest rate on a GIC; 31% MTR (Marginal Tax Rate)

Saving: $100.00
At 5.25% Interest: + 5.25
Pay Tax at 31%: - 1.63
___________
Net After Tax: $103.62

Inflation at 3.5%: - 3.50
Actual Return: $100.12

As you can see, you BARELY break even even at this rate. You must get about 5.25% or more in interest on your GIC to beat taxes and inflation. Also remember, the higher your rate of return, the more you will pay in taxes. At this point in time it is pretty much impossible to get 5.25% interest rate on your GIC. (To view current rates of GICs in all provinces in Canada, you can click on http://www.ratesupermarket.ca/gic_rates/)

Now, you can answer the question: Is it REALLY a "safe" investment? To me, the only thing 'guaranteed' is that, unless you're getting at least 5.25% in interest, you're going to LOSE MONEY!

Now lets just say 6 months into your term, an emergency comes up, and you need to take out money from you GIC. You call your bank, and let them know something has happened and you need the funds. What do they do? If they funds are in a locked-in GIC, they tell you that any interest you have accumulated up to that point will be lost, and you only get your original amount invested back. Does that seem like something you want to sign up for? Probably not.

Some would say "well, why go into a locked-in term to begin with?". The answer is quite simple; you will not get the best rate unless you lock the money in. Cashable (redeemable i.e. not locked in) GICs give very little return so they're not even worth it most of the time.

I hope this has helped you to understand how the Real rate of return is calculated, and how it affects you. I have sat down with many people and shown them this easy calculation, and they are completely baffled, because they have never been taught such a simple concept like this.

I have tried to hold an un-biased view on this topic, but it's hard to see many positives from this sort of strategy. I hope you've learned something! Please feel free to contact me for more information or any questions you might have!

Investing Early vs Investing Late: Pay Yourself First!

2009-06-04T10:46:00.005-04:00

In the 'wealth formula', point number 2 was 'Time'. In any sort of investment you need time to let your money grow and compound over and over. I've done a quick worksheet comparing 2 scenarios with 2 different people.

Person A starts investing $300/month ($3600/year) starting at age 25 and only invests for 7 years and then stop.

Person B starts investing the same amount, $300/month ($3600/year), but starts investing later in his life, at age 32 (the year after Person A stops contributing).

We will assume they are both investing in a tax-deferred account and are getting 8% return.

As you can see, at age 48, Person B surpasses Person A; however, Person A had only made a total contribution of $25,200. Person B had to contribute for 17 years, with a total investment of $61,200, in order to catch up to Person A. That's a difference of $36,000! The affects of compounding were in favour of Person A because he started early and let his money grow.

But lets think realistically, especially those of us who are married and have kids and other responsibilities (i.e. mortgage, taking care of elder parents etc...). Does it become easier to start saving early or start saving later? I think we can all agree that as time goes on it becomes harder to start saving. That's why it's VERY important for younger people, especially younger couples, to start saving as soon as possible.

As you get older it becomes harder to save because more expenses start to come up; for example maybe you just bought a new house and have a mortgage to pay, or your kids are now growing up and college/university expenses are coming up, or you need to start caring for elder parents. Whatever the case may be, something always seems to come up that makes us say "okay, I'll start investing next year". The key is to start investing early and build that discipline.

The above example is just for illustration purposes, so I'm not saying that you should only invest for 7 years and then stop, not at all! Investing should be done over the long term so you can take advantage of market cycles and compounding.

Procrastination is one of the main causes of failure, when it comes to accumulating wealth.

Now comes the point of some people who will say "I don't have $300/month to invest". What if we make some small changes in our life and spending habits that will help you get that $300/month -- $10/day? There's always things you can cut down, such as:

- Sodas
- Cigarettes
- Lattes
- Cable TV
- Games
- Sweets
- New Gadgets
- Shopping
- Driving a Big car
- Eating from outside
- Partying
etc...

You don't have to cut out every single one, but cutting back on a few of these things can be the difference between you retiring successfully, or un-successfully! You MUST have discipline and consistency if you want to win the 'wealth game'!

Formula for Wealth

2009-06-03T08:46:00.005-04:00

Since I've talked about savings/investments already, I thought I'd go back to the basics. We've all heard people talk about wealth and how to accumulate it, but its always been pretty complicated. Here is a simple formula that I show all my clients which is just the bare basics. The "Wealth Formula" or the formula to creating 'wealth' is:

MONEY
+ TIME
+/- RATE OF RETURN
- INFLATION
- TAXES
__________________
WEALTH

1. In order to create wealth, you need to start off with your own money. Whether it be lump sum contributions or regular (monthly, weekly, bi-weekly etc..) contributions, we need to start somewhere.

2. Time is a very important thing. A lot of people wait to start investing, which usually results in them not having enough money in retirement. Some excuses they use are "we'll wait until the kids are out of the house" or "wait until my debt is paid down" or the like. Most people will tell you, that some of those excuses will never pan out. You need to give your money as much time to compound as possible, so that you can live the type of lifestyle you want to live. Accumulating wealth is not done over-night; it takes years, sometimes even decades, to do it. Even if it's a small $25/month, start somewhere and then gradually increase.

3. There is always a rate of return that dictates how much return we get on our investments. You can either have a positive or negative return; obviously we all want a positive one. This kind of ties into point #2 of time, the longer you keep invested, the better chances you have of having a positive rate of return; your money will have time to compound and go through the market cycles.

4. This point is something that the vast majority of people overlook. Inflation pretty much erodes your purchasing power. In English: A dollar today is not worth a dollar tomorrow, as cost of living continues to increase - examples include Gas, Groceries, Clothing, Homes etc.. When investing, you must make sure that you're beating inflation, otherwise even though it might seem that you have a 'positive' return, you might actually be 'losing money'.

5. Like I said in my previous post, the only thing certain when living in Canada is death and taxes. Taxes can take a HUGE chunk out of your investments, especially if the plan is not set up properly. Have a financial professional help you with setting up your portfolio so that you can reduce and sometimes even eliminate taxes altogether. Wouldn't it be unfortunate to have to give 30% or 40% of your hard-earned money to the government when you're ready to retire?

A proper financial plan will take a look at every point discussed here. These days too many institutions are just focused on taking your money and don't set up a proper financial foundation with you. Building a strong financial foundation will drastically increase the chances of you retiring successfully and living the type of lifestyle you want to live!

If you have any questions about anything discussed, please do not hesitate to contact me!

Income Taxes!

2009-05-28T23:17:00.011-04:00

Living in Canada, you are certain of only 2 things: Death and Taxes! Now, we can't do anything about the first, but we can strive to reduce and even in some cases eliminate the second. The sad part is, living in this country, you're taxed even after you die. I like to refer to the 'tax man' as the "Maple Leaf Foundation".

There are many tax-reducing strategies that are there, but I won't get into all of them specifically in this post. In this post, I'm just going to talk about the different tax brackets. I won't get into too much detail about the different provinces, so I will focus mostly on Income Taxes in Ontario.

Canada's Tax system is setup in a 'tiered' sort of manner. This basically means, the more money you make, the more you will pay in taxes. Also, there are 2 tax rates we pay: Federal and Provincial.

First lets take a look at the federal brackets which are the same for all Canadian tax-payers:

- 15% on the first $40,726 of taxable income, +
- 22% on the next $40,726 of taxable income (on the portion of taxable income between $40,726 and $81,452), +
- 26% on the next $44,812 of taxable income (on the portion of taxable income between $81,452 and $126,264), +
- 29% of taxable income over $126,264

(Reference: http://www.taxtips.ca/taxrates/canada.htm)

Also note, there is a federal personal amount of $10,320, which means that you don't pay tax on the first $10,320. There is a tax credit of 15%, which means you will get $1,548 as a tax credit.

In Ontario, the provincial taxes are not as high, but still play a toll on the take-home income. For taxpayers in Ontario, the rates are as follows:

- 6.05% on the first $36,848 of taxable income, +
- 9.15% on the next $36,850, +
- 11.16% on the amount over $73,698

(Referece: http://www.cra-arc.gc.ca/tx/ndvdls/fq/txrts-eng.html#provincial)

Also note, there is a federal personal amount of $8,881, which means that you don't pay tax on the first $8,881. There is a tax credit of 6.05%, which means you will get $537 as a tax credit.

Example

Ontario Taxpayer earning employment income of $50,000.

First, Calculate the federal taxes payable:

15% on the first $40,726 = $40,726 x 0.15 = $6108.90
22% on the next $9,274 ($50,000 - $40,726) = $9,274 x 0.22 = $2040.28

$6,108.90 + $2,040.28 = $8,149.18

However, remember to subtract the personal tax credit of $1,548 --> $8149.18 - $1548 = $6,601.18. Therefore the federal taxes payable are $6,601.18.

Second, Calculate the provincial taxes payable:

6.05% on the first $36,848 = $36,848 x 0.0605 = $2,229.30
9.15% on the next $13,152 ($50,000 - $36,848) = $13,152 x 0.0915 = $1203.41

$2,229.30 + $1,203.41 = $3,432.71

However, remember to subtract the personal tax credit of $537 --> $3,432.71 – $537 = $2,895.71

By adding both the federal and provincial taxes, you will get the total taxes payable, which is $6,601.18 + $2895.71 = $9,496.90. This will give you an average tax rate of 18.99% ($9,496.90/$50,000 = 18.99%). The concept of “Average Tax Rate” is just a way of figuring out roughly how much of your income is going to the government in the form of personal income tax - remember, average tax rates serve no purpose when it comes for filing taxes.

Marginal Tax Rates (MTR) are different; they come into play for many calculations and are important in calculating the effects of certain financial strategies (for example, the amount of taxes you pay when withdrawing from an RRSP). Marginal Tax Rate, by definition, is "the amount of tax paid on an additional dollar of income". To calculate your MTR, you add the highest federal tax you pay and the highest provincial tax you pay. Using the above example, we can see that the MTR is 31.15% (22% federal tax + 9.15% provincial tax).

If you don't want to do the math yourself, there are sites that will calculate the taxes payable and marginal taxes rates for you, just by you inputting your income and province into the calculator. Some sites I found helpful were:

http://www.walterharder.ca/MarginalTaxRateCalculator.html
http://www.tax-services.ca/personal-tax.html

Taxes can be a very tricky thing, so please consult a tax professional for any strategies and advice. If you require any more information or have any questions, you can contact me or your tax professional!

Investments Part 3: TFSA

2009-05-26T22:31:00.011-04:00

As of January 1, 2009, Canadians have another vehicle they can use to invest for their future. The TFSA (Tax Free Savings Account) was introduced as a vehicle that is supposed to help Canadians save. Many investors were getting hit hard with taxes when withdrawing from their RRSPs; many of those because they were not educated properly in regards to the functionality of the RRSP.

First thing I would like to indicate is that the TFSA is supposed to be a mirror image of an RRSP. The two plans are designed to produce the same results. Lets take a look at some of the details of the TFSA.

Pros

- Tax-Free Growth
- Tax-Free withdrawals
- Can withdraw at any time
- Unused balance gets carried forward indefinitely
- Any amount withdrawn gets added to next years contribution limit
- Anybody over 18 with a SIN card can open (does not matter about previous years income, as it would with RRSP)
- No age limit for contributions
- Withdrawals and earnings do not affect government programs such as OAS
- Can contribute in spouse's name without the spouse having to report income
- Transfers to spouse on a tax-free basis upon death (when RRSP transfers to spouse upon death it is also tax-free, but spouse must pay taxes upon withdrawal)

Cons

- Contribution limit
- No tax deductions
- Investing with after-tax dollars
- Cannot re-contribute amount withdrawn until next calendar year
- 1% penalty per month on amount that is over contribution limit
- Cannot be joint or spousal

Many investors were also weary of investing into an RRSP because of the tax consequences upon withdrawal, so the TFSA was started as something to complement the RRSP, and not necessarily compete with it. That being said, there are certain circumstances where one is better then the other. One way of utilizing both vehicles at the same time is by using the money received as the tax refund to fund the TFSA (the same strategy can be used from the tax refund received from an investment loan).

Essentially, I believe the TFSA should be a compliment to either the RRSP, the Non-Registerd vehicle, or both! Lets look at an example of using only TFSA, and using RRSP and TFSA together.

Assumptions:
Annual Pre-Tax Contribution: $5,000
Rate of Return: 8%
Marginal Tax Rate: 40%
Length of Investment (Years): 20

Option #1: TFSA
Total After-Tax Contribution: $60,000.00 ([$5000 x 0.6] x 20 years)
Total Account Value after 20 years: $137,285.89
Net Benefit of Strategy (Growth): $77,285.89

Option #2: RRSP
Total Contribution (Pre-Tax): $100,000
Total Account Value after 20 years: $228,809.82
Net After-Tax Value (40% Tax Rate): $228,809.82 x 0.60 = $137,285.89

As you can see, the after-tax value for both the TFSA and the RRSP are the exact same. This is to prove that the TFSA is designed as a mirror image of the RRSP, because (usually) the money invested into a TFSA is after-tax dollars, whereas the money invested into an RRSP is pre-tax dollar. Let's take a look at using both strategies together.

Option 3: RRSP with TFSA
Total Contributions to RRSP: $100,000
Annual Tax Refund: $2,000 ($5000 x 0.40)
Total Account Value of RRSP after 20 years: $228,809.82
Net After-Tax Value (40% Tax Rate): $228,809.82 x 0.60 = $137,285.89

Tax Refunds invested every year in TFSA: $2,000
Total Contribution to TFSA (20 years): $40,000
Total Account Value of TFSA after 20 years: $91,523.93

Total Combined after-tax Value of the RRSP and TFSA: $137,285.89 + $91,523.93 = $228,809.82

As you can see, using both strategies together results in maximum account value. By using both strategies together, the result is the same as if you were to negate any taxes on the RRSP. So, in essence, both strategies can be benficial.

That being said, in some cases, one strategy is better then the other:

1. If your Marginal Tax Rate is higher at the time of contribution, then the RRSP strategy would make a better choice, because a) you will recieve a larger tax refund, and b) when you withdraw from your RRSP later down the road, you will pay less in taxes.

2. If your Marginal Tax Rate is higher at the time of withdrawal, then the TFSA strategy will be a better choice, because a) when the funds are invested, they are done so with more after-tax dollars, and b) when the funds are withdrawn, they are tax-free.

Lastly, I would like to discuss the investment of funds that are not taxed. For example, we might get a bunch of money for our birthdays, weddings, or just from loving grandparents. These gifts are rarely declared on taxes. Also, there are some professions that work on a cash basis (i.e. taxi drivers, some truck drivers, some labour jobs etc...). In these sort of situations where the cash is not being taxed, then the TFSA will definitely be a better strategy, since the taxation on the invested money is 0. Please note, I think paying taxes is very important, and I am not suggesting that we all try to hide income from the CRA. I think every citizen should pay their share of taxes (but not a penny more!).

Just as every other strategy, this isn't the be-all, end-all of investing. And as well as all other strategies, please consult your financial advisor and do your own homework. If you have any questions, please do not hesitate to contact me!

Investments Part 2: Open [Non-Registered]

2009-05-26T10:17:00.006-04:00

The second vehicle that people can use is the Open or "Non-Registered" vehicle. This is pretty much everything that is not within an RRSP or a TFSA.

The basics of the non-registered vehicle are as follows:

Pros

- No limit to amount of contribution
- No witholding tax upon redemption
- Withdrawal amount does not get added to earned income
- You are taxed ONLY on 50% of capital gains (i.e. You invest $100, and it turns into $200, you are only taxed on $50 --> ($200-$100)/2 )
- No age limit

Cons

- No tax deduction for contributions
- You invest with after-tax dollars
- You must declare any distributions as a part of earned income, whether or not you took them in cash

As you can see there aren't as many rules and regulations for the non-registered investment and there are some pros and cons for this vehicle as well.

If we were to do a dollar-for-dollar comparison between RRSP investing and Non-Registered investing - assuming same rate of return, tax brackets, investment timeline etc.. - RRSP will always win because of the tax-sheltering, tax deductions and tax refunds.

Example.

Lets take a look at an investor who's investing $5000/year for 20 years at a rate of return of 10%. Assumed Marginal Tax Rate is 35%. [all values will be rounded to nearest dollar]

RRSP
After 20 years @ 10% return, the investment will become approximately $315,012. When it comes to withdraw the money, the funds will be taxed fully at the MTR (marginal tax rate) of 35%.

$315,012 x 0.35 = $110,254
$315,012 - $110,254 = $204,758

Therefore, after taxes, the investor is left with approximately $204,758.

Non-Registered
After 20 years @ 10% return, invested will become approximately $206,745. When it comes to withdraw the money, the funds will be taxed at the MTR on only HALF the capital gains.

$206,745 - $100,000 [total invested --> 20 years x $5000/yr] = $106,745 --> Capital gains
$106,745 / 2 = $53,373
$53,373 x 0.35 = $18,681
$206,745 - $18,681 = $188,064

(Calculations came from http://www.mackenziefinancial.com/calc/jsp/RegNonReg/rrsp_vs_non_rrsp.jsp)

As you can see, when we compare dollar for dollar investment, then RRSP will beat out non-registered -- in this case, using the RRSP strategy, the investor would have approximately $16,694 more then the Non-Registered Strategy. This is because the RRSP is growing tax-sheltered and the Non-Registered is not; there are taxes paid annually.

Also to note, that the RRSP is getting a tax refund, so if the investor were to contribute the amount they received back from the government, the RRSP would have accumulated a lot more. But there also other strategies you can use for that tax refund, like paying extra on mortgage, or investing that refund into a TFSA (Tax-Free Savings Account - which I will discuss in the next post).

In the previous example we compared dollar for dollar investment. But, is that the only strategy? No, it is not. There is also the concept of 'leveraging' -- borrowing money to invest. The OPM (other peoples money) Strategy is something the wealthy (and all banks and corporations) have been using for years and years.

Leveraging

Pros

- Starting with a larger sum of money
- Money will grow faster
- Can have options to pay 'interest only' on the leverage loan
- Get a tax deduction for the amount paid in interest
- Money is growing as compound interest vs. interest being paid is simple interest
- Can benefit from tax-deferred compound growth

Cons

- If investments tank, you are still liable for the amount of loan that you took
- If interest rates rise, your payment will increase (however, so will your tax deduction)
- If you get a 'margin call' loan, the lending institution can call the loan at any time and you are required to repay it

Leveraging is also more suitable for those who have higher risk tolerance and longer investment horizon (I would say at least 7-10 years).

Example.

Now lets compare RRSP vs Leveraging for Non-Registered. We will use the same RRSP situation as above and assume that on a $100,000 leverage loan @ 5% interest, the interest charges will be $5000 [using round numbers to make calculations easier and more accurate to compare)

RRSP
After 20 years @ 10% return, investing $5000/month, the investment will become approximately $315,012. When it comes to withdraw the money, the funds will be taxed fully at the MTR (marginal tax rate) of 35%.

$315,012 x 0.35 = $110,254
$315,012 - $110,254 = $204,758

Therefore, after taxes, the investor is left with approximately $204,758.

Leveraging
Lets assume that an investor borrowed $100,000 at an interest rate of 5% - this means the interest payment will be $5000/year. At 10% rate of return, the investment will grow to approximately $672,750. Now lets say you are ready to retire and want to pay back the loan.

$672,750 - $100,000 [loan amount] = $572,750 Capital Gain
$572,750 / 2 = $286,375
$286,375 x 0.35 [MTR] = $100,231 [taxes payable]
$572,750 - $100,231 = $472,519

Therefore, after taxes, the investor is left with approximately $472,519.

As you can see, the leveraging strategy works out a lot better then the RRSP strategy; in fact, with leveraging, the investor would have made $267,761 more, then if he would have invested the same amount of money into an RRSP -- that's more then twice the amount of the RRSP!

If we were to put a twist on this, and assumed that the RRSP investor also invested his tax refund of $1750 ($5000 x 0.35) right back into his RRSP, making his annual contribution $6750, the RRSP would grow to approximately $425,267. After taxes, the investor would be left with approximately $276,424, which is still way behind the leveraging strategy.

(Calculations came from http://www.mackenziefinancial.com/calc/jsp/RegNonReg/rrsp_vs_non_rrsp.jsp)

That being said, be very careful with leveraging. It is NOT suitable for everybody. It requires a high risk tolerance and the investor must give time for their investment to compound over and over. Just as the RRSP is not right for everybody, the leveraging strategy is not either. Please consult your financial advisor before making any decision like this.

What might make sense is to do both strategies or mix and match different strategies together.

If you require any more information please do not hesitate to contact me!

Investments Part 1: RRSP

2009-05-24T22:25:00.012-04:00

We've already covered few things on the 2 other industries, the Debt(making) Industry, and the Insurance Industry. In this post we'll take a look into the 3rd industry, the Investment/Savings Industry, and more specifically, RRSPs (Registered Retirement Savings Plans).

Essentially, in Canada, we have 3 investment vehicles we can use to accumulate our assets/wealth. We can use RRSPs, Open (Non-registered) Plans, and the newly introduced TFSA (Tax-Free Savings Account). Each one of them has their pros and cons and each must be used according to the clients situation and goals.

What is an RRSP?

An RRSP is an investment vehicle that allows Canadians to grow money tax-deferred (this means you don't pay taxes on the money until it is withdrawn). When a person makes a contribution to their plan, they get a tax deduction for the amount that was contributed. This can be a great thing for those who are in higher tax brackets, and can also help them get into a lower tax bracket.

Any income within the RRSP is not taxable while it is still within the plan and grows tax-free until it is withdrawn. The funds can be withdrawn at any time, but not without any consequence. The withdrawn amount gets added to the persons earned income and can potentially put them into a higher tax bracket. There are also taxes that are witheld at time of withdrawal, which is based on the amount withdrawn.

A person can keep funds within an RRSP until the end of the year in which they turn 71, at which point it must be converted into a RRIF (Registered Retirement Income Fund -- something we will discuss at another point).

Why RRSP?

An RRSP can be a great way to invest for your future, if it is done properly. Lets take a look at a few benefits of the RRSP:

- Tax Deduction
- Tax Deferred Growth
- Possibility of putting you in a lower tax bracket
- You can use funds within an RRSP for First Time Home Buyers plan [HBP] (funds must be repayed within 15 years of withdrawal otherwise they are subject to taxation)
- You can set up a Spousal RRSP to split income (which will be discussed in another post)
- Unused contribution gets carried forward
- You can use funds within an RRSP for Lifelong Learning Plan [LLP] (funds must be repayed within 10 years of withdrawal otherwise they are subject to taxation)
- In the event of death, the RRSP can be transferred to a spouse's or a common-law partner's RRSP tax-free

As you can see, the RRSP can offer several benefits to those, IF it is used properly.

Things to be aware of

Even though there are many benefits to an RRSP, there are also many things to be aware of, that most people are not aware of because they are not told. Some of these things include:

- There is contribution limit (based on previous years income as stated on taxes)

- All growth within the RRSP is considered as "interest income" no matter which type of growth it was (capital gains, dividends, or interest). This means when you withdrawal, you will be taxed at your tax bracket and there are no tax benefits for different types of investments

- You will be taxed on the FULL amount of withdrawal, and not just the growth, within the RRSP

- Once you reach age 71, you MUST either a) transfer the funds into a RRIF (which results in forced withdrawal from the RRSP) b) purchase an annuity or c) withdrawal the amount in full

- You can end up paying more money in taxes in your later years if your income is higher; this could negate any tax deductions you had received in previous years; you can possibly pay more money in taxes in retirement then you saved in the earlier years

- There is a limit that you are able to contribute every year; A Tax of 1% per month applies on the portion of your RRSP contribution that exceeds your RRSP deduction limit and the over-contribution limit of $2000

- Interest on funds borrowed to invest into an RRSP are not tax-deductible (as they would if they were invested into an Open [non-RRSP] Investment)

- If funds are not payed within the specified timelines for the Home Buyers Plan and the Lifelong Learning Plan, you will be subject to taxation

Contribution Limit

The maximum RRSP contribution limit for 2009 is $21,000. However, if you did not use all of your RRSP contribution limit for the years 1991-2006, you can carry forward the unused amount to 2009. Therefore, your RRSP contribution limit for 2009 may be more than $21,000.
The maximum RRSP contribution limit for subsequent years is as follows:
2007 maximum RRSP contribution limit: $19,000
2008 maximum RRSP contribution limit: $20,000
2009 maximum RRSP contribution limit: $21,000
2010 maximum RRSP contribution limit: $22,000

(Source: http://www.tax-services.ca/rrsp-canada.html#RRSP_Contribution)

Now, it is evident that there are many things that you should be aware of before using RRSPs as your investment vehicle. Like I said before, they can be a great investment vehicle IF used properly. What I don't like is how they are marketed; they're marketed as the "one size fits all, for everybody, in every situation". The traditional industry (specifically the banks) have done a terrible job in setting up RRSPs and with educating Canadians about all the pros and cons of them.

When using this investment vehicle, do your homework and consult your advisor. Find out everything you think you will need to know about them. I hope this has helped! If you require any more information, please do not hesitate to contact me. Happy investing!

Life Protection!

2009-05-23T17:24:00.015-04:00

Now I'm going to talk about something that most people hate talking about. Proper protection, i.e. Insurance. For some reason when people hear this word they tend to run for cover, lock all their doors, turn off all the lights, and disconnect their phone lines. Yet, the thing is, most (if not all) families need some sort of insurance. There are a few different types of insurance, but in this post I will discuss Life Insurance only.

If I were to ask you, 'what is your biggest asset', most people would answer "my house" or "my car" or some other form of tangible object. But, what if I were to tell you that you're wrong? The most valuable asset you have is your ability to earn an income. YOU are your most valuable asset. Now ask yourself, if your income was not there anymore, what would your family's situation look like? What would the repercussions be? Who would be affected?

If you had a machine in your basement that printed off $50,000/year, would you insure it? Of course you would. Why? because if that machine broke down or had to be repaired you want to make sure that you're still getting the income that its providing for you and your family. You are that machine!

Insurance is something that is very key in providing a sound financial foundation for you and your family. We protect our homes and our cars because we're legally obligated to. But why are many too afraid or too lenient on the fact of insuring themselves?

There are many reasons why people get insurance. Replacing your income, education funding, home/property protection, funeral expenses, debt protection, taxes etc... The list goes on and on, not every family gets insurance for the same reason. At the end of the day, you want to make sure that when you do pass on, that your family will be okay! Your kids will be able to go to school, your family can still live in the home, they can still eat, buy clothing, pay the bills etc... When you pass away, it is going to be a emotional/psychological tragedy, no doubt. But at least you can make sure there is not a financial tragedy in the house as well.

Let us take a look at the different type of protection that you can get. Essentially there's 2 main types of insurance you can get: Term or Permanent. Their names pretty much say a lot about them, but let us go into a little bit more detail.

Remember, Insurance is a privilege, not a right, so every person must qualify for it as well.

Term

As per its name, term insurance will only cover you for a set period of time. Up until recently, most companies have covered for either blocks of 10 years or 20 years; recently some companies have come out with a 30 year policy. Basically, we can imagine term insurance to be like 'renting' a house. Every month you're paying money and at the end of everything, you walk away with nothing (unless you pass away within the policy term, in which case your family will get the lump-sum payment).

Say for example you buy a 10 year term policy. Every month for 10 years you will pay a premium that will cover you only if you die within those 10 years. If you die after 10 years and 1 day, then there is no payout to your beneficiary.

Term insurance is the cheaper of the two at the beginning, but over time it can be very costly. For example, if you're 30 today, and you buy a 20 year policy, it can be pretty affordable (based on your health conditions). However, if we fast track now 20 years later, that policy is now done; most companies have what's called a 'renewable' feature where you can renew your policy after the term has been completed. At this point, you are now 50 years old, but maybe you realize you still need coverage for another 20 years. What you will notice is that the premium will drastically increase, maybe even 4 or 5 (or more) times what you were initially paying.

This is an actual illustration that I have pulled up from one of the companies I deal with. This situation is of a non-smoker male age 30, with average health, getting $500,000 of coverage for 20 years.

Years 1 to 20 -- Annual Premium $497 ($41.40/month)
Years 21 to 40 -- Annual Premium $4941 ($411.75/month)
Years 41 to 50* -- Annual Premium $19,737 ($1644.75/month)

*Only to year 50 because most companies will only insure a person to age 80 or 85 (starting at age 30 plus 50 years of coverage) on a Term Policy.

As you can see, the premium spikes up very significantly from the first 20 years to the next 20 years. This is something to be aware of. Many insurance agents sell this product because its cheaper, but don't explain the consequences of having to renew the policy in the future. Now, term is not a bad product, IF its used for the right purpose. For example, if you know you will have a liability for a fixed period of time only (i.e. a mortgage or loan), then it might make sense to get a term policy. Every situation must be assessed individually.

Permanent

Now lets swing over to the Permanent plan - there are 3 types of plans out there (Whole Life, Universal Life, T-100), but in this post we will focus on one, which is called a Universal Life (UL) policy. Once again, its name pretty much describes its features. This type of policy will cover you 'permanently' until you die (usually up to the age of 100). It doesn't matter if you die at 35 or 52 or 93, your beneficiaries will still get compensated. Remember how I said term is like 'renting' a house? Well permanent is like 'owning' a house. Every month you're paying into the policy, but you're also building a kind of 'equity' within the policy, which is known as the 'cash value' or the 'savings component'.

This UL product is like Insurance & Investment combined. Traditionally, the two industries (insurance and investments) have had their pros and cons. The insurance industry hasn't really been great at getting returns on investments, but has been great with tax 'sheltering'. On the other hand, the investment industry has been pretty good with returns on investments, but hasn't been very strong when it comes from minimizing taxes. This UL product pretty much a 'hybrid' strategy that combines the best of both worlds; where you can have the potential for good returns, as well as the benefit of tax minimization.

Because the investment is within the insurance policy, it is not treated as an 'investment' for tax purposes. Essentially any gains within the UL policy are not subject to tax. This is a great added feature which can help people save thousands in taxes over the years. The premium is broken down into 2 components: Cost of Insurance (COI) and the Investment. For example, if you were to put $100/month into the UL policy, x % will go towards the COI and the remainder y % will go towards the investment. Anything over and above the COI will go towards the investment -- the younger and healthier you are, the lower the COI will be, so best to get this policy when you are young.

Now, when it comes to the amount of premium, initially, the UL policy will require a larger investment; because it is covering you for your entire life and there is also an investment component built into it. I say "initially" because over time, the UL policy usually tends to cost less overall then a term policy. You can structure so that you're paying the same x $ of dollars every month for a certain period of time and 'pay up' the policy -- similar to how you have an ammortization on a mortgage where you will pay off your house in 20 or 25 years.

But also, same as if you were to pay off a house, you have 'equity' available in the policy. Depending on how much you invest and how long you invest for, this can be a substantial amount of savings.

Wouldn't it be great to be covered for your entire life AND have a whole bunch of money saved up for retirement? From my experience, most life insurance policies cost less then car insurance policies; car insurance is covering you for what, $20,000 or $30,000? Whereas life insurance is usually going to be covering you for an amount into the hundreds of thousands, and for some, millions!

Using the same example as above, I have done an Illustration for an average health male, age 30, getting $500,000 of coverage. If he were to put in about $190/month for 20 years, and assuming 6% return in his investment, he could be covered for his entire life, with about $155,000 built into his investment portion of the policy. After the 20 years is up, there is no need to contribute more, as the policy will fund itself, but he would still be covered up to age 100.

However, just like I said the term policy is not all bad, the UL policy is not always suitable for a person. I said it above also, that every situation has to be assessed individually. Best to set down with your advisor and do a needs analysis and see how much investment each type of policy requires and budget yourself that way.

Even for young people who don't have the same responsibilities as some (i.e. kids, mortgage, debt etc...), the UL is a GREAT way to start saving, because eventually they will need to get protection, so why not get it when they're young and in good health, and also when the Cost of Insurance would be a lot lower?

Just one last thing, most term policies have a feature called "Renewable and Convertible" (R&C), which means that they can convert the term policy into a permanent policy at any time within the policy term. This is usually the case for those who are not able to invest the necessary premium required to fund the UL policy properly right from the beginning. If you cannot afford permanent, at least start off with term and then work your way from there.

I hope this has been helpful. You can contact me for more information or if you have questions!

Mortgage vs HELOC: Compound vs Simple Interest

2009-05-22T14:12:00.014-04:00

Let's talk financing for homes! Since the Mortgage is the largest financial headache (for most families), I thought it would be a great way to start this 'crusade' of mine.

Mortgage

Now, let's start with the conventional mortgage. Why do people get mortgages? Most people need to borrow money to purchase a home. There is a down payment for a percentage of money they need to borrow, and the lending company (usually the bank) provides the rest. We do this because most of us don't have the cash sitting in our bank account to purchase a home, which the majority of cases is in the hundreds of thousands. Therefore, we need help with financing the property which we need to purchase.

Most people walk into a bank, and the bank is often more then happy to provide a product called "The Mortgage" (granted the client qualifies for it). First let's break down the meaning of this product. It is actually comprised of 2 words "mort" and "gage": "mort", which is the root word of mortality, i.e. death, and "gage", which is like a 'pledge' i.e. debt. So the word "mortgage" pretty much means 'debt until death'. The way the product is designed today is pretty much to keep the client in debt for the rest of their lives. I often see the case, where there are people in their 50s and even 60s who have $200,000 or even $300,000 mortgages. They don't ever expect to pay it off, all they know is that when they pass on, their kids will be taking over the payments and will hopefully pay it off in their lifetime.

Mortgages are calculated as compound interest, which is calculated semi-annually. In English: every 6 months your mortgage calculates the interest you owe on the balance of the mortgage, at whatever your interest rate is, and then ADDS it to your mortgage balance. So, if you look at your mortgage ammortization payment schedule, you will see your mortgage balance increase a little every 6 months, after the previous months declining. This compounding effect can pretty much mean, after you've paid off your mortgage you would have paid the original value of the house 2 or 3 times over again.

For example, on a $300,000 mortgage, you could quite possibly pay 3/4 of a million bucks over the entire term (assuming interest rates stay around the 5% mark and there are no extra payments made during the term). I'm having a hard time finding proper mortgage calculators online which actually show the compounding effect, but the ones that don't show the compounding effect indicate that on a $300,000 mortgage, you will end up paying almost $600,000 over a 25 year term (assuming a constant 5% interest rate and no pre-payments). I would only assume that on a proper calculator that showed the compounding effect, that figure would be a lot higher.

To the majority of the population (the approximately 90% who will not retire financially independent), this 'mortgage' product is pretty much the 'be all, end all' of home financing. We're just not taught anything else different by the banks, lending companies, or even our mortgage brokers (I know this personally having worked in a bank for 6 years and having people in my family who are mortgage brokers).

But, what other form of financing can we use for our homes? The great mystery, is not really a mystery at all. The strategy that the wealthy have been using for years is pretty much right under our nose as well. It is called a HELOC, or a Home Equity Line of Credit; pretty much just a line of credit used to finance the purchase of your home. What's the difference between the two?

HELOC

-> Simple Interest -- you pay interest only on the balance remaining; therefore, no compounding, which can save you tens of thousands of dollars in interest, and reduce your borrowing term by years. Please also note that I suggest, if you can afford it, to put the same amount of payment toward a HELOC that you would have the mortgage. This is also how you can accurately compare the 2 products.

-> Flexibility -- There is an option to pay the minimum of interest only every month. Anything over and above that is your own choice. This is especially beneficial for those who might go through hard times. i.e. loss of job or large emergency expense incurred, where they are not able to afford the entire full payment that a mortgage would require.

-> Open-ness -- You can pay as much as you want, whenever you want; there is no penalty for paying it off early and no limit to extra payments (as opposed to mortgage which will only allow you pay a certain percentage extra per year -- usually 20% or 25% of the principal-- anything above that will be subject to penalty; there is also a penalty for paying off the mortgage before the term is up).

-> Taxes -- If done properly, some (or all) of the interest paid on the HELOC can be deducted off your taxes. I won't get into the specifics of this now, but if you need more information please consult your financial advisor or contact me directly for more advice.

-> Interest Calculation -- HELOC interest rates are 'open' and usually float with prime. They can be competitive with mortgages sometimes, although usually are a little bit higher. However, the great advantage is that, if you feel prime rate is going too high, you can change the HELOC into a mortgage and LOCK the rate in at any. Another added flexibility benefit!

-> Qualifications -- Essentially, the process to get approved for both Mortgage and HELOC are pretty much the same. However, it is a little more difficult to get approved for a HELOC because the maximum Loan-to-Value ration is 80%. In English: Means you have to put a minimum of 20% down payment when purchasing the property. This might be a challenge for some who do not have that amount saved.

Now, begs the question: Why aren't we told about the HELOC?

The answer is very simple: Money talks! This can be said true for both the banks/other lending companies and some brokers out there. It is a lot more profitable for the banks to sell this product as opposed to a HELOC (and remember, every bank carries a HELOC type product), because they make a LOT more money off the interest from selling a mortgage.

For brokers, they get paid more money to sell a mortgage, as they would a HELOC. Some banks don't even pay the broker to sell HELOC, which is why many don't ever talk about it to their clients. The scary thing is, many brokers I've sat down with don't know the difference between the 2 and are not able to distinguish the difference between compound and simple interest.

Now, this is not to say that HELOC is ALWAYS better then a mortgage, and not to say that all brokers are only in it for the money, but if we were to assume the same interest rate on both products, then I would go for a HELOC over mortgage any time. Also note, that the 'rich' have been dealing with this strategy for decades; those high-network investment firms (the ones who don't sit down with clients unless they have at least $500K of investable cash), mostly deal with this product for their clients, because they know the benefits of going simple interest vs compound interest when you're borrowing money.

Many people would be weary of doing a HELOC because it's not 'fixed rate' (i.e. its variable rate, floating with prime). But, people don't realize the power of using the variable rate. There was a study done by Professor Moshe A. Milevsky, at York University (in Toronto) that I found on the RBC Mortgage website (http://www.rbcroyalbank.com/products/mortgages/variable-rate-advantage.html), and he came up with a couple of conclusions:

- Choosing a variable rate mortgage would have saved consumers $20,000 in interest
payments over 15 years (based on a $100,000 mortgage).
- Consumers would have been better off borrowing at prime rate (variable) compared to a 5-year fixed rate 89% of the time.

(full research paper found here: http://www.ifid.ca/pdf_newsletters/PFA_2007SEPT_Mortgage.pdf)

Also note, that savings of $20,000 in interest is based on compound interest vs compound interest. Imagine how much more would be saved if it was simple interest being calculated vs a compound interest fixed term mortgage. Once again, this is why the rich get richer; because they know these strategies and are taking advantage of them, while the banks try to convince all of us to go into fixed rate mortgages because its "safe".

Again, this is not something that every client should be doing, because everybody's situation and habits are different. This post is just to shed light on another option that is available for home-owners out there, that is not being promoted often. Every strategy has its pros and cons, so best to sit down with your financial advisor and they can show you all the numbers, and see what makes sense for you.

I hope you have learned something from this post, and if you have anymore questions about these 2 products or want me to clear something up, please do not hesitate to contact me!

My Crusade

2009-05-22T13:01:00.009-04:00

I like to consider myself to be on a 'crusade' to help as many families as I can to get out of their financial burden.

Coming from a childhood where our family was not financially sound, which later ended up to be the breakup of our family and health problems for some in our family, I know what it feels like to be in that financial trap. So I'm trying to do what I can to educate those around me to take their financial situations into their own hands and help themselves with simple concepts and strategies that nobody has really taught us; unless you're in the wealthy top 10% of the population, that is.

We all know the old expression, "the rich get richer, and the poor get poorer". This is not a far off comment. The reason the rich get richer is because they teach their kids and grandkids about how money works and how to make money work for them. This is because the big investment firms have taught them that. Having said that, the poor just keep getting poorer because they don't have this education. Chances are if a person has grown up in a home where being 'poor' and always in debt is normal, then that person will inevitably grow up to live that same sort of lifestyle. This is due to the lack of education given to us by the 'traditional industry'.

Having worked in a bank for almost 6 years I pretty much know all the ins and outs and what the intentions really are. Banking officers are trained to push products and aren't really encouraged to educate clients (because the banks know if the clients are educated, that they'll take their money out and do something smart with it). You can't really blame the banking officers though, they're placed with goals and totals that they have to meet, and are pressured by the banks to sell products to clients; what sometimes happens is that they're so desperate to reach their goals, they will push a product on a client even if that client doesn't need it. This is the 'traditional industry'.

I'm in the strong belief that what people really need is education, not just another salesperson knocking at their door. I'm not putting salespeople down, but the most effective ones are the ones who actually educate their clients -- and this only represents a small percentage of them. Let's start a new culture of proper money management, so our children can learn from us, and their children from them. The banks and other investment/insurance companies have not done their job and have caused people to lose trust and faith in the industry. I hope to bring some of that faith back.

I hope you enjoy!