Scary Financial Facts for Halloween

 

It’s that time of year when scary things come out on Halloween. However, when you open your door on October 31, will you be confronted by anything scarier than these hair-raising financial horror stories?

Will debt destroy your future?

  1. Student loan debt has reached $1.45 trillion dollars in the U.S. and $42.9 billion in Canada. U.S. graduates owe on  average of $37,712 and $27,000 for Canadians.
  2. Credit card debt is increasing in both countries. Americans carry an average of $16,000 and $4,100 for Canadians
  3. 107 million Americans have auto loans for a total outstanding debt of $1.2 trillion. It is estimated that 40% of the 120 billion dollars in auto loans in Canada are financed for 7 years or longer.
  4. Mortgage debt in Canada is a bigger problem than the U.S. because mortgage interest is not tax deductible. Average mortgage in Canada is around $200,000 (much higher in cities like Toronto & Vancouver) and $192,000 in the U.S.

Will someone steal your identity? 

First we find out that the Yahoo hack in 2013 exposed the information of every single one of their 3 billion accounts and then we find out that a data breach at Equifax exposes the personal information of 145.5 million people. Is there a single American who hasn’t been hacked yet?

The odds are great that your personal information is for sale to identity thieves or already in their hands. Can you foil them with credit freezes and other ID protection measures before it’s too late? Is it already too late? Does your VISA card contain mysterious purchases for 10 large screen TVs from Best Buy?

U.S Health Care Nightmare

Who knows what horrors await you if you become sick and your insurance premiums are too high for you to afford? Average out-of-pocket medical costs continue to rise, topping $10,000 in 2016. Meanwhile, premiums continue to rise on the health care exchanges.

Over the past four years, premiums in the individual marketplace have more than doubled. As insurers back out of some markets and political uncertainty reigns, premiums on the state insurance exchanges continue to rise rapidly. For example, rates in Georgia are up by 57%.

Scary lack of retirement savings

According to a report from the Economic Policy Institute (EPI), the mean retirement savings of all working-age American families, which the EPI defines as those between 32 and 61 years old, is $95,776. Almost 40 million households have no retirement savings at all.

Only 65% of Canadians are saving for retirement and on average have about $84,000 in retirement accounts. (RRSP & TFSA)

Frightening Canadian Energy Policies

  1. No access to foreign markets for oil & gas (besides the U.S.)
  2. Cancellation of Energy East pipeline (buying oil from the Middle East, selling discounted oil to the U.S.)
  3. Construction delays in Trans Mountain & Keystone XL pipelines
  4. No accountability for carbon tax revenue (how is this money spent?)
  5. 4 billion dollars of extra interest payments for reduced hydro rates in Ontario

Release the Nukes

What list of potential horrors would be complete without the prospect of nuclear war? The current tense relations between the U.S. and North Korea make that horrible concept more plausible and in addition to the terrible death toll and destruction of property, the financial impact on the world economy would be hard to imagine.

Remember the famous quote of Albert Einstein, “I know not with what weapons World War III will be fought, but World War IV will be fought with sticks and stones.”

Now remember the leaders who have their fingers on their respective nuclear buttons. ARE YOU FRIGHTENED YET?

HAPPY HALLOWEEN!

 

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A few suggestions on how to invest a $300,000 inheritance

Last week’s post contained a real life Canadian couple’s financial dilemma on how to invest a surprised inheritance. I asked writers and readers of financial blogs to email me their suggestions. This couple is in their mid-fifties and are hoping to retire in 8 to 10 years. They are debt free, have poor paying jobs and only managed to save $55,000 for retirement. Unfortunately, my bullet point list of Canadian tax info wasn’t very clear.

Additional clarification of  the Canadian Tax system

Canadians have three choices for saving for retirement if they don’t have a company pension.

Registered Retirement Saving Plan (RRSP)

  • Contributions are limited to 18% of working income (max. $25,370 investment income not included)
  • Tax deductible, refund based on your tax rate (lowest 20%, highest is 53%)
  • Tax free compounding, withdrawals are 100% taxable at your personal tax rate (lowest 20%, highest is 53%)
  • Government requires you to make withdrawals at age 72
  • Not usually recommended for low income families

Tax free Savings Account (TFSA began in 2009), geared to low income families

  • Personal contributions are limited to $5,500 per year, not tax deductible
  • Unused contributions are carried forward indefinitely
  • Tax free compounding, withdrawals are not taxable
  • No restrictions on withdrawals, money can be taken out and put back in the following year.

Taxable investment account

  • Interest income, foreign interest and foreign dividends are 100% taxable at your current tax rate (lowest 20%, highest is 53%) Plus there is 15% foreign tax withheld. If personal your tax rate 30%, foreign dividends of $100 minus  $30 personal tax – $15 of foreign tax = $65
  • Canadian Dividends have an eligible tax credit that increases the after tax yield. In theory, a Canadian could earn $40,000 in dividends tax free if they had no other income.
  • Capital gains has the lowest tax rate because only 50% of the gain is included in income, so only $50 of a $100 gain would be included. High income earners (53% tax bracket) would only pay 26.5%  in income tax.

I only received two suggestions and didn’t receive any input from any Canadian bloggers or readers.  So, I asked a financial planner who works at one of my local bank branches to weight in.

From the United States, Bear with the Bull offered the following:

I am not sure I am most qualified to be a financial adviser and I really do not know Canadian tax laws. I would think they might want a mix of income, bond, possibly cash, and growth stocks.  For my 401, I have about a 60/40 split of stocks and income/bond allocation. So if they are looking for more cash / income, maybe they would be more comfortable with something more 40/60 instead. 

They probably would look to a portion to be cash or bond fund that could be used to maximize yearly retirement contributions and or have readily available should they need it.  Since the Canadian real-estate market is seemingly doing well, how about investing in some Canadian REITs?  It would have a short term growth opportunity and dividends as well.  ETF’s also seem to be the latest investing vehicle and generally have lower fees than mutual funds.

  • The 40% equities ($120,000) 50% Canada 40% U.S 10% Emerging markets
  • The 60% fix income ($180,000) Perhaps a 1/3 split.  $60,000 Bonds, $60,000 Reits, $60,000 Cash

Realize that this response and $5.00 will get you a good cup of Starbucks so take it for what it is worth.

From Belgian, Amber Tree Leaves offered the following:

Here is a potential solution, as I am not sure to fully understand the Canadian system, I will skip that part.

General comment: As they have not yet accumulated a lot of assets, it might be tough to retire in the next 8-10 years. It is reasonable to expect a severe correction in that period. As it seems that they have little investing experience, it might be better to go for an approach that generates cash from dividend stocks. The assumption here is that it generates higher yields than ETFs. 

  • allocation: 70 % stock and 20 % bonds and 10 % gold.
  • The 70% equities 20% in Canadian dividend stocks, 50% world wide in dividend paying stocks

The gold is there as a hedge against the really bad times. It should be managed in a way that it needs to be sold and converted into stock/bonds when the price rises a lot. Timing this is hard, it is not the goal to get the absolute top.

Bank Financial Planner

First of all, I believe that money has different weights or “gravity” depending on how you acquire it.  Inheritance money seems to have the most weight as often people feel they “owe” a higher degree of care of duty to it and are less likely to deal with it the way they would a lottery win or an insurance settlement.

Obviously, the first thing I would need to do is get a better understanding of their situation and their time horizon and risk tolerances.  Let’s assume they are comfortable with a balanced approach. I would recommend 60% equity/40% fixed income.  ($180,000 in equity and $120,000 in fixed income.)

I would recommend they start by contributing fully to TFSAs, which would account for $102,000 between the two of them.  In the TFSA, I would use a ladder of market linked GICs to give them diversification, security of capital and the potential for higher returns than offered by traditional GICs.  This allows them their only chance to earn interest without paying tax on every penny of it.  It also means there are no fees to pay on almost one third of their investments. 

For the non-registered account, I would recommend a core holding of a growth ETF portfolio ($100,000 with additional positions in our Canadian ($30,000), US ($15,000 and International ETF funds $25,000), with a portion in our US Dollar ETF $15,000) for additional diversification on currency. 

After the initial investment occurred, I would want to have an annual strategy to move the maximum TFSA contribution for each of the clients.  This would involve selling a position of the non-registered investments (unless there are additional savings available) and reinvesting in the same fund inside the TFSA to maintain the balance in the overall account.   This would allow the gradual transition into the TFSA accounts, helping with taxes and probate fees down the road.  A portion of capital gains (or losses) would be triggered each year, smoothing the tax impact on the clients.

I am not sure if this inheritance is big enough to bail out this couple’s retirement plan. A key element is understanding after tax returns when investing.

 

 

 

Still doing tax returns for my adult children & their spouses

Every year I ask myself, should I continue to offer to do tax returns for my adult children and their spouses? All of them have university degrees and are smart enough to file their own tax returns. My daughter was willing to do it one year using tax preparation software with only a little help from me.

Part of my problem is Canadians are not even aware of how much tax they pay. Plus we keep voting for governments that buy votes using our tax dollars. The average Canadian family will pay 42.9% of their income in taxes imposed by all three levels of government in 2016. (Federal, provincial and local) Tax freedom day was June 7, 2016 if Canadians paid their total tax bill up front. Our U.S. neighbours tax freedom day was April 24th and they will only pay 31% of their income in taxes.

There are a number of reasons why I continue to offer to do tax returns for the whole family. Having worked as a financial advisor, tax planning is a key element when putting a financial plan together. My tax knowledge and skill comes from working many years with accountants and tax lawyers ensuring that my whole family pays the least amount of tax.

Plus, the Canadian tax system is very complicated and is constantly changing with every federal and provincial budget. For example: many tax credits that were given by the Conservative government have been taken away completely by a new Liberal government.

For the 2015 tax year, the Liberals cancelled income splitting for families, a maximum tax credit of $2,000 for transferring up to $50,000 of income to a spouse with a lower income if they had a child under 18 years of age.

Some changes for 2017 include the elimination of the following credits:

  1. Education and textbooks credit
  2. Children’s fitness credit
  3. Children’s arts credit
  4. Public transit tax credit

Now, most retired Canadian seniors who don’t have a pension from their former employer are not even aware of a $2,000 pension credit. It requires opening a RRIF account, transferring $2,000 from their RRSP and then taking it out. They don’t have to wait until they reach the age of 71 in order to open a RRIF account. Plus, RRIF income can be split with your spouse if both of you are 65 years of age which could potentially add up to $4,000 of income tax free per year.

The Federal Liberal government will introduce a new budget on March 22 and there are rumors of more tax increases. Three things that Canadians should worry about;

  1. Higher capital gains inclusion rate from 50% to 75%
  2. Reducing the dividend tax credit
  3. Taxing your principal residency 

I will end this post with two well known proverbs. ” In this world nothing can be said to be certain, except death and taxes.” & “A penny saved is a penny earned.”

 

Tips on rebalancing your retirement portfolio

rebalance-moneyunder30

Many investors are in for a rude awakening when they open their year-end retirement plan statements. The bond portion will probably show negative returns. It could even wipeout a good portion of their positive returns from owning equities.

Now, the most common method used in rebalancing your established asset allocation mix would be to reduce the holdings that are up in value (sell stocks) and buy assets that have fallen in price (buy bonds). This practice may have worked very well in the past but interest rates are going up forcing bond prices down.

The chart below compares the S&P 500 with the IShares 20 plus year Treasury bond ETF

tlt

“The decades-long bull market in U.S. Treasuries has finally drawn to a close following Donald Trump’s surprise presidential election victory, according to mutual-fund manager Bill Miller.”

“Miller isn’t the first to call time on the bond bull market. Economist Henry Kaufman, the original “Dr. Doom” who is credited with calling the last bond bear market in the 1970s, told the Financial Times this week that the current bull run is at an end.”

In the past, when the Federal Reserve decided it was time to unwind its easy monetary policies, it would raise the federal funds rate fairly quickly. The Fed believes a neutral stance on monetary policy is reached somewhere above the 4% level. The current Federal Reserve is moving slower than normal. Based on an average of three rate hikes per year, it will take the Fed a little over 4 years to normalize interest rates.

Tip # 1

Short-term, reduce or eliminate investing in target date mutual funds since they automatically rebalance from equities to bonds. Plus they increase your bond exposure the closer you are to retirement.

Tip # 2

During a period of rising interest rates, the prudent strategy is to reduce the duration of your bond portfolio. That could mean using a short-term bond ETF or a ladder of GICs both of which would allow you to benefit from an increase in rates.

Tip # 3

If you’re comfortable with a little credit risk, use short-term investment-grade corporate bonds to get a little more yield.

Tip # 4

Cash is by far the safest asset class. Move some of your equity allocation and some of your fixed income allocation to cash. I have my doubts that President Elect Trump can get congress to pass all his stimulus agenda and even economists are unsure if these policies will actual increase economic growth.

Corrections in the bond market are not as uncommon as you think. Most have been short in duration. See the chart below:

lt-treas-losses

Keep in mind that in the past, rate hikes were implemented  at a much faster pace than what the current Fed has purposed. Losses in the bond market could continue for longer than expected.