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Should I Sell my Cottage and Rent Instead?

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May 23, 2011 , ,

Benefits of Renting instead of Owning Cottage Ever wondered if you should hang on to your cottage or sell it? What are the benefits of renting a cottage instead of owning it?

A cottage brings great joy to many people, but along with the joy can be a fair bit of grief. The more clients we talk to, the more we hear people complaining about the upkeep and the cost, and the family squabbles. There must be a better way. Today, there is a way to have your cake and eat it too. Simply type in “cottage rentals” in Google, and you can see thousands of cottages in minutes.

So here now are 5 reasons why we think you should consider selling your cottage and renting:

1. Avoid big tax bills at death. This is one of the biggest estate planning problems. The family cottage was bought for $40,000, 40 years ago. Today it is worth $600,000. The older parents want to keep it in the family and pass it to their 3 children. When the second parent passes, there is a tax bill of $135,000. Only 2 children want to keep the cottage. Only one of the kids has the money available to pay the tax bill. Lots of headaches (although proper insurance planning can help).

2. Avoid big family conflict. Examples abound in terms of one child’s family using the cottage much more than another, and creating conflict. One family looks after the cottage well, while the other leaves everything a mess.

3. Avoid all that work by just renting for 2 or 3 weeks. A window needs replacing, and the deck needs new wood- owning a cottage can be hard work, not to mention expensive (and we haven’t even talked about property taxes!) Instead- rent a cottage and there is no fixing, few worries.

4. By renting, you can easily get the right cottage each summer for your stage of life. The right cottage for a young family is different than for a family with teenagers, which is different than the right cottage for a retired couple.

5. Feel free to see the rest of the country or the rest of the world during the summer. What if you weren’t tied to the cottage? You could take a summer vacation anywhere in the world, whether at a cottage or in the city. You could even use the extra wealth from the sale of your cottage to fund this.

We are not suggesting that selling the cottage is the right decision for everyone, but when you look at the list above, it certainly makes you think. To understand if this is the right option for now, why not try out our “Creation of True Wealth” Questionnaire? It helps you understand what “wealthy” means to you, not in a financial, but philosophical sense. This can help you decide if owning a cottage is part of that equation or not.

Deferred Sales Charge (DSC) on Mutual Funds

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For mutual funds investors, deferred sales charges (also known as “back-end fees”) can cause a lot of headache when investors come to realize that their investments are essentially locked-in by deferred sales charge (DSC).

The following information is based on what I wrote as an original article for the Globe and Mail.

What is a Deferred Sales Charge (DSC)?

The DSC is a fee that gets charged to a client (5-6% in year 1, declining to 0% in years 6-7) if they sell a mutual fund without transferring it to another mutual fund from the same company.

How DSCs started

Canadian mutual fund executives pay stock brokers or mutual fund salespersons and their companies a 5% up-front fee. The problem is if a client decides to move the assets out of the fund family, the mutual fund company needs to recover this commission already paid out.

It does this by having the client pay the DSC commission fee, which can be large if they leave the fund in the first few years. In many cases, clients keep their money invested with the same fund family solely to avoid paying this fee.

Mutual fund sellers claim that these fees are supposed to encourage people to “buy and hold” for a longer time. However, if somebody is not getting the level of return they would like, this just traps people to stay with the same fund company. Investors might be interested in “buying and holding” but with a different fund; the DSC fee effectively prevents this.

Investor solution

As a consumer, the solution is simple: watch out for DSC fees. If you want to invest in mutual funds, learn about the different mutual fund fees first and consider your options (including low-load or no-load funds that do not have DSC fees).

Mutual-Fund-Back-End-Fees

 

Industry solution

There are many steps that regulators could take. The best would be to make the adviser pay the DSC if a client leaves early. By putting the adviser on the hook, you can be certain that far fewer of them would sell funds on a DSC basis.

Regulators can make all of the requirements for full disclosure and signatures that they want – and they should – but until you make the adviser pay, there will still be a strong incentive for stock brokers and mutual fund salespeople to sell mutual funds with a DSC.

An alternative to mutual fund investments can be segregated funds. Read this short, informative post about the benefits of investing in segregated funds.

At TriDelta Financial we help our clients to invest intelligently, tax efficiently and never with DSCs. If you want to learn more about how we can help, contact me at 1-888-816-8927 x221 or email me at tedr@tridelta.ca

Ted Rechtshaffen MBA, CFP
TriDelta Financial

Canada: Proper Tax Planning is Not Yearly Tax Minimization

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May 20, 2011 , ,

Contrary to conventional wisdom (and some advice from accountants and tax software), getting your year-end taxes to be as low as possible is not necessarily good tax planning. It looks good on paper, but to truly be tax efficient, you need to think beyond this year.

Here are three examples of short-term tax planning strategies that may cost you thousands in lifetime taxes:

1) Refusing to withdraw money from your RRSP until you are forced to at 71.

In many cases, people don’t take money out of their RRSP in their 60s because it will increase their tax bill in that year. All this does is defer large taxes for the future. If your income now is lower than it will be after you are 71, start withdrawing from your RRSP. You will be taxed at a lower rate. In addition, you can prevent your income from going beyond the Old Age Security threshold. Finally, you will prevent your estate from taking a massive tax hit as your remaining RRIF balance is taxed as “income earned in one year” upon death.

2) Always putting off taxable capital gains as long as possible.

Again, if you are in a low-income situation in a particular year, it may make sense to take the capital gain now, and not put it off.

As an example, if you have a $10,000 gain on a stock and sell it, your capital gain tax could be $2,300 (23% in Ontario) if the sale takes place in a year when you are in the top marginal tax bracket. If, instead, you are in a much lower tax bracket in a particular year, the tax bill on the same stock sale may be $1,200 (12% in Ontario). If your income fluctuates, save on capital gain taxes this way.

Proper Tax Planning is Not Yearly Tax Minimization

3) Always getting the tax refund from your RRSP contribution.

It doesn’t always make sense to claim an RRSP contribution in a low-income year – even though it will always lower your current tax bill. Let’s say you make $35,000 this year, but next year you expect to make $90,000. You can still make an RRSP contribution to get the tax sheltering this year, but it is better to carry forward the deduction until the next year. In this example, you could get an extra 23 per cent refund by waiting one year to claim the deduction. That is a pretty good return in any year.

In all of these cases, it is important to understand your long-term financial picture instead of trying to simply lower your yearly tax bill. To get a sense of your long-term tax bill, try out the free Tridelta Retirement Tool. It calculates the amount of taxes you will have paid over your lifetime based on a few simple questions.

Critical Illness Insurance or Long-term Disability Insurance?

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May 16, 2011 ,

Long-term disability insurance and critical illness (CI) insurance are both types of living benefits  insurance Canadians set up to protect themselves, their families and their financial assets in case of physical hardship. The two are easy to confuse, but they address different needs and hardly overlap. Here are some of the frequently asked questions about the two types of Living Benefits:

What exactly is Long-term Disability insurance?

Long-term disability insurance is designed to replace your income from employment or self-employment. It pays out a monthly benefit, typically a percentage of what you earned before becoming disabled. The benefits may last for a few years – and possibly until you’re ready to retire, if you can’t go back to your own job or any job.

What is Critical Illness insurance?

Critical Illness insurance is a product that pays out a tax free lump sum in the event that someone acquires a critical illness like cancer, heart attack or stroke, to name a few. The money can be used to travel to the U.S. or elsewhere for treatments, cut back at work, pay off debts, take a sabbatical, fund home care. It is flexible. If you stay healthy and have the right product, you can even get back every premium dollar.

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What is the difference between Long Term Disability (LTD) Insurance vs. Critical Illness (CI) Insurance?

Critical-Illness-Disability-Insurance
Which one is better for me: Long Term Disability Insurance or Critical Illness Insurance?

The answer is dependent on your personal life circumstances; statistics show that since more people are likely to get cancer, heart attacks or strokes – the major illnesses covered by CI – than to become and remain disabled for more than six months, CI tends to be a more popular product choice. If a Critical Illness occurs prematurely, the insurance benefit will be significant considering it was not funded for a long period of time – which is what this coverage is essentially for.  If you live a full life, the option to have all premium dollars returned is there and can be incorporated into your retirement years.

To calculate the amount of critical illness insurance you might need, try out the free RBC Critical Illness Insurance calculator.

The Benefits of Segregated Funds for Older Investors

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May 15, 2011 , , ,

For older investors, segregated funds provide the benefits of a low-risk option with good returns.

What are segregated funds?

Sold by Canadian insurance funds and advisors, segregated funds are a type of investment vehicle that allows your money to grow, while providing certain guarantees such as reimbursement of capital upon death. Put simply, segregated funds offer you the growth potential of a mutual fund with the guarantees of life insurance.

While those interested in avoiding market risks used to focus on GICs and short term bonds, particular segregrated funds now allow older Canadians the full ability to take advantage of the upside of investments with protection against losses!

Advantages of Segregated Funds

a) If you are under the age of 70 as a new investor, most segregated funds guarantee 75% or 100% of your principal investment over 10 years OR when an investor dies, as long as you are under the age 0f 70. For older investors, Empire Life, a large Canadian insurance company, now has a great segregated fund offer with 100% guarantee for all clients who are under 80. This 100% death guarantee has some real value if you are 70+. This benefit becomes very valuable for an individual who is not in great health (there is no physical health check required). This ability for an older investor to still have a 100% death benefit guarantee is crucial to this opportunity as it means that the guarantee might kick in over a much shorter period than the traditional 10 years.

b) Because it is considered an insurance product, the proceeds (on death) for non-registered money will pass directly to your beneficiaries’ tax free and without probate.Segregated-Funds-Benefits

c) Segregated funds are not only offered as Balanced or Income funds. Traditional “higher risk, higher reward” asset class funds are also available. For example, Empire Life’s Elite Equity Fund has an annualized return of 10% going back to 1969.

d) Unlike mutual funds, the segregated funds can be reset up to twice a year. If the value of your funds increase, you get to lock in a higher floor value.

e) As an example, Empire Life only charge fees in the 2.5% to 2.75% range. While this would seem high in comparison to an ETF or index fund, the principal guarantees, reset features, and avoidance of probate fees make this investment significantly more valuable for older investors.

If this article was of interest to you, read about why an age-based investing strategy might not be right for you!

The RSP: Minimize Your Biggest Future Tax Bill

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May 12, 2011 , , , ,

In the future, your biggest tax bill will be your RSP taxes.

We all know of the benefits of tax refunds and tax-free growth for RSP, but what happens after you retire?

Here is how the RSP taxation works:

• Your RSP grows tax-sheltered until you draw out money. Any money you withdraw each year is considered “yearly taxable income” for tax purposes.

•If you wait to withdraw your money, the year you turn 72, your RSP turns into an RIF, which means that the government mandates you must withdraw at least 7.48% each year and pay tax on it. If you are married and you pass away, the RSP/RIF will simply transfer over to your spouse.

• The year the surviving spouse passes away, the entire value of the RSP/RIF is considered one year’s taxable income. If you have a $500,000 RIF left at that point, the government will take $212,000 in taxes!! This is often shocking to the estate.

A few tips to help you avoid your biggest future tax bill

How do you avoid this huge tax hit?

1. Don’t save so much in your RSP in the first place. Unless you are in the top tax bracket (and enjoying the maximum RSP refunds), saving too much now can lead to a massive tax hit at the end. In low income years, put less or nothing into your RSP.

2. Draw more money out while you are alive to enjoy it. From a pure financial perspective, you want to draw out registered money in years when it can be done at a lower tax rate – those years when you have very little other income. From a philosophical point of view, you want to draw out the funds when you are still able to enjoy it.

3. You can use strategies like the RSP meltdown to effectively draw out more money from your RSP by creating a tax deduction equal to the amount withdrawn. This strategy can be quite effective for many people, but does require some leveraged investing, and you might require professional advice.

The main message here is that you need to have a long-term tax minimization strategy, instead of simply saving up RSP funds.

One quick and free tool is the The Tridelta Retirement 100, which helps you see your likelihood of running out of money, your likely estate size and lifetime tax bill. By playing with RSP numbers, you can see the impact yourself.

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