We thought this would be a timely article given the season. For advice on your specific situation, please don't hesitate to give us a call.
This article is courtesy of www.advisor.ca
What to do with the tax refund?
May 23, 2008 | Mark Noble
All that tax-planning work is now paying off and your client's rebate cheque is likely in the mail. The issue now is what to do with it. A popular answer is to pay off the mortgage.
BMO Financial has released some statistics that make a strong case for paying down the mortgage before doing anything else with the tax refund. According to John Turner, director of mortgage sales for BMO, a $1,400 investment now at the beginning of a 25-year mortgage could save a client as much as $38,000 in future interest payments.
"Typically with a mortgage amortized over 25 years, if we use the simple example of $200,000 at a 6% fixed rate, the interest accumulated over that amortization period would be $184,000," Turner says. "According to Revenue Canada, the average income tax refund this year is $1,400. If that's applied to the mortgage, it will save about $38,000 in interest costs over the life of the mortgage, and at the same time reduce amortization."
Debt reduction is obviously not an investment return; still, there are few investments that guarantee to put that type of money in a client's pocket. A refund could also be deployed to pay down higher interest debts on loans or credit cards, but Turner notes the amortization period of the mortgage makes it highly compelling to pay off as early as possible — even it if means carrying higher-interest debt on other things.
"Loans and credit cards tend to have the highest interest rates, but those amortizations are shorter," he says. "Depending on how the payment situation is, it may make more sense to put it towards the mortgage because of the amortization. In terms of total interest costs, right at the beginning of the mortgage is the best time to pay it down, because the sooner you can pay down the mortgage or increase your payment, clearly the more interest you'll save over the life of the mortgage."
David Phipps, a CFP and senior financial advisor with Assante in Ottawa, says debt-repayment should factor high on deployment of the refund, but he generally believes higher-interest debt should be tackled first.
"Sometimes these things are so obvious you kind of feel like an idiot even mentioning them, but I would say an excellent use of tax refund is to reduce debt. You should start with the debt that has the highest interest rate," he says. "It doesn't make sense to put the money against the mortgage if you have $1,000 debt on your credit card that never gets paid off."
Phipps stresses it's important to consider the specific circumstances of the client before definitively deciding to pay off the debt first.
"Assuming they have RRSP contribution room and assuming a reasonable rate of return in the RRSP, they are probably better to take that money and put it in their RRSP because so many Canadians have not fully used their contribution room," he says. "If you've got somebody who has fully maxed out their RRSP room, the next best thing to do with it is to pay down some debt. If a person has significant RRSP contribution room and if the contributions are reducing tax at a high marginal tax rateit makes sense to put money in the RRSP rather than pay down debt."
Phipps determines which type of debt to pay off first by considering whether it's tax-deductible or not. A home equity line of credit being redeployed for investment purposes would not rank as high as a traditional mortgage where the interest is non-tax-deductible.
"You shrink your liabilities in the following order: non-tax-deductible debt at the highest interest rate, non-tax-deductible at the lowest interest rate and finally tax-deductible debt," he says. "Home equity line of credit they borrowed to purchase an investment so that the interest is tax-deductible is not the first place you've got to pay it down, because having tax deductible debt alters the after-tax cost of the loan."
Fellow Ottawa-based CFP Diane Koven says there is no surefire answer as to whether it's better to invest the refund or pay down debt. She tends to favour the latter purely for the reason that it gives her clients peace of mind.
"There is no way to know what is better until you're looking back from years ahead, from when you did the calculations. You can't really know in advance what is going to be better in a dollars and cents way," she says. "Usually it turns out that there is not a tremendous difference or none at all. The main thing that tips the scale is the psychological aspect. Paying down the mortgage makes people feel more secure."
Koven attempts to bridge the two schools of thought by insisting her clients maximize their RRSP contributions and then use the income tax refund to pay down the mortgage.
"When you get the refund, you'll contribute to the mortgage. It feels good. You can sleep easier when you've done it. It no longer becomes an either/or situation. You've accomplished both, you're taking care of the future from both angles and you don't really feel like you're second-guessing yourself," she says.
Peter Ficek, a Calgary-based CFP, agrees that psychology factors heavily into the decision to use the refund against the mortgage.
"When it comes to paying down the mortgage versus RRSP decisions, most people reduce their planning to the flip of a coin," he says. "If the decision is to pay down the mortgage on a principal residence, people think the decision is a personal one and view it in a qualitative context, as in 'would they sleep better at night with a paid-down mortgage or with a retirement pension?'"
Ficek says because of the emotional nature of the decision, this is a classic situation where the objective advice of a financial planner is needed.
"Seek out a qualified planner and sit down and go over the quantitative and qualitative issues rather than just doing the flip of the coin," he says. "A mortgage broker is going to tell you to pay down the mortgage and an RRSP salesman is going to tell you to pay down the RRSP. A financial planner is going to make a decision by looking at the client's goals and objectives."
Tuesday, May 27, 2008
Thursday, May 1, 2008
Simplify Your Banking - Simplify Your Life
Everybody seems to have a fast-paced, needed-it yesterday lifestyle these days. Does the simple life still exist? Sure. And the good news is that when it comes to your valuable time, routine changes can free up precious hours and days. Some simplifications, like how you bank, can save both time and money.
Consider the financial and personal lifestyles of people in their mid-30s to early-50s. Their careers are demanding but fulfilling. They are able to afford things they struggled to get before. Still, they are stretched in every direction. They have full social calendars, and participate in their kids' schedules as well – whether those kids are joining every extracurricular activity imaginable, embarking on a university degree, enjoying “financially assisted” independent living or getting married. Many people in this age group also have parents who require more support and assistance as they grow older.
For this “sandwich” generation, the challenge is managing the present while keeping an eye to the future. They need to spend wisely, putting aside enough money to provide tomorrow's income while meeting their current obligations. A financial plan is important, and a trusted advisor can also help people change their banking and day-to-day finances.
THE WAY WE BANK TODAY
To save minutes in bank line-ups, many people have become self-serve bankers. However, an expanding range of financial transactions (such as debits, cheques, pre-authorized payments and transfers among accounts) is making the job more complex. Many Canadians have a chequing account to manage daily expenses. Income goes into the account, while bills, mortgage payments and other monthly expensesflow back out. If there is anything left over at the end of the month, the money may be invested or put away in a “high-interest” savings account for a rainy day, emergency or vacation.
Many also have mortgages for their home and perhaps cottage. Loans or lines of credit (sometimes based on home equity) can be arranged for larger expenses, such as new cars, furniture or home renovations. And, of course, there are also credit cards that may provide benefits at a particular store, offer convenience or earn reward points.
SPAGHETTI PLATE MANAGEMENT
The bottom line is that, on average, Canadians likely have eight or nine separate banking products from two or more financial institutions. Sometimes, you may find yourself playing one product against another. For example, you might write a cheque on your chequing account to reduce a credit card balance, only to discover that you need to transfer funds from a savings account because payday is still two days away. Furthermore, you may use a credit card for smaller purchases because you're not sure there is enough money in your chequing account. In fact, the management of so many different cards, debts and accounts can be such an onerous accounting process that it has been referred to as “spaghetti plate” banking. People often devote so much time and effort to untangling their finances that they resign themselves to muddling their way through. But the problems don't stop there.
DIVERSIFICATION OF DEBT
It's safe to assume that each product has its own set of administrative costs built into the pricing. Each product also has a different interest rate attached to it, based on the risk of defaulting payment to the lender or the benefit to the user. For example, credit cards often carry an interest rate of 18 per cent or higher because they are unsecured debt. In other words, there's a greater risk a cardholder will not repay the balance because the debt isn't tied to a specific security. Credit cards may also be subject to higher rates because they can be susceptible to fraud. A mortgage, on the other hand, is secured by the property (i.e., the lender can force the sale of the home to recoup the money), so mortgages often offer the lowest rate around. Professor Moshe Milevsky of York University conducted a study in 2005 that looked at the way Canadians manage their debt. His conclusions and recommendations were very clear: the strategies people use are costing them time and money.
He observed that Canadians diversify their debt by “space” (spreading debt over several different products) and by “time.” In other words, because of the way people bank, they delay paying off debt even though sufficient money sits idle in their accounts. So they end up paying more in interest costs than necessary.
CONSOLIDATION OF DEBTS AND ASSETS
Professor Milevsky's advice is to eliminate as many banking products as possible by consolidating debts and making better use of short-term, non-registered assets. For instance, if you can eliminate non-secured credit cards, personal loans, car loans and lines of credit and wrap them all into a single secured loan, such as a mortgage, you could significantly reduce the amount of money you're currently spending servicing the debt at higher interest rates. As a simple example, if you had a $2,000 credit card debt attracting an 18 per cent interest rate and a personal loan of $8,000 at 7.5 per cent, your monthly interest costs would be roughly $80. If that debt were consolidated into a line of credit at six per cent, the monthly interest cost would be $50 - that's a reduction in cost of almost 40 per cent! Multiplied over time and larger loan amounts, this one change in how you manage your finances could save you thousands.
Milevsky also suggests that there is a more effective way to manage money than having special-purpose savings accounts. Even if your savings are earning three per cent interest, he advocates applying that money against your debt. The interest earned on your savings account is taxable, but using it to pay down your debt means everything you save goes straight into your pocket. How does this work? Taxes will reduce your savings account earnings, but reducing a debt that is charging six per cent means a six per cent after-tax benefit to you. Why would someone want to use all their short-term assets to pay down their debt? Well, if you're using a line of credit, you can always take that money back out if you need it. Instead of having money sitting idly around earning virtually nothing in pre-tax dollars, you can apply it against debt and save some real money, until you need to use it.
THE IDEAL SOLUTION
Imagine the possible savings if you were able to combine all your debts into a lower interest rate product (such as a secured line of credit), but could also make that line of credit your chequing account. If every deposit into this account reduced your level of debt, then why not flow your income through the account as well?
That's exactly what “all-in-one” accounts are designed for. An all-in-one account offers a host of advantages:
* It eliminates “spaghetti plate” banking, thereby reducing your banking time and effort
* It offers the potential to significantly reduce interest costs
* It provides a way to maximize the benefit of every dollar you have
* It gives you increased flexibility in monthly payments now, instead of meeting fixed monthly obligations, you have the option to pay interest only, if you like
* It simplifies your financial life – just one account to worry about and a clear picture of your financial situation, while every banking receipt gives you a snapshot of your finances.
Life can be exciting, chaotic and sometimes exhausting. That's why it makes sense to find ways to streamline your activities and reduce the demands on your time and money. A good place to start is by simplifying your banking. Not only can a few easy steps save you time, money and effort today, but this approach can go a long way to helping you get out of debt faster. And that's the first step towards sound retirement planning.
Content provided courtesy of Manulife Investments
© Copyright of this article is held by The Manufacturers Life Insurance Company (Manulife Financial). You are free to make copies of this article and to distribute it, either in paper form or electronically, as long as you do not change or remove any part of this work. All other uses are prohibited.
Consider the financial and personal lifestyles of people in their mid-30s to early-50s. Their careers are demanding but fulfilling. They are able to afford things they struggled to get before. Still, they are stretched in every direction. They have full social calendars, and participate in their kids' schedules as well – whether those kids are joining every extracurricular activity imaginable, embarking on a university degree, enjoying “financially assisted” independent living or getting married. Many people in this age group also have parents who require more support and assistance as they grow older.
For this “sandwich” generation, the challenge is managing the present while keeping an eye to the future. They need to spend wisely, putting aside enough money to provide tomorrow's income while meeting their current obligations. A financial plan is important, and a trusted advisor can also help people change their banking and day-to-day finances.
THE WAY WE BANK TODAY
To save minutes in bank line-ups, many people have become self-serve bankers. However, an expanding range of financial transactions (such as debits, cheques, pre-authorized payments and transfers among accounts) is making the job more complex. Many Canadians have a chequing account to manage daily expenses. Income goes into the account, while bills, mortgage payments and other monthly expensesflow back out. If there is anything left over at the end of the month, the money may be invested or put away in a “high-interest” savings account for a rainy day, emergency or vacation.
Many also have mortgages for their home and perhaps cottage. Loans or lines of credit (sometimes based on home equity) can be arranged for larger expenses, such as new cars, furniture or home renovations. And, of course, there are also credit cards that may provide benefits at a particular store, offer convenience or earn reward points.
SPAGHETTI PLATE MANAGEMENT
The bottom line is that, on average, Canadians likely have eight or nine separate banking products from two or more financial institutions. Sometimes, you may find yourself playing one product against another. For example, you might write a cheque on your chequing account to reduce a credit card balance, only to discover that you need to transfer funds from a savings account because payday is still two days away. Furthermore, you may use a credit card for smaller purchases because you're not sure there is enough money in your chequing account. In fact, the management of so many different cards, debts and accounts can be such an onerous accounting process that it has been referred to as “spaghetti plate” banking. People often devote so much time and effort to untangling their finances that they resign themselves to muddling their way through. But the problems don't stop there.
DIVERSIFICATION OF DEBT
It's safe to assume that each product has its own set of administrative costs built into the pricing. Each product also has a different interest rate attached to it, based on the risk of defaulting payment to the lender or the benefit to the user. For example, credit cards often carry an interest rate of 18 per cent or higher because they are unsecured debt. In other words, there's a greater risk a cardholder will not repay the balance because the debt isn't tied to a specific security. Credit cards may also be subject to higher rates because they can be susceptible to fraud. A mortgage, on the other hand, is secured by the property (i.e., the lender can force the sale of the home to recoup the money), so mortgages often offer the lowest rate around. Professor Moshe Milevsky of York University conducted a study in 2005 that looked at the way Canadians manage their debt. His conclusions and recommendations were very clear: the strategies people use are costing them time and money.
He observed that Canadians diversify their debt by “space” (spreading debt over several different products) and by “time.” In other words, because of the way people bank, they delay paying off debt even though sufficient money sits idle in their accounts. So they end up paying more in interest costs than necessary.
CONSOLIDATION OF DEBTS AND ASSETS
Professor Milevsky's advice is to eliminate as many banking products as possible by consolidating debts and making better use of short-term, non-registered assets. For instance, if you can eliminate non-secured credit cards, personal loans, car loans and lines of credit and wrap them all into a single secured loan, such as a mortgage, you could significantly reduce the amount of money you're currently spending servicing the debt at higher interest rates. As a simple example, if you had a $2,000 credit card debt attracting an 18 per cent interest rate and a personal loan of $8,000 at 7.5 per cent, your monthly interest costs would be roughly $80. If that debt were consolidated into a line of credit at six per cent, the monthly interest cost would be $50 - that's a reduction in cost of almost 40 per cent! Multiplied over time and larger loan amounts, this one change in how you manage your finances could save you thousands.
Milevsky also suggests that there is a more effective way to manage money than having special-purpose savings accounts. Even if your savings are earning three per cent interest, he advocates applying that money against your debt. The interest earned on your savings account is taxable, but using it to pay down your debt means everything you save goes straight into your pocket. How does this work? Taxes will reduce your savings account earnings, but reducing a debt that is charging six per cent means a six per cent after-tax benefit to you. Why would someone want to use all their short-term assets to pay down their debt? Well, if you're using a line of credit, you can always take that money back out if you need it. Instead of having money sitting idly around earning virtually nothing in pre-tax dollars, you can apply it against debt and save some real money, until you need to use it.
THE IDEAL SOLUTION
Imagine the possible savings if you were able to combine all your debts into a lower interest rate product (such as a secured line of credit), but could also make that line of credit your chequing account. If every deposit into this account reduced your level of debt, then why not flow your income through the account as well?
That's exactly what “all-in-one” accounts are designed for. An all-in-one account offers a host of advantages:
* It eliminates “spaghetti plate” banking, thereby reducing your banking time and effort
* It offers the potential to significantly reduce interest costs
* It provides a way to maximize the benefit of every dollar you have
* It gives you increased flexibility in monthly payments now, instead of meeting fixed monthly obligations, you have the option to pay interest only, if you like
* It simplifies your financial life – just one account to worry about and a clear picture of your financial situation, while every banking receipt gives you a snapshot of your finances.
Life can be exciting, chaotic and sometimes exhausting. That's why it makes sense to find ways to streamline your activities and reduce the demands on your time and money. A good place to start is by simplifying your banking. Not only can a few easy steps save you time, money and effort today, but this approach can go a long way to helping you get out of debt faster. And that's the first step towards sound retirement planning.
Content provided courtesy of Manulife Investments
© Copyright of this article is held by The Manufacturers Life Insurance Company (Manulife Financial). You are free to make copies of this article and to distribute it, either in paper form or electronically, as long as you do not change or remove any part of this work. All other uses are prohibited.
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