Tag Archives: taxes

Wills – Even Death Has a Fee

death-tax

I recently got a will. I went through a lawyer, and was quoted a notarized will for my wife and I at $400 each. With the lawyer, it was an intimidating experience at first, but I did some research on my own and found that you can get a will drafted for free, and notarized for as little as $15. Currently, I am in the process of trying to get a more competitive rate.

How did this all come about? I remember a few months ago seeing a story about a wealthy, well respected family being torn apart over an inheritance. Millions were collectively spent on lawyers. I don’t know how that mess turned out, but I’ve heard about crazy family members who launch lawsuits over an inheritance dispute. To add to the deep emotional damage such a conflict would inflict, the truth is that the only people guaranteed to benefit will be lawyers.

It seems that every family has crazy relatives, and it seems that if you have any considerable worth in your estate at all, you might want to spend the extra time and money to be clear on how you want your estate divided and passed on and stop any potential conflicts from ever happening.

What kind of things are part of your estate? The first thing to be factored is any debt you have, including credit cards, mortgages, and car loans. They are paid off before your estate and any estate beneficiaries. Once debts are settled, all your remaining assets with financial value, such as insurance policies, cash, TFSAs, homes, cars, appliances, and furnishings are added up and considered to be the value of your estate. If your spouse survives you, your estate is considered to be shared 50/50.

Once the value of your estate is ascertained, the provincial government will then proceed to tax it. As per the Ontario Ministry of Finance, the inheritance tax will be $3100 on an estate valued at $240,000.

Note that your RRSPs can be directly transferred to a family beneficiary with no tax penalty at all. You can setup an RRSP tax beneficiary at any time. If you don’t, your RRSP will be converted to cash and taxed as income in your final year and added to your estate to then be subjected to the inheritance tax.

If you don’t have a will, it will be up to the government to decide how to divide your estate. You should check how your province divides your estate as different provinces follow different guidelines. Often, your spouse and/or children will get everything. If you want to leave something for siblings, friends, charities, your community, university, or any other person or thing, you’ll want to put a will together. If you are looking for some ideas, you should search to see what unusual things people have left in their wills.

 

Unavoidable Trifecta of Investment Costs (UTIC)

unavoidable-trifecta-investment-costs

There are costs that can be eliminated, like the constant buying of disposable razors, and costs that can merely be reduced. When it comes to investing your savings, there are 3 costs that are unavoidable: taxes, inflation, and fees.

These 3 costs are especially repugnant because they add up to a lot. Bill Gates, still one the worlds richest people, claimed in 2013 that he had paid over $6 billion in taxes. You lose about 2 cents for every dollar you have in a regular bank account every year to inflation. And fees are baked in to nearly every financial service you can think of.

Though you can never be free of any of these costs, you can certainly reduce how much you end up paying. You could get a financial adviser or an accountant. Indeed, legally avoiding taxes is a giant industry. But the more help you get, the more fees you incur. Generally, fees are lower than taxes, but not always.

If advisers and accountants aren’t for you, or if you at least want to better understand all this stuff, there is, of course, this blog 🙂

In a nut shell, to minimize tax payments, put your savings in a Tax Free Savings Account (TFSA), where it can grow tax free. If you’ve maximized your annual TFSA contribution, there’s always Registered Retirement Saving Plans (RRSP).

The best way to avoid fees is to learn about how your money works on your own. The more comfortable you are with saving and investing, the less need you will have for more expensive services, like advisers or accountants.

Unlike the other two prongs of this trifecta, inflation is truly unavoidable. The only thing you can do is make sure your money is growing faster than inflation, which isn’t always the case with high interest savings accounts.

 

Financial Goals – What It’s All About

financial-goals

What am I saving money for?

For myself, this is the most important of all financial matters to get right. If I didn’t have a financial goal, I would simply lack the motivation to save. Having a goal constantly reminds me of what I’m working for, and gives me a light at the (far) end of the tunnel. To me, it is the most reassuring thing to think about after a rough day, knowing a plan is in place, and underway and that I’m not simply spinning my tires.

As I mentioned in my first post, my personal financial goal is to become financially independent as soon as possible. How will I be financially independent? I will be living off the the interest of my savings! The S&P 500 has a long term annual return of 12.65%. If you had $1,000,000, that would be $126,500 in interest a year! Of course, once you factor in inflation, fees and taxes, you would be looking at a more modest, but still ample, return.

My goal helps me in more ways than giving me a sense of purpose, it also helps me know where to put my money. The S&P 500 is a great long term (at least 5 years) investment, which is what I need for my personal financial goal.

But what if your reason to save money is more short term? What if you are saving up for a down payment on a house, or something that will require you to spend your money within 5 years?

The S&P 500 is pretty safe as far as stock investments go. But it still has its down years, like 2008, the year of the great recession. Had you invested at the end of 2007, it would have taken 5 years for the S&P 500 index to grow back to the price you bought it at.

If you are investing for the short term, that probably means you have something fairly specific in mind you want to buy (house, car, vacation, etc). If you say “I want to save up $100,000 for a down payment on a house in 5 years,” you may value the added certainty of knowing your money will be there in 5 years with a little bit of interest accrued, rather than be less sure your money will be there in 5 years, but with more interest accrued. The cost of safer investments is a lower return, and is a cost worth bearing if you are looking for a more short term place to invest your money.

For shorter term investments, I suggest looking at government bonds, GICs, or even a high interest savings account. There are also many safe mutual funds and Exchange Traded Funds (ETFs) that will also achieve the same effect. They will not grow your money much, but they are very safe. The small amount they grow is better than nothing. Having anything offset the constant encroachment of inflation is important. And if you need a place to stash your cash short term, these are great savings options.

 

 

Taxes – The Unavoidable Cost of Civilization

taxes

It is said that only 2 things are absolute in life: death and taxes. Taxes have been around for thousands of years. The purpose of taxes is to pay for the government, and various government expenditures, like police, fire, hospital, garbage collection, clean drinking water, education, food inspectors, military, and wars.

All these things cost money and various levels of government have been able to find ways to get more tax revenue every time someone discovers a new way to make money. Because taxes have been around for so long, everywhere, they are ingrained in the very fabric of society. You simply cannot avoid paying taxes in some way, which is why, along with inflation and fees, taxes are the 3rd and possibly most costly of the Unavoidable Trifecta of Investment Costs (UTIC)

Kinds of taxes include:

Consumer Taxes

In Canada, consumer taxes are:

  • Goods and Services Tax (GST), which is a federal tax (ie. national, run from Ottawa) and is spent across the country.
  • Provincial Sales Tax (PST), which is run at a provincial level, so the money is directly collected by Quebec City, Regina or Halifax and is not shared with other provinces. Only Alberta has no PST.
  • Or Harmonized Sales Tax (HST), which is a combination of PST and GST in one tax. Currently, only 5 provinces have HST instead of PST and GST:
    • Ontario
    • Nova Scotica
    • Prince Edward Island
    • Newfoundland
    • New Brunswick

As its name suggests, you will pay a lot more in consumer tax if you buy a lot of stuff, ie. consume.

Income Taxes

In Canada, both the federal government, ie. the Canada Revenue Agency (CRA), and provinces, eg. Fredericton, Regina will take a significant chunk of your paycheque before it even reaches you. Every year, you have until the end of April to complete your income tax return. Your income tax return is basically you telling the government how much money you made in a given year (including money from investments, foreign properties, and pretty much anything else you can make money on), and the government making sure you’ve paid your fair share of taxes on the income you claimed.

The CRA, ie. federal government, takes 15% of your income if you made less than $44,701, up to 29% on anything more than $138,586.

The provinces each take a different amount of your income. In Alberta, the provincial government in Edmonton simply takes 10% of your taxable income, no matter how much you made. In other provinces, your income tax will be determined by your income: the provincial government will take as little as 5% in BC and Ontario for low income earners, up to 21% in Nova Scotia for high income earners.

Property Taxes

Canadian cities and towns are all run by local governments and mayors, but the only taxes they are legally allowed to collect are property taxes. Because there are so many municipalities in Canada, there is a wide range of property taxes. Typically, your land will be assessed by the municipality you live in to determine the value of your property, taking into account renovations, the local housing market, amenities, proximity to good things like schools and transit. You will then pay an annual tax on the estimated value of your property that goes straight to city hall.

Capital Gains Taxes

This one is just for investors. If you make an investment, and sell it to collect a profit, you have to pay taxes on that. It doesn’t matter if it’s a house (as long as it’s not your only house) or stocks in your favorite company, the government wants you to give a share of the proceeds back to public coffers.

In Canada, you pay a capital gains tax on 50% of your investment profits. That means if you invest $10,000 in an unprotected fund (ie. outside of a TFSA or RRSP), and make a 40% profit, and then withdraw your $14,000, you would need to pay your current income tax rate on half your profit of $4000.

50% of $4000 (the income from your investment) is $2000. If your income tax rate is 37%, 37% of $2000 is $740 in capital gains taxes. The CRA has another example of calculating your capital gains here.

 

There are many other kinds of taxes and fees governments charge, like corporate taxes, inheritance taxes, carbon taxes, custom taxes, tariffs, etc. But there are also many kinds of tax deductions / breaks you can apply for to avoid paying a significant portion of your regular taxes.

It is controversial to say if tax payers get good value for the taxes they pay or not, but certainly, it is hard to argue that society would be better off without the kinds of services governments offer.

Compound Interest – The Double Edged Sword

compound_interest

In my first post, I mentioned that I make decisions to buy certain things by weighing having something vs the value of that item in 20 years, with interest, for when I retire. I mentioned buying an Xbox One, let’s say that costs $500. If I spend $500 now, I have an Xbox One, but what if I instead put that money into my S&P 500 TFSA?

Well, it just so happens that I have a Google spreadsheet that tells you exactly what happens right here. The document assumes we invested $500 into the S&P 500, in our tax protected Tax Free Savings Account (TFSA), so we don’t have to pay taxes at all on this. It assumes the particular S&P 500 fund we want to invest in keeps its current fund fee of 0.08%, and inflation runs at 1.5% annually. You’ll see that our $500 investment grows to about $3900.

For me, $3900 can easily be enough to let me live comfortably for a month or two when I decide to retire. So Xbox One now, or 1-2 months of extra retirement in 20 years? As a PC gamer, the choice was easy.

I remember first hearing about compound interest, it sounded like you could turn on the ‘compound interest’ switch and start making serious money. Albert Einstein described compound interest as “The eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it”

Compound interest is the growth of your principle investment, and collecting interest on that growth in the next year (or compound period).

To illustrate with another example, let’s assume you have $1000 invested and your investment grows by 10% a year. Here is how that would work over 5 years:

  1. At the end of year one, your $1000 will grow by $100 (10% of $1000) to $1100.
  2. At the end of year two, your $1100 will grow by $110 (10% of $1100) to $1210
  3. At the end of year three, your $1210 will grow by $121 (10% of $1210) to $1331
  4. At the end of year four, your $1331 will grow by $133 (10% of $1331) to $1464
  5. At the end of year five, your $1464 will grow by $146 (10% of $1464) to $1610

Compound interest is the interest that grows off interest you’ve already accumulated. Notice that after 5 years, your investment has grown to $1610, that is the base amount of your assets for year 6. Because of compound interest, it will take just over 7 years for your investment to double at a 10% annual rate of growth.

But compound interest can also work against you. Mortgages and credit card debt are good examples of that. If you have a credit card with an annual interest rate of 30% (the high end of interest rates in Canada currently), that 30% will be applied monthly or even daily by your credit card company. If it is monthly, you will be charged 2.5% (30% divided by 12 months) per month. As credit cards usually have a higher interest rate on overdue balances than most investments can return, this means that you can double your credit card debt in only a few years. This is one of the reasons why many financial advisers suggest paying off all your expensive debt before saving or investing your money.

If you are in the position of wanting to buy a house in Toronto or Vancouver, and happen to have an amazing down payment where you’d ‘only’ need a $500,000 mortgage, what would the (compound) interest be in 25 years? Using online mortgage calculators, at a historically average 7% interest rate the banks will charge you, you’re looking at $550,623 in interest charges alone over 25 years. That is more than double the amount you borrowed.

Compound interest is the only way you can grow your savings and investments, it truly is the engine that drives the value of your savings up. But if you have a tough time controlling your spending, it also has the potential to cripple you in debt and force you to waste your time working only to pay off interest.

Fees – The Unavoidable Cost of Service

fund fees

Fees are one of the Unavoidable Trifecta of Investment Costs (UTIC), taxes and inflation being the other 2. Fees are unavoidable because you really can’t even save your money, let alone grow it, without the services fees yield. Without banks, for example, you would have to store your paper money in a physical location in your house, which suddenly becomes vulnerable to fire, theft, and other bad things.

Types of fees to expect:

Bank fees / credit card fees – It is really hard to function in our economy without a bank account. In addition to the physical protection and government insurance that blanket your money, banks provide loans to people who would otherwise not be able to launch their business idea, or buy their first house. Banks have many annoying fees (ATM fees, having a savings account with little money in it), but provide a lot of services that make buying things easier and safer. Certainly a necessary cost.

Stock trade fees – As reviewed in my post about actually buying stocks, you will need a web broker that will execute your order. These typically cost from limited-time-free to $10 per trade. That means if you want to invest a bit of your money every month into the S&P 500, you might have to pay as much as $120 a year in web broker fees buying new shares.

Fund management fees – Every fund has a management fee that is charged to investors like us to pay for the management of the fund. This fee can include everything, include marketing and legal costs for the company that runs the fund. Generally, if the fund is human managed, you can expect fees of up to 1% – 2%.

1% – 2% may not sound like a lot, but it adds up to a lot over time. To illustrate, I’ve put together a spreadsheet in Google Docs that has a table with a breakdown in money invested, investment growth, and fees. You can’t edit it from your web browser, but if you go to the top right and click File -> Download as, you can download the spreadsheet as your own .xlsx to play around with.

The spreadsheet can be found here, in it you’ll clearly see how investing $200,000 over 20 years will result in a total take-home (before taxes) of $409,000 after $53,000 in a typical fund’s management fees are applied. If you play around with the spreadsheet, you’ll find that the more money you have invested, the more scary your fees will be.

Index funds, like Vanguards S&P 500, also have fees, but because index funds are run by a fairly straight forward computer program, humans generally aren’t involved. That makes index funds comparatively inexpensive, Vanguards S&P 500 has a Management Expense Ratio of 0.13%.

Financial adviser

Not everyone has a financial adviser, most don’t. But those who do will need to pay for them. Lots of large financial institutions will typically pay their financial advisers commission. Your financial adviser will probably take a fraction of that 1-2% fund management fee, or they might take a cut of any mortgage or other financial service they are providing you.

I personally don’t like this payment model, it is one of the reasons why I decided to manage my finances myself. The problem is that obfuscating how your financial adviser is paid will hide the fact that they are paid (and thus, motivated) more for selling you more profitable services, like insurance. And obviously, a financial adviser working and ABC Bank will only be able to help you with funds and services that ABC Bank provides, meaning you’re only getting the best products and services from ABC Bank, not the best products and services available.

Doing Taxes – It’s a Dirty Job

homer

There are few things on this planet more confusing and divisive than taxes. In Canada alone, there are federal, provincial, and municipal taxes (municipality taxes are mainly limited to property taxes). Depending on the province you live in, your tax rate will vary. In fact, there are so many factors that ultimately influence what you pay in taxes that there are probably as many variations in tax returns as there are people; everyone’s different.

Taxes have been around for thousands of years and come in many colors and flavors. Tax laws and tax deductions (aka. tax breaks) change all the time. Every year governments across Canada adjust how different things are taxed. Tax deductions are generally meant to reward people doing what the sitting government thinks is good for the nation, things like taking transit, saving for retirement, renovating your home, giving to charity or a political party, living in the far north, paying for tuition or text books, putting your child in little league soccer, doing artistic activities, etc. All these are current federal tax deductions everyone is eligible for, in fact there are hundreds of tax deductions that offer something for everyone.

The onus to do taxes is completely on you. If you do not file your taxes and owe the government money, they will hunt you down. You will also be subject for any interest fees due for any delays in payment, or a fine, or jail time. The Canada Revenue Agency (CRA) takes this stuff very seriously and expects you to also take it seriously.

There are generally 2 ways to do taxes in Canada: get an accountant / tax adviser to do them for you, or do them yourself with software like ufile.ca or turbotax.ca. There are pros and cons to both, but no matter what you chose, make sure you have all your tax documents together. All your receipts you want to claim tax deductions for, all documents the CRA has sent you. For me, my taxes aren’t that complicated, I don’t claim that many things. But I can see things getting out of hand quickly if you are an average family of 4, run your own business, own your house and spend lots of money improving it.

If you don’t really have it in you to go through the complete list of federal tax deductions, I don’t blame you. If you think your taxes might be complicated, get an accountant to do your taxes for you.

Tax adviser pros:

  • The biggest advantage to a human tax adviser is that they are better at tying your personal situation to any tax deductions you are eligible for, but not aware of.
  • They are usually accessible. If you have any questions, you can call them up.
  • If there are any complications, they can help take care of them.

Tax adviser cons:

  • The only real drawback is that they are going to be more expensive than DIY tax software.

I used to think tax software was gangling and cumbersome. But I used turbotax.ca to file my taxes for the 2014 tax year, and was impressed with how intuitive it was, and how everything was broken down into small steps. The website was also good at suggesting tax deductions I may be eligible for. It reminded me of my TTC transit passes that I forgot to claim.

Tax software adviser pros:

  • Inexpensive. It cost me $35 to do taxes for both my wife and I (H&R Block has a website that will do it for free)
  • Easy and instant. See how each change affects your tax return amount.
  • Getting better at advising on potential tax deductions.

Tax software adviser cons:

  • Though they’ve come a long way in a short amount of time, the software isn’t yet smart enough to cater to everyone’s squeaky wheel, though they do have a 1-800 number for anyone looking for a helping hand.

Having a human tax adviser is great, they can take a lot of the stress out of doing taxes. But with the tax deadline only days away, if you haven’t found someone to do your taxes, try out turbotax.ca.

RRSPs – The Taxman Giveth A Bone

taxtreat

Deciding to invest your retirement money in something like the S&P 500 is an important step in setting up your personal finances. Being able to safely grow your money is important, but so is avoiding paying as much tax as possible when it’s time to retire and begin withdrawing from your savings.

Taxes are one of the three main agents of money corrosion (fees and inflation are the other two). If you follow the law, you will always pay some taxes. The trick is to figure out how to pay as little as possible.

Because the Canadian Pension Plan (CPP) pays out so little (currently $640 – $1060 per month), the government has given Canadians an incentive to take care of their own retirements by introducing Registered Retirement Savings Plan (RRSP).

RRSPs are a type of investment account that is registered with the government, they are designed to defer tax payments until you retire. They are not themselves accounts, but an account designation. That means that many types of bank accounts can be used as an RRSP: savings accounts, web broker accounts and mutual funds can all be designated as RRSPs.

The idea behind RRSPs is this:

When you are working, you are making much more money than when you retire. That means you are also paying more income tax too. By putting your money into an RRSP, you get a tax break next time you file your income taxes. If you make $100,000 per year, and you invest $18,000 into RRSPs, the tax break you get is the difference in tax you would pay if you made $82,000 instead of $100,000. The government lets you pay less income tax when you put money into your RRSP.

But later in life, when you retire and start tapping into your RRSPs, you pay regular income tax on whatever you withdraw. Because what you withdraw when you retire is likely to be less than what you made while you were working, you would be paying less income tax on that retirement income. Withdrawing $50,000 a year (for example) will still require you to pay income tax as though you had a regular income of $50,000. But a $50,000 income is in a significantly lower tax bracket than $100,000, you would end up paying far less tax overall.

Not only are you paying less tax when you invest in an RRSP, the money you get back allows you to immediately invest it so that you have even more money that can grow over the years.

Some RRSP facts:

  • The maximum amount you can contribute for 2015 is $24,930, or 18% of your income, whichever is lowest.
  • You can buy and sell equities (stocks) and take a profit in an RRSP without paying any taxes.
  • You cannot contribute if you are 71 or older.
  • You can withdraw up to $25,000 to help with the down payment on your first home, but you have to pay that amount back within 15 years.
  • If you can’t contribute the maximum amount, the difference will be carried over to the next year.
  • You will be charged 1% per month if you contributed more than your contribution limit.
  • When you are ready to retire, you need to convert your RRSP into a Registered Retirement Income Fund (RRIF). You can do that at any time.

Because the money you get back from the government when you contribute to your RRSPs is based on what income tax bracket you are in, the higher the tax bracket, the greater the tax break. But if you are in a lower income tax bracket, the benefits of contributing diminish. You can use an RRSP contribution calculator to see what you would get back from the government if you contributed to your RRSPs.

Using an RRSP calculator, you will notice that if you live in Ontario, make $40,000 per year and contribute $5,000 you will get a return of $1003. But if you make a salary of $100,000 and contribute $5,000 your return more than doubles to $2170.

RRSPs are a great way to help grow your money tax-free, but they are designed for average to above average income earners or households. If that’s not you, that’s OK, because Tax Free Savings Accounts (TFSAs) offer an even better way to save your money, and the benefits of TFSAs apply equally to everyone, as I will explain next week.