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.

Why Should You Care About Your Health Care Spending Account?

Families may not realize that they have a great opportunity to significantly reduce the cost of medical treatments and therapies through a health care spending account (HCSA). These accounts are not well understood and, if available, are typically underutilized due to a lack of awareness of how they can help.

In essence, the HCSA helps families pay for eligible medical expenses by using pre-tax money. For families who incur medical expenses that are not traditionally covered by their employer’s group benefits plan, an HCSA can be a very powerful tax-saving tool. Typically, if you are an employee of a company, you have access to the HCSA as a supplement to your traditional group benefits program. If you do have this access, you may receive a portion of your total compensation in the form of HCSA funding, up to a certain limit.

Tax Savings Available

If your family has qualifying medical expenses above $2,302 (2018) or 3% of your income per year and your marginal tax rate is greater than 20%, then the HCSA could be a valuable tool for your family.

To estimate your potential tax savings from using an HCSA, simply take the difference between your combined marginal tax rate and the federal and provincial tax credit (METC) amount on qualifying medical expenses. If you are an individual in the top marginal bracket living in Ontario (53.53%), the tax savings are your qualifying medical expense amount (incurred during the year), multiplied by the tax rate difference between your marginal tax rate (53.53% less HCSA administrative costs of 8%) and the METC credit (15% federal plus 5.05% Ontario resident), which is approximately 25.48%.

For a family with large medical expenses during the year (such as respite services), the resulting tax savings can be significant. For instance, if a family incurs qualifying medical expenses of $15,000 in a year, the resulting tax savings from using an HCSA instead of the METC is close to $3,822! In addition, if qualifying medical expenses are incurred regularly every year, this is an ongoing tax savings to the family.

Business owners can improve both their financial situation and that of their employees by making a health care spending account part of their benefits offering

Implementing an HCSA as part of your benefits offering can be very valuable for you as a business owner. Up front, the business receives a tax deduction on contributions to an HCSA, while the employees do not pay tax on contributions to the HCSA or on eligible expenses. As a result, the employee is farther ahead by avoiding income tax on HCSA eligible expenses. In addition, the business owner has clarity of costs with an HCSA, as it is the employer that elects to contribute and at what amount. This contrasts with a traditional group benefits plan, which can have variable costs due to the group’s unpredictable claims experience.

In some circumstances, business owners might just offer an HCSA without a traditional group benefits plan. In this case, the employee has full flexibility to use the HCSA dollars for whatever purpose they prefer, while the business owner doesn’t have to worry about escalating benefits costs.

If, however, the employee would still like the option of a traditional group benefits plan, they can use their HCSA dollars to purchase a plan for themselves, as premiums are an eligible expense for HCSA purposes.

Navigating the details of a health care spending account program is challenging. Despite the complexity, it is an important planning tool for families and business owners to use, to improve wellbeing and financial outcomes.

Links Of Interest

Canada Revenue Agency (CRA) – Eligible medical expenses you can claim on your tax return: www.canada.ca/en/revenueagency/services/tax/individuals/topics/about-your-tax-return/tax-return/completing-a-tax-return/deductions-credits-expenses/lines-330-331-eligible-medical-expenses-you-claim-on-your-tax-return.html

Canadian Broadcasting Corporation (CBC) – HSAs the best health plans you’ve never heard of: www.cbc.ca/news/business/hsas-the-best-health-plans-you-ve-never-heard-of-1.990547

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.

Building A Secure Future: Supporting Families With Special Needs

Planning for their children’s financial future is very important to all parents; for families with special needs children, it can involve more complex and emotional decisions. The cost of supporting a special needs child can be more than double the cost of raising a child without special needs. However, some relief may be available to support families to meet their child’s needs. Here are some tips from an investment advisor on how to access those.

While there are many challenges to support your child, the financial aspect can seem daunting to your family. The need to pay for therapies, medical equipment, special programs, along with a parent’s lost income due to time commitments, makes up a large portion of this added cost. If you have a child with special needs, the path to creating a plan to financially support them can be a challenging one that may require the experience and expertise of a financial professional.

As part of your planning, you may wish to learn about help that may be available to you through tax credits, savings vehicles and government programs that support families to meet their child’s needs.

Tax Credits May Be Available

Starting out, families should obtain approval from the Canada Revenue Agency (CRA) to receive the Disability Tax Credit (DTC). This process requires that a medical professional sign off on a government form to establish the child’s eligibility. The DTC provides the parents of a special needs child a transferable credit on their taxes of about $13,000 (in 2018 and assuming child is < 18 years old).

Oftentimes, families may be eligible for the DTC and not even know it. Families may typically associate the DTC with an individual with a visible disability, when in fact, the DTC covers both visible and non-visible medical conditions. For instance, families with loved ones with the following medical conditions may qualify for the DTC: Autism, Cerebral Palsy, Diabetes (Type 1), Down Syndrome. While this list of medical conditions is not exhaustive, the ultimate decision made by CRA will be dependent upon the opinion of a qualified medical professional, on a case-by-case basis.

The Tax Credit Gives Access To Matching Programs

In addition, the DTC allows the family to open a Registered Disability Savings Plan (RDSP). The RDSP provides access to government matching grant and bonds, similar to a Registered Education Savings Plan (RESP). Focusing on the government grant, a family’s contribution to an RDSP of $1,000 a year will be matched by a minimum of $1,000. Also, the family’s contributions along with government bond and grant can be invested in a tax-deferred manner, similar to a Tax-Free Savings Account (TFSA). Combined with government incentives, this tax deferral creates the opportunity for the family to build retirement income for their child’s future to offset lifestyle and support expenses.

Government support programs can also include provincial government support. For Ontario residents, this can include the Ontario Disability Support Program (ODSP). The ODSP is accessible once the child reaches the age of 18. The ODSP is a monthly benefit between $1,000 to $2,000 per month depending on the individual’s circumstances, plus medical, dental, vision, education and job training support. The benefit is paid directly to the special needs individual to cover living expenses.

Estate Planning Is A Must

It is critical for parents of special needs children to update their Will and Power of Attorney (POA) documents. Doing this will ensure proper guardianship of their child when they pass away or are unable to care for them. From a financial perspective, there are many opportunities in your estate plan to ensure that your child is provided for. One of the more common and powerful strategies is combining life insurance on the lives of the parents with a Henson Trust in the parents’ Will.

Navigating the details of these programs and plans can be challenging. Despite the complexity, it is important for families to have a plan and to reach out for professional support. Doing so will ensure the family has access to the financial support and peace of mind they require, so they can focus their time and attention on their children.

LINKS OF INTEREST

Disability Tax Credit Application Form (medical professional required to complete): www.canada.ca/en/revenue-agency/services/tax/individuals/segments/tax-credits-deductions-persons -disabilities/disability-tax-credit/step-step-instructions-filling-form-t2201.html

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.

Will I, Or Won’t I?

You’ve met with your lawyer and drafted your last will and testament. Congratulations – you are doing better than half of your fellow Canadians! But drafting your will should never be a “one and done” exercise. It’s generally best practice to review your will every three to five years, to make sure that it still does what you want it to do. Certain life events should also trigger a review of your will. What are some of those?

Changes In Your Relationships

Significant changes in your relationships or family situation should trigger a review. Examples of these changes include:

  • One of your beneficiaries has passed away.
  • You have had a falling out with a beneficiary, executor or guardian named in the will.
  • Maybe you designated a portion of your estate to a favourite cause, but now you’ve identified a different charity that will be a better fit for your legacy.

MARRIAGE

In most provinces, your current will is automatically revoked when you get married, but there are some exceptions to this general rule.

For example, if the will contains an “in contemplation of marriage” clause that identifies your future spouse by name, that will would not automatically be revoked. If your will is revoked and you do not make a new one, when you die you will be considered to have died “intestate,” and your estate will be distributed according to the succession laws in the province where you live.

It is worth noting that these laws vary widely between the provinces, including whether or not they cover common-law spouses. The provincial family law legislation may also interact with the succession laws to provide additional options for the surviving spouse – so reviewing your will when you get married is an absolute must!

DIVORCE

The impact of a divorce on your will also depends on your province of residence. In some jurisdictions, the entire will is revoked, while in others only those provisions relating to your former spouse are revoked.

If you are legally married, separation from your spouse will generally not have an impact on your will. The impact of a separation for common-law spouses varies from province to province, so you should consider making a new will whenever a legal marriage or a common-law relationship ends.

NEW ADDITIONS TO YOUR FAMILY

The birth or adoption of a child is another event that should trigger an update of your will. In addition to selecting a guardian for your minor children, you may want to establish a trust to hold the property for those children until they reach a specific age.

You should review these sections periodically to ensure, for example, that the person whom you have selected as the guardian still has the time, interest and ability to devote to looking after your children.

And, if your will was to establish a trust for your children until age 25, as you see your children grow is that still the right age? Or are they mature enough that they could handle their inheritance at, say, 18 – or maybe not until they are 30 years old?

You should also consider whether your will should be updated when the youngest of the children reach maturity, finish post-secondary education, or get married or divorced as well.

Changes In Your Assets

In addition to major changes in your relationships, significant changes in your assets should also trigger a review of your will.

The need to review may arise through changes in the relative value of your assets. For example, if you plan to leave your home to one child, the family business to a second child and your investment portfolio to the third child, and the relative value of those assets has changed, you may want to change the terms of the will to be fair to all of your beneficiaries.

Another factor that may affect the value of the assets could be changes to Canadian tax legislation, or international tax legislation if you own any foreign assets.

When you review your will after a significant life event or change in your assets, it is also important to review the named beneficiaries for your Registered Pension Plan, Registered Retirement Savings Plans, Tax-Free Savings Account and life insurance policies, to make sure that these reflect your current situation and wishes.

It’s also a good time to review your powers of attorney, which name someone to act on your behalf if you are unable to. There are two kinds of power of attorney: one for property, naming the person who can make decisions about your financial affairs; and one for personal care, naming the person who can make decisions about your healthcare, housing and other aspects of your personal life.

Finally, as noted above, the laws governing family law, wills and estates are provincial, rather than federal, so if you move between provinces it’s time to review your will and other related documents.

Your CPA Can Help

In addition to consulting with your lawyer, reviewing your estate plan with your CPA will help give you peace of mind that your estate will be distributed in the most efficient and effective way possible, in accordance with your wishes.

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.

TFSA and Death: Have You Planned For What Will Happen With Yours When You Die?

If you own a TFSA, you undoubtedly started it because it allows you to invest and earn dividend or interest income and make a capital gain without paying tax.

Unfortunately, similar to any investment vehicle, complications may arise after your death unless you address the tax consequences in advance. Consider the following circumstances that can affect what happens with your TFSA after you die.

SUCCESSOR HOLDER

If you have named a survivor — your spouse or common-law partner — as a successor holder, then that individual acquires all the rights of the original holder and thus becomes the new account holder.

With this scenario, the TFSA does not terminate and thus there are no tax consequences to the new account holder. An additional benefit may accrue if the original holder has overcontributed before they passed and the new account holder has contribution room in their TFSA.

In this situation, the overcontribution by the deceased can be absorbed by the new account holder into their TFSA, thereby eliminating the chance of future overcontribution penalties (currently at 1% per month).

ROLLOVER PERIOD

Assume for a moment that the deceased did not designate the spouse or the common-law partner as a successor holder. What then?

If the spouse or common-law partner named in a will are accorded an inheritance that includes the TFSA, they can transfer their spouse’s TFSA to their own TFSA within a prescribed time period, called the “rollover period.”

The rollover timeframe is explained as starting at the time of death until December 31 of the following year. During this rollover period the investment income is sheltered from income tax.

If the beneficiary decides to transfer funds to their own TFSA during the rollover period, these transfers are considered to be “exempt contributions” and as such do not require that the beneficiary have room in their own TFSA. However, the amount of the transfer is limited to the fair market value (FMV) of the TFSA as at the original holder’s time of death.

Thus, if at the time of death, the FMV was $50,000 but at the time of transfer the value of the TFSA was $55,000, then the $50,000 could be transferred without any impact.

However, the $5,000 increase would either have to be absorbed by the beneficiary if they have room within their TFSA or be included within the beneficiary’s income within the year of the transfer.

NAMED BENEFICIARY

When you die without a spouse or common-law partner, the TFSA is collapsed at the date of your death. The amount of the TFSA can be transferred to the named beneficiary tax-free, but only up to the amount of the FMV of the TFSA at the date of death. Naturally, the beneficiary would need to have TFSA room to absorb the FMV transfer.

For instance, if the beneficiary had $30,000 of accumulated TFSA room and the FMV of the transfer was $55,000, $30,000 would be transferred tax-free while the excess $25,000 would be considered withdrawn and part of the beneficiaries inheritance with no additional Canadian tax consequences.

This calculation does not account for any increase in FMV that may have occurred since the date of death.

FORM RC 240

It is worth noting that when a contribution is made to the successor holder’s TFSA, the successor holder has 30 days from the date of contribution to fill in Form RC 240, Designation of an Exempt Contribution Tax-free Savings Account (TFSA).

As you can see, there are potential tax complications with a TFSA when a taxpayer passes. Remember also that the provinces and territories are responsible for the rules governing the transfer of assets of a deceased.

Fortunately, the CRA and their provincial/territorial counterparts have agreed that having the named beneficiary on the TFSA application will allow transfers without inter-jurisdictional complications.

Quebec may be an exception, wherein the TFSA transfer goes to the estate and the will of the deceased comes into play.

Since TFSAs are registered with the CRA, an astute taxpayer would want to determine the tax consequences, either when their TFSA has a named survivor or when the will takes precedent.

It’s probably worthwhile to confirm that your CPA is aware that you have a TFSA. Then, should you die unexpectedly, your tax advisor can assist your successor holders or beneficiaries.

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.
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