Tag Archives: planning

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.

Do I really Need Life Insurance?

Yes, you do.

As a parent, life insurance is a necessary part of planning, because it takes care of your family if something happens to you.  It is not an enjoyable topic, but it is something you should look into.  You will likely be surprised at how inexpensive a program can be.  The big questions is “how much should I get?”  That is different for everyone, but basically, there are three main reasons we buy life insurance:

  • To pay off debt (usually the mortgage and/or student loans)
  • To replace the lost income of the person who is gone
  • To pay for expenses what may arise when one or both parents are gone.

In the first example above, the amount is easy to understand.  If you have a mortgage of $200,000, you should have a corresponding amount of insurance to pay off the debt should something happen.

Replacing lost income is a bit more complicated.  What industry experts recommend is that you should have approximately 60-70% of your family’s annual income available should something happen to either spouse.  So, if both parents are earning $50,000, the family income is $100,000.  If something should happen to one of them, then there should be funds available to create an additional $10,000 to $20,000 per year, likely until the kids are finished at least high school.  If the children are young, this could mean that the surviving spouse needs this income for 15-20 years.  The insurance amount for this situation would be to create a benefit of $150,000 to $250,000 in the event that one of the two income earners is gone (this would be in addition to the insurance that is earmarked for debt repayment).  Here are two calculators to explore – Sun Life, LSM Insurance or there is a good one available at the Bearing Capital Partners website.

Finally, families should consider the added costs to the family if one of the parents is gone.  Will there be an increased need for daycare or housekeeping as the surviving spouse continues to work?  This could cost an additional $15,000 to $20,000 per year, depending on the number of children, etc.  For two children, a working single parent would need to have some kind of back-up, and we estimate that cost at an additional $15,000, until the kids are 16.  This would be funded in much the same way as the lost income, and would require approximately $100,000 to $200,000 (in our example) of insurance benefit.

Last, you might want to consider adding some small extras, such as an education fund and some final expenses, in order to deal with added burdens to the surviving spouse. The big question is “where do I get this stuff?”  There are two sources.  First, your company employee benefits plan likely has some kind of benefit, and there might be the opportunity to apply for more.  These company plans tend to be less expensive, but you run the risk of losing coverage if you leave your employer.

Your other option is to find a licensed insurance broker who can take you through the options.  Most young families should consider term insurance, which is an inexpensive method of providing a benefit.  There are other plans that have more permanent options, and that build up an investment value over time, but these can be looked at later, when you have some excess savings.  The important thing is to get some insurance in place and make sure that everyone is taken care of.

Heads Up Dad – Money

Hi all, and welcome to Heads Up Dad, Money.

The intent of this section is to generate some discussion about the financial strains of parenting.  Believe it or not, parenting and finances generally don’t mix.  Kids are expensive, and there are not a great deal of programs that help parents run the finances and their families at the same time.  Canada is a great country to live in, and we are lucky to be able to raise kids here (one year parental leave, etc), but financial literacy has only recently come into the foreground in our education system (too late for us!).

Some ground rules about this section:

  • questions are always appreciated, and gives lots of ideas about future posts
  • feel free to post comments publicly to generate discussion and debate
  • feel free to contact me directly if you feel the question is more discreet
  • let’s keep this away from an investment forum (you can try my company blog for that – see RSS feeds to the right)

So, Dads, what we have to do is find time to negotiate the various pleasures and pitfalls of parenting, and also understand that money is an integral part of keeping a household running smoothly.  Money does not buy happiness, to be sure, but lack of money can create stress and strain in even the strongest of family relationships.

The main focus of this section will be to try and shed some light on some common strategies and opportunities to help you make the money problem a little easier and more enjoyable to deal with.  Most people agree that they will remain healthy if they eat wisely, stay hydrated, and get lots of sleep—and if they do all of that, they will have a better than average chance at a long and healthy life.  The good news is that, with similar simplicity, your wealth and financial success is going really to come down to how you approach three broad elements:

  • planning
  • discipline
  • tax

Avoiding, reducing, or simply dealing with taxes can be the single most important way to help you bolster your wealth as you move forward.  Planning and discipline you can supply on your own, perhaps with some coaching. Keep your eyes away from the financial junkfood that you see day-to-day on TV about “the markets” and how people who claim they have a one-size-fits-all solution that can help you achieve your retirement goals – picking the “hot stock” or latest investment product will not make your financial situation any better.  Instead, trust your gut and instinct, stick to some simple, straight forward basics, and you should be well on your way to making money—an situation that enhances your experience as a Dad, not one that frustrates the journey.