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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

Saving Money Purchasing Computers

I have a very definite philosophy for buying computers. I tell it to anyone I meet who is planning a purchase, they all agree that it makes complete sense, and then none of them ever actually do it.

Computers drop in value quickly as we call know. They’re right up there with cars (except worse) in that you buy it and it starts depreciating quickly and immediately. This isn’t going to change in the near (or arguably far) future (I can post arguments backing this up if you want, but just Google Moore’s Law and you’ll get the basic gist if you don’t believe it).

Based on this, my philosophy has always been to buy the cheapest computer that will meet my CURRENT needs, and give myself permission to upgrade once I run in to ANYTHING I want to run that the computer can’t handle. Even if its fairly frivolous (such as watching videos with cutting edge video encoding or playing a new game). You will have to upgrade more often following this approach, but if you’re buying $1000 machines instead of $3000 machines the math still works out.

Say a cutting edge machine costs $2500. Six months from now, it’ll be the “budget beast” they’re selling for $600. Buying the high end machine will give your computer an added lifespan of 6 months. I usually get 3 years out of the low end machines I buy, so I’m paying ($600 / 36 = $16.67 / month). With the higher end machine, lasting the extra 6 months, you’d be paying ($2500 / 42 = $59.52 / month).

So clearly (even if you want to quibble about the numbers) we’ve disproved that paying more for a computer “so it will last longer” is a good strategy. Related to this is the idea “if I pay more for a computer, it’ll be higher quality”. It won’t. Computers are made with commodity hardware (it all pretty well functions the same way), and more expensive is usually just newer, not higher quality (some exceptions to this, but you can actually buy lower performance higher quality parts cheaper than higher performance lower quality parts).

The second argument people make for buying an expensive new machine is “it will let me do XYZ which the cheaper one won’t”. Often XYZ is something the cheap one WILL do (you can’t purchase a computer that isn’t powerful enough to surf, playing music and write e-mails). Unless you’re going to be doing video editing or playing the latest first person shooter game (3D games where you run around blowing other people up), you probably don’t need the latest and greatest machine. If you think you *MAY* want to do one of these processor intensive activities, get the cheap machine, find an older version of the software, and if you do use it and like it, then buy the more expensive machine (most peoples’ intentions are never followed through on, so paying lots of money to have a machine powerful enough to run software that you’ll never use is a waste).

I’m a computer nerd, work in the field, do a fair bit of programming and whatnot, and I’m using a 3 year old notebook (notebooks are less powerful dollar-for-dollar than desktops). A low-end new computer is more hardware than I need (although if its cheap enough I’ll take it), how many people are out that that honestly need more horsepower than I do?

The third argument, which no one ever says out loud, is that a new computer has bragging rights. Your friends come over to a dinner party and are interested in seeing the new Vista. Computer nerds will help fix your computer so you can send an e-mail, and admire how fast it runs. Bragging rights are great and all that (hell, how many expensive cars would be sold if not for bragging rights), but is it really worth an extra $2K to try to make people envious?

Next time you’re going to buy a computer, look at the one you would have bought, buy a cheap one instead, put the difference in a PC Financial bank account ear-marked as your “new computer fund”. When you run into something your old computer can’t handle, buy a new one out of that fund. I can guarantee you that the same amount of money will last you FAR, FAR longer than buying top-of-the-line would have, and after the first computer, you’ll be running a more powerful machine too (the second cheap one will be way better then the first expensive one would have been).

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
Personal Finance

Deciding Where to Live

Some time ago, in a comment, Telly expressed interest in how I go about comparing different living situations. This seems to be as good an inaugural topic as any :-).

My current living situation is a house that’s rented out by the room (with 3 of us in the main house) plus a basement apartment that’s rented out separately. I pay $500 / month all inclusive (with one shared bathroom and a shared kitchen). Before this, I lived with my ex-girlfriend paying half the rent ($440) + cable + some utils. Before that I rented a basement apartment for $650 / month all inclusive.

I’m considering staying here, renting a cheap downtown bachelor or buying a house / condo and renting out the extra rooms.

For a downtown bachelor, the advantages would be lower transit fees (I wouldn’t need a monthly pass if I was within walking distance of my job, this would probably cut my $99 tax-deductible transit costs to ~$40 / month), shorter commute (I spend 1.5 hours on the subway each day) and not getting annoyed by my roommates. The cons would be more expensive (it’d probably be a minimum of $750 for anything within walking distance of my work), I’d probably need to make a 1 year commitment, I may change jobs (but would then have an apartment that might not be close to my new work).

Buying a house or condo and renting out rooms is tempting. The pros would be I could be living for $500 or less a month, with my rent going to the housing expenses. On a place like the condo I currently own, I could live in the solarium, then rent out the two bedrooms. If I could get $500 for each, that’s pretty well cover my costs (and basically my downpayment / equity would be covering my monthly shelter costs). The negatives include room-mate aggravation, a longer commute (since the area I’d want to purchase in is even further from downtown then where I am currently) and having more cash tied up in real estate (this is a debatable con).

Another option (that I just came up with while writing this), would be to rent a house or a multi-bedroom apartment/condo then rent out individual rooms to subsidize what I’m paying. I came across a 3 bedroom house for $1200 / month. If I could get $500 each for the two other bedrooms, I’d be living pretty darn cheap.

Currently I’m leaning toward staying where I am (moving is a pain), but recently one of my housemates gave me the silent treatment for 3 days because I wouldn’t get off the phone with a friend and go help him with his computer, so after experiences like that a studio apartment starts looking mighty appealing…

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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.

Categories
Announcements

Carnival Links

Just wanted to let you know that I was in a couple of Carnivals recently.

kmull hosted the #117th Carnival where I submitted my article “Ignore the Last Ten Years”.

Money, Matter, and More Musings (MMMM) – clearly a prime candidate for the Carnival of Long Blog names, hosted the #118th Carnival and included my submission “Save Money by Returning Items”.

Categories
Investing

Benefits of RRSPs Part 2

Recently I wrote a post about the benefits of RRSPs and showed a simple model comparing a dividend stock in a rrsp versus a non-registered account. In that model, the rrsp investment came out ahead.

Today I want to cover another scenario which involves an investment that has capital gains and no dividends. We’ll compare what happens if this investment is held inside an rrsp or in a non-registered account. In this case there is no “tax drag” from annual dividends.

One of my favourite readers, “Telly” pointed me to an excellent article that covers this very scenario on martingale’s site. This article explains exactly why the investment in the rrsp does better than outside the rrsp much better than I ever could. Basically he is saying that since the money in the non-registered account has already been taxed once (when it was earned), any taxes (interest, dividend or capital gains) are double taxation. The money in the rrsp has never been taxed so even though it’s taxed as income upon withdrawal, it comes out ahead of the non-registered investment because it is only taxed once.

In the attached spreadsheet I did a fairly simple model for this scenario. Martingale’s article uses the proper equations but I like to see the numbers year-by-year on a spreadsheet. In this case I used a $10,000 contribution into the rrsp and there is 40% tax deferred. In the non-reg account, there is only $6,000 because the 40% tax was paid upon earning it. After 20 years the investments in both accounts are sold while the investor is still working. This isn’t perfectly realistic but it keeps it simple.

At the end of 20 years the proceeds of the rrsp account are $27,966 and the non-registered account is $23,573. The rrsp account ended up with an after tax return of 8% and the non-reg got 6.3%. The rrsp account ended up with 19% more money than the non-registered account.

I think the moral of this story is that when considering the differences between rrsp accounts and non-registered accounts we have to remember that the non-registered money has already been taxed at the marginal tax rate of the investor. A lot of investors (including me) intuitively think that because the rrsp money is taxed at the marginal rate upon withdrawal that unless you are in a lower tax rate in retirement (when the money would be withdrawn), you might be better off having the money in a non-registered account. Clearly this is not the case.

As far as long term investments go (ie retirement money) you should put this money into an rrsp if possible and only invest outside the rrsp if there is no more room.