Person using a calculator at a desk with a spreadsheet and credit cards.

5 financial mistakes to avoid when you’re young

As a fresh graduate, saving for the future can be hard to envision. But being money-wise in these earlier years can have exponential pay-offs in your later years. 

According to experts, avoiding several spending traps when you’re early in your career can help set you up for a more stable financial future.

Accumulating credit card debt

Spending within your means may seem obvious, but when you’re fresh out of school and looking for a job, this can be challenging.   

“I think a lot of young people, even in university, don’t really have steady employment and end up spending more than they would have spent in cash,” says CPA David Trahair, a personal finance expert and author of CPA Canada’s free practical guide, Survive and thrive: Move ahead financially after losing your job.   

Credit cards in and of themselves aren’t bad – in fact they’re a helpful way to establish a credit history – but it’s important to understand what you’re signing up for. High-interest rate cards can accumulate debt quickly, if you’re not paying down the balance each month, Trahair says. Spending only what you can afford – or only what you must, where possible – can set people up for better financial health, since they are actively trying to keep balances low. 

If you do find yourself in a position where you need to take on debt, try to use a lower interest rate, point-free card. “The benefit of the points rewards is often less than one per cent a year,” says Trahair. “It doesn’t make sense to carry a balance when the credit card rate is as high as 20 per cent or more.” 

Another option is to obtain an unsecured line of credit, he says, to avoid high-interest rate credit cards. However, without having previous past credit to build up a good credit score, a parent may have to guarantee the credit card or loan to qualify the candidate.

Investing before paying off debt

While the idea of saving and growing money is attractive, investing money only makes sense if your credit card debt is paid down, says Trahair. 

“When you’re in credit card debt, the company is charging you interest,” he says. “To save, you’re taking money that would otherwise be spent to pay down that credit card.” With companies charging between 20 to 24 per cent interest, credit card debt quickly accumulates.

“People like the idea that they have savings,” says Trahair. “They’ll say, ‘So I owe $10,000, but I have $2,000 of savings.’ They’re in worse shape than the person that only has $8,000 on that credit card [because of the accumulating interest]. The best investment is paying down that credit card debt.”

Delaying life insurance investments

Often when you’re young, obtaining a life insurance policy isn’t top of mind – but it should be, says CPA Garth Sheriff, who runs CPD consulting firm Sheriff Consulting.

“Theoretically, it’s when you’re the healthiest,” he says. “You’re more likely to get a lower premium plan and, if you get something that you can lock into, it can also be a savings return vehicle. It’s not only a safety net, but it also builds equity.”

Plans such as universal life insurance and whole life, he says, work like investment policy funds that have a cash surrender value – meaning you don’t just acquire funds in death, but the cash value builds up as savings. Each plan has its own risk tier, so be sure to research the appropriate plan and available options, he says. 

Not setting an end goal

Understanding why you are trying to save money leads to a more successful outcome, says Trahair. While this goal may be different for everyone, ultimately, each person has a life target they want to meet, whether it’s buying a home or planning for retirement.

“The best thing you could do for your personal finances is track where your money’s going,” he says. Trahair recommends using free budgeting apps or those available through banking services to help identify spending habits. 

Budgeting, he says, requires historical information. But, if you’re just graduating or starting out on your own, you won’t have this data. If you track your spending even for just one month, you’ll reveal a strong financial picture, as most people tend to have the same habits (save for the odd month where there may be a big-ticket item purchase or vacation, etc.), he says. 

Reducing the number of spending sources is also advised. “If you have three or four bank accounts and three or four credit cards, this exercise is going to be very difficult,” he adds.

Living paycheque to paycheque

This is the least desirable scenario for anyone. Sheriff recommends striving for six months to a years’ worth of funds if possible – and start that saving habit when you’re young. Having a financial safety net has the added benefit of improving your borrowing power in the future. 

“That early time in your life, as you’re building your credit history and your ability to borrow, is really important,” he says. “Even if you don’t know what your plan is.”   

Whether you’re saving for an additional designation or taking a year off, Sheriff says being prepared for the unexpected can help you remain in good financial standing and possibly avoid additional stress and debt, adding, “You never know what life is going to throw at you.”

Registered Retirement Savings Plan VS. Tax-Free Savings Account—What’s The Difference?

Both the Registered Retirement Savings Plan (RRSP) and the Tax-Free Savings Account (TFSA) allow you to build savings in a tax-sheltered environment. So, what are the differences between the two – and when does it make sense to invest in one over the other?

The purpose of the RRSP, as its name states, is for long-term savings for your retirement. The TFSA is a more flexible vehicle to save for more immediate goals, such as buying a new car, house, or creating an emergency fund. And it may also be used to save for retirement.

Who Is Eligable?

The RRSP has no minimum age, but you must have “earned income” in the prior year to create contribution room. Earned income includes income from employment, self-employment and certain other sources, and is reduced by some employment-related expenses, and business and rental losses. The RRSP matures in the calendar year in which you turn 71.

For the TFSA, you can begin contributing as of age 18, and there is no maximum age.

How Much Can You Contribute?

With an RRSP, you can contribute up to 18% of your earned income in the preceding year, up to a maximum annual limit ($27,830 for 2021). Your contribution room is reduced when you have an employer-sponsored pension plan. The contribution for the year must be made by the 60th day of the following year – so, close to the end of March – and you can carry forward any unused contribution room indefinitely.

Keep in mind that if you overcontribute to your RRSP by more than $2,000, there is a penalty of 1% per month. You can deduct up to the greater of your actual contributions and your contribution limit for the year from your taxable income, reducing the amount of tax you pay on other sources of income.

TFSA contributions must be made by December 31 of the relevant year. Here are the annual contribution limits:

2009-12               $5,000

2013-14               $5,500

2015                  $10,000

2016-18               $5,500

2019-21               $6,000

Similar to RRSPs, unused TFSA contribution room can be carried forward. For example, if you turned 18 in 2018 and have never contributed to a TFSA, your limit in 2021 is $23,500 ($5,500 + $6,000 + $6,000 + $6,000).

And as with an RRSP, you also face a 1% per month penalty if you go over your contribution limit.

Withdrawing from The Fund?

With an RRSP, you may be able to withdraw funds to buy your first home or finance a return to school without being liable for taxes right away.

  • The Home Buyers Plan (HBP) allows you to withdraw up to $35,000 to help pay for your first home; you pay this money back into your RRSP through instalments over 15 years.
  • Under the Lifelong Learning Plan (LLP), you can withdraw up to $10,000 in a calendar year, to a maximum total of $20,000, to finance full-time education or training for you, or for your spouse or common-law partner. These funds must be paid back through instalments over 10 years.

Any unpaid instalments for either the HBP or LLP are added to your taxable income for that year. Any other withdrawals from your RRSP are also included in your taxable income in the year that you receive them, and you cannot re-contribute that amount once you have withdrawn it.

Just as there was no tax deduction for TFSA contributions, you do not pay tax on TFSA withdrawals. You can recontribute the withdrawn funds to your TFSA in a subsequent year (just not the same year you withdrew it). The amount withdrawn gets added to your contribution room for future years.

How Does Having A Spouse Help?

If you have a spouse or common-law partner, you can invest up to your contribution limit to a spousal RRSP. Generally, the amounts your spouse withdraws from these plans would be included in their taxable income, rather than in yours. Some restrictions apply.

If there is a significant difference between the incomes of two spouses, the spousal RRSP can minimize the total tax that the family pays in retirement by splitting income between one spouse in a higher tax bracket and the other in a lower tax bracket.

There are no spousal TFSAs. However, you can give money to your spouse for their own TFSA contribution and the income earned will not be subject to tax.

When To Invest In One VS The Other?

There are many factors that would affect whether investing in your RRSP rather than your TFSA may make sense, and these can be quite complex. Here are some general factors that you may consider helpful.

YOUR TAX BRACKET

If you are in a higher tax bracket when you are making the contribution and expect to be in lower tax bracket when you will be withdrawing the funds, the RRSP can offer significant advantages. But if you are in a lower tax bracket when contributing, those benefits will not be as great – though you still benefit from deferring tax from the year you made the contribution to the year that you withdraw the funds.

YOUR TIMELINE FOR WITHDRAWAL

The timeline for when you expect to need the funds is another important factor. When your RRSP matures in the year that you turn 71, you have two options for relief from being liable for taxes immediately: You may transfer the balance in the account to a Registered Retirement Income Fund (RRIF), or use it to purchase an eligible annuity.

RRIF plans require that you withdraw a minimum amount each year, based on your age. It’s also worth noting that any RRSP or RRIF withdrawals or annuity payments are added to your taxable income and may trigger a 15% clawback of the Old Age Security for income above a certain amount ($79,845 in 2021).

While the HBP and the LLP offer you some flexibility to access your RRSP funds without paying tax, the TFSA is much more flexible since you can withdraw funds on a tax-free basis and recontribute them in a future year.

YOUR INVESTMENT TYPE

Your choice of investment type may also affect your choice of RRSP vs. TFSA. For example, if your portfolio includes United States stocks, their Internal Revenue Service (IRS) recognizes the RRSP as a retirement savings account and does not withhold tax on the dividends you receive.

On the other hand, the IRS does not recognize the TFSA in the same way, so there will be a 15% withholding tax charged on those dividends. There is no foreign tax credit to offset that 15%, as there would be for investments in a non-registered account.

The RRSP and the TFSA are both important savings vehicles for Canadians. Understanding the differences between the two can help you make the decision when to use either (or both!) to meet your savings goals.

Disclaimer:
Avisar Chartered Professional Accountant’s blog deals with a number of complex issues in a concise manner; it is recommended that accounting, legal or other appropriate professional advice should be sought before acting upon any of the information contained therein.

Although every reasonable effort has been made to ensure the accuracy of the information contained in this post, no individual or organization involved in either the preparation or distribution of this post accepts any contractual, tortious, or any other form of liability for its contents or for any consequences arising from its use.

Take The Right Steps Now, Avoid “Pension Envy” Later

If you work in the private sector and are wondering how you can replicate the “gold plated” pensions of your friends in the public service, envy not! You can enjoy a similar pension experience while complementing your private investment savings (e.g., RRSP, TFSA, etc.).

My wife, brother and some of my friends are teachers, and my parents are retired teachers, so I am well versed when it comes to what’s on the minds of teachers. One topic that never seems to concern them is retirement security – if you bring up retirement and investing, they are happy to boast about their incredible pension.

And why shouldn’t they? Teachers and most other public service pensions are what you call the “gold plated” pensions in Canada because they are the best available for retirement income. This is mainly because these pension funds are shrewdly managed and have thus yielded historically high returns, and the payout formulas that determine benefits typically work in the recipient’s favour. Also, the pensions are backed by the power of the government and, under most circumstances, are protected from inflation.

If you are a private sector employee, your pension might not have all these bells and whistles. For instance, I am helping a client complete her pension package after years of working for one of Canada’s big banks; the pension package she received shows the pension is underfunded (meaning they don’t have enough assets to cover their obligations to pensioners), no inflation protection at all and underwhelming pension formulas.

Governmet Pension Benifits Available To Canadians

In Canada, we are fortunate to have access to two government-sponsored pension plans outside our workplace pensions: Canada Pension Plan (CPP) and Old Age Security (OAS). CPP is based on your earnings while working, while OAS is based on how long you have lived in Canada.

As prospective retirees approach retirement age (say, age 60-plus), understanding when to begin collecting your pensions becomes an important planning point and forms my central argument on how to overcome any pension envy you might have.

TRADITIONAL VIEWS OF GOVERNMENT PENSION PLANS

Historically, it seems that most Canadians have decided to start their government pensions as early as possible (CPP at age 60 and OAS at age 65). Reasons Canadians have reported that they elect to start these benefits early are:

  • They are predicting a certain life expectancy.
  • They do not have enough personal savings to supplement their retirement income until their government benefits start.
  • They want to manage any tax consequences.
  • They wish to attend to their estate planning.*

In my experience, the other key reason I believe Canadians tend to start their pension benefits early is because, quite simply, they can. If the government is handing out cookies to Canadians in the form of government pension benefits today, it’s no surprise that Canadians would not want to wait to start eating them.

How to Reduce Pension Envy

It is possible to achieve similar pension benefits to your family and friends in the public service. How? By considering the option to defer your entitled government pensions (e.g., OAS and CPP).

More specifically, you have the flexibility to select when to start your CPP benefits (between age 60 and 70) and your OAS benefits (between age 65 and 70).

This decision on when to start your government benefits is a critical choice that you only have one chance to make. So, you want to make sure you are making it with your eyes open.

WHAT IS AT STAKE?

How about $83,000 more in retirement income, lower risk of outliving your money and higher-quality income, to start? Consider these factors for help deciding whether delaying your pension benefits might fit in with your overall retirement plan:

Enhanced income: Each month you defer CPP and OAS, you receive an increase in your pension benefits of close to 0.7% per month, or 8% per year.

Here is how this would look if you lived to be 90: If you are eligible for the maximum of both pensions and defer each pension from age 65 to 70, your retirement income will be $83,390 higher overall, and you will receive greater cumulative dollar value after your 81st birthday.**

Lower risk of outliving your money: Over the last two decades, private-sector pensions have shifted from a defined benefit (similar to public service pensions) to a defined contribution pension scheme. This change has meant that retirees may have less certainty of their guaranteed pension income over their lifetime.

You can lessen this worry by maximizing your government pension sources, as these provide retirement income for life. In this way, Canadians – who are living longer than ever – can rest assured that they will continue to receive a higher retirement income, with annual inflation protection to boot.

Higher-quality returns: As noted in the first point above, each year that you defer your CPP and OAS to the maximum age 70, your retirement benefit goes up by close to 8% per year.

Going forward, if you are a typical Canadian retiree running a balanced portfolio with your retirement savings (such as in RRSPs), a return of 8% per year is likely to be a difficult target for you to reach without taking on excessive risk. Half of your balanced portfolio invested in fixed income is only earning between 0 and 2% today. More importantly, your returns on your private savings are likely not entirely guaranteed, while your government pension deferral benefit is.

Over the past few decades, changes to pension regimes have highlighted the value of the public service pension plans. As part of your detailed retirement plan, electing to defer your government pensions may help reduce or eliminate your pension envy.

To be sure if this retirement strategy is ideal for you, it is important to work with a financial professional to come up with a plan that is ideal for your unique retirement circumstances.

* “Taking CPP early can come at a steep long-term cost” by Rob Carrick, published in the Globe & Mail print edition on December 9, 2020.

** For the examples used in this article, we assume that the person is eligible for the maximum of both CPP and OAS benefits, with no inflation adjustments in the calculations.

Disclaimer:
Avisar Chartered Professional Accountant’s blog deals with a number of complex issues in a concise manner; it is recommended that accounting, legal or other appropriate professional advice should be sought before acting upon any of the information contained therein.

Although every reasonable effort has been made to ensure the accuracy of the information contained in this post, no individual or organization involved in either the preparation or distribution of this post accepts any contractual, tortious, or any other form of liability for its contents or for any consequences

Tax Considerations When Buying or Selling a Home

Buying or selling a home is often an exciting, yet stressful time for most. This article highlights several important tax considerations to be mindful of when buying or selling a home.

The Principal Residence Deduction

The principal residence deduction allows individuals and families to avoid paying taxes on the sale of their primary place of residence. Each year, an individual or family can designate one property that they own as their principal residence as long as the property is primarily used to live in by the individual/family.

SALE OF A PRINCIPAL RESIDENCE

CRA now requires individuals to report the sale of their principal residence on their personal income tax return in the year the property was sold. In many cases, the principal residence deduction eliminates any taxes that would otherwise result from the sale.  However, disclosure of the sale is still required.

To report, the taxpayer must disclose the address of the property, the year it was purchased, as well as the proceeds from the sale. Failure to report the sale of a principal residence can result in penalties and/or denial of the principal residence exemption.

Renting & Flipping Property

If a property is purchased with the primary purpose of renting or selling it, the property is not eligible for the principal residence deduction and the subsequent sale will cause a taxable capital gain or loss.

It is the original intention when the property was first acquired which is the determining factor.

Homebuyers’ Amount

The CRA provides a $5,000 tax credit to first-time homebuyers (those who did not live in another home owned either by themselves, their spouse, or common-law partner in any of the four previous years). To qualify, the property must be purchased with the intention of the individual/family occupying it as a principal residence within one year of purchase.

Homebuyers’ Plan

First-time homebuyers may also be able to withdraw up to $35,000 from their RRSPs to help purchase or build a home as long as the withdrawn amount is repaid within 15 years.

GST/HST Rebate for Newly Built Homes

If you have bought a newly built home, or have substantially renovated a house to use as your principal residence, you may qualify to receive a rebate for some of the GST/HST that you paid on the purchase through the CRA’s GST/HST new housing rebate.

By making yourself aware of potential tax planning opportunities before you buy or sell a property, you can avoid an unexpected bill from the taxman. After all, nobody likes surprises at tax time.  

Disclaimer: Avisar Chartered Professional Accountant’s blog deals with a number of complex issues in a concise manner; it is recommended that accounting, legal or other appropriate professional advice should be sought before acting upon any of the information contained therein.

Although every reasonable effort has been made to ensure the accuracy of the information contained in this post, no individual or organization involved in either the preparation or distribution of this post accepts any contractual, tortious, or any other form of liability for its contents or for any consequences arising from its use.

GIC vs GIC

GIC VS GIC—What’s The Difference? TIME & MONEY!

Confused? You would not be the first person to mix up these two GIC investment vehicles: Guaranteed Investment Certificates and Guaranteed Interest Contracts. Although their acronym is the same, the differences between these GICs could have material implications for your money, especially when it comes to transferring wealth to the next generation.

Individuals often find themselves holding a large portion of their wealth in non-registered investments. This may have been a result of an inheritance, shrewd saving, recent downsizing to a condo or the sale of a business.

Whatever the scenario, the risk to the non-registered money if you pass away, is that your estate and this money will be subject to probate – along with the delays and fees that come with it.

The Perils of Probate

Let’s first review this key concept: Probate is the legal process where a judge reviews the deceased’s will for validity and authenticity and appoints the executor of the estate. It comes with a cost that is levied to the estate.

Each province has its own set of probate fees. For example, in Ontario on an estate worth $200,000, the probate costs would be about $2,250, or close to 1.1% of the estate’s value.

Moreover, in Ontario, the probate process will delay the release of estate funds by six to nine months. In the meantime, while your estate’s funds are tied up in the courts, your surviving loved ones may be required to pay the cost for certain final expenses, such as funeral and burial costs, and the additional professional service fees that accompany the administration of the deceased’s estate, including accounting, legal and executor fees.

In the end, for a $200,000 estate, these costs may subtract another $3,900: for a combined estate cost of $6,150, or close to 3% of your estate.

The GIC Protects More Assets

So, why does this matter to your non-registered GIC portfolio? Well, if you would like to ensure a smooth, cost-effective transfer of your wealth to the next generation, then choosing the right type of GIC is important.

Although both bank and insurance GICs operate in much the same manner while an individual is alive, it is the treatment of the GICs within the estate that shows the important difference between the two.

If you hold an insurance GIC, it will help protect your non-registered assets from these influences, as you can select a beneficiary to your insurance GIC that allows the non-registered assets to flow directly to them – and bypass probate. Holding a traditional bank GIC will expose your non-registered assets to the probate, potential delay and additional fees discussed above.

More information to help you plan

The table below expands on these similarities and differences between the two investment vehicles. Use this information as part of your overall investment planning, for a clearer picture that helps you make a more informed choice to fit your goals.

FactorsGuaranteed investment certificate (Bank GIC)Guaranteed interest contract (Insurance GIC)Comment
IssuerBankInsurance companyBank GIC is structured as a traditional savings vehicle, while the insurance GIC is set up as a standard insurance contract
Interest rateYesYesDifference is ~+15% in favour of Bank GIC
Term1 to 5 years1 to 10+ yearsMore maturity options are available for the insurance GIC
GuaranteeCanadian Deposit Insurance Corporation (CDIC) – up to $100,000Assuris – up to $100,000Different providers insure these investments, but they both offer similar coverage
Pension tax creditNoYesInsurance GIC income qualifies for the pension income tax credit
Legacy providedNoYesYou are able to designate a beneficiary for a non-registered Insurance GIC
Avoids probate/estate administrationNoYesMoney transfers directly to your beneficiary and avoids probate costs and public record of your estate disposition
Protected from creditorsNoYesInsurance GICs held in a non-registered account are protected from creditors (in most provinces)

Disclaimer: Avisar Chartered Professional Accountant’s blog deals with a number of complex issues in a concise manner; it is recommended that accounting, legal or other appropriate professional advice should be sought before acting upon any of the information contained therein.

Although every reasonable effort has been made to ensure the accuracy of the information contained in this post, no individual or organization involved in either the preparation or distribution of this post accepts any contractual, tortious, or any other form of liability for its contents or for any consequences arising from its use.

Reverse Saving: Borrowing To Invest In The Stock Market

Legendary investor Benjamin Graham said that the investor’s chief problem and even their worst enemy is likely to be themselves. Indeed, borrowing to invest is not for the faint of heart.

Why Borrowing to Invest In The Stock Market?

Traditionally, discussions with your financial professional related to borrowing and investing occur at the same time. This typically happens when the two following market conditions are present:

For instance, there was nowhere to hide in the first quarter of 2020: With the novel coronavirus spreading rapidly around the world, economies were closed for business as stay-at-home orders were issued in Canada and abroad. Stock markets and interest rates both fell dramatically, offering investors these traditional incentives to pursue a leveraged investment strategy.

Are You Fit to Borrow to Invest?

These two key factors should dictate whether borrowing to invest is right for you:

  • your ability to take risk
  • your willingness to take risk

To assess your ability to take risks, you would look to the factual details laid out in your financial strategy or retirement plan. If your retirement plan cannot sustain higher expected risk (in other words, your cash flow is tight), then this investment strategy is not something you should consider. Borrowing to invest in a better strategy for investors who have excess cash flow and need help building long-term equity outside their principal residence and/or business. Those who typically might benefit from this strategy are professionals with their own practices, such as partners at law, accounting firms, doctors or dentists.

Next, consider your willingness to take risks. If you can’t sleep at night because your portfolio of investments using your own money has declined in value – never mind other people’s money that you are considering borrowing from the bank – then this strategy is not right for you.

However, if you are among the investors who have survived previous “bear markets” (i.e., stocks declining 20% or more) and have not panicked, then this strategy is one for you to consider.

Another situation that favours this investment strategy is that Canadians are traditionally very good at paying down debt, but they may struggle with building equity through savings outside their registered RRSP and TFSA accounts. So, this leveraged strategy of borrowing to invest could make sense – it forces the investor to save while they focus on paying down debt, which they have historical experience doing aggressively.

Leveraged Investment Plan: A Double-Edged Sword

Whether you acquire real estate with a mortgage or a stock portfolio using borrowed funds, the returns on those investments are magnified by the use of leverage and the cost of borrowing. As a result, you will see an enhanced and asymmetric impact on returns – the returns swing up and down.

In plain language, this means that if your portfolio (half borrowed and half not borrowed money or “equity”) earned or lost 10% in a given year, the impact on the equity within your portfolio will move up and down by 17% and 23% (this is a highly simplistic example that assumes a 3% per annum cost to borrow).

You can see that although the portfolio returns were symmetric – both up and down 10% – the equity return is asymmetric: it is higher and lower than the portfolio return, and it increases and declines by unequal amounts.

The enhanced equity returns up and down are caused by the use of leverage, while the asymmetry in returns is caused by the cost of borrowing. This asymmetry in returns creates the added need to get the timing right on your leveraged investment strategy.

If you implement the leveraged investment strategy and your portfolio declines in value, stress and emotion can kick in and derail even the most seasoned investor’s plan, resulting in a bad outcome overall.

Keep Your Leveraged Investment Plan Clean and Tax-Deductible

Borrowing to invest is tax-deductible in Canada when money is invested in a non-registered account. To keep your cost of investing clear for the Canada Revenue Agency (CRA), set up a line of credit dedicated only to your leveraged investment strategy. That way, it will be crystal clear how much it cost you to invest.

Success is Based On Diversification

Although we like to believe we can predict the future, we must accept that uncertainty is a part of the investing process, so with this realization, you should spread out your investment risk to accommodate various scenarios. One way to achieve this is by owning stocks in different sectors that are thus exposed to different economic influences.

A common idea behind this leveraged strategy is to cover your cost of borrowing by purchasing dividend-paying stocks. You can find dividend-paying securities in almost all sectors of the economy, not just in the long-established Canadian banking sector.

Another way to diversify is to look at your portfolio in a North American context, and not just focus on Canadian stocks. Although you can realize tax advantages to owning Canadian dividend stocks through the dividend tax credit, tax considerations should be secondary in your mind to enhanced diversification.

Canadians who invest a portion of their leveraged strategy in the United States are likely to find many more stocks in a wider range of sectors of the economy (technology, health care, consumer discretionary, etc.), which can enhance your portfolio’s diversification and outcomes. In addition, exposure to the U.S. greenback has historically provided Canadian investors with an enhanced source of diversification against market uncertainty.

The Golden Rule

Ignoring all the factors already discussed, the golden rule for anyone contemplating borrowing to invest is to look at the worst-case scenario.

Consider what would happen if your leveraged investment strategy went to zero and you still owed the bank the loan and interest. If this scenario would impair your family’s current and expected lifestyle, then you should reconsider this strategy. Because, in essence, this strategy should be viewed as being more aspirational: We are trying to achieve the lifestyle we want in future, but not by losing the foundation (our needs) we have at present.

Disclaimer:

BUSINESS MATTERS deals with a number of complex issues in a concise manner; it is recommended that accounting, legal or other appropriate professional advice should be sought before acting upon any of the information contained therein.

Although every reasonable effort has been made to ensure the accuracy of the information contained in this letter, no individual or organization involved in either the preparation or distribution of this letter accepts any contractual, tortious, or any other form of liability for its contents or for any consequences arising from its use.

BUSINESS MATTERS is prepared bimonthly by the Chartered Professional Accountants of Canada for the clients of its members.

Authors:

We are not Through the Pandemic Yet Ian Brown, CA

Whole Life Harmony – The New Work-Life BalanceKatie Wright, PCP

Things you Need to Know When it Comes to U.S. Taxes for Individuals Cyndy Packard Osode, CPA, CA, CPA (TX, USA), CGMA

Reverse Saving – Borrowing to Invest in the Stock MarketAdam McHenry, CFA

Disclaimer: Avisar Chartered Professional Accountant’s blog deals with a number of complex issues in a concise manner; it is recommended that accounting, legal or other appropriate professional advice should be sought before acting upon any of the information contained therein.

Although every reasonable effort has been made to ensure the accuracy of the information contained in this post, no individual or organization involved in either the preparation or distribution of this post accepts any contractual, tortious, or any other form of liability for its contents or for any consequences arising from its use.

Taxation Of Stock Options

Stock options are beneficial to employees, allowing them to purchase shares in their employer corporation (or related company) below fair market value. Stock options can be a useful way to remunerate key employees when a company has a cash shortage (and the options would actually bring cash in when an employee exercises them), although this would also dilute the existing shareholders’ ownership of the company.

Employees granted company stock options are not taxed; however, employees who exercise the stock option and purchase the shares are considered to have received a benefit. How and when that benefit is taxed depends on who the employer is and whether the stock option price is below the fair market value of the shares at the time the option is granted.

Public Company Employers

If the option price is below the fair market value of the shares at the time the option was granted by a public company employer, the employee is deemed to have received a benefit that is included in their employment income when they exercise the option to purchase the shares.

The amount of the benefit is equal to the difference between the fair market value of the shares at the date of purchase and the option price the employee paid. If the employee sells those shares at a future date, they would recognize a capital gain or loss equal to the difference between the sale price and the fair market value at the time the option was exercised.

For example, assume Pub Co. granted an option in 2017 to a key executive named Sarah to allow her to purchase 1,000 shares at $10 per share when the fair market value of the shares was $12. Sarah exercised those options in 2018 when the fair market value was $14 per share, and she sold them in 2019 for $15 per share. Sarah’s fully taxable employment income in 2018 would be $4,000 [1000 shares × ($14-$10)]. She would also report a capital gain in 2019 of $1,000 [1000 shares × ($15-$14)], half of which is taxable.

Note that if Sarah had exercised the option in 2017 when it was granted, her employment income would have been $2,000 [1000 shares × ($12-$10)] in that year, and the 2019 capital gain would be $3,000 [1000 shares × ($15-$12)]. While the total income over the three-year period would be the same as in the first scenario, her total taxable income would decrease by $1,000, since a greater portion is a capital gain and only half of that is taxable.

If a public company employer grants stock options that do not have an immediate benefit to the employee (i.e., the option price is equal to, or greater than, the fair market value of the shares at the time the option is granted), the employee can deduct half the employment income benefit when the options are exercised as a “stock option deduction.” This leaves half the benefit taxable in the year that the option is exercised – similar to the way that capital gains are taxed.

If Sarah’s employer had set the option price at $12 (the fair market value of the shares at the time the option was granted) instead of $10, her 2018 employment income addition would have been $2,000 [1000 shares × ($14-$12)], but she would have been able to deduct $1,000 from her taxable income in that year as a stock option deduction.

Canadian-Controlled Private Corporation (CCPC) Employers

If the employer is a CCPC, the employment benefit is not taxable until the shares are sold, rather than when it is exercised. If the employee owns the shares for two years after the acquisition, half of the employment income addition can be deducted from taxable income as a stock option deduction. If the employee does not hold the share for two years, then they can claim the stock option deduction only if the option price is equal to, or greater than, the fair market value of the shares at the date the option was granted.

Note that although the effective tax rate for stock options that qualify for the stock option deduction is similar to that of capital gains, they are not considered capital gains (i.e., you cannot use them to offset any capital losses).

Federal Budget Changes for 2019

The original purpose for the preferential tax treatment of stock options was to assist the growth and development of small businesses (in the preliminary stages when cash flow may be limited) and compete with larger, higher-paying companies to attract and retain talent. However, the government became increasingly concerned that stock options were often used to provide preferential tax treatment on the compensation paid to employees of large, mature companies.

The Budget proposed to cap the amount of stock options for which employees of “large, long-established, mature firms” could claim the stock option deduction at $200,000 per year. These changes are not intended to affect employees of CCPCs or “start-ups and rapidly growing Canadian companies.”

The $200,000 cap is determined for shares that become vested in a calendar year (generally the first year in which they can be exercised) and is based on the fair market value of the shares at the time the options are granted. The cap will be applied separately for employers that deal at arm’s length.

Essentially, the Budget proposed that there be qualified options, which are subject to the current tax regime outlined above, as well as non-qualified options. While the employee is not entitled to the stock option deduction for non-qualified options, the employer can deduct the total option benefits recognized by the employee from the corporation’s taxable income if certain conditions are met. In such cases, non-qualified options would be treated the same as any other employment income.

At the time the options are granted, employers who are not CCPCs or “start-ups, emerging or scale-up companies” can take the options that meet the conditions to be qualified and designate them as non-qualified instead. These changes will not apply to stock options granted before 2020.

The characteristics of “start-ups, emerging or scale-up companies” will be defined by regulation following a stakeholder consultation period, which ended in mid-September 2019. Given the October election results, it is important that affected employees and employers continue to monitor and assess the potential impact of these changes.

Disclaimer: Avisar Chartered Professional Accountant’s blog deals with a number of complex issues in a concise manner; it is recommended that accounting, legal or other appropriate professional advice should be sought before acting upon any of the information contained therein.

Although every reasonable effort has been made to ensure the accuracy of the information contained in this post, no individual or organization involved in either the preparation or distribution of this post accepts any contractual, tortious, or any other form of liability for its contents or for any consequences arising from its use.

Why Is Bay Street Soaring As Main Street Suffers?

Despite one million Canadians being out of work since the pandemic took hold and while small businesses struggle to pay the rent and stay in business, how is it that Canadian stocks almost broke even for 2020?

The answer is “easy money.” Monetary authorities around the world, including the Bank of Canada, have cut interest rates and enhanced liquidity to financial markets to support economic activity and stem further economic impacts related to COVID-19.

While the rhetoric of Bank of Canada officials and politicians has focused on how these actions will support small businesses and Canadian workers, the reality is that a big chunk of the provided liquidity has found its way into financial markets, and financial assets have grown as a result. The outcome is a bifurcation between the real economy (Main Street) and financial markets (Bay Street).

Stock Markets

Canadian and U.S. stocks rallied back strong from the depths of the pandemic in March (all data to Oct 30, 2020, total returns, in Canadian dollars). Canadian stocks rose 49% from trough to peak (meaning from their lowest level reached to their highest, which took place during the time span from late March to mid-August) and ended down 9% overall for 2020, to date. In the U.S., stocks rose 40% from trough to peak and are positive 4% for 2020, to date.

Markets will likely continue to be volatile amid ongoing concerns related to COVID-19. Nevertheless, companies in North America have begun to report their third quarter 2020 operating performance, and the vast majority of companies are doing much better than expected.

In addition, the economy in both Canada and the United States is recovering from shutdowns in early 2020 at a much faster rate than most market participants expected. This strong performance should provide a supportive backstop to any continued uncertainty stemming from COVID-19 in the months to come.

Bond Markets

Bonds were flat in the third quarter of 2020. Policymakers in Canada and in most other developed market economies have eased monetary policy in response to COVID-19, to combat concerns about financial market liquidity and credit. Credit spreads, an indicator of investor risk sentiment, have recently decreased, signalling that investors are becoming more comfortable with corporate lending despite the ongoing economic headwinds posed by COVID-19.

Credit conditions should continue to improve as policymakers spare no expense to talk down interest rates and use their central bank accounts to enhance market liquidity.

Canadian Dollar

The Canadian loonie has been on quite a rollercoaster ride this year so far. In the first quarter of 2020, the loonie depreciated about 9% versus the U.S. greenback, with the perceived safety of the American dollar attracting investors in the face of COVID-19 uncertainty. Since the end of March, with its exposure to economically sensitive commodity prices (such as energy), the loonie has come roaring back. This is in part because investors became more aggressive on seeing economic impacts of COVID-19 becoming less dire.

Market performance (as of October 30, 2020, total returns in CAD$, rounded. Data source: Refinitiv Eikon)

MarketDecline % (Feb 20 to Mar 23)Recovery % (Mar 23 to Aug 26)Q3 2020 % (Jul to Sep)2020 Year to Date % (to Oct 30)
Canadian Equity (S&P/TSX Composite Index via XIC ETF)-37+49+4-9
U.S. Equity (S&P 500 Index via XUS ETF)-27+40+7+4
International Equity (MSCI EAFE Index via XEF ETF)-26+29+4-6
Canadian Fixed Income (FTSE TMX Canada Universe Bond Index via XBB ETF)-7+110+5
U.S. Fixed Income (Bloomberg Barclays U.S. Aggregate Bond Index TR Index via AGG ETF in C$)+7-40+7
Currency Exchange Rate (USD$ in CAD$)-9+10+2-3

Investing wisely during these market conditionsWith COVID-19 entering its second wave, elevated uncertainty continues to weigh on financial markets. Although we cannot control financial market fluctuations, we can control your financial plan and individual investment strategy. By focusing on this plan and strategy long term, you will see a materially larger impact on your financial success than you would by worrying and speculating on short-term market events.

Disclaimer:

BUSINESS MATTERS deals with a number of complex issues in a concise manner; it is recommended that accounting, legal or other appropriate professional advice should be sought before acting upon any of the information contained therein.

Although every reasonable effort has been made to ensure the accuracy of the information contained in this letter, no individual or organization involved in either the preparation or distribution of this letter accepts any contractual, tortious, or any other form of liability for its contents or for any consequences arising from its use.

BUSINESS MATTERS is prepared bimonthly by the Chartered Professional Accountants of Canada for the clients of its members.

Authors:

Federal government support related to COVID-19: Tax implications you can expect in 2020              Susan Cox, CPA, CA

Things you need to know when it comes to U.S. taxes for individuals: General filing requirement       Cyndy Packard Osode, CPA, CA, CPA (TX, USA), CGMA

GIC versus GIC … What’s the difference? Time and money!                                                        Adam McHenry, CFA

Why is Bay Street soaring, while Main Street suffers?                                                                 Adam McHenry, CFA

Disclaimer: Avisar Chartered Professional Accountant’s blog deals with a number of complex issues in a concise manner; it is recommended that accounting, legal or other appropriate professional advice should be sought before acting upon any of the information contained therein.

Although every reasonable effort has been made to ensure the accuracy of the information contained in this post, no individual or organization involved in either the preparation or distribution of this post accepts any contractual, tortious, or any other form of liability for its contents or for any consequences arising from its use.

Common Financial Guidelines When Planning For Retirement

Preparing for retirement can be a very stressful experience, with so many factors that you need to consider.

  • How much money will I need to maintain my standard of living?
  • How much will I want to travel?
  • How long will I live?
  • What if I outlive my money?

Financial “Rules of Thumb”

There’s so much uncertainty, that financial rules of thumb for planning your retirement have become very popular – following them relieves at least some of that uncertainty.

It is important to understand the assumptions and the limitations of these guidelines so that you understand whether they are relevant for your particular situation.

YOU NEED 70% OF YOUR PRE-RETIREMENT INCOME IN RETIREMENT

This popular guideline incorporates the fact that you will not have certain expenses in retirement that you had while employed, like commuting costs and buying clothes for work.

You also won’t be saving for retirement anymore. However, there are some personal factors that can make this more of a myth than a guideline, including:

  • whether you own your home and your mortgage is paid off
  • whether your children are financially independent or you are still helping fund their university education
  • your own personal goals for retirement – your personal income replacement factor could be significantly lower, or higher, than 70%

A better way to estimate how much retirement income you will need is to track your current expenses and then adjust for the changes in your lifestyle once you retire, such as an increased budget for vacations and hobbies.

There are tools and apps that you can use to help you categorize and summarize your current spending.

However, check with your bank first, as using third-party tools that automatically download transactions from your bank accounts may violate your online banking agreement and expose you to liability if there are unauthorized transactions in your accounts. Many banks provide their own tools to help you manage your finances, or you can download the transactions and use spreadsheet software to create your own summary.

Once you have your recurring annual budget amount, adjusted for lifestyle changes, you should also budget for expenditures that do not occur annually, such as purchasing a new car or major house renovations.

If, for example, you plan on purchasing a new car every eight years, you should factor in an annual “car replacement fund” over that period to give you a more comprehensive budget amount.

Similarly, you should budget a certain annual amount as a fund for major home repairs – you might not need that money every year, but planning for bathroom and kitchen renovations, new furnaces and roofs should still be built into your retirement budget so that they don’t end up being a nasty surprise when they happen!

Budgeting a percentage of the purchase price of your home, or a specific dollar amount per square foot, are common ways to do this. As with all rules of thumb, these should be adjusted for the age of your home and how often you want to renovate it.

THE ‘4% RULE’

One of the most commonly-cited rules for estimating how much income you can withdraw from your investment portfolio without risking running out of money is “the 4% rule.” This rule comes from a study conducted by William Bengen and first published in The Journal of Financial Planning in 1994.

Bengen explored the concept of “portfolio longevity” – how long your investment portfolio would last if you withdrew a specific percentage of it in the first year of retirement – and then adjusted that amount for inflation in each successive year. He tested this against the stock market returns for a person retiring in each year from 1926 to 1976, and for initial withdrawal rates from 1% to 8%. With an initial withdrawal rate of 4% the portfolio lasted more than 33 years – even for those worst-case scenarios of retirees who lived through the Great Depression or the 1973–74 recession.

The rule provides a simple answer to how much you need to save for retirement or how much retirement income you can take from an investment portfolio, but there are some important assumptions behind this rule. His sample portfolio in the data above was 50% invested in U.S. common stocks and the remaining 50% invested in intermediate-term Treasury Bills, and it was rebalanced annually. That may be more risk than some retirees are willing to assume.

Bengen did explore this issue in his study, comparing the returns from various portfolio mixes of stocks and fixed income assets. While the 50/50 split seemed to be optimal in terms of maximizing the longevity of the portfolio, increasing the equity portion of the portfolio to 75% increased the value of the estate passed on to the heirs while having minimal impact on the portfolio longevity.

Bengen updated the study in 2006 and concluded that 4.5% was the safe initial withdrawal rate. Whether it is 4% or 4.5%, this can give you a good guideline for how much you will need to have saved by retirement to feel confident that you will not run out of money.

Once you have calculated your budget based on the retirement lifestyle that you want and subtracted what you expect to receive from the Canada Pension Plan, Old Age Security and any defined benefit pension plan, you can divide that net amount by 4% and have a reasonable target for your portfolio at retirement.

100 MINUS YOUR AGE RULE

You often hear that our tolerance for risk in our investment portfolios should decrease as we get older, theoretically, since you will have less time for your portfolio to recover from a financial catastrophe, which is where the “100 minus your age” rule comes in to play – the proportion of your investments invested in equities should be 100 minus your age, with the remainder invested In safe, fixed income assets, such as bonds. So a 40-year-old should have 60% of their portfolio invested in equities, while a 70-year-old should have a portfolio with only 30% equities.

However, with the increase in life expectancy since this rule was introduced, and with the historically low returns on fixed-income investments, retirees will risk running out of money by following this rule.

Some advisors have adjusted the rule to “110 minus your age,” or even “120 minus your age,” to address the increase in life expectancy, while another study evaluated the minimum and maximum returns for various portfolio mixes against the “100 minus your age” portfolio over a 50-year period.

This research found that the “100 minus your age” portfolio consistently underperformed against both the minimum and maximum returns for two constant mix portfolios: 60% equity / 40% bonds and 70% equity / 30% bonds. This is consistent with Bengen’s conclusions. While every individual’s tolerance for risk is very personal, the link between that risk and the expected return on the portfolio is very clear.

In summary, these common guidelines can be a good starting point for thinking about your retirement, and how prepared you are for it, but each situation is unique and therefore understanding the assumptions and limitations of the guidelines is important.

Disclaimer: Avisar Chartered Professional Accountant’s blog deals with a number of complex issues in a concise manner; it is recommended that accounting, legal or other appropriate professional advice should be sought before acting upon any of the information contained therein.

Although every reasonable effort has been made to ensure the accuracy of the information contained in this post, no individual or organization involved in either the preparation or distribution of this post accepts any contractual, tortious, or any other form of liability for its contents or for any consequences arising from its use.

Self-Directed Investments

Fundamentally, there are four avenues that the average Canadian may consider over their lifetime:

  • Registered Retirement Savings Plan (RRSP)
  • Registered Retirement Income Fund (RRIF)
  • Tax-Free Savings Account (TFSA)
  • Non-Registered Investment Account (NRIA)

The first three account types are registered with taxation authorities and as such are accompanied by rules and regulations that must be followed to obtain specific tax advantages or to avoid penalties for non-compliance.

The NRIA is not encumbered by the requirements of the registered accounts and about the only requirement is to ensure that the CRA receives full disclosure of income earned, capital gains or losses and administration fees that may be incurred throughout the calendar year.

Many taxpayers that have one or more of these investment vehicles relinquish management of such to institutional investors, not realizing that all these investments can be placed into a self-directed investment vehicle within their financial institution or investment firm.

ADVANTAGES OF SELF-DIRECTED INVESTMENTS

  • Lower cost per trade. Most institutions will allow trades, buying and selling, for approximately $10.00
  • per trade transaction.
  • Investors can make trades online quickly and efficiently without the need to contact your broker.
  • Most self-directed trade sites provide information about the investment. Reports show important information that includes, to mention a few areas:
    • balance sheets, income statements, cash flow statements quarterly or year to date
    • history of dividend payments
    • high and low market value of the investment for not only the current but past years
    • other investors’ analyses of the company and, in some situations. a rating of whether to buy,
    • sell or hold the investment
    • current news updates on the company
  • The investor has control of the investment rather than leaving the decisions in the hands of an investment firm or another individual.
  • The investor is not locked into specific investment vehicles such as Mutual Funds, Exchange Traded Funds, specific individual stocks, bonds or GICs that may be an institutional investor’s approach.

Some financial institutions offer a “play” account wherein you can practice trading using their software to become accustomed to how the system works and also gain insight into how well the investments would have done if you had invested.

Many financial institutions aid investors wanting to self-direct their investments.

DISADVANTAGES OF SELF-DIRECTED INVESTMENTS

  • An unsophisticated investor may not have sufficient knowledge to determine the appropriate investment decisions considering factors such as their age, portfolio diversification, and risk tolerance.
  • Familiarity with the investments that are allowed and not allowed in registered investment vehicles is required.
  • Investments in foreign jurisdictions may become problematic if foreign tax authorities require registration or reporting in their country.
  • Investors may not be familiar with tax requirements.
  • Record keeping is essential for non-registered investments as taxation authorities need to know the buy price, sale price, commissions, dividends, income, capital gains, capital losses, and administrative cost. Some online brokerages may provide this reporting for their investors.
  • A starting portfolio with low investment may not offer a return on investment comparable to an investment firm that can comingle smaller amounts to create a large investment portfolio.
  • A minimum deposit amount may be required to open a self-directed account.
  • Financial investors may charge an annual fee. These fees may be hidden in the RRSP or TFSA investment vehicles. These fees are not tax-deductible but simply reduce the overall amount that is available for investment. Similarly, within an NRIA, the more that it costs to administer or complete trades, the less that is available for investment growth. Investment fees within an NRIA are tax-deductible.

OTHER CONSIDERATIONS

  • The transfer of all four investment categories from a managed portfolio into a self-directed portfolio in kind is permissible. Many investments held in a managed portfolio can simply be transferred over to a self-directed account without the need to liquidate and repurchase. Some investments can only be held in a managed portfolio and accordingly would have to be liquidated. Generally, there are no tax implications of liquidating assets held in an RRSP or TFSA (as long as the funds are not withdrawn from the account). Naturally, you must stay within the confines of a financial institution. You may be charged an administration fee. Most online brokerages cover the fees for transferring your investments.
  • Investors must determine if they want interest, dividend or capital gain growth in their investment. Unlike dividends and interest growth, the capital appreciation of a stock compared to its original cost does not necessarily result in an increase in cash, unless the stock is sold. Accordingly, if an investor chooses to hold stock and its value subsequently decrease, that money is no longer available to invest.
  • A capital loss within a registered vehicle is not tax-deductible. It merely reduces the amount of the investment when the stock is sold.
  • A capital loss on an NRIA under normal circumstances can only be used to offset capital gains, though these losses may be carried back or forward to other taxation years.
  • There are limitations on investments that can be made in registered accounts. The CRA considers these investments to be qualified investments. Investors should be familiar with investments by visiting the CRA website and referring to the publication Income Tax Folio S3-F10-C1, Qualified Investments-RRSPs, RESPs, RRIFs, RDSPs, and TFSAs. Failure to follow the rules and investing in non-qualified investments could result in a tax of 50% of the fair value of the investment at the time it was purchased or became non-qualified.
  • An investor could choose a company for its dividend potential. However, if the market value drops below the original cost, the dividend income may not be sufficient to make up the capital loss.
  • Investors must determine whether they are going to purchase and hold or actively trade. The CRA has been cracking down on TFSA abuses where investors have been allegedly running a trading business in these accounts.
  • You can invest in debt obligations, mortgages, precious metals, warrants and options, securities on designated stock exchanges, money and deposits with Canadian banks, trust companies and credit unions (GICs). However, before making an investment outside designated stock exchanges or GICs, ensure you understand the requirements and restrictions.
  • You cannot invest in digital currency.

Converting a managed investment vehicle to a self-directed vehicle is not for everyone. Those who are anxious about their ability to take on the responsibility for their retirement nest egg may not mind paying a management fee and thus are best to stay with a managed account. Others who feel confident in their investment prowess may determine that the risk of self-investing is more than offset by the potential increase in their portfolio value that they may realize by investing the administration fees they did not have to pay.

Disclaimer:
Avisar Chartered Professional Accountant’s blog deals with a number of complex issues in a concise manner; it is recommended that accounting, legal or other appropriate professional advice should be sought before acting upon any of the information contained therein.

Although every reasonable effort has been made to ensure the accuracy of the information contained in this post, no individual or organization involved in either the preparation or distribution of this post accepts any contractual, tortious, or any other form of liability for its contents or for any consequences arising from its use.