Too many people will be relying solely on the Canada Pension Plan (CPP), the Québec Pension Plan (QPP) or Old Age Security (OAS) in their golden years. Perhaps they feel that the income those plans provide will be enough to adequately fund their retirements. It won’t. Those programs are not designed to provide enough income for Canadians to enjoy a retirement lifestyle that is anywhere near the lifestyle they lived while they were working. They are there to supplement your retirement savings, not to replace them.
Not only does the money inside your RRSP grow tax-free while it is inside your “vault,” you also get a break on your income taxes the year you contribute the money. Any money you contribute to your RRSP is deducted from your taxable income, which means you end up paying less income tax that year. The more money you contribute to your RRSP, the less income tax you pay. Once inside the RRSP your money grows tax-free through the incredible power of time and compound interest. You do not pay any income tax on either the principal contribution or the interest earned on your savings until you take the money out of your RRSP.
To that end, there are limits on how much they will allow you to contribute to your RRSP each year. You may not contribute more than 18% of the past year’s income, less pension adjustment, up to a maximum amount which is adjusted every year.
Any money you put into a TFSA has already been taxed. In other words, you cannot use your TFSA to reduce your income taxes today.
While it’s true that younger, lower income earners can possibly save more tax overall by putting their money in TFSAs rather than in RRSPs, they won’t realize those tax savings until they are older. However, with RRSPs they get the tax savings now, when they are younger, lower income earners and they likely need it more. The tax savings today can help them fund their RRSP contributions.
Look at it this way: all other things being equal, would you rather get a $1,000 windfall at age twenty-seven when you are trying to scrape together a down payment for a house or a $1,300 windfall at age seventy when you have close to $1 million in savings?
However, if you take money out of your RRSP early, the Tax Man is going to nail you. Hard. Painfully hard. They will take up to 30% of your money at source, before you even see it. That will cost you $4,500 in taxes on a $15,000 withdrawal.
All said, my preferred strategy is to take full advantage of your RRSP to save for your retirement. Start early and leave it alone. Then, use your TFSAs to save for other stuff in the short term, like a down payment on a house, a great vacation, or that new boat.
Remember, the CRA will only allow you to contribute up to 18% of your previous year’s income, up to the maximum allowed.
You start building RRSP contribution room as soon as you start filing income tax returns. If you don’t use that room by contributing the maximum to your RRSP, you can “carry forward” the unused room to future years. Try not to use this feature. It allows people to delay their RRSP contributions and, as we’ve seen, time is critical to compounding interest,
When you contribute 18% of your income to your RRSP it’s important to keep in mind that you still have 82% of your income left for living today, and that’s before factoring in the money you are saving on your income taxes. In reality, you will still have approximately 86% of your income left for living in the here and now. RRSPs really are a great deal.
I can hear the objections already. “How can a tax refund not be a good thing? The government gives me money.” No, they do not. They give you back money that they borrowed from you interest-free. If you get a tax refund, you overpaid your taxes and lent the government some of your money. They gave you nothing for it. Let that sink in for a minute. You personally lent the government your money interest-free. They gave you nothing for it.
If, on the other hand, you want to reduce your taxes, you will need to obtain a separate form—the T1213, which can be found on the CRA website. You need to fill it out and submit it to your local taxation office (their address can also be found on the CRA website). When you submit the form you will also need to provide proof of your regular RRSP contributions, which you can get from your RRSP provider. (1) After about six to eight weeks, the CRA will send you a letter that you then take to your employer, authorizing them to reduce the amount of taxes that are deducted from your pay cheque each period.
Make sure you are not loaning the government money by getting a tax refund when you could be using that money yourself. Instead, take advantage of the T1213 form to reduce the tax on each pay cheque and pay that money to yourself.
A stock index is a benchmark that shows the performance of hundreds of the largest and most frequently traded stocks on a stock exchange like the Toronto Stock Exchange (TSX) or the New York Stock Exchange (NYSE). Rather than trying to predict which individual stocks are going to be “hot” year after year (an impossible feat, which is precisely why all actively traded funds have bad years) an index fund’s performance doesn’t try to predict anything. It assumes that the value of the overall market will always increase over the long-term. This assumption has always proven to be true. Index funds can’t underperform the market because they own the market.
Additionally, as index funds do not require research teams, professional management, or any other expenses that come with an actively managed mutual fund they are significantly less expensive. A good index fund should have a MER of around 1%. Any more than that and I believe you are paying too much.
Robo-advisors provide each of their customers with a customized portfolio of Exchange Traded Funds (ETFs) which are selected to best suit the client's individual goals and investment profiles.
But there are also a couple of ways that ETFs and index funds differ. First, ETFs have even lower fees than low cost index funds do, sometimes substantially lower. Which is awesome. Remember, even lower fees mean you will end up with even more money further down the road—a ginormous plus for the ETFs. You might be thinking (you should be thinking), “Hey, that sounds great! How can I get my hands on some of these groovy ETF things?” This brings me to the second difference between ETFs and index funds. Just like individual equity stocks, ETFs are traded on stock exchanges. Index funds are not.
The robo will not only choose which ETFs are best for you but also how much of each ETF your portfolio should contain (the fancy term for this is asset allocation). In the end, you get a professionally managed, globally diversified portfolio of ETFs.
Once you’re invested, sophisticated algorithm-based software automatically rebalances your portfolio (buys and sells your ETFs at optimal times) as the markets change. This is hugely advantageous for the investor because it virtually removes human emotion from the investment process. Piles of research show that when we human beings make investment decisions, we tend to do it emotionally rather than logically; we buy when we should be selling and we sell when we should be buying. Emotions are the kryptonite of sound investing.
I’m not a fan of borrowing to make your RRSP contributions in most circumstances. You will need to pay back whatever you borrow, and if you can afford to make those payments then you were probably able to afford weekly or bi-weekly RRSP contributions in the first place. The loan will end up costing you more than the contributions would have because the bank is going to charge you interest.
Asking your bank how much you are “allowed” to spend on a house is a bit like asking Ronald McDonald if you are allowed to supersize your Big Mac and fries.
All other things being equal, a bigger house means a bigger price. That bigger price means a bigger mortgage. That bigger mortgage often means a longer amortization period. A big mortgage amortized over a long time means that the powerful combination of time and interest have a lot to work with. And this time they’re not working for you.
The bank will plug your household’s gross monthly income into a formula to determine the maximum—repeat maximum–mortgage they can approve you for under current legislation. In other words, they will calculate a house purchase for you that will be the most profitable for them.
When you buy a house, Canadian law requires you to pay a portion of the purchase price up front as a down payment. If you put down 20% of the purchase price or more, your mortgage will be a conventional mortgage. If your down payment is between 5% and 19.9% of the purchase price, you have to get a high-ratio mortgage. Conventional mortgages can be amortized over as much as thirty years, while high-ratio mortgages can be amortized over a maximum of twenty-five years.
High-ratio mortgages require the mortgagor (borrower) to purchase mortgage default insurance, usually through the Canada Mortgage and Housing Corporation (CMHC). The insurance protects the mortgagee (lender) against the mortgagor defaulting on the mortgage. This insurance does nothing for you, the home buyer, except allow you to make a smaller down payment and cost you money. This is the reason Luigi had insisted on making a down payment of at least 20%. He didn’t want to waste his money on mortgage default insurance.
what usually happens is that your lender pays for the insurance and then adds it onto the mortgage amount. Then you get to pay them back over the entire length of the mortgage. You pay compounded interest on your mortgage and on the cost of the insurance. The CMHC makes money. Your bank makes money. You pay it.
You may have heard that renting is a waste of money. It is not. Renting is a valuable financial tool which, properly used, can help you save for your first house. It is important to understand that renting costs a lot less than home ownership.
Another potential source of money for your down payment is your RRSP. The federal government will allow you, as a first-time home buyer, to borrow up to $25,000 from your RRSP for a down payment, stipulating that you must pay the money back to the RRSP over the next fifteen years or it will be added to your taxable income each year. Don’t do it. Remember what your RRSP is for. It is your tax-sheltered savings vault for your retirement. It should not be a savings vehicle for the down payment on your first house. Leave it alone. Even a small withdrawal today would mean the loss of thousands—possibly tens of thousands—of dollars when you retire. A large withdrawal for a down payment would mean the loss of much more. The reason you started your RRSP early was to take advantage of the power of time and compound interest. Please leave it alone. I promise you won’t regret it.
Circumstances vary, so plan on having at least 2% of your home’s purchase price set aside for closing costs.
I recommend a three- or a four-year term instead. You can usually negotiate an interest rate on these terms that is equivalent to what you could get with any other term. At the same time, a shorter term will give you more opportunities to “trim” some time off the length of your mortgage, which is a fantastic way to reduce the overall amount of interest you have to pay on your mortgage. Here’s an example of how “trimming” works. Jessica buys her first house and decides to amortize her mortgage over twenty years with a three-year term. When those three years are up and the term ends she will have seventeen years left to go on her mortgage. Jessica is a clever girl, so instead of renewing the mortgage for the full seventeen years, she “trims” a year off it and amortizes her mortgage over sixteen years with another three-year term. Jessica’s payment will go up a little, but her mortgage will be paid off a year sooner and she will save a boatload of money overall in interest.
An open mortgage is one that can be paid off or renegotiated at any time during the mortgage term.
All mortgages become open at the end of their term and can be paid down or renegotiated at that time. A closed mortgage cannot be paid off or renegotiated until renewal time without paying a penalty. Closed mortgages usually have better interest rates than open mortgages. Most closed mortgages include some sort of pre-payment option. These options allow you to pay down a set percentage (10% is typical) of your mortgage’s principal at specific times, usually once a year.
With a fixed rate mortgage the interest rate remains the same for the duration of the term. A variable rate (or floating) mortgage allows the interest rate to vary based on the prime interest rate set by the Bank of Canada. Your payments always remain the same but the amounts of principal and interest you are paying with each payment will vary when the interest rate changes.
Variable rate mortgages can save you some money, especially when interest rates are expected to go down. However, if you have better things to do with your time (meaning you have a life) than keep an obsessive eye on interest rates, you’re probably better off with a fixed rate. Whichever way you go, be sure to negotiate the best rate you can get and don’t hesitate to shop around. A half percentage point may not seem like a lot now but it can make thousands of dollars difference over the length of your mortgage.
The more frequent your mortgage payments, the less total interest you will pay over the length of your mortgage. Accelerated weekly payments good; monthly payments bad. The difference is substantial.
If history teaches us anything, it’s that some things never change. While the story of Casa Loma is from a bygone era, its lessons are as relevant today as they were then. Too much house can destroy you financially.
If the payment due date on your credit card bill is June 20 and you make a complete payment on June 21,
If you do not pay off the entire balance by the due date each month, your grace period is gone. If you rack up $4,000 on your credit card in a month and you make a payment (on time) of $3,999 the next month, you will be charged interest. You will not be charged on one dollar and you will not be charged from the date you made the payment. You will be charged interest on the entire $4,000, right back to the date the purchases were made.
A cash advance is when you withdraw (borrow) cash with your credit card. A late or short payment won’t have any impact on the grace period for your cash advances because there isn’t any grace period on cash advances. Any time you go to a bank or an ATM and withdraw cash with your credit card, the interest charges kick in as soon as you get the cash in your hand.
Premium cards, such as gold, silver, or platinum cards, often have a premium annual fee attached to them. It never ceases to amaze me how many people are willing to fork over $100 a year or more just so they can feel good about the colour of a piece of plastic in their wallets.
Study after study, report after report, survey after survey, year after year prove with absolute certainty that people who shop and pay (borrow) with their credit cards spend more than people who pay with cash.
This is my favourite idea to help you keep your credit card spending under control: Do not pay your credit card bill every month. Instead, pay your credit card bill on the same day that you use your card. When you get home after using your card, immediately go online and make a payment to your account equal to the amount you borrowed that day. I love this idea because once you commit yourself to it you instantly become acutely aware of your spending habits.
An old but telling joke: “If you want to get rich, don’t rob a bank. Open one.”
A line of credit, business or personal, is basically a financial institution pre-agreeing to lend you or your business an undetermined amount of money, up to a pre-determined limit. You can borrow as much or as little of that money as you want, whenever you want, for whatever you want. Lines of credit have low interest rates and are structured so that the payments are very small, in fact (and this is key) the payments are often made up of nothing but interest—they don’t pay off any principal at all.
Currently, the outstanding balance on your mortgage plus your HELOC cannot exceed 80% of your home’s value.
There are two very important things you need to understand about consolidation loans. First, a consolidation loan does not eliminate your debt; it converts your revolving debt into more manageable installment debt. But it’s still debt nonetheless and it still has to be paid. Second, it’s imperative that anyone who bundles his debts into a consolidation loan does not allow himself to spend his way back into the revolving debt cycle that got him into trouble in the first place.
Here’s my advice: If you have overdraft protection, get rid of it. I’m confident you will quickly adapt to the new “line” at zero dollars and never have a negative balance in your account again. Goodbye fees and goodbye interest charges.
We need to establish “self-imposed balance lines” and use them to build up positive balances inside our bank accounts. The resulting cushion becomes your emergency fund for when stuff happens, like an unexpected car repair or, worse, a loss of income.
When you do that, you suddenly realize that her choice wasn’t between Choo shoes and non-Choo shoes. It was a choice between Choo shoes and non-Choo shoes plus lunch with a friend, groceries, a bottle of wine, lipstick, her daughter’s swim class registration, a tank of gas in her car, and saving $150 in her TFSA towards a dream trip to Italy. Because that’s an example of what Buddy-Lou could have done with the $520 instead. Economists refer to this as opportunity cost.
Opportunity cost is asking yourself: “What could I do with this money instead?”
Just like the dieter who finds himself eating less as soon as he starts monitoring his calorie intake, you will find yourself spending less of your money as soon as you start tracking what you are spending it on.
Advocates of leasing will always point out that the monthly payments for a leased car are smaller than they would be if you had purchased and financed the same car. And they’re right. However, the price you pay for those smaller payments is that you will be making them perpetually, as in forever, while you are leasing.
Just like we saw with houses, the cost of a car is more than just the price. Taxes, fees, insurance, maintenance, repair, borrowing costs, and more—all of these things play a part in the total cost of a car and they always cost more on an expensive “prestige” ride than they do on a humbler model.
Canada’s wedding industry generates over $4 billion a year with the average wedding today costing over $25,000. Twenty-five thousand dollars or more just for one day. Twenty-five thousand dollars for one day, at a time in most people’s lives when they can least afford it. It’s ridiculous.
You’ll never hear a contractor say this but most home renovations have little or no impact on a home’s value five years after they are done.
If it looks like a duck, quacks like a duck, and waddles like a duck. . . .
A good rule of thumb is to avoid any deal—automotive or otherwise—that touts the phrase “low monthly payments.” That phrase is usually synonymous with “you will be paying for this for a very long time and you are going to regret it.”
Back in Chapter 4, I said that borrowing the money for your down payment from your RRSP under the federal government’s Home Buyers’ Plan was a bad idea. Six chapters later, it remains a bad idea. Supporters of this plan will say that you are borrowing money from yourself and, in a way, this is true. However, it’s more accurate to say that you are stealing money from a future version of yourself. Taking money out of your RRSP early for any reason completely contradicts the reason you started the RRSP in the first place—to save for your future with a little help from time, interest, and some tax deferment.
The more critical issue is figuring out how to rebuild your decimated retirement savings plan after you’ve taken money out of it. If you don’t want to be working the graveyard shift at Taco Bell on your seventy-fifth birthday, you are going to have to: 1. Figure out a way to pay back (with after-tax income) all of the money that you took out of your RRSP. 2. Continue to make your regular RRSP contributions at the same time. 3. Understand that those contributions will have to be maxed—and likely supplemented by humongous TFSA contributions—if you’re going to have a snowball’s chance in hell of making up for all of the compounding opportunity that was lost when you withdrew the money from your RRSP. And don’t forget, you just bought your first house. So, the chances of any of this happening are somewhere between slim and not a hope. Your retirement plan is now screwed. Borrowing from your RRSP under the Home Buyers’ Plan is a bad idea. Don’t do it.
You are more than the total sum of your stuff. Your character will be determined by your outlook on life, the choices you make, and the relationships you enjoy. Don’t underestimate the happiness that comes from being secure enough with who you truly are to say no to something when you know you should. Not to mention the happiness that flows from being able to say yes to something when you know you can truly afford it.
A spousal RRSP allows higher income earners to contribute to an RRSP in their lower earning spouse’s name while using the tax deduction for themselves. This will help balance their income during retirement, which will be tax beneficial at that time. There must be at least three years between contribution and withdrawal to do this, otherwise it will be taxed under the contributor’s income.
Instead of rich, a word that I have always preferred is comfortable. Comfortable is about more than the money. Much more. It’s about sleeping comfortably at night and not being afraid to check your mailbox or your inbox in the morning. It is about being comfortable driving to work in a Corolla rather than a Lexus when you are thirty-three so that you won’t have to drive to work at all when you are sixty-three. It is about being comfortable enough in your own skin to say no when you know that you should.
Put some money away for your future. Live in a house that makes sense. Be smart about how you spend your money. Spend less than you earn. Be comfortable living within your means. It really is that simple.