Tag Archives: tfsa

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 ūüôā

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.

 

Taking Action – Buying Stock

taking action - buying stock

Tired of savings accounts that lose you money? Want more¬†growth and less fees than your bank’s mutual funds¬†can offer? Thinking about giving the S&P 500 a whirl, but don’t know where to start? This post is for you!

Last week, we looked at stock markets and how their purpose is to let the¬†public buy and sell shares in publicly traded companies. I mentioned that to invest in the S&P 500, you’ll need to buy an Exchange Traded Fund (ETF), like Vanguard’s S&P 500 index fund.

In order to buy and sell shares on a stock market, you need an stock broker, someone who has gone through various training programs and is regulated by the stock exchanged they work on. A stock broker is traditionally a person who takes buy/sell orders from individuals and fulfills those orders on the stock market floor by yelling and screaming at other stock brokers. Stock brokers usually charge a commission on every trade, that means if you want to buy some shares in company A and sell shares in companies B, that would be 2 separate trades, and your broker will charge you for each.

These days, the job of stock broker has been largely replaced by computers. So what we really need is a web broker. For you and I, a web broker is a website where we fill out a form specifying how many shares to buy or sell, at what price, etc. We then hit ‘Enter’ to buy and sell stocks. The web broker then trades your money with another web broker. The whole transaction could take seconds.

There are dozens of web brokers to chose from and every major bank in Canada has one, they are cheap and easy to use. How cheap are they? Well, that depends on what kind of investing you’re going to be doing and how often. As I mentioned, they will typically charge you per trade and web broker prices currently range from limited-time-free to $10 per trade.

The cost of a web broker is a fee, the third prong in the trident of costs (taxes and inflation being the other 2) and means that if you want to invest money every month, that could be $120 per year, which won’t be that big in the¬†grand scheme of things, especially compared to some mutual fund fees. But I suggest planning on buying shares of¬†TSE:VFV every¬†3 or 4 months to cut down on fees. Some web brokers can set up automated buying so all you need to worry about is having¬†money in the bank.

Finding and opening a web broker account is easy. I would go to whoever your current bank is and tell them you’d like to open a web broker account. Here is a list of the¬†5 big banks and their web brokers:

If you aren’t with any of the above banks, you can still open a web broker account with them, or google around for another one. As long as the web broker allows you to trade on the Toronto Stock Exchange (TSE or TSX), you should be fine.

To open a web broker account, I would suggest physically walking into your bank and telling them that you want to open a web broker account, and someone will meet you to go over whatever steps are needed to setup an account. The banks do all the work for you, but there are quite a few forms they have to fill out, the process can easily take 30 minutes.

I would open up a web broker account for your TFSA, and a second web broker account for your RRSP. This will allow you to transfer money into your tax sheltered accounts, and buy and sell as much as you want without incurring any taxes. You would only pay taxes when you withdraw money from your RRSP web broker account. You will never pay any taxes on money withdrawn from any TFSA account, and you are able to withdraw money from your TFSA whenever you want.

Once your account is open, and you have a trading password, you are ready to buy a stock! The stock we want to buy is Vanguard’s S&P 500 ETF I mentioned earlier. It¬†trades under the symbol: TSE:VFV.

This means <stock exchange>:<company stock symbol>, so TSE is the stock exchange, VFV is the symbol of the fund or company we want to invest in.

Things you’ll need to know to buy stock on any exchange:

  • The account the funds to make the purchase are coming from.
  • The action you wish to take (buy, sell, other stuff we don’t care about).
  • The company symbol.
  • How many shares you want to buy.

When deciding how many shares to buy, remember to factor in any web broker fees. If you have $1000, you can only buy 9 shares that cost $100 (9 x $100 = $900, + $6 (web broker fee) = $906)

You can buy VFV from your web broker’s website, or you can phone up the web broker directly and¬†have a human to actually make the trade for you. Note that web brokers are neutral parties when buying/selling shares. They will not give you investment advice, so don’t bother asking them if buying particular shares is a good idea.

Don’t bother trying to time when you buy the S&P 500, in the long run, that won’t matter. Once you’ve bought your shares, hold them. Literally do nothing for decades and watch the value of your investment grow.

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 Р$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.