Author: Mike Holman

Categories
RESP

The Big RESP Series

This post is part of the Big RESP Series. See the entire series here.

I decided to do a detailed series on the RESP program available to Canadians (my apologies to our non-Canadian readers). This topic has been covered by other blogs and myself in various posts but it’s really a topic for several posts. The tricky part of planning this series was to make it long enough to contain most, if not all of the information an investor may want to know about RESPs but not so long that no one would read it because it would contain too much useless information. My plan is to post this series once a week. This first post briefly explains what an RESP is and the various topics I’ll be covering in the series.

These rules are valid as of 2008.

What is an RESP and how does it work?

Registered Education Savings Plan accounts are government sponsored accounts that you can set up at most brokerages, banks or through a financial advisor. You can contribute money into the account and you will get a 20% grant from the government up to a certain amount. There are no taxes payable on investment income during the life of the account so any interest, capital gains or dividends will not be taxed. When the money is withdrawn to be used by a student then it is taxed in the hands of the student, however the original contributions are not taxed upon withdrawal. If the child does not go to school then the plan is collapsed and there are extra penalties to be paid on the plan.

I’ll be covering the following topics in this series. They won’t all be separate posts but some of them will be. Feel free to send me a question or topic if I’ve missed anything.

  • Contributions and CESG – rules and regulations.
  • Other grants – Canada Learning Bonds, Alberta (ACES) plan.
  • Withdrawals – how they work.
  • Eligible Institutions.
  • Plan Collapse – what happens if the student doesn’t go to school?
  • How to set up an account.
  • Pooled plans.
  • Asset allocations and sample portfolio.
  • Accounts – individual and family.
  • Financial analysis of resp vs. non-registered accounts.
  • My suggestion for a better RESP program.
  • How to deal with problems with your accounts.
  • RESPs – Keeping them in perspective.

See the next post – RESP Contributions.

Categories
Real Estate

Anecdotes and Advice from a First Time Home Buyer Part 1 – First Steps and Pre-Approved Mortgages

My friend Christine has kindly agreed to write a series of posts on her experiences with buying a home for the first time which will be posted occasionally.

And so the search begins…..

It goes without saying that home ownership is an enormous financial responsibility, and like many other individuals, I agonized over how my husband and I would be able to afford it. What eased our anxiety was coming up with a manageable monthly amount that we would be able to pay towards a mortgage. We created a realistic budget listing all our expenses to evaluate how much we could afford to spend on our first house without stressing out about the big number. The rough amount that we arrived at is one with which we are comfortable based on our lifestyle. I would suggest that this budget take into account unexpected emergencies or financial difficulties. Lenders advise that the ratio of your debt (including housing payments, car payments, credit cards and utilities) to your income should not exceed 40 per cent of your monthly income.

Online mortgage calculators are a useful tool found on the web pages of CHMC, major banks and lending institutions. What was frustrating though was that they work on the premise that you have a house in mind and know what the mortgage, property taxes and heating will cost. To plug in the numbers, I looked at the feature sheets of recently available homes in my desired neighbourhoods that I was able to obtain from the MLS, on the websites of local real estate agents and of course from open house visits. While the results of your qualifying mortgage will not be precise, at least they will be a reasonable estimate of what you can afford.

My next step in arriving at our financial big picture was to get a pre-approved mortgage (PAM) by talking to a couple of banks and mortgage brokers to determine how large a mortgage we could carry and what lending rate we could obtain. A PAM is a financial lender’s guarantee of a particular lending rate for a specified period of time, usually 90 days, based on your income, down payment and existing debts. A note of caution though with pre-approvals. We learned from a realtor that multiple credit checks can be detrimental to your credit rating. If several banks or brokers will be conducting a credit bureau check, do advise each organization about the multiple reference checks. Some lending institutions can also evaluate your mortgage circumstances based on the information you provide without doing a hard credit check.

The standard mortgage discount seems to be 0.9% below prime to 5.35% on a variable mortgage and a 1.5% discount to 5.74% on a fixed rate mortgage. Do shop around though as your assets and liabilities may impact your ability to negotiate a better deal. Incidentally, ING offers the same rates I found upfront without any haggling; they seem to have a very competitive mortgage product.

Rather than approach banks individually, you may consider using a mortgage broker. These are companies which have the ability to negotiate with a large number of different lenders and are often able to offer a lower rate at a bank than the average person. There is no cost for the services of a mortgage broker as it is the lender whose deal you accept which pays the broker. The Financial Services Commission of Ontario has a list of registered mortgage brokers on their website.

My husband and I have decided not to go the mortgage broker route yet as we have a PAM with a reasonable rate. We will be checking with other banks as we also want to determine what rates we can negotiate as we are also thinking of moving over our line of credit and bank accounts. The other thing that we learned is that you may be obliged to use a mortgage broker that does a full PAM and rate comparison for you even if you do eventually find a better rate elsewhere. Not sure about the veracity of this information; however it is something to verify upfront with a mortgage broker. As it could be months before we find a house, we are taking our time about finding a better rate since our PAM is reasonable and will help us be competitive in the case of a bidding war.

Read the next post in this series “Down Payments and Financing“.

Categories
Personal Finance

Why Over Insuring Is Like Buying Lottery Tickets

In a previous post I indicated a simple formula that can be applied to determine how much life insurance you need. I also went through a real life example (moi) and talked about how you should try your best to calculate how much insurance you need (and how long you need it for) and only buy that amount or even a bit less since your financial situation should improve over time which will lessen your insurance needs.

Sometimes people are tempted to buy large amounts of insurance because they want financial freedom if their spouse dies. Or in some cases they really believe they need an excessive amount of life insurance.

In my opinion the best level of life insurance is an amount that ensures that the surviving spouse can maintain their current lifestyle. Typically a million dollar 20 year policy will provide the surviving spouse with a large increase in their standard of living. Now you might be thinking that the monthly premiums are not that much larger for a million dollar policy than say for $750k but those monthly amounts add up. As well, getting a million dollar policy for 20 years will result in a lot more premiums being paid compared to someone who gets insured for $750k for 10 years and $250k for 20 years.

The problem is that they are paying extra money for premiums for extra insurance that will increase their standard of living. The reality is that they are extremely unlikely to collect this money so this extra money is similar to buying lottery tickets where typically someone might take a small amount of money ie $25/month and play the lotto in hopes of an unlikely payoff which will result in an increase in their standard of living.

The best insurance you can have is financial independence which is usually a long time coming for most of us but saving even $25/month on insurance premiums will hasten its arrival.

Categories
Announcements

Linkfests

Just a few links to posts that really stuck to my mind lately:

Violent Acres, who is easily my favourite blogger came out with this gem recently. I should warn you that her posts are not for family viewing. It’s a bit early but that post might be the post of the year for me.

PaidTwice attempted what I consider to the be the ultimate test in black belt frugality – Making her own baby wipes. As a relatively new father (13 months), I would rank this feat up there with jumping the Snake River Canyon or perhaps sewing your own seat belts. It didn’t really work out for her, but she sounds like she will give it another shot.

The Baglady wrote about her SuperDuperUltraCheap x-boyfriend. This guy puts Mr. Cheap to shame, and I have to agree with Baglady that she made the right choice. There’s something wrong with that guy!

I was in the latest Carnival of Personal Finance hosted by Blunt Money. My interview with favourite reader “Telly” regarding her situation of living in Canada and working in America was listed in the Carnival. I have no idea what “Blunt Money” refers to but she did a pretty good job with hosting the carnival and even created a special puzzle which was quite nice.

This material is original.

Categories
Personal Finance

Changes to 401k Contributions and Canadian Tax Returns

Favourite reader “Telly” left a comment on her “Living and Working in Different Countries” post regarding a recent change to the taxation laws which affect cross border workers:

BTW, some very useful info for any Canadians working in the US (resident or not).

On Friday, the Canada-US Income Tax Treaty was revised and will apparently enter into force on Jan. 1, 2008. Basically, employee contributions to a US pension plan (401k) will be deductible on Canadian tax returns.

Yay!

Here’s the description and link if anyone is interested:

http://www.fin.gc.ca/news07/data/07-070_1e.html

Pensions & other registered plans – mutual recognition

Who it affects: Cross-border commuters – individuals residing in one country and working in the other – who contribute to a pension plan (or any of certain other employment-related retirement arrangements) in the country where they work. Also individuals who move from one country to the other on short-term (up to five years) work assignments, and continue to contribute to a plan or arrangement in the first country. In certain cases, such persons’ employers may also benefit.

Current rule: No rule in respect of contributions, meaning no assurance that they may be deducted for tax purposes in the country of employment.

New rule: Provided certain conditions are met, cross-border commuters may deduct, for residence country tax purposes, the contributions they make to a plan or arrangement in the country where they work. Similarly, those who move for work and meet certain conditions can deduct, for source country tax purposes, their contributions to a plan or arrangement in the other country, for up to five years. In both cases, accruing benefits are not taxable.

Examples: (1) A resident of Canada is employed in the U.S., and contributes to an employer-sponsored pension plan there. The employee’s contributions to the plan (up to the employee’s remaining RRSP deduction room) will be deductible for Canadian tax purposes. (2) An employee of a Canadian company is assigned for three years to a related U.S. company. The employee keeps contributing to the employee pension plan of the Canadian company. For U.S. tax purposes, both the employee and the U.S. company will be able to deduct the contributions.

Significance: Facilitates movement of personnel between the two countries by removing a possible disincentive for commuters and temporary work assignments.

Application: Applies for taxation years that begin after calendar year in which the Protocol enters into force. However, if ratification is completed in 2007 the rule applies for taxation years that begin in 2008 (i.e. the same calendar year that the Protocol enters into force).

Categories
Personal Finance

How Much Life Insurance Do I Need?

Calculating the amount of life insurance you need is a lot like planning for your retirement. You need to figure out your financial goals, calculate how much income is necessary for those goals then figure out how much money you need to make that income happen.

Please note: this only applies to term insurance. Universal insurance (which I don’t recommend by the way) is an entirely different product. Term insurance is insurance where you pay a monthly or annual premium for an amount of insurance for a set amount of time which will be paid into your beneficiary if you die. For example someone might buy $250,000 of insurance which is valid for ten years. If they die within those ten years then the $250k will be paid to the beneficiary or the estate.

Calculate how much life insurance you need

I’ll use myself as the example on this calculation. My wife doesn’t work and we decided that our goal for life insurance was to get enough to ensure that she wouldn’t have to work again. This doesn’t mean retiring in luxury but making enough money to pay the bills and hopefully have a similar standard of living to what we have now.

Annual Living Expenses

First thing to do is figure out how much money is needed to maintain our current lifestyle. We kept track of our expenses for the first six months of this year and determined that our basic living expenses are about $32,000 per year. This does not include mortgage payments or any other debt payments since they will be paid off with the insurance. Since the plan is for my wife not to work and she won’t qualify for any government pensions for quite a few years we need enough insurance to be able to pay off our debts and then generate $32k net income per year which is about $35k gross assuming a portion will be coming from Canadian dividend stocks. I’m assuming that any of the $32k in expenses that are because of me, will be able to cover expenses for our one child. If you have more kids then you might want to increase the annual amount to compensate for this.

Required Portfolio Size for self-insurance

How much do you need to generate $35k per year? The normal figure for retirement planning is to use the 4% rule. I think for this purpose assuming that you can take 5% of a portfolio is safe enough that you won’t run out of money. So therefore $35k is 5% of $700,000. We need enough insurance to make sure that we end up with a portfolio of $700k and no debts. If my wife worked then I would subtract her income from the $35k amount.

Currently we already have a portfolio of $230k and our debts are about $200k.

Therefore: insurance needs = final portfolio amount + debt – current portfolio = $700k + $200k – $230k = $670,000. In fact I have about $750,000 of insurance which is too much.

Summary:

  1. Calculate a gross income desired according to your financial goals. Use taxtips.ca for guidance regarding taxation amounts.
  2. Use the following formula: insurance amount = (gross income desired – survivor income) / 0.05 + total debt – current portfolio.

A couple of points. I use the divisor of 0.05 but if you want to be more conservative then use 0.04 (4% rule).

I’m assuming in my example that the beneficiary is reasonably young and won’t collect any type of pension for a long time. If the survivor will be older ie 50+ then you might want to increase the divisor to 0.06 because they will be eligible for government pensions which will eventually reduce the amount of insurance income necessary.

When I talk about taking 4% rule or 5% rule this refers only to the amount of money withdrawn from the portfolio in the first year. Every year after that is the initial amount adjusted for inflation. Ie in the example above, the withdrawal in the first year is $37k. If inflation is 3% then the withdrawal in the second year is $37k + 3% = $38,110. In the third year you would take $38,110 = 3% = $39,250.

You’ll notice that two of the main factors in determining the amount of insurance needed are current debt and current portfolio value. Because of this there is no point in stressing out about the perfect amount of insurance to get because that ideal amount will change every year. This is why you don’t want to get too much insurance – more about that tomorrow. Generally speaking if your debt is going down and your investment portfolio is going up then your insurance needs are going down so if you buy too much insurance today, then in a few years you will have way too much insurance.

Another thing to avoid is to have too much insurance for too long. You might need $750k or even a million dollars according to your plan but you probably don’t need it for 20 or 30 years. Try to figure out how long you need this insurance for and buy accordingly. In my case I bought $500k for 10 years (plus $250k I already had from a group plan) and after that I might only need $250k for about another 5 years or so. Once I’m retired or close to it (hopefully in about 15 years) then I won’t need any insurance at all because our debts should be zero and our investment portfolio will provide all the necessary income.

Why Over Insuring Is Like Buying Lottery Tickets.

More info

Senior Term Life Insurance

Categories
Announcements

Mr. Cheap and Four Pillars are Joining Forces!

Welcome to the new blog! Mr. Cheap & Four Pillars have decided to team up and publish from one blog instead of two. Why are we doing such a crazy thing? Mainly because we want to keep blogging for a long time and judging from the number of blogs that come and go, it appears that posting on a regular basis for any significant length of time is a tough thing to do. Looking around the Canadian personal finance blog world it appears that there are only two blogs (Canadian Capitalist and Canadian Financial Stuff), which have been posting five times a week for longer than a year.

The other reason is for variety, having two different posters plus the odd guest poster should add a lot more experience and expertise to post from which should result in a better product for our readers.

The scheduled posts will remain the same for the blog – one new post every weekday morning with the occasional bonus post now and then.

You’ll notice the new title of the blog which reflects both of our old blogs as well as the new theme. If you’re thinking the theme looks a bit familiar it’s because it’s the same one as used by Canadian Capitalist. It would have been nice to find a theme that was more original but it really is a good theme!

Feel free to let us know what you think!

Categories
Business Ideas Frugal

I can be frugal too

I’ve read a lot of posts on various blogs about being frugal. I’ve never been one to worry about my spending until about a decade ago when I decided to stop spending more money than I made. Since then I’ve been a lot better with money but it’s only been the last year or so when I’ve really started to think of myself as being more frugal than I used to be. I’m still not very frugal by a long shot but I thought I would share an example of where I wanted to buy something pretty expensive but in the last year or so I changed my mind and choose something much cheaper.

When we bought our new house I had my heart set on getting a natural gas line run to the back of the house and buying a natural gas bbq. The main benefit of natural gas over the normal propane is that you will never run out so you don’t have to go and get the tank filled up every so often. We did get the gas line run but I didn’t buy the bbq because we were too short of money. I never did price out the natural gas bbqs but I’ve heard they are at least $500 which is a lot of cash.

This year the “new me” decided that it wasn’t worth it to buy the more expensive bbq and I would get a cheaper propane one instead. A couple of months ago Loblaws (local grocery store) had bbqs for $100 so I grabbed one. I have to say that this bbq is one of my best purchases ever. It was relatively easy to assemble and works great. My old bbq was not that safe anymore, was much hotter on one side than the other and it used to shoot a lot of flames at me while I was trying to cook which I didn’t much like! The new bbq is the same size as the old one, very hot, perfectly even temperature and although the food doesn’t taste any better, it’s a lot easier to cook without burning everything. I still have to fill up the tank once in a while but there is a gas station just around the corner from where I live so it’s no big deal.

I have to conclude that I’m happier with the cheap propane bbq than I would have been with the expensive natural gas version.