Tag: Saving

Si, si, si – Translating YES into your financial planning

For many people – especially young adults breaking into their careers – financial planning may feel like learning another language.  There are new concepts, words and phrases, and time required to master how and when to apply them.

Now I’m not suggesting that Spanish is required, but you probably know that “si” means yes.  By repeating that three times, si-si-si, you have a simple acronym that takes you through common stages in your actual life as a way to look at decisions in your financial life:

S chooling
I ncome
S aving
I nvesting
S pending
I nheritance.

Elements of all of these are at work at any time, so these titles are really meant to highlight the principal focus at a particular stage.  As well, the time spent at any one stage will vary from person to person, sometimes with significant overlap and blurring of lines between them.  In fact, you may go back through repeated cycles over your life, so think of this as isolating key issues to help you identify, build and apply your financial planning skills.

Schooling that fits your outlook

Education is the foundation for your life ahead.  Choices you make at this stage can both open up and close off where you may be going, whether that’s formal schooling, hands-on experience or a blend of the two. Whatever path you take, this is when you are almost always spending more than you are earning, but it is truly an investment in yourself.

Income that supports the lifestyle you are living

As an income earner, you will be able to pay off education debt and move into positive cash flow for your current purposes.  Managing this flow can be tricky, so be aware how much of your spending is going to needs and how much is consumed by wants.  Those wants are what makes life more livable, but if they push beyond your current financial means, it’s time to either scale back or look for ways to improve your earning capacity.

Saving towards your future self

You have a past, you are in the present, and you will have a future.  With a good handle on your present finances, you can devote a manageable amount of excess income to feed your future.  With increasing clarity of that future vision as savings grow, you won’t experience saving as a pain of loss, but rather as a gain of future comfort and flexibility.

Investing your savings

Investing is not saving.  It is what you do with savings.  To this point the emphasis has been on building your skills and behaviours, in order to create savings distinct from your own earning power in the labour market. Investing layers on top of that, providing the opportunity and necessity of putting your money to work in the capital market, delivering the growth, protection and accessibility to meet your later life requirements.

Spending later rests on the decisions you make much earlier in life

Obviously you spend throughout your life, but in retirement it is the dominant feature of your finances.  You may continue some work as a way to ease into it, but eventually your only income will be from your invested savings, with assistance from government sources.  While retirement coincides with advancing years, a comfortable retirement is not simply based on reaching a particular age, but rather relies on having accumulated sufficient financial resources to sustain you in what will be your non-earning years.

Inheritance

Just as we are tied by love and emotion to the family and friends around us, we often have intertwined and interdependent financial lives.  Providing an inheritance to others is a combination of moral force, financial need and legal obligation.  Be conscious how this affects your planning, so that that you have a high degree of certainty that you will meet your needs and expectations through your life and beyond.

Millennials’ top 3 financial priorities

Pay debt, own home, fund retirement

According to the Ontario Securities Commission (OSC)*, millennials – people born in the 1980s & 90s – are the largest contingent in today’s labour force.  Roughly aged 18 to 38 today, this demographic cohort spans those deciding what interests to pursue, to those now hitting stride in their chosen field.

At the personal financial level, it runs the spectrum from emerging from full dependence on your parents, through your own independence, and on to being someone on whom others depend.

The OSC recently surveyed Ontario millennials to get a sense of their investment practices, attitudes and behaviours.  On a high level, here is what came out.

The pre-priority: Saving 

Millennials do save, or at least 80% do.  That doesn’t explain much on an individual basis, but it reinforces the collective wisdom.  From there, the top three financial priorities are reducing debt, buying a home and saving for retirement.

Like any journey, managing finances can be overwhelming to tackle all at once. The necessary first step is to manage spending so that you have savings to work with.

1.  Get that debt

Debt allows you to obtain things you need at times in your life when you don’t have the immediate financial resources to afford them.  Eventually though, you must pay it back, and in the meanwhile pay the cost of carrying that debt.  More than 80% of millennials see this as very or extremely important, with it being the top priority for 1 in 5.

Whether it’s student debt as a headstart, a consumer loan to get ahead, or a credit card that has gotten ahead of you, these types of debt are costly.  With the exception of some regulated student loans, interest payments are not tax-deductible.  That means you have to earn income, pay tax on it, then use what’s left over to pay your interest – and that’s even before you pay down the principal, which is also non-deductible.

Of the three financial priorities, you should make debt reduction proportionately the largest priority in your mind, if not your wallet.  This will free up your cash and concentration to address the other two priorities more effectively.

2.  A home of your own

Homeownership can provide stability, though renting often aligns better with a mobile/flexible lifestyle, especially early in life.  Carefully consider your motivations and financial capacity before deciding if and when to take the plunge as a homeowner.

For millennials in the last half decade, ownership fell four percentage points, which still kept it in line with rates in the 1980s & 90s, at around 40-45%.  This time it has been fueled by low interest rates and by almost half of first-time homebuyers receiving gifts or loans from parents.  However, close to 2/3 are left feeling cash poor after housing costs, with half concerned about meeting mortgage payments if interest rates rise.

If you are a would-be owner, you should stress test your capability by researching and analyzing the full financial commitment of ownership.  Once you have determined that figure, set aside the difference above and beyond your rent every month.  Your expected down payment (less existing savings) divided by that difference is roughly the number of months until you’re financially ready to commit.  If you find yourself having to dip into those savings, then you need to reassess your resources and timing expectations.

3.  Moving from saving to investing

While it appears that millennials are ready to save, the same blanket statement cannot be made about investing.  Less than half are investing those savings.  Of non-investors, the majority are held up by other financial commitments and debt repayments.  Even without those constraints, almost 60% say they delay because they don’t understand investing.

All hope is not lost though: the OSC survey shows that as millennials age, investment understanding rises.  By regularly gathering information, you not only build your store of knowledge, but also the comfort and confidence to know when and how to use it.

On that last point, among your millennial peers 46% have no plan as to how they will meet their financial goals. And of those who claim to have a plan, only 13% have it in writing.

Understanding investing may be a long haul, but understanding yourself is always within reach.  Take the time to sort through your own financial priorities, and put that into a written plan, even a simple one.   As your knowledge grows, you can get more sophisticated, but for the time being the task at hand is to get started.

Your tax refund pre-funding an RRSP tax bill

And nine more smart things you can do with your refund

Whether it arrives by mailbox or inbox, a tax refund can feel like “found money.” But alas, it’s not; it’s basically an overpayment of tax that the government eventually gives back to you – at a zero rate of return.

For many of us, it’s the result of payroll taxes being withheld during the year based on assumed annual income. The full picture only becomes clear once your tax return is filed and all credits and deductions are fully accounted for.

When the refund does arrive, what you do with it can have significant long-term implications. Contributing at least some of it to a registered retirement savings plan (RRSP) could be a way to systematically pre-pay future tax on the plan. Here are the numbers to illustrate that strategy and a few more tax-savvy options to consider.

1. Grossing-up your RRSP

The apparent simplicity of RRSP arithmetic can be deceptive. For a person at a 40% marginal tax rate, a $1,000 contribution will generate a $400 refund. But that is literally only half the story, as the eventual drawdown will be taxable, netting right back to $600 spendable. Some savers may be quite content with that, knowing that in the meanwhile growth will be enhanced by the tax-deferred nature of a registered account.

On the other hand, some of that future tax liability could be pre-funded by contributing the refund back into an RRSP. To give full effect to this, each successive refund ($400 + $160 + $64 + …) would have to be similarly applied. In truth, this is simply an increase to annual savings but with a specific purpose in mind. Leaving aside investment returns, this would build the principal towards $1,667 in this example, which nets to $1,000 spendable. 

Now obviously a person’s tax bracket can vary over time, with the key expectation of being in a lower bracket in retirement. Rather than being a drawback to a pre-funding strategy, it makes even greater use of tax breaks in high-bracket years to fund future low-bracket retirement-income years.

Given that tax refunds are themselves tax-free, there is no drain on future income, so the process can effectively be self-funding. It takes some discipline, but ideally a conscientious savings habit and a tax pre-funding strategy could operate in concert on an ongoing basis.

Reduced withholding at source

For some, a refund may instead be viewed as cash that had been needed for current expenses, but was trapped in the tax system. If that’s so, an alternative is to file Canada Revenue Agency Form T-1213 to reduce tax deductions at source. In our example, this would have released the $400 as cash flow during the year, though the net RRSP contribution is left at $1,000. 

Alternatively, if the household budget can bear it, the pre-funding strategy could be coordinated with Form T-1213. In our example, the RRSP contribution would need to be $1,667 presently, as opposed to building in that direction over the years. 

2. Spousal RRSP

A spousal RRSP builds on the use of an RRSP to arbitrage from high to low tax brackets across time by also doing so across taxpayers – to a spouse expected to be at a lower future tax bracket. 

3. Pay down discretionary non-deductible debt

Regardless why it’s there, this kind of debt can often compound against us faster than we can accumulate savings. Eliminate such costly commitments as soon as is manageable.

4. Retire RRSP loan in the current year 

An RRSP loan can help get money into an RRSP, but if not paid off in the current year, it puts a strain on future years’ living expenses and savings. As well, the interest is non-deductible.

5. Mortgage reduction

Importantly, a mortgage funds future housing, but principal and interest are non-deductible. Retiring a mortgage allows more of a monthly budget to be devoted to retirement savings. 

6. Tax-free savings account (TFSA)

Funded out of after-tax money, the TFSA allows tax-free growth and tax-free withdrawals. The annual allotment of TFSA room for 2016 is $5,500.

7. Registered educations savings plan (RESP)

An RESP boosts education saving through income splitting, tax sheltering and government grants of up to 20% federally, with some provinces offering further financial support.   

8. Registered disability savings plan (RDSP)

Families with disability issues can face large financial challenges. The RDSP enables income splitting, tax sheltering, free government bonds and up to 300% in matching grants.

9. Non-registered investments

Registered savings form the core of retirement savings. Projected spending patterns may show a need to supplement that, and investing a refund can get that part of a plan underway.

10. Live it up … a bit

After all, saving is just spending-in-waiting – but it’s a good idea to try to keep it in balance.