Author Archives: JamieList

Protecting your Estate: Where there’s a Will…

HeadsupDad.com
To love what is lovely, but will not last

There are a variety of things that we don’t like to do. Taking out the garbage comes to mind, as a task that is unpleasant, but absolutely necessary to the proper functioning of a household.

So it is with a legal Will. Many families, particularly young families, put off the inevitable conversation about their Will. It is an unpleasant conversation, and there are a good deal of difficult decisions to be made and discussions to be had, to solve some problems that will (hopefully) never arise.

Its not about you…

At the end of the day, there is nothing more important than protecting your family and their future in the event of an untimely meeting with your maker. Everything you have done, every nickel you have saved, every asset you have accumulated does not want to be tied up in court while they try to figure out what to do with it. You don’t want your creditors, government, family, any of your beneficiaries to be arguing, fighting, negotiating over your assets at a time when they should be taking the time to deal with their own losses and come to terms with their new realities.

Bottom line: Drafting a legal Will and a Power of Attorney is a necessary and fundamental part of the financial planning process.

The downside to dying without a Will is that there is a time lag between that event and when your estate is cleaned up. When someone dies, the courts need to probate your estate, and then approve the passing of assets on, even if that person is a spouse. With a proper Will, the courts can quickly move things along. Without a proper Will, this can draw out and lengthen the process—which is already full of emotional burden.

There are two significant roles and responsibilities you need to appoint before you begin:

  1. Executor – this is the person that is in charge of carrying out the terms of the will.  Many spouses appoint each other, but often there is an alternate appointed in the event of a common disaster (i.e. both parents pass away).
  2. Guardian – this is the person that you appoint to take care of your children should you not be able to.
  3. Powers of Attorney – this is a person who will be able to make decisions on your behalf if you are incapacitated.

Once you have these roles determined, and before you see a lawyer, you should also take account of the following:

  • make a list of all assets (investments, RRSP’s, pensions plans, real estate, family heirlooms, i.e. anything you own of significance financially or emotionally)
  • make a list of all debt (mortgage, student loans, etc.)
  • identify all insurance policies (personally owned, group/employer policies)
  • identify any other legal arrangements that may impact your planning (pre-nuptial agreements, shareholders agreements, etc.)

Finally, when you go to see the lawyer to draft your will (I would encourage spending the money on a lawyer, and not using a will planning kit), you should also prepare your powers of attorney.  A power of attorney outlines who has the legal right to make decisions if you are incapable of making those decisions for yourself.  Usually people draft two powers of attorney: one is for their wealth (for decisions about their money), and the other is about health, (decisions about healthcare).

Identifying the key roles in your will and POA planning, as well as a thorough list of assets, liabilities and insurance in advance will go a long way to speeding up the process of drafting the will.  As with Life Insurance, a small investment of time and money well spent and a few prudent but simple and easy steps today, will make things that much easier for those that are left behind. The good news is that this will help you save some money on legal fees, even if you won’t be around to spend it.

In the end, you will have a document that will protect your family and will streamline a stressful process during what will certainly be a very difficult, tragic and traumatic time (unless by chance you are not only dead, but a Deadbeat Dad—but of course you are not one of those. You would not be here right now, sitting with that concerned look on your face, reading this post while looking up your lawyer’s telephone number on your Blackberry or your iPhone—there it is, that was not so hard now was it? Go ahead, hit the dial button).

Questions? Concerns?

Please feel free to post your comments and questions here. We’ll be happy to help.

Debt and the RRSP contribution – Worth it?

RRSP loans are generally recommended as a way to “jump-start” your savings, or advertised as a way to create wealth where it did not exist previously (check out this sample Google search I did – most of these entries encourage debt).  There are a number of strong opinions out there that can debunk the myth that borrowing to invest is  good for you.

Borrowing to invest is a tricky straegy at the best of times.  Using debt for investment will increase both the gains and the losses that you receive in the market.  However, using debt can mean that you lose more than you actually have – you have lost someone else’s money.  

Leverage can do more harm than good, and must be done carefully.  If you are going to make the executive decision to use debt to invest in the RRSP, then you should be able to answer yes to one or more of the following questions:

  1. Am I at the highest marginal tax rate? If you are, then you will get the maximum benefit (i.e. tax refund) from your RRSP deduction.  If you deduct at lower tax rates, you will get less in the form of a refund at tax time.
  2. Am I going to be able to pay this off before the next RRSP season?  If you are (or you expect some compensation, a bonus or some inflow of cash that you do not currently have) then go ahead.  If not, you will likely just be in the same boat next year, forced to borrow again, and get into a “vicious” circle of debt again and again.
  3. Am I going to get a cash refund by making the contribution?   If you are, then you can have some confidence that you will soon be able to reduce your debt.  If you are not going to generate a cash refund and instead only reduce your taxes owing, then you will not be able to reduce the balance of your “quick loan” at tax time, and you will be encumbered by a great deal of debt.
  4. Is your other debt generally under control?  If so, then you might consider this as a one-time event.  However, if the reason that you have not made an RRSP contribution in the past is because your cash flow is committed to servicing other debt burdens, then this is definitely a bad idea.  Spend time getting your debt under control, and then revisit your RRSP savings later on.

So, in general, an RRSP loan is not a good idea, unless you are simply using it as a bridge until you get other funds coming in.  Also note that the interest payments on RRSP loans are not tax deductible, so there is no added deduction benefit to the investor.

I would venture to guess that, over the long term, taking a year off your RRSP contribution would serve you far better in the long run.  Perhaps, instead of borrowing to make an RRSP contribution, you start a monthly deposit plan and get ahead of the debt curve.

Your RRSP and Long Term Wealth

Maximizing Your RRSP

RRSP’s are the central planning tool for many Canadians’ retirement objectives.  Say what you like, but the tax advantages of the deductible contribution are a powerful incentive to add to this tax-deferred investment vehicle.

It is important to note that the RRSP is just that – a tax deferral.  Most Canadians understand that their wealth accumulates tax free in an RRSP (more specifically, free from accrual taxation), however what most investors do not properly recognize is the effect of unwinding their RRSP.  If you are not careful, the tax that you are saving currently will be recouped by the government again later on.

So the bad news is that the RRSP is not a perfect vehicle.  The good news is that it does the trick up front, affording you tax incentive for savings, and defers tax on growth.  However, there are a variety of strategies that can help you maximize the after-tax value of your RRSP, both to you while you are living, and to your estate if/when you pass the assets to beneficiaries.

The Facts about RRSP’s

There are two main attributes of the RRSP/RRIF that we are looking to deal with in this article.  The first is the tax liability generated when the RRSP is converted into a RRIF and income is taken on an annual basis, and the second is the tax liability that exists when the RRSP/RRIF is passed along through the estate.

  • First – income that you receive from your RRSP is taxed just as though it were interest or employment income, meaning at your top marginal rate for the given tax year.  Most individuals recognize this in their planning.  The rules for RRIF payments is that there is a minimum amount that must be taken out each year, based on your age, or the age of your spouse (whichever is more beneficial).  This means that you can be forced to take out more than you need.
  • Second – in the year of death of the second spouse, the entire balance of your RRSP is included in order to calculate income tax payable on the RRSP/RRIF.  This income would come in excess of any other investment, dividend, and/or capital gain income declared on the final return.  This means that, if your RRSP was the only income you took in your final year (in Ontario), a $1,000,000 RRSP would have a tax liability of roughly $448,000, leaving your estate with only $552,000.

The tax treatment of the RRSP/RRIF at death is what we are most concerned about in this article – effectively, how do we reduce a tax liability that will erode almost one half of the savings you have worked so hard to accumulate?

Three simple approaches

Broadly defined, there are three different categories you can take to managing the ongoing and terminal tax liability in your RRSP.

  • Effectively manage your tax brackets while you take income from your RRSP.  Tax bracket management for estate planning takes a little bit of discipline.  Essentially what you are trying to do is remove income from your RRSP/RRIF at a tax bracket lower than what it would be at death.
  • Reconsider your asset allocation to reduce double taxation of Capital Gains in the RRSP structure.  Look at the tax treatment of the assets you have, and allocate the least tax efficient assets into your RRSP/RRIF.  Income producing assets are going to be taxed at the highest rate, so leave them in the RRSP/RRIF.  However, dividends and capital gains are tax-advantaged vehicles; leave them in your non-registered portfolio.
  • Use complimentary assets and strategies in combination with your RRSP to maximize the value that the RRSP delivers to you while you are living, and to your estate.  The first and simplest would be to incorporate a permanent insurance strategy into your planning, starting early if possible.  Simply put, life insurance will be able to fund the tax liability that exists within your RRSP/RRIF.  Furthermore, most permanent life insurance contracts allow you to accumulate assets within the contract on a tax deferred basis (returned tax-free if the proceeds pass on at death).

When considering a plan to minimize taxes, please remember that any tax driven strategy should be considered carefully by an independent tax professional.  The information presented above depends on certain assumptions which may or may not be relevant to all of our readers.

The long and the short of it is that the RRSP/RRIF is a great planning tool with powerful front end benefits that the average consumer enjoys – a tax deduction for savings.  But be careful: without proper planning, those savings will be eliminated by the government in retirement, or, at the latest, at death.  If your intent is to maximize your after-tax income during retirement, or to maximize the value of your estate to your heirs, careful attention should be paid to your RRSP/RRIF and how it is interacting with your tax rates and other assets and cash flows you have at your disposal.

Power Corrupts, Entitlement Corrupts Absolutely

  • “Power tends to corrupt, and absolute power  corrupts absolutely.” – Lord Acton, 1887
  • “Unlimited power is apt to corrupt the minds of those who posses it.” – Earl of Chatham, 1770 

In light of recent events (Tiger Woods, anyone?), many would believe the above statements to hold true.  It seems, in our society, that increasing power inevitably leads to a complete erosion of moral and ethical boundaries.  Consider former US Attorney General Elliot Spitzer, or Senator John Edwards preaching family values as a campaign slogan while committing adultery.

However, power may not be the entire story.  I recently read an article in The Economist (Jan 23-29, pp. 75-76) that looked at a study by two professors (one in Europe and one in North America), who conducted a series of experiments to see if this was indeed true.  In the tests that they organized, they arranged so that one half of the group felt entitled to their power, whereas the other half did not.

What they found was interesting.  The research suggests that the individuals who were made to feel entitled to their power were far more likely to commit immoral or unethical acts than the group that was led to believe that they did not deserve their power.  In addition, the research went on to consider the actions of those in power who did NOT feel entitled to the power they were given.  Not only were they more likely to be much more harsh in the judgement of immoral acts, but as a group, they were also more harsh on themselves when judging their own acts than on others.

Huh.

So why did I bring this up in the money column?  I think that this is a very strong analogy about how people, and specifically children, act when confronted with money (note: this is my opinion now, but go with me here).  I have seen many clients come and go, and come to know their families relatively well over the years.  I have also listened to many people speak about the plans they have for their retirement and estate plans, and most feel that leaving “too much” money would have a negative effect on their families, or more specifically, their kids.

So how do we teach kids about money and responsibility?  There are loads of fantastic resources around the web.

However, we are often so preoccupied with saving and spending wisely ( heck, that is what this column is designed to discuss! ), that we fail to consider whether or not our culture (I must have this video game/car/home/toy/etc.) is making our children to feel entitled to the money that their families earn.  Parents may work their fingers to the bone to earn this stuff, but there is likely no activity, strategy or website that will teach them the importance and impact of money unless they learn they will have to earn it, not that they deserve it.

The Registered Education Savings Plan – A primer

The Registered Education Savings Plan, or RESP, is likely the best opportunity that a parent (or other relative) can establish to contribute to a child’s future education, and to help with the parents’ financial planning into the future.  Here are some things that you should know:

  • Almost anyone can deposit money into an RESP, as long as the parents agree
  • The money deposited into the plan grows tax free
  • The money deposited into the plan gets a government grant
  • You can invest it how you choose, or with the help of a qualified investment professional
  • The funds in the plan can be used for a wide range of post-secondary education, such as university, college, trade school or other programs that may qualify
  • If unused, the a portion of the balance of the RESP may be transferrable back to the parents later in life

So – sounds like a good deal?  It is.  The government established this program to encourage parents to save for their children’s future, and the government grant program (the Children’s Education Savings Grant, or CESG) creates a powerful incentive.  Here are the rules:

  • You can deposit up to $2,500 each year to get the “current year” grant, or 20 cents per dollar, per child.
  • You can deposit a lifetime maximum of $50,000 into the plan, per child.
  • You can receive a maximum of $7,200 of grant, per child, by the year in which they turn 17.
  • Note that there are special rules for beneficiaries (i.e. the kids) on the plan who are 16 or 17 years old, so consult a professional to discuss if your older child qualifies
  • There are added benefits for families with family incomes as described below:
    • incomes of less than approx. $77,000 there is an additional GESG incentive of $50 for the first $500 deposited
    • family incomes less than approx. $38,000 there is an total additional GESG incentive of $100 for the first $500 deposited in addition to qualifying for the Canada Learning Bond, which is $500 in the first year your family qualifies, plus $100 each year after

The math is fairly good for in favour of starting this plan.  If you look at the grant as free money (which is it), you are getting an automatic 20% return on the first $2,500 you put into the plan each year, and that grows tax-free.  In the current market, that seems a fairly strong argument to use this structure to plan for the future!

Investment Management Fees – Buyer beware

Now that you are looking towards the future, and perhaps are beginning to take a serious look at your long-term savings options, let’s take some time to understand how you might be charged (and how you can avoid) fees as you invest.

For some, fees will be paid to an advisor involved at some point in the process.  That advisor might be a planner or a broker who takes commissions or trailer fees as a result of managing a clients’ account.  Or, fees may be paid to an investment manager, either indirectly through ownership in mutual fund, or directly as a result of a discretionary or segregated account with that manager.

Essentially, the amount and type of fees you pay are what determines the kind of practice your investment advisor runs.  Instead of just asking “how much” the fees are, perhaps examine the types of fees you are paying, why you are paying those fees, and what incentive it gives to the recipient of those fees.

Trading Commissions

By far, the most common method of compensating advisors is still commissions.  However, all commissions are not created equal.  There are basically three types of commissions:

  • Brokerage commissions: when trading securities, a fee is charged based on the size and type of trade.  Some brokers will pre-arrange a fee schedule for their clients that provide a certain number of transactions for a fixed cost
  • “Spreads” on Bonds:  Many investors are unaware that there is a commission paid on a bond.  That commission is called the spread, and it is the difference between the actual rate being paid on a bond, and the rate at which it is sold to you.  For most bonds the spread is between 10 and 25 basis points (0.10% and 0.25%).
  • Mutual Fund “Front End” commissions: when an advisor recommends a fund, the client is charged a percentage of their investment in order to purchase units in the fund recommended.

In all cases, the commission here is a fee paid as a result of a transaction.  Make sure that, when you are working with an advisor, you are comfortable with what those commissions mean.  This method will reward the advisor when you act on their advice.  So, it is reasonable to say that their bias will be to implement a portfolio solution that prefers transactions.  If you are an active investor, then this will compensate an advisor who continues to bring quality investment ideas to you.  However, if you are an inactive or conservative investor, you may feel that you are pressured to take action that you do not feel is in line with the objectives of your portfolio.

Deferred Sales Charges

Mutual Fund “Back-end” commissions are a contentious topic among investment professionals and the investment public.  These “deferred sales charge” occur when a client purchases a new fund within a mutual fund company.  The advisor is paid a commission by the fund company, but the client is required to remain with that fund family for a certain period of time to account for those fees being paid, usually either 3 of 6 years.  After the first year, those funds pay a trailing commission to the advisor of roughly 25 to 50 basis points.

The upside is that there is no immediate cost to the client.  In addition, the commissions paid are usually either 2.5% or 5.0%, and this allows advisors to receive compensation from smaller accounts, and enables them to spend the appropriate time with those smaller clients to deliver proper advice.

I believe that the significant downside, however, is that this form of compensation provides incentive for advisors who meet and satisfy new clients, rather than existing clients.  If an advisor is being paid 5% on a new client and 0.50% on their existing clients, the attention of their practice is likely biased towards the initial portfolio set-up, and not necessarily the ongoing management of your account.  If your advisor recommends the use of these charges, ensure that you are comfortable that you will continue to receive the same quality of advice into the future.  In addition, your advisor should not be asking you to re-invest in deferred sales charges again once the deferred sales charge period is over.

No Load

No load compensation schedules are generally by advisors working with mutual funds, and are intended to mimic the type of compensation schedule that investment managers receive (see below).  The no load schedule means that the advisor receives their compensation as a percentage of the assets they have under management.  This means that their bias is towards maintaining the assets they already have, as there is no extra incentive for them to attract new clients, and there is nothing stopping them from leaving if they are unhappy with their service.  These are a form of servicing commissions, as above, but are the only form of fees these advisors receive for clients invested in these funds.  Thus, their bias will be towards more inactive clients.

Servicing Commissions

Servicing commissions are fees that are paid by fund companies (generally) to advisors for maintaining the accounts that they have.  Servicing commissions vary depending on whether the advisor has recommended a front end load, no-load, or deferred sales charge fee options for their clients.  Reasonably, these are the fees that the advisor receives for maintaining your account over the long term.  These are also referred to as “trailer” fees.

Investment Counsel Fees

A direct relationship to a discretionary portfolio manager usually means a fee schedule much like the “no-load” schedule described above.  These fees are usually lower, as a result of the size and structure of accounts being managed.  In addition, it is generally accepted that these fees are tax deductible for non-registered accounts (although taxpayers are advised to consult their tax professional to ensure this is the case for them).  The fees paid to these managers can also be mixed with an incentive fee of some sort, such as a share in a percentage of profits.  This is more commonly found in managers with higher risk or specialty mandates.  There are a variety of “retail” solutions like this that are available to clients through advisors that mimic this relationship.

Your Objectives

If your objectives do not fall in line with the method in which your advisor receives fees, it will be difficult for you both to see eye to eye on an investment strategy.  The fee discussion tends to raise the blood pressure of both clients and advisors alike (for different reasons), it is a discussion that you must have with your advisor, and you must be comfortable with as a client.

Good quality advisors are likely going to give good quality advice to their clients, regardless of the fee schedule.   However, even good quality advisors are running a business, and the business decisions that they have made about their practice are going to impact how they deliver their advice in the future.