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

Coping With Stress - Avisar Charter Professionals

6 Simple Ways To Cope With “New Normal” Stress

We can all agree that adapting to the changes brought by the coronavirus has been stressful for all of us. But what does it mean when we acknowledge that we are “stressed out”? And what can we do to cope as we continue to navigate these unusual times?

For almost a year now, we’ve had to rearrange our schedules, homeschool our children, isolate from our loved ones and deal with empty store shelves. The most stressful part is likely living with the fear that our loved ones could be harmed by this virus.

Of all the things the pandemic has taught us, we’ve learned that what is most important to us as human beings is our health and well-being. And while we’ve been adjusting to keep ourselves and our families safe, we’ve had to endure an incredible amount of stress along the way. How does that affect our health?

Let’s paint a picture … imagine you’re camping, and you encounter a grizzly bear. Your family is in the tent, but you’re outside making a fire before the sun goes down. You lock eyes with that grizzly bear, and your body immediately releases the stress hormones adrenaline and noradrenaline, and the more critical measure of stress, cortisol – lots of it. Your heart races, your breathing quickens, your pupils dilate, and you focus on nothing else but the situation at hand.

Your automatic response will be one of two things: Stand your ground and scare off the grizzly, or slowly back away and get the heck out of there with your family. This response is what is commonly known as the “fight or flight” response. Now, that’s an extreme example, but that same physiological response is triggered on a lesser scale when you encounter daily stressors. When that becomes chronic, your body is constantly in fight-or-flight mode, which can lead to a slew of health problems down the line. There is a reason stress is called “the silent killer.”

How Stress Manifests Day-to-Day

You might be thinking, “I can handle my life. I don’t feel stressed out.” The problem with chronic stress is that it manifests in small ways that we become so used to, that we don’t even realize it’s happening! Here are some ways you can tell you’re battling chronic stress:

ENERGY

  • You wake up feeling unrefreshed.
  • You have difficulties getting out of bed in the morning (even after 8-plus hours of sleep).
  • You have difficulties falling and/or staying asleep.
  • You find yourself unable to keep up with work the way you used to.
  • You are experiencing “brain fog.”
  • Exercise makes you more tired.

NUTRITION AND DIGESTION

  • You often crave salty or sugary foods.
  • You have difficulty digesting your food.
  • You often have heartburn or reflux.
  • You are constipated and/or have loose stools.

PHYSICAL AND MENTAL HEALTH

  • You are gaining or losing weight (without trying).
  • You are less interested in sex.
  • You often get sick or acquire infections.
  • You are becoming more irritable and impatient.
  • You are starting to experience more physical pain.
  • You are experiencing low moods, making it difficult to find joy in life.
  • You are having panic attacks.

If any of these seem familiar to you, you could be dealing with symptoms of chronic stress and maybe even burnout. The response I talked about earlier – the release of adrenaline, nor-adrenaline and cortisol – is an adaptive response that helps us survive.

The problem is, when we are chronically stimulating the release of cortisol, it affects how our bodies function by influencing changes in our hormones, the function of our gut (think: gut-brain connection) and changes in the neurotransmitters in our gut and brain. This negatively affects our mood, our energy, our sleep quality, our blood sugar and blood pressure, our digestion and so much more.

What Can You Do To Ease Your Stress?

Taking a step back from daily duties to allow yourself to heal would work wonders; but, as a professional, I know that’s nearly impossible. Gathering with loved ones, going out for a social outing, or travelling are usually great stress relievers for people, but these, too, are near-impossible in the world’s current climate.

But there are some measures you can take that are proven to decrease stress and help get you back as much normalcy as possible:

  • Meditate! If you haven’t yet tried it, or are skeptical, it can be difficult to get into. However, studies have proven that meditation can decrease cortisol levels. As a stress-relief method, it’s both effective and free!
  • Try a cortisol-managing supplement. Just remember to always first get advice from a naturopathic doctor (ND) on which supplement is right for you. Each supplement marketed for stress will affect your cortisol levels in different ways.
  • Decrease your caffeine intake. I know, I’m sorry. Caffeine can mimic the symptoms of stress and anxiety. Try to keep it to just one cup of dark roast, black or green tea per day.
  • Have a regular bedtime. Melatonin, the hormone that helps you fall asleep, works on an opposite cycle with cortisol: When melatonin is high, cortisol is low, and vice versa. Try wearing some blue light-blocking glasses to get that melatonin flowing every evening!
  • Do nothing for 15 minutes per day. And I mean nothing. Don’t eat, clean, read or use your phone. Find a spare 15 minutes to allow your mind to rest. This is an alternative if you’re resistant to meditation.
  • Exercise. Unless you are at the point where exercise exhausts you, 30 minutes of exercise per day is a proven way to decrease your cortisol levels and help manage your stress. You can combine this with the previous 15-minutes tip – go for a walk and, instead of listening to music or a podcast, let your thoughts keep you company.

While we cannot change many of the factors that are causing us stress, these small lifestyle adjustments are still within reach.

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.

Trust Returns: Enhanced Reporting Requirements

There will be new and enhanced trust reporting requirements that will apply to taxation years ending on or after December 31, 2021.

Which Trusts Are Affected?

The requirements are applicable to all express trusts that are resident in Canada. An express trust is a trust created with the settlor’s express intent, such as through a trust deed or a will.

EXCEPTIONS

There are a few trusts that are exempt from the filing requirements, these include:

  • A trust that has been in existence for less than three months,
  • A trust that holds less than $50,000 in assets throughout the taxation year (provided that their holdings are confined to deposits, government debt obligations and listed securities),
  • A trust that is a registered charity,
  • A graduated rate estate, and
  • A qualified disability trust

What Are The Reporting Requirements?

Affected trusts will be required to provide additional information about each person who is a trustee, beneficiary, and settlor. The information to be provided includes:

  • Name,
  • Address,
  • Date of birth,
  • Jurisdiction of residence,
  • Taxpayer identification number (ex. Social insurance number, business number, trust account number or a taxpayer identification number used in a foreign jurisdiction).

Trusts will be required to file an income tax return each year with the above information, even if the trust does not have any income to report.

Since some of the above information may not be readily available, we recommend that Trustees and Executors start compiling this information well in advance of the filing deadline for taxation years ending on or after December 31, 2021.

Penalties

The CRA will apply additional penalties for those who knowingly or due to gross negligence, make a false statement or omission on the trust income tax return. The penalty will also apply to those who fail to comply or fail to file an income tax return.

The additional penalties will be calculated as the greater of:

  • 5% of the total fair market value of all the property held by the trust in the year and
  • $2,500

The current existing penalty for failing to file a trust income tax return is $25 per day with a minimum of $100 and can increase up to $2,500.

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.

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.

Cleaning Your Finances

Cleaning Out Your Financial Closet Under Quarantine

Sheltering in place has been tough; not being able to meet with family or friends, nor being able to step outside your home for a break required us all to adjust. There were some positives to the lockdown, though, including finishing off home projects you’ve been putting off. Another “to-do” that you might want to think about is whether there have been changes in priorities that could impact your financial affairs.

If you haven’t addressed this yet while spending more time at “home base,” here are some recommendations which I hope will inspire you to get organized, feel empowered and emerge confident in your financial future.

Review Spending, Saving and Cash On Hand

The recent pandemic and the economic shock that ensued certainly made clear that having emergency cash on reserve for times like this is highly important. The idea behind an emergency fund is to see you through a period of uncertainty concerning your employment or health, without the need to run up debt or tap into your retirement savings.

For the size of your emergency fund, recommendations vary from three months to a year of expenses. The amount will vary based on your specific circumstances; however, at a bare minimum, you should store away three months of spending for a “rainy day,” like the type of events we’ve seen during COVID.

Building an emergency fund and creating sustainable wealth requires that you calculate and understand the most material parts of your cash flow situation. Here is an example of how to make this calculation, along with some comments to make the process easier.

Calculate Your Cash Flow

Annual estimateCash flow exampleAdam’s comment
Income $$100,000T4 income on your last tax return will do, or you can calculate annual income based on your most recent pay stub
Taxes $$23,708*Use the Ernst & Young combined income tax calculator to calculate your expected taxes based on your income estimate
Savings $$12,000You might save a monthly amount, say, of $1,000 per month, or instead do a lump sum for $12,000 at the RRSP deadline each year
Spending $$64,292(Assuming you are not hiding money under your mattress), this figure is the result after deducting your taxes and savings from your annual income

* This tax figure is for an Ontario resident in the 2020 tax year

Revisit Your Investment Plan

You are likely contributing the savings you are setting aside to a Registered Retirement Savings Plan (RRSP) or a Tax-Free Savings Account (TFSA). These are tax-efficient investment accounts and a good place to grow your savings.

If the recent downturn in the stock market had you up all night, then it’s likely that your investment plan does not fit your expectations. Your investment plan should be based on two key, interrelated factors: your ability to tolerate risk (facts about you, such as your age) and your willingness to tolerate risk (feelings you have, such as whether investment risk makes you anxious).

If you set your investment plan up correctly, then even in challenging markets like we had recently, being clearer on your expectations should help quell any anxiety.

Protect Your Family Through An Insurance and Estate Plan

Protecting your family from the COVID-19 virus has been a priority for many parents and families recently. Purchasing face masks, hand sanitizer and disinfecting wipes are some of the investments many have made to combat the virus. Over the long term, life insurance coverage is something that can protect your family as well.

Although we don’t like to ponder our mortality, the recent pandemic has obviously made us hyperaware of the fragility of life. Given the current situation, today, many insurance companies are providing life insurance coverage faster and easier than ever before. Since having a paramedical nurse come to your house to take your blood, etc. is no longer acceptable in the time of COVID, you can now acquire up to $2 million in life insurance coverage simply through a telephone review with a nurse.

Are Your Documents in Order and Easy to Find?

Just as you would organize the garage or kitchen cupboard, make sure you sort and store your financial records (i.e., will, insurance policies, investment statement and online passwords) in a safe place. Why is this important? If you happen to pass away, your loved ones and executors will need to be able to retrieve these documents to deal with your estate efficiently.

If you have been avoiding completing or updating your will and power of attorney, now is always the right time to engage a lawyer to help you complete those critically important documents.

A will and power of attorney don’t just protect and organize your financial assets; they also ensure that any dependents you have (your children) go to the caregivers you designate.

Also, make sure to review the beneficiaries on your registered investment accounts (RRSP, TFSA, etc.) to ensure that you have designated a specified living beneficiary. Updating this information could save your estate and loved ones thousands of dollars in unnecessary tax.

Take The Next Steps – Talk To A Financial Advisor

Not comfortable cleaning out your own financial closet? Don’t have an investment plan in place? Now’s a good time to get one! Then, consider meeting with a financial professional who can establish a financial and investment plan so that you will know what to expect.

At my investment practice, we create financial and investment plans for each of our clients. As a result, our clients understand what they can expect from their wealth in challenging times and the potential risks to their plans. In the end, our clients are more confident in their future and walk away with the “peace of mind” of knowing they can weather future events like COVID-19.

To learn more about how you can become more confident and comfortable in your financial future, contact a financial advisor.

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:

Mistakes Canadians make regarding U.S. taxes Cyndy Packard Osode, CPA, CA, CPA (TX, U.S.A), CGMA

Update on COVID-19 federal government support Susan Cox, CPA, CA

Preserve cybersecurity while working remotely                                         Imran Ahmad, LL.B, LL.M

Cleaning out your financial closet under quarantine                                  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.

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.

Your Credit Score: What Does It Mean?

We’ve all received email ads for websites that can help us find our credit score, with monthly updates, for free. It’s little wonder that many Canadians are now fixated on that three-digit number. Surely a good credit score means that you are on the right path to financial security, right? 

Unfortunately, no! A high credit score is no guarantee that you will not face financial difficulty, or even bankruptcy, in the future. There are many misunderstandings about what the credit score is, what factors affect it and who it was developed for (hint: it’s not you).

What Is A Credit Score?

Credit scores are a product developed by credit bureaus to sell to banks and other lenders as well as insurance companies. They are portrayed as a “measure of trust” – that is, a higher credit score provides lenders with more confidence that you will pay them back. Lenders are primarily interested in maximizing their profitability, which depends on you carrying balances and paying interest as well as paying them back. What’s in their best interest is not necessarily what’s in yours.

The credit bureaus access data from your financial institutions and phone and utility companies. They then apply their algorithms to come up with a three-digit score. Credit scores from different credit bureaus can be different, as they weigh the importance of certain factors differently or use different time frames for your credit history.

What factors affect your credit score?

The most important factor that affects your credit score is your repayment history, accounting for 35% of your score. To have a high score, it is important that you make all required payments on time. However, you get no benefit for paying the balance in full or for making extra payments against a debt. Nor are all payments tracked; for example, faithfully paying your rent on time will not improve your credit score.

Your credit utilization (i.e., the ratio of your credit card balance to your credit limit) accounts for 30% of your score. It is meant to track whether you are getting close to “maxing out” your available credit, which will make you a riskier customer for a new lender. It is suggested that you maintain a balance of no more than 30% of your borrowing limit. Credit utilization only applies to “revolving credit,” such as credit cards and lines of credit. It doesn’t apply to instalment loans, such as mortgages or car loans. Perhaps surprisingly, your credit score does not take into account your salary or other sources of income, though this may be considered by lenders when they determine your credit limit.

The credit score rewards those with a longer credit history, which accounts for 15% of your overall score. It considers the age of your oldest account as well as the average age of all your accounts. It also rewards you for having multiple sources of credit, such as credit cards, car loans and mortgages. This credit mix accounts for 10% of your score.

The number of credit enquiries can impact your credit score. These are distinguished between soft enquiries for non-lending purposes (e.g., by you or a potential landlord) versus hard enquiries (e.g., when you are applying for a mortgage or loan). Isolated hard enquiries will not likely raise any red flags. However, if you apply for a lot of credit in a short period of time, lenders may get concerned that you are shopping for loans and potentially getting in over your head. Other factors that may affect your credit score include your personal stability (e.g., if you move frequently) and your professional stability (e.g., if you change jobs frequently).

It may seem counterintuitive, but paying off your car loan or mortgage or closing an old credit card that you no longer need could have a negative impact on your credit history and credit mix, which may actually reduce your credit score.

These algorithms may result in a scenario where a person who is unemployed, behind on their rent, and has a seven-year car loan that is “underwater” (i.e., the remaining balance on the loan exceeds the current value of the car), but who makes the minimum payments on their credit card every month, could have a higher credit score than someone who has paid off their mortgage years ago and has just one credit card that they pay off in full every month.

How can you improve your credit score?

Once you understand the factors that do and don’t affect your credit score, you can assess whether some of the common suggestions for improving it are in your best interests or in the best interests of the lenders. Obviously, making sure that you make all minimum required payments on all your debts is important to maximize the payment history.

There are several ways that you can keep your utilization rate under the 30% target. You might consider making multiple payments during each month if you have a significant purchase, or if you are approaching the target because of regular charges throughout the month.

Two methods that are often suggested, but should be approached with caution, are to ask for an increase in your credit limit or to take out an instalment loan to pay down the balance on a credit card (which could also have a positive effect on the credit mix factor). Both methods come with the risk of additional borrowing if you are not disciplined about managing your finances. It’s also worth noting that carrying credit card balances of up to 30% of your credit limit means that you will be paying a significant amount of interest each month.

You could improve your credit history by taking out longer loans, but, like many of the other suggestions, this will result in you paying more interest to the banks.

It is important to know your credit score and to check your credit report from each of the credit bureaus annually to ensure that there are no mistakes. Just remember that the credit score was developed by and for lenders and that it was not designed as a measure of your personal financial health.

And those free services with monthly updates? They make money by recommending financial products to consumers, for which they receive a referral fee. Some even have “coaches” to provide personalized tips to improve your credit score and offer product recommendations. So, if you receive a recommendation to get a consolidation loan to pay down your credit card balances, remember that that’s how these services make money. Don’t focus on improving your credit score by making decisions that are in the lenders’ best interest and not your own!

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.