Whichever, it’s important either way.
I’ve been following with great interest the recent efforts in this country to look into and improve financial literacy.
At time of writing, there is eager anticipation – and it’s not just me – for the release of the Task Force on Financial Literacy report, slated for the end of 2010. As you are reading this then, hopefully the industry and the public in general are abuzz with the recommendations placed before the Minister of Finance.
As participants in the financial advice field, we obviously have an active interest in the present and future state of financial literacy. Combined with the concurrent federal-provincial dialogue on reforming the pension and retirement system, I’d go so far as to say that this year will be viewed in hindsight as a maturity point in the development of the industry.
On an individual advisor level, this public spotlight presents the ideal platform for reinforcing to clients the value of your professional advice.
Advisor as educator
Perhaps I would be in the minority for suggesting this, but I believe that the number one skill for an advisor is the ability to educate.
But shouldn’t expertise such as arithmetic talent, market familiarity and product knowledge be at least on an equal plane? Without downgrading those requirements, I would contend that those are exactly that: “requirements”. They are table stakes to get the license, but to really be a good advisor, you must be a good teacher.
Without that facility to build interest, foster comprehension and motivate action, all the rest is academic.
Speaking of tax
Similarly, I hold myself to that standard in communicating with advisors on matters of tax and estate planning. If I can’t explain it to you so you can explain it to them, then I need to go back to the drawing board.
To state the obvious, literally half of a person’s income could be spent in taxes. The importance of having at least a working knowledge cannot be overstated. As reinforcement (as if we need it), one of the most frequently mentioned items during the Financial Literacy consultation was “knowledge of the tax system, especially as it relates to credits and deductions that are designed to encourage saving”.
Here then are some fundamental tax learning points for you to share with your clients. You’ll recognize most, if not all of these, and hopefully this will help you enunciate them that much more effectively with your clients. If they can digest these guidelines then that should help pave the route from financial literacy to financial prosperity.
1. Marginal versus average tax rates
An obvious starting point is that the amount of taxes paid divided by income is your average or effective tax rate (ETR). The rate you pay on the next or last dollar earned is the marginal tax rate (MTR). A $75,000 income taxpayer has an ETR of 25% and an MTR of 35%. (All figures here and below are approximate 2010 national averages.)
2. METR
Building on the prior point, we now consider “marginal effective tax rate”. An often cited example of this is the Old Age Security (OAS) clawback, which causes 15% of OAS benefits to be returned to the government when earnings are over a specified income level. To illustrate, a $75,000 income retiree has an MTR of 35% on the next dollar out of a RRIF, but an METR with the clawback of almost 45% once you lose the after-tax value of the OAS clawback. (Plan carefully or lobby the government… or both.)
3. Income by source
RRSP/RRIF income is taxed at a person’s MTR at progressive rates as one moves up through the federal-provincial brackets. Outside of tax-sheltered structures, interest is similarly taxed at MTR, but only one-half of capital gains is taxable, and the rate on Canadian eligible dividends (those generally arising in an investment portfolio) can range from to zero to a little more than the rate on capital gains. At a $75,000 income level, the rate on these dividends can be as little as a third of the rate applying to interest or even less, depending on province.
4. Income splitting with RRSPs
We income split with ourselves using an RRSP, pushing income from high MTR working years to expected lower MTR retirement. A spousal RRSP likewise splits from now to retirement, and also with another person. If a person expects to be at a higher MTR when the funds will be used, a tax free savings account (TFSA) will produce a better result relative to an RRSP. Strategically, TFSA and RRSP complement rather than compete with one another
5. Understanding TFSA
The $5,000 of TFSA contribution room is an after-tax allotment, whereas RRSP room is pre-tax. Let’s say a $75,000 income taxpayer had maxed out her RRSP and wanted to know how much more of her current income she could get into a tax sheltered investment. At 35% MTR, approximately $7,692 would allow her to make full use of her $5,000 TFSA room.