Throwback Thursday!

Pay Yourself First!

When I say 'pay yourself first' I am not talking about buying that new pair of shoes, or the latest gadget. The way I like to think of paying yourself is through a me tax; and think of that me tax as being paid to The Government of YOU!

What do you do after you get that money deposited into your bank? Go to the mall? The grocery store? Gas station? You are not alone. 98-99% of Canadians today get their paycheque and immediately go and spend their money on their needs and their wants. Then if there is any money left over, they put their money into some sort of a savings plan. You may remember from my prior post on the first cornerstone of financial planning we talked about two separate people; Person A and Person B. Let's look at these two people again.



Like I just discussed, we can see that Person A receives their paycheque and immediately spends their money on their needs and wants, then if there is any money leftover they then save.

However, Person B is who I strive to get all of my clients to become, it doesn't happen overnight, but through taking baby steps we will be able to move you more and more towards the financially independent Person B.

Every paycheque we are all used to seeing a certain percentage of our income deducted by the wonderful government, after all the other deductions we may have (CPP, EI, benefits etc.) we are finally left with our take home pay. Person B receives their paycheque and immediately takes a percentage off the top (like to government) and deposits it into some sort of a savings plan; this is why we refer to it as a me tax; think of that account as 'The Federal Reserve of You!'. 

The most effective way to set this up is so it is virtually automatic; the timing should be perfect here. What I like to do is set up your withdrawls so that they happen the same day you get paid. That way, the money is deposited, then withdrawn, and you barely even realize it was every there!

So I challenge you, set up a plan to pay yourself first! Better yet, call me and we can set up a rock solid plan! If you are already doing this, great! You one of very few people who are doing this! But where is your money going? Is it truly the best option for you?

If you would like to contact me, please send me a message in the box to the right. You can also reach me at Scott.Loney@Freedom55Financial.com or by phone at (905) 475-0122, ext. 411.

Who Gets The Cottage?

May seem simple and I’m sure if you have a cottage, you have a succession plan. Most people today leave their cottage to their children in the form of a will split equally. Unfortunately, when your children have children of their own and begin their own family traditions, how will they agree on who gets the cottage? Another thing to think of are the tax liabilities that may be incurred from your children taking over your property. Later I will show you an example of this, an example that would result in your children in handing a $45,000 cheque to the Canada Revenue Agency (CRA).

Any assets you own at the time of the owners death may incur capital gains taxes. When we look at some cottages which have been in the family for decades, these rising prices of property could result in fairly large capital gains. With the recent real estate boom in Canada, cottages and other vacation properties have increased significantly in value. These properties are now worth substantially more than their purchase price. At death, 50% of this increased value is subject to taxation.

Are you aware of the impact this capital gains tax liability could have on your estate? A lack of proper planning could mean that your family cottage won't stay in your family. Your estate might need to sell it to pay the tax.

Let me first show you an example:

If a cottage was purchased 30 years ago for $60,000 and has now grown in value to $259,317, then the capital gains tax owing on the death of the owner or sale of the cottage today would be $45,843. In other words, if you pass away or dispose of that property tomorrow, the CRA will be knocking on your door for a cheque of about $45,000…not too nice is it.

Fortunately there are ways to lessen this tax liability and that’s what I want to show you.

First option we have is the use of the principal residence exemption which can be used to transfer or sell the cottage to family members. Without this principal residence exemption, there could be heavy fees involved in the way of taxes. The CRA states that you can have one principal residence listed per tax year. With this you can change your ‘principal residence’ to your cottage in order to get around having to pay capital gains taxes. Also, there are no stipulations on what has to be listed as your primary residence. So long as you ordinarily live there at some point in the year you can list it as your residence. However, with this option being explored, one thing to keep in mind is other property you may own and the gains that may be incurred on those properties.

Let me illustrate how you can use the exemption to your benefit.

Let’s say you have two properties you bought at the same time in 1991. You sell one of these properties tomorrow (2014), and one in 2021. If you don’t report the gain on the first property, you are assumed to have used the exemption and therefore pay no tax on the property. Then when you sell your second property, you will have 23 years of gains to pay (while you held two properties) and 7 years of tax-free growth.

The next option for covering this tax liability would be through life insurance. This can be a cost effective option to cover the tax liability by using the tax-free death benefit to cover any capital gains taxes that may occur when you pass away.

 Let me show you another illustration to see how life insurance can cover these capital gains.

Let us say we have a couple today Sally (50) and Roger (52), both non-smokers and in good health. They have a house worth $600,000 and a cottage worth $500,000. The house is listed as their primary residence and the cottage as their secondary. Let us also assume they are in at 42% tax bracket.

When they bought the cottage in 1991 it was worth $175,000 so they therefore have a gain of $325,000. With 50% of the gain being taxable at their current tax rate, we can see that they will have a tax liability upon the second death of the couple of $68,250.

This couple decides to take out a life insurance policy of $70,000 today to cover their tax liability and reinvest any dividends in their permanent policy to account for future growth of the property.

By paying $298.28 per month, Sally and Roger can cover that tax liability, and when dividends are issued within the policy, they will purchase more life insurance to ensure the death benefit keeps a reasonable pace with the growth of the property.

I have now shown you a bird’s eye view of two ways you can protect your estate for efficient transfer to your heirs. To discuss this in greater detail please contact me. I would love to show you how to protect your estate and protect your family in times of loss.

This material is for information purposes only and shouldn't be constructed as legal or tax advice. Every effort has been made to ensure its accuracy, but errors and omissions are possible. All comments related to taxation are general in nature and are based on current Canadian tax legislation for Canadian residents, which is subject to change. For individual circumstances, consult with legal or tax professionals.

Cornerstone Four: Financial Security at Death

I know we are all ten feet tall and bulletproof; however unfortunately, the fact of the matter is that someday our time will end here on earth. When that happens, what I like to do is make sure your family is now financially impacted by your loss. What I will show you first are the four changing needs for life insurance.

First, I want you to think, have you ever heard the approximate price of a funeral today in Ontario. I have heard of some as low as $4000 and have heard other stories where funerals have cost upwards of $40,000! However, the average funeral and burial cost in Ontario today is approximately $10,000. This is what we would call a final expense; something that is there no matter your age when you pass away. We see this in the light blue area above. There is a slight increase because as you age, there are additional debts to be covered, as well as taxes and fees that are incurred with your death. So think about yourself today; think about the cost of a funeral and your current debts; believe it or not, that is your immediate need for life insurance.

Next thing I want to talk about is another changing need for life insurance called income replacement and debt elimination. Over time you are expected to earn more money, not only due to inflation, but we can also assume that you are going to move up in your company and earn more and more money. If you were to pass away prematurely, think about what burden your family would be left with if they no longer had your income coming in to pay the bills every month. If you are the sole provider for your family, that impact could be huge! In addition to this, as you earn more, you spend more. You buy a bigger home, a nicer car, a nice getaway on the lake, if you have debts from those large purchases, unfortunately they do not disappear. This income replacement and debt reduction is the second changing need for life insurance as you can see in the yellow shaded area above.

I will now address the third changing need for life insurance which we refer to as your estate. As I addressed earlier, as you earn more money, you may buy more toys. They may have been in the family for a while and losing those would be a huge detriment. Through life insurance, there is actually a way you can protect your estate from all of the nasty taxes that are imposed upon the second death of a couple. Through the use of life insurance, you can protect your estate from all probate fees, taxes and any other fees that may be incurred. Believe it or not, when your kids inherit your cottage, the gains on the property are actually taxed! Let me illustrate the fees that may be associated with the transfer of a secondary property. 

Here we see a cottage that was purchased for $60,000 30 years ago; today, that property is now worth $259,317. Assuming 50% capital gains inclusion rate and a 46% tax rate, the total taxes payable on the cottage to be rolled over to your children would be $45,843! That is the total fee payable for taxes only! On top of that, you may have lawyer fees and other fees that the government may impose. Would you want to leave your dependents with that tax liability?

The final use for life insurance is using the policy to actually enhance your retirement! I am not going to go into too much detail with this one however you can always contact me to learn more about this! In a nutshell, you can use your life insurance policy to actually provide you money during your retirement and there are ways to structure this so that every single dollar would be tax free!! That is a lesson for a later date and one we should discuss in person. 

I want to close this post by talking about your insurable interest. Today, if we were to go to the insurance company with an application, they may (based on underwriting) insure you for up to 20 times your current salary. However, if you were to delay taking out life insurance for say 20 years, the insurance company may only be willing to insure you for about five times your current salary! This is due to changes in medical history, as well as your age.

The two biggest factors in taking out a life insurance policy and the cost involved come down to two things: age, and whether you are a smoker or non-smoker. So put time on your side and call me today. Unfortunately you are never younger than what you are right now!

I can be reached in the contact box to the right, or by phone at (905) 475-0122 ext. 411.

Cornerstone Two: Retirement

Retirement is something most of us dream of and everyone looks forward to. From stopping or scaling down your work and travelling, to just relaxing at the cottage, everyone has different retirement dreams. However, what you do now determines how your retirement looks in the future. The plan you put in place will ultimately determine whether you are golfing on the beach in Florida, or mini putting at a miniature scale putting green.

If you are in your twenties and are reading this PERFECT! You are going to learn what you can do now to set yourself up for your dream retirement. If you are well into your working career and are reading this thinking about how much you procrastinated, it may not be too late, we just have a lot of catching up to do.

The first huge impact on how we save for retirement is inflation and the effects of inflation on not only the goods we purchase, but also how inflation erodes your money. To illustrate the effect of inflation I will use arguably the most debated topic of gasoline.

In August of 2000, the average price of fuel across Ontario was 70.3¢ per litre.

In August of 2014, the average price of fuel across Ontario is 139.2¢ per litre.

*http://www.energy.gov.on.ca/en/fuel-prices/fuel-price-data/?fuel=REG&yr=2000

Using these two numbers, we can see that in 14 years, the average price of fuel has risen 198% and almost doubled in price! Think if everything rose that much, what we would be paying for everything!? Now think how much of an impact that would have on your savings you are putting away today.

Through inflation alone, in the next 20 years your expenses are expected to double. So if we look at a 25 year old today with expenses of about $1500 per month, their expenses by the time they are 45 (due to inflation alone) are expected to double to $3000. Then if we look at their expenses by the time they are at retirement age of 65, they are expected to double again (again due to inflation alone). We all know that your expenses fluctuate over time however, this illustrates what consequence inflation will have on your overall cost of living!

Now that I have scared you away talking about inflation, I am now going to talk about how we can use compounding to battle inflation.

Compounding is the ability for your money to make money. How does this happen? Well the way I like to describe it is to think about a snowball. You can start out with a small little snowball and roll it down a hill. That little snowball is still there, however as it rolls down the hill it is gathering more and more snow and growing larger and larger.

How does this relate to money? Think of a small amount of money, say $100. Now lets say that money is put into a fixed investment that earns 4% over 5 years. The chart below illustrates how that $100 grows.

Beginning of Year	End of Year
$100	$105
$105	$110.25
$110.25	$115.76
$115.76	$121.55
$121.55	$127.63

As you can see, not only is the interest applied to the original $100, but it is also applied to the end of year balance from the previous year. This is a small scale example, now lets look at the procrastinator who delays their retirement until they are well into their working career, for this we will look again at Person A and Person B.

Person A is 25 years old today and starts to put away $2500 per year into some sort of a savings plan. Over the course of their working career, assuming they retire at age 65, they will be putting $100,000 into a savings plan. Now, assuming a conservative 4% interest rate, we can say that their $100,000 investment is expected to grow to approximately $250,000. Thats $150,000 of unearned money. Meaning you didn't have to put any effort in to make that $150,000!

On the flip side, lets look at Person B. This person procrastinates and procrastinates their retirement then realizes by age 45 they have nothing in place for their retirement. So at this point, instead of putting away $2500 they start putting away $5000 per year. They are still putting away the same $100,000, however assuming the same 4% interest rate, their money is only expected to grow to $150,000. Thats a difference of $100,000 and about 60% more!

You might still be wondering and asking, well Scott, how does that work? To explain this let me go back to the snowball example.

Person A is young today and since they are young chipper and in shape, they can climb all the way to the top of the hill. They make a small snowball and roll it from the top. Since they have the whole distance of the hill to roll their snowball down, their snowball grows quite large.

Person B however is 20 years older. Since they are older and not quite as in shape as they once were, they can only climb half way up the hill. They make the same size snowball as Person A started with, however their snowball is rolling for a shorter distance and doesn't grow to nearly the same size as Person A's snowball does. 

Now that I have illustrated both the nasty effects of inflation and how you can use compounding to battle this, I have now concluded my talk about retirement. I hope that you have started your retirement savings, and if you have congratulations! If you have not, get something going. Every little bit helps. Maybe instead of buying all your coffee's at Starbucks, you can start to make them at home!

Start early and put time on your side. As I talked about in liquidity the government and our employers are giving us less and less so you are the largest part to contributing to your retirement.

If you would like to start your retirement savings now call me. We can work through your exact situation and create a retirement plan that will help you retire in Florida or at your new cottage, rather than in your backyard.

If you have started your retirement savings great! Let's still sit down and evaluate what you have. Let's have a look at what you are putting away and if that truly is enough to retire comfortably with. 

And finally, if you are retired, congratulations! Do you know if your money will last you for your whole retirement? What if I told you I can predict if and/or when that money will run out. Let's sit down and look at your current situation.

I can be contacted be email at Scott.Loney@Freedom55Financial.com or by phone at (905) 475-0122 Ext. 411.

Thank you and stay tuned!