Building Wealth

For the first 30 or so years of working, saving and investing, you’ll be first in the mode of getting out of the hole (paying down debt), and then building your net worth (that’s wealth accumulation.). But don’t forget, wealth accumulation isn’t the ultimate goal. Decumulation is! (a separate category here at the Hub).

Advisor’s Alpha

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By John De Goey, CFP, CIM

Special to the Financial Independence Hub

One of the great debates around the investing world revolves around the extent (if any) to which advisors add value.  Many in the media say the number is either small or negative. Many advisor cheerleaders say the number is substantial.  Everyone should be skeptical.  What follows is my unscientific assessment of the pseudo-debate (two opposing factions that have a story to spin where it is difficult to ascertain or refute either position).

The people at Vanguard have long been touting their own research (complete with quantified bandwidths for varying activities) on this topic.  Their general position is that advisors add about 3% in “value” to their clients’ portfolios.  Colour me skeptical.  To begin, it is possible to drown in a river that is, on average, only two feet deep.  Averages can be deceptive, especially when the variance in the things being measured is likely to be wide.  There is really no such thing as an average advisor or an average client.  Using the word “typical” might be a bit more accurate and helpful, but frankly, I doubt it.

There are some good advisors out there – and some lousy ones, too.  When I hear people talk about the suite of services that might be offered, the usual presumption is that all advisors are doing all those things.  That’s simply not true.  In short, almost any assessment of value added (say 3%) is likely to be truest only of the very best practitioners.  Only the very best are likely to be doing all the good things that cause advisors to score highly.  Ordinary advisors don’t do those things.  Poor advisors might very well be doing the opposite.

That’s my major beef, but there are others.  Remember that advisors are not monolithic.  They’re all over the place regarding what they do, how they do it and who they do it for.  Part of that is because their clients are all over the place, too.  Some are slothful to the point of it being difficult to get them to do anything; others are hyper-sensitive to media hype and short termism.  Good advisors provide focus and discipline, but that is difficult to reliably quantify and, at any rate, likely looks different for different clients.

Two counter-narratives

Allow me to offer two counter-narratives to the idea of (most?) advisors (consistently?) adding 3% over a long-term time horizon.  The first is the annual Dalbar study, the “Quantitative Analysis of Investor Behaviour” (QAIB).  Dalbar admits that while the study purportedly shows how investors can do unnecessary harm to their return by (among other things) chasing past performance, the people at Dalbar have no way of disaggregating causation.  Continue Reading…

Are you tax planning for you …. or for your estate?

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By Aaron Hector, B.Comm., CFP, RFP, TEP

Special to the Financial Independence Hub

“In this world nothing can be said to be certain, except death and taxes.” – Benjamin Franklin

While death and taxes may be certain, the variables in and around them are certainly not. That’s why they warrant attention and planning. The following analysis provides some food for thought when deciding whether to use proactive tax planning to optimize your living net-worth or your after-tax estate.

A tisket, a tasket, a future tax basket

Most retirees have baskets of “future tax” that are just sitting there in abeyance. The most common of these tax baskets is the one that’s attached to RRSP accounts. When you contribute to your RRSP, you get a tax deduction which gives you a break on the taxes payable in that year. But when the time eventually comes to make a withdrawal, each dollar you remove from your RRSP will be fully taxable and increase your income accordingly.

Depending on the situation, there could be several other future tax baskets as well. For example, you might have unrealized capital gains that are attached to a non-registered investment account, or even an additional property. When these assets are sold in the future, the capital gain at that time will be subject to taxation.

Our tax system is progressive, which means the tax rates continue to increase as your income does, thus moving you from a lower tax bracket to a higher one. When you die (without a surviving spouse), all of the remaining tax baskets are dealt with at that time. This often results in a significant amount of taxable income that’s exposed to the highest marginal tax rates which can exceed 50%, depending on your province of residency.

Managing future tax

What can be done to manage this future tax in a way that avoids exposure to such high tax rates? One popular approach is to look at your projected retirement income and identify when in the future there might be years where income is lower than average or higher than average, and then try and shift income away from the high years to fill in the low years. This “tax averaging” often results in an acceleration of income in earlier years, which then lowers the exposure to high tax rates later in life or upon death.

If you think this sounds challenging, remember that any financial planner worth their salt should be able to review your assets and liabilities, then map out your projected income going forward on a year-by-year basis. The low-income years most commonly occur immediately following retirement; the paycheque has stopped, but maybe you have ample cash and non-registered savings that can be used to fund your lifestyle. It’s quite possible that the income you would report on your tax return in these years would be minimal. However, by the end of the year that you turn 71 your RRSP accounts must be converted into RRIF accounts, giving rise to forced annual withdrawals that are fully taxable. These mandatory withdrawals might mark the beginning of your high-income retirement years and may even result in your Old Age Security (OAS) being clawed back. That being said, it really depends on one’s individual circumstances.

The nice thing about the future tax is that, for the most part, you have flexibility in deciding when you convert that future tax into current tax. Just because you can wait until age 72, when you are forced to make your first withdrawal from your RRSP (RRIF), doesn’t mean that you must wait until you are 72. Furthermore, this doesn’t need to be a cash flow decision. If you don’t need the money to fund your lifestyle, then you can simply take the money that is withdrawn from the RRSP and then (subject to withholding taxes) reinvest it back into another account such as your TFSA or non-registered account. The point here is that you have the option of choosing what you believe to be an optimal year to increase the amount of income that will be reported on your tax return.

Similarly, you can choose to trigger a capital gain within a non-registered account at any time. A sale of a stock doesn’t need to be an investment decision – it can be a tax decision. Simply sell the stock, thereby triggering the capital gain, and then immediately rebuy it. The capital gain will then be reported on your tax return in the year it was sold, and your taxable income will be increased accordingly.

In a nutshell, every dollar of income that you accelerate is a dollar of income that you don’t have to report in the future, and you get to choose what tax rates get applied to that dollar; the current marginal rate, or the future marginal rate (which could be higher). It’s easy to see how this process can result in your paying a lower average lifetime tax rate.

How to impact your lifetime assets and estate

Let’s dig a bit deeper. How do these choices carry forward and impact your lifetime assets and ultimately your estate? I’ll begin with some foundational ideas and then provide a real-life example.

Imagine a scenario where your current marginal tax rate is 30% while living, but if you died then the marginal tax rate on your final tax return would be 50%. Continue Reading…

10 ways Americans and US expats can minimize their Tax Liability

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By Mark Strohl

Special to the Financial Independence Hub

On your journey to financial freedom, tax season will always be an obstacle you have to deal with. However, taking advantage of the various deductions and credits provided can lead to less money owed to the government, and more money remaining in your bank account. Some incentives afforded to you are dependent on many factors, such as your status of employment, while others are universal to individuals living in the United States. In this guide, we discuss ten ways you can minimize your tax liability, allowing you to save more towards your goal of financial freedom.

Taking advantage of Tax Deductions

Tax deductions are all about lowering your taxable income. There are two types of deductions you can claim: the standard deduction, or the itemized deduction. The standard deduction is a pre-set amount provided by the IRS, and is dependent on your filing status. For the year 2020, the standard deduction amounts are [all US$]:

  • Married filing jointly – $24,800
  • Single or married filing separately – $12,400
  • Head of household – $16,650

It is estimated that around 90% of tax filers in the US take the standard deduction, including all filing statuses. However, the itemized tax deduction can still be useful, even though the passing of the 2018 Tax Cuts and Jobs Act has reduced the range of items that are counted towards deduction. The following are all items that can still be counted towards itemized deductions:

  • Interest on home mortgages that $750,00 or below
  • Medical and dental expenses that exceed 7.5% of your Adjusted Gross Income
  • Charitable contributions (donations)
  • Stale/local income, personal property, and sales taxes up to $10,000
  • Student loan interest (up to $2,500)
  • Investment interest expenses

In certain circumstances, the amount you owe could be less when deciding to take the itemized deduction. However, these requirements are very specific, and it is best if you work with a qualified CPA to discuss what deduction is best for you.

Contribute more towards your Retirement

Whether you contribute to a traditional 401k or an IRA, retirement account contributions are great for reducing the amount of income that can be taxed. Not only is the amount you contribute exempt from taxable income, but the growth the accounts generate is also not taxable until you withdraw from the accounts. However, keep in mind that only the first $6,000 that you contribute to an IRA can be deferred, and the first $19,500 contributed to a 401k. Continue Reading…

Retired Money: What to do with “Found Money” from the Covid lockdown

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MoneySense.ca: Photo created by pressfoto – www.freepik.com

My latest MoneySense Retired Money column looks at what to do with the “found money” most of us are experiencing during this extended Covid-19 lockdown. Click on the highlighted text to access the full column: What to do with $500, $1,000 or $10,000 right now.

In it, four experts are asked what they’d recommend clients do with an extra $500, $1,000 and $10,000. One was Adrian Mastracci, portfolio manager with Vancouver-based Lycos Asset Management Inc., who suggests any extra savings should be “parked out of sight” for a month or two while you analyze your needs and options.   Repaying debt – particularly high-interest credit card debt – is always a top-notch, risk-free way of deploying cash, Mastracci says.

Certified financial planner Aaron Hector, vice president of Calgary-based Doherty Bryant Financial Strategists, suggests those nervous about their employment status should leave the money parked while they “wait and see” what transpires. “Cash provides flexibility,” he says. You also need to determine if there really are true savings or you are simply experiencing a delayed expense, as may be the case if a planned vacation abroad was cancelled because of Covid. If so, that money will eventually be spent.

Covid-19 has forced everyone to re-think our financial goals and objectives, says fee-only planner Robb Engen, the blogger behind Boomer and Echo, “For some retirees, that has meant putting off large projects such as a home renovation until better times. But for those who have enough income to meet their spending needs and then some, I’d recommend squirreling away any extra cash savings in a high-interest savings account to ensure you can pay cash for your next big-ticket purchase without cashing in any investments.”

Asset Allocation ETFs a good choice for $10,000

Engen — one of the MoneySense experts on the annual ETF All-Stars feature — suggests an asset allocation ETF, assuming all short-term goals have been funded and accounted for. For older folk wanting some fixed income to cushion any further Covid-related market volatility, consider VBAL or VCNS (60% and 40% equities respectively.) Keep in mind that iShares has a similar set of asset allocation ETFs, as does Horizons ETFs, all highlighted in the latest ETF All-stars package. Continue Reading…

5 steps to take to retire before 40

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By Veronica Baxter

Special to the Financial Independence Hub

So you think you want to retire early? Here are five proven steps to take to make that happen, if by “retiring” you mean no longer working.

Step #1:  Work Wisely

Notice that this does not say work hard, or work 80 hours a week. To work wisely means to choose a job or a career that is lucrative and that you get some satisfaction from. You don’t have to love or even enjoy your job but you do have to tolerate it and feel a sense of self-respect in being paid to do it.

If you are still in school there are career services where you can seek counseling about what sort of careers pay well that you might be able to do and feel satisfied doing. Oddly enough, right now our economy needs more tradespeople because the boomers brought their children up to expect to go to college and get a white-collar job. As a result, there are fewer workers in trades such as plumbing, electrical, carpentry, and these people are in high demand.

Whatever you choose to do, ideally, you want to be your own boss eventually. That way you have control over the quality and quantity of work and you also have control over business expenses, which you can then keep to a minimum. Then if you can grow your business and eventually have employees work for you, you can multiply your earnings by however many people work for you. Then, eventually training someone to supervise the work means you can step back and… perhaps retire!

Whatever you decide to do, craft a 2-year plan, a 5-year plan, a 10-year plan, and a 20-year plan. These plans should include training or education goals, financial goals, and a vision of what your work life looks like at every stage. Revisit these plans in an annual self-audit to keep yourself on track, and revise them if necessary. You’ve heard of the phrase, “fail to plan, plan to fail”? Well, it’s true. Harness your imagination and dream big. Reach for the stars, you may get the moon.

Step #2:  Pay Yourself First

This is crucial. When you craft your household budget, the first expense you must pay is into your savings or retirement account. What percentage of your income you put aside is up to you, but first, you will need an emergency fund of 6-8 months’ living expenses, then you will need to put money aside for retirement.

There are online calculators that can help you figure out how much you will need to live off the income from investments, or, you can seek the advice of a financial planner to help you figure out how much to set aside and to select the right investment vehicle for your goals. Keep in mind that if you plan to retire before age 40, you will need investment vehicles in addition to traditional tax-deferred retirement plans because you will be too young to withdraw from those.

Step #3:  Live Below Your Means

Whatever percentage of your income you decide to set aside, you should figure out how to live comfortably on 80% of the remainder. Why? Because having what you perceive as “extra” money at the end of the month gives you a mental boost like nothing else. When you feel like you are in control of your finances and you have more than enough money to do what you need to do, you are activating the law of attraction.

What do you do with that “extra” money? Take a small portion and treat yourself in some small way to reward yourself for being frugal, then invest the rest in your business or deposit it in your investment accounts.

Step #4:  Maintain Good Credit

It is crucial that you pay all bills in full and on time. Take out and use credit cards, especially if there is some sort of reward for use such as cashback or airline miles, but pay them off every month. Get a car loan. Continue Reading…