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How To Use Your Tax Refund

You were a good citizen. You were organized, gathered all of your tax forms, receipts and filed your taxes promptly.

As a result, you are now the recipient of a nice chunk of change from Justin and the Premiers in the form of your tax refund!

Your tax refund might feel like free money, but it is not. In actuality, this is the repayment of an interest-free loan that you gave the government without even knowing it. Throughout the year, you either make periodic remittances if you are self-employed (or otherwise required) or you have tax taken off each paycheque by your employer. Your tax refund is the return of overpayments that you made relative to the income tax that you actually owed at the end of the year. Hence, this is why it is called a refund. Your tax refund was indeed your money all along.

But now, the big question is, “How should I use my tax refund?”

Before you buy that new iPad or fly to Jamaica, here are a handful of recommendations.

How You Should Use Your Tax Refund

1. Pay Down Consumer Debt

Consumer debt is debt related to consumption, instead of debt that is tied to an asset that can appreciate.

This is priority #1. This would likely be priority #1 on any list for that matter.  Paying down your consumer debt is so important that it should likely be #1, #2 and #3 on this list.

This prolonged low-interest rate environment that we have lived in seems to have lulled many Canadians into a false sense of security around carrying consumer debt. According to the 2018 BDO Affordability Index, 46% of Canadian households don’t earn enough income to live debt free.

But not all debt is created equal. The largest area of concern is high-interest debt.  High-interest debt generally comes in the form of credit cards (up to 20% APR), payday loans (>100% APR and upward), and high-interest lines of credit (10% APR or more).  Rates mentioned are illustrative and not a minimum threshold for concern.

If you are carrying high-interest debt, paying it down will almost always be the best use of your funds. You should focus on paying down your debt with the highest interest rate first.

In essence, consumer debt is what you owe for the material things or that you already have or the experiences that you have already had. To put it another way, instead of using your tax refund to buy an iPad, you still need to pay for the iPad that you purchased years ago.

2. Open An RESP For a Family Member

Education costs are continually on the rise.  A year of post-secondary education at a Canadian university can cost up to $20,000. Starting to save early in a child’s life is prudent given the rising costs.

RESPs are an excellent way to save for a child’s education for a few reasons.

  • Free Money!

The Government of Canada matches 20% of your contributions, up to a maximum of $500 per year. This is called the Canada Education Savings Grant (CESG).

There is also lifetime maximum for CESG contributions that the government will make of $7,200.

  • Tax-deferred investment growth

Money held within an RESP grows tax-deferred. Similar to an RRSP, all of the growth of the funds within the RESP has the benefit of tax-deferred compounding. Tax-deferred investment growth has been proven to be a winning wealth builder.

  • Taxed in the hands of the beneficiary

Unlike an RRSP, contributions made by yourself into the RESP are not deductible from your income. As such, you will be contributing after-tax dollars into the account, similar to a TFSA.

However, the CESG amounts and the investment income are then taxed in the hands of the beneficiary (i.e. your child or niece/nephew) upon withdrawal. This can provide significant tax savings. Students are typically in a low-income period of their lives during schooling, and they should generally be in a lower tax bracket than the contributor during this time.

These advantages should be capitalized on early and often in the life of the beneficiary to maximize the CESG and tax deferral. Use your tax refund to start an RESP and take the free money!

3. Contribute to your RRSP/TFSA

If you don’t require the free CESG money for a family member, you can shift your attention to your personal savings.

Whether you contribute to your TFSA or your RRSP will vary based on your individual situation. I prepared a rundown on things to consider when answering the question, “Is an RRSP contribution right for me?

When making your determination of where to put the money, the primary question that you should ask is “When will I need the money?”

Funds in your RRSP are intended for your retirement, but they could also be withdrawn to buy a home using the Home Buyers Plan or to go back to school via the Lifelong Learning Plan.

Another perk of an RRSP contribution is that it can increase your tax refund for next year if you deduct it against your 2019 income.

If you need this money for the near term (other than for purchasing a home or for going back to school), TFSAs provide added flexibility around withdrawals. This is an ideal place to keep your emergency fund. If you do not have an emergency fund in place, then bump this up ahead of the RESP plan in terms of priority.

If you have questions around what option is best for you, you should speak with a financial planner.

4. Mortgage Paydown

The market is sending mixed messages about where interest rates are going in the intermediate term. However, we know that we have been experiencing a prolonged low-interest-rate environment.

The party should come to an end sooner-or-later, and rates could rise.

There are a few key benefits to paying down your mortgage:

  • Defence against rising rates

As rates rise, so will your mortgage payments on a variable mortgage. Even if you have a fixed rate mortgage, it will come up for renewal inevitably, and all else being equal, your payments will increase along with the interest rate.

  • Guaranteed rate of return

Let’s assume that you have a mortgage rate of 3.5%. By paying down a portion of your mortgage, you have just achieved a guaranteed after-tax return on your investment of 3.5%! I challenge you to find a guaranteed investment that will pay you that rate of return after-tax.
This guarantee, however, doesn’t contemplate foreclosure risk, or any of the other risks associated with homeownership. That said, paying down your mortgage is an excellent way to achieve your long-term financial goals.

  • Lower monthly payments

As you lower your outstanding balance, your monthly payments become lower.  Some mortgages implement these changes immediately, while others will update the payments a set interval.  In either case, when you have less to pay back, you can pay less each month.

  • Mortgage renewal flexibility

A lot of digital ink has been used lately discussing the challenge that some are facing renewing their mortgages.

The Government of Canada introduced rules to stress-test an individual’s ability to afford their mortgage payments when rates rise. As interest rates rise, so does the benchmark rate for the stress-test.

By paying down your mortgage, your outstanding balance and future payments will be reduced, and this will ease the challenge of meeting the stress test.

When deciding whether or not to use your tax refund to pay down your mortgage, you should investigate the repayment terms before making your decision. Some are flexible, while some are stringent and may come with fees or penalties. Speak with a professional to understand the implications of making a pre-payment against your mortgage.

5. Get a Fee-Only Financial Plan

Naturally, this is a self-serving recommendation, but I wouldn’t be doing my job if I didn’t mention it.

A financial plan is an investment in your overall financial well-being.  Having a solid financial footing sets you up for success in all other aspects of your life.

A good financial plan can help you better understand your spending, ensure that your investment mix matches your risk tolerance, identify if your current savings will allow you to reach your goals, assess your risk management, or map out how to make your savings last through retirement. And let’s face it, if you are reading this article, then you probably have questions about how to optimize your financial situation.

A financial plan can also help you assess each of the above options for the use of your tax refund based on your individual situation.

An additional benefit is that many of Novel’s clients have been able to achieve significant savings on their investments by executing a Novel Fee-Only Financial Plan. This ultimately means that, depending on your current investment products, the cost of a fee-only financial plan can pay for itself, even in the first year!  Investment options that can pay for themselves tend to be few and far between in this day and age.  Taking steps to secure your financial well-being is an excellent use of your tax refund.

The Brass Tacks On Using Your Tax Refund

Don’t be so quick to spend that tax refund. After all, it was your money to begin with, not the government’s. There are several things that you can do to put that money to work for you.  Each of the options have pros and cons, and they may not all be appropriate for your situation. Resist the urge to spend it frivolously and instead use your tax refund wisely. Then again, sometimes you just need to go to Jamaica.

If you would like to schedule a free consultation to discuss your options for maximizing the use of your tax refund, please contact us.


RRSP Contributions should be planned to maxmize your nest egg

Beware of RRSP Season

By any chance, have you been off the grid for the last month or so?  No?  Then I am certain that you have seen an advertisement for RRSPs during that time.

This is a big season for the average bank, fund provider, asset manager and just about anyone else involved in the investment or financial services industry.

The reason that this is such an important RRSP sales time is simple.  RRSPs stay invested – for a long time.

Let’s use a simple example.  In this example, you invest $10,000 in an average mutual fund within your RRSP.  You are 30 years old when you contribute and plan to retire at the age of 65.  Let’s say this mutual fund has a 2% Management Expense Ratio (MER) and grows at a rate of 5% a year.   By the time you reach retirement, the mutual fund will have earned $10,326 in fees over that 35-year period.  $10,000 of income, from a single contribution!  In addition, you will keep your funds invested throughout your retirement as you withdraw from your RRSP as a source of income.  This example doesn’t contemplate admin fees, transaction fees, or management fees paid to your advisors.  These fees would be over and above the MER for the mutual fund.

As you can see, RRSPs are BIG business for the industry.

The problem with the sales cycle that we experience during the early part of the year is that it doesn’t contemplate the most important factor.  YOU!

Blindly contributing to your RRSP is not a winning financial strategy.  When deciding whether you should contribute to your RRSP, you should take into consideration your individual financial situation. 

Isn’t Saving For Retirement A Good Thing?

Absolutely!  Start saving.  Right now.

According to a study by BDO, nearly two-thirds of Canadians say that they don’t have much, or anything, saved for retirement.  A key statistic from the report is that 47% of millennials have no retirement savings.

Saving for retirement helps to solidify your financial future.  Of the people surveyed in the study, 75% of those who haven’t retired yet expect to work longer than their parents did. 

Saving for your retirement is critical and I encourage you to do so, but blindly contributing to an RRSP is not the only way to achieve either your retirement or your broader financial goals.

Is An RRSP Contribution Right For Me During RRSP Season?

There are several considerations to take into account when determining your tax and retirement strategy.  RRSPs are an integral component of both.  Here are a few of the key items that you should keep in mind.

  1. Am I carrying credit card debt?

Not only is it RRSP season, but it is also the time of year that we have to pay off our credit cards from the December spending spree.  Paying down high-interest credit card and other types of debt should be prioritized over contributing to your RRSP.

  1. Do I have an emergency fund?

Retirement is a long way away for some.  You need to get there first.

An often-overlooked area for most, an emergency fund is requisite to weather the ups and downs of life.  Identity theft, cracked foundations, leaky roofs, unexpected medical expenses, job loss, serious injury, elderly parents in need of care, vehicle breakdown or a surprise baby on the way.  These are just a sampling of the reasons that you should ensure that you have an adequate emergency fund at the ready.

  1. Can I lock these funds in until retirement?

An RRSP isn’t a typical savings account.  When you put money into one, the expectation is that you will keep the money there until it is time to fund your retirement.  As such, you won’t have access to the funds without penalty.  Funds that are withdrawn early experience 2 major consequences.

First, the funds withdrawn have a withholding tax applied against them.  The Federal withholding tax rate is 30% for amounts over $15,000.  This means, that if you will need access to $10,000, you need to withdraw roughly $14,285 in order to be left with the cash that you need after federal withholding tax.  When you file your tax return for the year of withdrawal, the $14,285 would be included in your income.  If you have a marginal rate below the 30%, you should receive a refund for the difference, but you have just given the government an interest-free loan for the period between your withdrawal date and when your tax refund gets paid out.

Second, you lose the RRSP contribution room forever.  Unlike a TFSA, when you make a withdrawal from an RRSP, you do not get to put the withdrawal back in.  With a TFSA, you can re-contribute the amount that you withdrew in the following year.

  1. What is my marginal tax rate, and what will my tax rate in retirement be?

This is the money maker when it comes to using RRSPs.  The best use of an RRSP is when you contribute money at a higher marginal tax rate than your planned marginal tax rate in retirement.  In a simple example, if you contribute at a 30% tax rate, but withdraw at a 35% tax rate, you will be paying more tax than you would have saved on the contribution.

That being said, the tax-deferred treatment of the investments within an RRSP can still result in a positive outcome despite the above tax rate scenario.  This will depend heavily on investment performance and the length of time the funds are invested.  Whether or not this will make sense for you will depend on several factors, however.

  1. How much tax do I have to pay this year?

One of the main benefits of an RRSP is that it reduces your tax payable in the current year.  If you contribute too much in the wrong year, you may be wasting some of the taxation magic that an RRSP contribution can provide. 

  1. How much contribution room do I have?

Unfortunately, the benefits of an RRSP are not unlimited.  You accrue 18% of your employment income as RRSP contribution room every year.  If you have a limited amount of contribution room, you may be better served by using it in a later year when your marginal tax rate is higher.

  1. Do I already have enough in my RRSP?

There is also the possibility that you don’t need to make any contributions.  If you have a workplace defined benefit pension, this may satisfy your retirement income needs by itself.  This is not a typical scenario, however.  In another scenario, if you have ample RRSP savings already, with additional contributions you could put yourself in a position where when you convert the RRSP to an RRIF you will end up in too high a tax bracket.  If this is the case, TFSA, non-registered accounts or Spousal RRSP contributions are more appropriate for your situation.

Buyer Beware: RRSP Loans

Another tactic that the financial industry likes to use is the offering of RRSP loans.

The general idea is that you take out a loan to contribute to your RRSPs, and then pay off as much of the loan as you can with your tax refund.

The major problem with this approach is that when you borrow money to invest in an RRSP, the interest that you pay on the loan is not tax deductible.  In addition, as with most loans, there is an inherent risk.  The risk here is that unforeseen events could arise, or you simply get invited to go on a great spring break trip, and you may not pay the loan off in full.  All the while, you can’t deduct the interest because it was used to fund your RRSP.  Not a winning play.

Your Bonus & RRSP Season

Another item to consider is that this also happens to be when many employee bonuses are paid out.  If your employer offers a savings program, such as a Group RRSP, then typically your employer will provide you with the option of having your bonus paid straight into your workplace RRSP plan.  In addition to the items mentioned above, there are additional considerations to keep in mind around this option.

  1. What is the timing of the bonus payment?

This is critical from an RRSP perspective.  If the bonus will not be paid until after March 1, 2019, then it won’t be eligible for your 2018 tax year filing.  If this is paid prior to March 1, and you elect to contribute it to your Group RRSP, then you would have the option to apply it to either the 2018 or 2019 tax year. 

A word of caution here – your bonus will be taxed as income in 2019.  If you contribute it and elect to use the RRSP deduction for the 2018 year, you would have to pay the income tax on it in 2019, as you wouldn’t have the deduction available following its use for 2018.  As such, this would not be a generally recommended approach. 

  1. What are the fees associated with my Group RRSP?

This is one that you will have to do some research around.  Mind you, this is research that I would recommend you perform no matter what.  Gaining an understanding of the investment products that are offered as part of your employer-based savings plans, and their fees will help piece together the overall cost of your portfolio.  While the fees associated with the products offered can vary, there may be an offsetting benefit to utilizing the savings plan, such as an employer savings match.  For example, if you contribute 5% of your savings each month into the plan, they may offer to match this 5%.  A 100% match of your money will offset the increased fees that they may offer. 

However, when it comes to your bonus, there won’t be an accompanying match on your contribution.  High fees may make this option an unattractive one.

  1. Do I need the cash from the bonus payment for another purpose?

If you do not contribute your bonus to the savings plan, this will be paid out just like your normal paycheque.  However, there will be one key difference.  When the bonus gets paid out, there will typically be a withholding tax at a fairly high marginal rate, along with CPP and EI deductions.  Similar to the early RRSP withdrawal example above, this means that some of your money may be tied up until you file your tax return in 2020, for the 2019 tax year, and get your refund.

The Brass Tacks

RRSPs are powerful financial tools. 

The financial industry is full of intimidating salespeople.

This can result in some unwise decisions being made.

In order to determine whether contributing to your RRSP is the right thing for you, there are a number of important factors to consider.  You shouldn’t simply blindly contribute to your RRSP like the salespeople would like you to.

To discuss your tax and RRSP strategy for the coming year as part of a Fee-Only Financial Plan please contact us.

Did you find this blog post helpful?  Anything else you think that we should include?

Please let us know in the comments below.


Two women talking while sitting on a window sill

The Stigma Around Money

Let’s Break The Stigma Around Money

Many people living with a mental illness report that negative stereotypes about mental illness, and the resulting potential for discrimination, cause them more suffering than the illness itself. As a result, two-thirds of those suffering from mental illness are too afraid to seek the help that they need.

Mental illness affects people of all ages and from all walks of life. It can take many forms, including depression, anxiety and schizophrenia. Most individuals find ways to live with their illnesses but how they are treated by others often proves to be more of a challenge than the illness itself.

As another successful Bell Let’s Talk Day draws to a close, breaking stigmas and changing the conversation is top of mind for many Canadians.

Your finances are a key building block to your overall life goals.  When we are on a solid financial footing, the rest of our lives become easier.

Unfortunately, one of the largest causes of stress and anxiety for most people is around money and their financial situation. 

The Research

According to a study commissioned by the Financial Planning Standards Council, stress caused by money isn’t getting any better.  This study was performed in 2014 and updated in May of 2018.  This study did not include participants from Quebec.

  • 41% of respondents indicated money as their largest stressor, which was the #1 answer.
    • 41% was also the score in the 2014 survey, and it was also the #1 answer
    • Other potential responses included health (23%, up from 19%), work (22%), relationships (14%, down from 17%)

Embarrassment & Keeping up with the Joneses

An interesting metric from the study was whether or not people felt pressured to keep up with their peers’ financial status.  This metric increased since the 2014 survey from 20% to 23% in the most recent survey.  This rate was most pronounced within the 18-34 age bracket at 52%.  This is hardly surprising given this demographic’s use of social media to share their best selves with each other and the world.

“Too many people spend money they earned… to buy things they don’t want… to impress people that they don’t like.” –Will Rogers

Adding to the stigma is that Canadians tend to be embarrassed when it comes to money.  They seem to think that they might be the only ones making financial mistakes. 

The FPSC study found that 51% of Canadians are either always or sometimes embarrassed about lacking control around their current financial situation, up from 44% in 2014.  Similar to the pressure measure above, this was most prevalent in the age bracket of 18-34 which sat at 70%.  The embarrassment rate also declined as the age of the respondent increased.

However, given the levels of consumer debt in Canada, this embarrassment may not be warranted.  You are not alone in your concern around your money decisions. 

Debt

Our financial planning services tend to cater more toward those with manageable debt and assets that they need to manage.  Their stress tends to come from not knowing if they will have enough for retirement, or not knowing how much they need to save for their children’s education, etc.  These are examples of very common concerns experienced by the typical Canadian.

However, there is a significant portion of the population that live paycheck to paycheck and have sizable concerns about their debt.

BDO published their first inaugural affordability index and found that 3 in 4 Canadians have personal debt and that the average non-mortgage personal debt is nearly $20,000 per person.  This would include car loans, lines of credit, credit cards, etc.  This means that the average Canadian couple carries nearly $40,000 in non-mortgage debt.  These are alarming numbers.

For the segment of the population in debt trouble, the situation can snowball quickly.  High-interest debt, such as payday loans or credit cards, are a primary cause of the growing debt problem.  High-interest debt payments can often have little-to-no impact on reducing the balance owing.

Compounding this problem is that the social stigma around money makes it difficult for people to discuss these issues openly, even with finance professionals.

The debt carriers often don’t know where to turn.  

They don’t think that there is a light at the end of the tunnel. 

But there is.

Feeling like you need help is okay. 

Most people need help when it comes to their finances.  For those that feel like they need help with their debt, there is a solution.  Credit Counselling Canada (CCC) is the national association of not-for-profit credit counselling agencies that work provincially, regionally and locally throughout Canada. Only not-for-profit or charitable organizations are accepted as association members according to their website.  One such member organization is Credit Counseling Society (CCS).

These organizations can help those with debt issues develop a plan to tackle their money issues head-on.  CCS has a summary of their recommended approach to dealing with debt stress and tackling your debt problem.

This is only one example of the CCC member organizations, and anyone of their member organizations will be able to assist you.

“You must gain control over your money or the lack of it will forever control you.” –Dave Ramsey

The Brass Tacks

Studies show that money is the #1 cause of stress for Canadians.  Social stigma prevents us from speaking openly about our financial situations, as we often feel pressured to keep up with the lifestyles of our peers.  This is only exacerbated in the social media era. 

As money anxiety grows, people need to be aware of their options.  For those with significant debt, a non-profit member organization from Credit Counselling Canada will assist you in tackling your debt challenges.  For those with manageable debt and assets to manage, fee-only financial planners can ensure that you receive unprejudiced advice to help you establish a solid financial footing, take control of your finances and reduce your stress.

Don’t let social stigma around money prevent you from addressing your challenges.  You are not alone.  There is light at the end of the tunnel.

The Canadian Association for Suicide PreventionDepression Hurts and Kids Help Phone all offer ways for getting help if you, or someone you know, is suffering from mental health issues.

In case of an emergency, please call 911 for immediate help.

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Desk with phone notebook and plants

A Novel Beginning

You’re probably thinking, “Great.  Another financial services firm”.

You are probably not alone.

If that were the case I would completely understand.  There are literally thousands of organizations out there that address some component of the financial services market.

The problem is that most of them don’t care about you.

The average fund manager cares about their performance relative to their benchmark and the amount of their assets under management (AUM).

The average financial advisor cares about their commissions and their management fees charged on assets under management.

The typical bank wants to direct you to products that they sell, not the best available products, or products that are best suited for you.

The fee-only financial planning approach works in stark contrast to these conflicts of interest.

How The Fee-Only Financial Planning Journey Began

The unfortunate realities of the typical advisor model played out for me recently.  My Mother invited me to join her at a meeting with her financial advisor, as she wanted to make sure she was on the right track.  She recently retired from a career as a teacher and was transitioning from the accumulation phase of her life into the drawdown phase.  The plan that was set out for her to follow was a logical one.  The options presented were very reasonable from an approach and strategy standpoint. 

When it came time for execution, this is where the reasonability went off the proverbial cliff.  This came to light as I asked 3 critical questions:

  1. What is the fee structure of this financial plan/arrangement?
  2. What product options do we have within the financial plan framework?
  3. Is there a more cost-effective way to implement this financial plan?

With respect to the fee structure, the advisor was going to be investing in a balanced fund charging 2% of AUM.  In addition, the advisor would be taking a 1% of AUM management fee on top of the costs of the funds.  In total, this plan would cost 3% of AUM each and every year.  Something to keep in mind is that we could substitute AUM with life savings in any sentence in this article.  What this ultimately means is that the investments would have to return 3% just to break-even!  As you know, interest rates are very low in the current environment and earning 3% is not a given.  How do you think you would do in the 100-metre dash if you started from 130 meters away?  Why would you want to put your life savings in the same situation?

When it came to product options, we did have some to choose from.  Segregated funds, mutual funds and annuities were all provided as options.  Each of these options has their own merit and can provide value to certain individuals depending on their situation.  However, I asked if there was a way to move to a lower cost ETF based approach.  The advisor’s response was, “I am not licensed to sell ETFs”.  So, now you only get to choose from products that they have agreed to sell? 

These investment products undoubtedly have a commission being paid to the advisor from the fund company, because for every client an advisor can direct to them, it means that the fund company will now get paid each and every year that you invest with them.  For 1% of my life savings, I would expect that an advisor could bring all appropriate options to the table for me.

Lastly, I asked if they would be open to moving to a flat fee-based model as opposed to the percentage of AUM model that they were currently utilizing.  They declined to entertain the idea. That’s their prerogative as a business person, but it was worth a shot. 

At the end of the day, this is a classic example of an expensive advisor using expensive products because it suits them best, not their client.  Luckily, it’s your prerogative to explore other options!

Harsh Reality of Working With a Typical Financial Advisor

My mother and I inevitably left their office following the meeting. We had some discussion and she quickly realized how much money had been paid to this advisor over the years. Literally 3% of her hard earned money was given away every year.

It was this day that drove me to launch Novel Financial.  I wanted to be able to provide quality financial planning advice to all Canadians at a cost that was commensurate with the service being provided.  Thanks to this meeting, it turned out that on this day Novel had inadvertently also found its first fee-only financial planning client.

Your best interests are our best interests.  That’s Novel.

Learn more about the Fee-Only Financial Planning Advantage.