Category Personal Finance/ Estate Planning

Get Up to Speed on Your Financial Status

Polls often suggest that many Canadians don’t have a firm understanding about their finances and maintain some misconceptions about credit.

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The Low Down on Credit

To get a better handle on your debt, it helps to know how financial institutions calculate the charges on your monthly credit card statement.

If you always pay the amount owed by the due date, you pay no interest at all. But if you carry over balances, there are differences in charges for various transactions:

  • Cash advances and balance transfers carry interest from the moment you make the transaction. There is no interest-free period.
  • Old purchases are unpaid transactions from a previous statement. On these, you are charged interest either from the date of the transaction or the date the purchases are posted to your account, until they’re paid in full.
  • New purchases can be interest-free under certain conditions. The interest-free period has two parts: The time between the purchase and your statement date, and the time between your statement date and your payment due date. This grace period can vary from 19 to 26 days.

Read the fine print when you take out a new credit card, use the ones you have, or take advantage of low introductory offers.

Not knowing how your rates are calculated can cost you more than you realize.

To protect your credit rating, many financial specialists recommend making the highest payment you can on credit cards, make all payments on time, and avoid signing up for multiple credit cards.

Other information that is critical to maintaining a healthy credit standing includes knowing that:

  • You are responsible for joint accounts and co-signed loans. Activity on those accounts shows up on your credit report.
  • Paying off a negative record doesn’t completely remove it from your credit report. Collection accounts, late payments and bankruptcies can remain on your report for as long as ten years, even if the bills are paid off.
  • Checking your credit reports will not lower your credit score and is a good way both to monitor your credit, find errors, and reduce the chances of identity theft.
  • Changing old accounts can actually lower your credit score rather than improve it. When you close old accounts, you shorten your credit history and that can actually lower your credit score. If you want to close your accounts, start with the newer accounts to help preserve your long established credit history.

Among other things, surveys have shown that many Canadians don’t have a household budget and don’t know their credit rating, a key tool in managing finances and debt. Moreover, Canadians who have credit cards often lack such critical knowledge as the annual interest rate they pay on their most-used card and that credit reports contain information about every loan, credit card, line of credit, mortgage or fault of payment incurred. (Equifax Canada and TransUnion Canada will provide a free copy of your credit report by mail or online for a small fee.)

Moreover, sizable numbers of Canadians don’t consider the effect changing interest rates will have on their borrowing costs.

This lack of understanding along with certain misconceptions about credit can hurt your credit score, which determines your ability to borrow, cost you thousands of dollars in unnecessary extra payments, and hinder your ability to save (see right hand box for some of the common misconceptions).

Assessing Your Situation

Two tools are critical in helping you evaluate your current financial situation and, when prepared and reviewed annually, they can help keep you on track toward your financial goals.

With the help of your accountant, work up a net worth statement and a spending analysis. You may then also want to work out a budget.

The net worth statement lists your assets and liabilities. The difference between them is your net worth. The statement should include all assets including retirement plan balances, personal property, jewelry, and household items. Value the assets at the price they could fetch now.

Once the statement is prepared, review it with your accountant and discuss the following:

1. Your ratio of assets to liabilities: A ratio of less than one to one indicates you have more liabilities than assets and a negative net worth. If that is the case, talk to your accountant about steps to take to cut your liabilities. As your debt declines, the ratio should increase. Ideally, the ratio should be at least two to one or greater.

2. Net worth growth compared to inflation: Growth in your net worth should outpace inflation. If it isn’t, determine why and take steps. Otherwise inflation is just eating away at your net worth.

3. Good vs. bad debts: The amounts and types of debt you have weigh heavily on your financial health. Mortgages are typically used to purchase items appreciating in value and are generally considered “good” debt. Credit card balances and auto loans finance items that typically don’t appreciate and should be kept to a minimum.

4. Liquid vs. nonliquid assets:Nonliquid assets such as a home and other real estate, jewelry, and works of art may increase in value but be difficult to sell quickly at full market value. Liquid assets such as bank accounts and stocks are more easily converted to cash. You want enough of them to cover emergencies.

Once you have a handle on your net worth, analyze your spending patterns and identify ways to increase savings, if necessary.

Start with a cash flow statement that details all sources of income over the past year and all expenditures by category.

Divide the expenditures among:

1. Fixed and essential expenses (such as housing, insurance, taxes and savings),

2. Variable and essential expenses (such as food, medical care and utilities), and

3. Discretionary expenses (such as entertainment, clothing, and charitable contributions).

Cancelled cheques, credit card receipts, and tax returns can provide much of the needed information. If you are unable to account for large sums of money, keep a journal of all expenditures for a month or so.

The spending analysis could lead you to decide you need a budget to help guide you toward your financial goals. Points to consider include:

  • Make conscious spending decisions. Don’t just assume you’ll spend the same amount as last year.
  • Prepare a flexible budget. Unexpected expenditures are bound to happen and your budget should incorporate that possibility.
  • Budget for large, periodic expenditures, such as tuition or insurance premiums.
  • Don’t try to be too exact. All family members should have a reasonable personal allowance that can be spent without accounting for it.
  • Periodically compare actual expenditures to your budget to ensure you stay on track.

List Your Home Successfully

lores_for_sale_sign_real_estate_nhIf you want to sell your home and increase your chances of getting a decent price even when market conditions are rough, there are a few steps you can take that will help you reach your goal.

The first step is to know what else is out there. Study your local market to see what other sellers are asking and what buyers are paying. Ask your real estate agent for selling prices in your area, but don’t rely just on price lists. Visit open houses to evaluate the competition, to determine what features come with the price, and listen to what other viewers are saying about the properties.

Once you have that information in hand, here are three other tips the can help ensure your home makes the cut with potential buyers:

1. Price to sell

If you genuinely want to sell you must be competitive. You may not be able to simply set the price you want and wait for the bidding. If buyers think your home is overpriced, they will move on. Remember, the more listings there are, the more choice buyers have. That means they can wait to find their perfect home for their perfect price. Consult with your agent to determine if setting an asking price just below what the market will bear would generate more traffic and put your home into serious play.

2. Negotiate

You may boost your chances of a successful sale if you offer such concessions as making minor repairs. Buyers weigh the time, effort and cost they will have to invest, even the smallest repairs. If there is a glut of listings, the little things take on even more importance. Most buyers are looking for a home that is ready for immediate occupancy. Talk to your agent about hiring an inspector so you know what to repair before the property goes on the market.

3. Highlight the assets

It’s up to you to impress buyers. Repaint the interior and get rid of clutter to make the house appear more spacious. The idea is to help the potential new owners see themselves in their new home. Clean out the closets and garage. You can donate items to charity and receive tax credits, or hold a garage sale and make some extra cash. Don’t worry about taxes on money earned at a garage sale. It is generally tax-free, unless you sell an item for more than you originally paid. Some inexpensive landscaping can also help speed up a sale.

Sometimes, however, you need to know when to simply take the money. The longer your house stays on the market, the more you risk losing. If you get a reasonable offer now, even if it’s below your asking price, you may want to take it. Otherwise you could find that after some time you may have to lower your asking price anyway and still be unable to sell. If local sales are sliding, and you feel you need to sell, you might want to get out while you can.

It can be difficult to gauge the right time to simply take less than you hoped for. If a cooling market means making a smaller gain than you expected, consider relocating to a less expensive area to get more house for the money.

Talk to your real estate agent and professional advisor who can help you decide if you would be better off waiting before you put your home on the market and help you get the best price if you do decide to list your house.

Save on Taxes with an Estate Freeze

lores_building_corporate_offices_entry_amEstate freezes are a handy estate planning tool that helps avoid taxes, primarily capital gains taxes that apply on the transfer of assets to beneficiaries at the death of the parent.

An estate freeze restructures the beneficial ownership of certain types of assets. As a result of the freeze, the value of the existing equity is fixed, while future growth is transferred through shares or a trust into the hands of the named beneficiaries. This usually limits the value of the parents’ estate to the value on the date of the estate freeze.

Tax liability is determined by fair market value of property at time of death. By implementing a freeze beforehand, the value of one’s estate that is subject to tax is reduced and the value of assets received by beneficiaries is maximized.

An estate freeze makes sense in cases where the value of estate assets is expected to appreciate. The most common form of estate freeze involves the transfer of estate property to a corporation, or the reorganization of an existing corporation.

It locks in the corporation’s current value, leaving it in the hands of the founders. Their children are brought in as the new owners and will reap the benefits of any future growth of the corporation.

Typically, when the corporation is created the original holders receive shares with a nominal value from $.01 to $1 each. Years down the road, when the founders want to pass on the operation of the business to their children, those shares are usually worth considerably more. Now assume the parents want to stop working and need money to finance their retirement but the beneficiaries may not have the money or want to take on high debt to acquire the stock.

Adding to the conundrum are the tax consequences. Because the shares will be sold to a related party, the Lifetime Capital Gains Exemption on qualified small business corporation shares is affected. The parent can claim the exemption, but the tax cost of the shares to the child is reduced by the amount claimed. As a result, the children may have to pay taxes if they sell the shares.

An estate freeze can solve both the financing and tax issues. The parents swap their voting shares for preferred shares with a redemption amount equal to the value of the company at the time of the swap.

Section 85 of the Income Tax Act allows the swap to be recognized at any value between the fair market value of the new preferred shares and the tax cost of the old voting shares. The exchange value that is chosen is normally one aimed at letting the lifetime exemption shelter the resulting capital gain from taxes.

Typically, the founders also receive new voting shares with no redemption value that are then sold to the children. Because all the value of the corporation lies in the preferred shares, the voting shares have only nominal value and can be sold to the children without significant tax consequences. If the children sell the shares, they can claim their own lifetime exemption.

The founders then redeem the preferred shares as they wish. The redemptions are financed by the profits of the business rather than money the children borrowed.

Redeeming the shares produces a taxable dividend added to the parents’ income. That reduces the capital gain on the redemption and any resulting capital loss can be used to offset other capital gains.

Estate freezes are complex, but can be advantageous. Talk to your accountant about this or other methods that can help minimize taxes in your estate.

Regularly Review Your Property Insurance

When you bought your home, you may have simply purchased a homeowners’ insurance policy sufficient to satisfy the requirements of your mortgage lender. But lenders only require policies that protect the house, not its contents.

lores_umbrella_rain_shade_insurance_weather_protect_sun_mbThose possessions are likely to grow in quantity and value over time and they need to be insured. You may also need optional coverage, called riders, for earthquakes, windstorms and other natural disasters or to increase the amounts paid out on certain items. In addition, remodeling, adding a room, and getting married or divorced are just some of the changes in your life that should prompt you to review your policy’s terms.

Here are some frequently asked questions about property insurance. The answers provide only general information. Consult with your financial advisor about your specific situation.

Q. What types of homeowners’ insurance can I purchase?

A. There are three types of policies:

  1. Standard, which protect against several named, or listed, perils that could damage your home and its contents, such as lightning, windstorms, hail, theft and certain types of water damage.
  2. Broad, which upgrade coverage on the structure to include all risks, but leaves the contents on a named perils basis. All risks policies generally list what is excluded from coverage, such as faulty workmanship and general wear and tear.
  3. Comprehensive, which provide all-risks protection on both the structure and its contents.

When you purchase a policy it’s important that it will cover at least 100 per cent of its replacement cost. This is not the same as market value of your home or the cost you paid for it. The market value of a home is the amount a willing buyer would pay to a willing seller, excluding the land, regardless of how much it would cost to rebuild the home. Replacement cost is what you would have to pay to repair or rebuild the entire home.

It’s impossible to predict what the exact cost will be to replace your home, so it’s critical to have enough coverage to take that into account. An appraiser can help you determine what it would cost to completely replace your dwelling. Also, check to be sure that the policy will automatically adjust to increases or decreases in construction costs in your area.

Q. What should I look for when it comes to water-damage coverage?

A. Generally look for policies that cover damage from plumbing overflows, holes in a roof, burst pipes and windows shattered during a storm that allow rain to blow in. Policies generally don’t cover damage from continuous seepage or sewer backups, but you can purchase that protection as a rider. For the most part, flood insurance isn’t available in Canada because flooding is considered inevitable. You should take whatever steps are necessary to protect your home and belongings from such disasters.

Q. How do deductibles work?

A. Your deductible is the amount you pay for covered damage before the insurance kicks in. Higher deductibles mean lower premiums but additional financial risk. Usually a deductible is a flat rate that can be as low as $500.

Many insurers offer percentage deductibles, particularly for coverage of damage from earthquakes, hurricanes and windstorms. Under these policies, you pay a certain percentage of your home’s insured value before you get reimbursements. For example, if your policy has a two per cent deductible and your home is insured for $250,000, you pay the first $5,000 in damages. Be sure your deductible is an amount you can afford to pay.

Q. Can I get a discount?

A. Many insurers offer discounts to people who own newer homes, have installed such safety features as smoke detectors and burglar alarms or have not filed claims for a specific period of time. Some companies even offer discounts to non-smokers.

Q. What is liability coverage?

A. This covers unintentional injuries to visitors or accidental damage to a neighbour’s house as well as legal costs if you are sued. A minimum of $1 million is recommended.

Q. How are claims paid on personal possessions?

A. Most policies cover personal possessions at a rate of 50 per cent to 70 per cent of the amount of insurance you have on the dwelling. In other words, if your home is insured for $100,000, your policy would cover from $50,000 to $70,000 of the value of the contents. You can purchase two types of coverage:

  1. Cash value policies that pay the depreciated value of the item, which is the replacement cost minus a deduction based on the age and condition of the original item.
  2. Replacement cost policies that reimburse you for the full amount. If you have this coverage and opt for a cash settlement, you will be paid on a depreciated basis.

Q. Are there monetary limits on the coverage of specific possessions?

A. First, standard and broad policies don’t generally provide coverage for such valuable items as furs and jewellery. But even with comprehensive insurance, the dollar limits may be inadequate not only on those items but also on stolen cash, garden tractors, computer software, bicycles, and collections of coins, stamps and cards. The good news is that you can generally purchase reasonably priced riders for supplementary coverage. When it comes to art and antiques, you need to look for specialty insurance policies.

Q. Will my homeowner policy pick up the extra cost of having to conform to new building codes if I have to rebuild my home?

A. No, most insurance policies do not pay for this. You may be able to purchase a rider, but it may pay only a portion of the increased costs.

Q. I live in a condominium and the condo corporation carries insurance. Do I need my own policy?

A. Yes, because the corporation’s insurance covers only items that are part of the building. You need insurance for upgrades you make to the unit, for your possessions and for personal liability.

Q. What is title insurance?

A. Title insurance compensates you for losses from such factors as unknown title defects, existing liens, encroachment issues, fraud, and other issues that can hinder your ability to sell your property. When considering this insurance, carefully review the exclusions.

Caution Is the Rule in Naming RRSP Beneficiaries

Selecting beneficiaries of your registered retirement plans is one of the most important financial decisions you will make, and with a little thought you can maximize the benefits to your heirs by deferring taxes and keeping the assets out of probate and away from creditors.

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Review and Revise

Review your Will and other estate documents often to ensure that all the paperwork is consistent or problems can arise.

For example, say you name your daughter the beneficiary of a particular RRSP. You later make out a Will leaving all your RRSPs to all your children, but you leave your daughter’s name on that one plan. A Will can generally override an RRSP or RRIF beneficiary on file at a financial institution when the Will was prepared or updated at a later date. That is an unintended consequence of failing to review and compare documents periodically.

When you have more than one plan, it’s a good idea to list in your Will the number of each, the institution holding it and the intended beneficiaries to help avoid confusion and potential contention.

The most important action is to actually name someone to receive the assets from your Registered Retirement Savings Plans (RRSPs) and your Registered Retirement Income Funds (RRIF). Otherwise, the plans automatically go into your estate, which pays taxes that can devour as much as half the value of the assets.

Your estate will also have to pay probate fees and the assets become subject to creditors’ claims. (See right-hand box for other potential complications to avoid.)

When considering your registered plans it is critical to note that if non-dependent children or others are left plan assets in your Will, the full value will be taxed as income in your final return and only then will they receive their share of the estate.

Tax-Deferring Strategies

You can defer taxes if your beneficiary is:

  1. Your spouse or common-law partner, or
  2. A financially dependent child or grandchild who is either under the age of 18 or is mentally or physically infirm.

When you name your spouse or an infirm dependent, the assets are simply rolled over into the person’s registered plan, including a Registered Disability Savings Plan (RDSP). With an infirm beneficiary, the assets can also be used to purchase an annuity.

Spousal rollovers don’t use contribution room, but RDSP rollovers reduce the lifetime contribution limit of $200,000 and don’t generate a federal contribution.

Healthy financially dependent minors have the sole option of purchasing an annuity that must mature when they turn 18. The annual payments will be taxable.

In all these cases, the beneficiaries will pay taxes on plan withdrawals or annuity payments.

Successor Annuitants

Your options widen a bit when you name your spouse or common-law partner beneficiary of your RRIF. You can:

  1. Name your spouse the “successor annuitant,” where he or she simply starts receiving the payments.
  2. Arrange a lump sum payment. The fund will be collapsed, the investments sold and the proceeds rolled over into the spouse’s RRSP or RRIF. Among the disadvantages of this option is that the timing of the collapse may not be the best for selling the assets and there will be management fees.

Other Beneficiaries

Estate: It may make sense to name your estate the beneficiary if you want to:

  • Spread the tax liability among all your heirs;
  • Distribute assets to several people in different amounts;
  • Impose conditions on an heir in order to receive the assets, and
  • Hold the assets in trust.

Charity: You can name a registered charity and receive a tax credit of as much as 100 per cent, which can effectively eliminate taxes on your final return. You can instruct the charity how to distribute the assets through a Letter of Direction.

These are just some of the complexities involved in choosing beneficiaries for your registered retirement plans and minimizing taxes on your final return. Your accountant can guide you through the maze of estate planning.