Your Financial Advisor and his hidden fee

Hidden Fees are almost synonymous with the financial world, patricianly financial advisors.  Millions of ordinary investors might or might not be aware of the dreaded Mutual Fund MER.  But for those who have retained a financial advisor, there are even more fees, hidden fees that are invisible. You probably have no idea what I am talking about, they are so hidden, that you will never see them in any prospectus.

One of the most common fees financial advisors charge is a 1% annual fee, based on the assets that are managed.  Every quarter or annually, this amount is deducted from a client's account and put into the financial advisor's firm's bank account.  Tho this insane amount of money being charged for financial services is a fee, it's not the hidden fee I was talking about.

It's what we called in University, the opportunity cost of your money every time this deduction occurs.  An example would probably help at this time.

Example

Ronald is 40 year old Director of Finance in a construction company.  He recently finished paying off his student loan and is approached by a financial advisor who is offering his services to manage his $500,000 RRSP account for a 1% annual fee.  Ronald has paid more than that on his student loans and his credit card interest rates are way higher than that.  He thinks this is an amazing deal, where can you get a financial advisor for 1%?  Sign me up.

Over the next 10 years, let's assume the market and Ronald's portfolio achieves that long term average of 7% gains per year.  So now we are 10 years into the future, and Ronald's RRSP account is now worth $892,000.

Over that same period, Ronald would have paid his financial advisor $68,290.  Even a director of Finance would think that is a pretty penny.

But at least Ronald can clearly see this money withdrawn from his account.  However as the quarterly or annual payments come out of his account, he is sacrificing all future growth or opportunity cost on that money.

If the payments were quarterly, Ronald's 1st payment would have been $1,271.  If he kept that money for 10 year, it would have been worth $2,459 nearly double its original amount.

Over the 10 years, Ronald would have given up $25,421 in missed returns.  Add that to the actual fees that he paid, and Ronald is nearly out $94,000 over 10 years.  Nearly a fifth of his original $500,000 portfolio.  Now can you see why financial advisors are so friendly, if they have 5 clients like this, they are set for a long time.

Let me stop here and make one thing clear.  I am not saying all financial advisors are only in it for the money or that they do not provide a valuable service, after all most of them are friends you trust or family members.  However if you do use a financial advisor or money manager, take a long hard look at my example above with Ronald and ask the advisor, "Am I getting my money's worth?"

If the answer is no, do something about it.  Relatives, neighbours, and your financial advisor will tell you that you are making a mistake, or that investing is too complex (I've shown in this blog it is not).

Start by crunching your own numbers.

But don't waste time, with every day that you have your advisor, your losing money whether you see it or not.

RRSPs are not just for retirement - 4 options to use your RRSP dollars

Even though the word "retirement" is one of the 4 words in the RRSP acronym, many savers may not know that an RRSP can be used for more than income in your twilight years.

The 4 options discussed will be:

1. An emergency source of income in case of job loss.
2. Home Buyer's Plan (HBP)
3. Lifelong Learning Plan (LLP)
4. Holding your mortgage inside your RRSP

If you lose your job, the 1st few months will feature severance payments and after that, there is Employment insurance.  Ideally, you should not touch your RRSP but if the unemployment drags on for 2 years, then you may need to get withdraw some RRSP monies, ideally when you are in the rock bottom tax bracket.  So to give you some idea of what to do, wait until the new calendar year after your EI and severance is nearing the end.  The basic personal exemption amount is $11,327 in 2015 and has increased to $11,474 ion 2016 so the first few months will be either tax free or minimal.  Once your withdrawals past the basic amount, then taxation starts.

Be aware that when you withdraw RRSP monies, there will be withholding tax.  The lump sum tax rates take effect here.  Under $5,000 is 10% tax, $5,000 to $15,000 is 20% and $15,000 and above is 30%.

Traditionally, financial advisors recommend taking out amounts in $5,000 chunks.

With the HBP, each member of a couple can withdraw up to $25,000 tax free in any calendar year to use as a down payment to buy or build a first house.  That's $50,000 per couple.  But there is a consequence with the HPP, you would need to pay back into your RRSP in 15 years in equal amounts of the amount your withdrew from your RRSP starting in the 2nd year.  If you miss a payment, that payment becomes taxable.

Similar to the HBP, the LLP lets you and your spouse withdraw up to $20,000 tax free ($10,000 max in any given calendar year) from your RRSP to enrol in a community college, university, or certain approved institutions of higher learning.  Since you are borrowing from your future self ( Marty McFly anyone) you must repay yourself, just like the HSP example.  In this case, you must repay in 10 years in equal amounts.

There is a fourth option that RRSPs make possible.  Holding your mortgage inside your RRSP.  An easy way to explain it would be to say "borrowing the money from your left pocket and lending it to your right pocket in the same pants"

So you have a $100,000 mortgage with a bank.  You also have $100,000 in RRSPs holding mutual funds (yuck) or other securities.  You could sell them inside the RRSP to create money inside your RRSP, arrange a private mortgage that can be used to pay off the bank mortgage, then make future mortgage payments to your RRPS (i.e yourself)

There will be costs to setup this up, rules about interest rates.  Check with your bank if they offer this service.  Also check with your investment and tax professional to see if this fits your financial needs.

RRSPs for Millennials

In the 1st 60 days of any calendar year.  If you walk into any of the nation's financial institutions, you will for sure see posters and reminders of the upcoming RRSP season and how it is time to contribute.  If you use human tellers at the bank, odds are that they will mention this to you.  If you are an ATM person, no doubt there will flash a reminder on the screen of the upcoming RRSP deadline.

We will assume that for this article that you are in the millennial generation, that demographic bracket aged 18 to 34 years old.  Much media attention has been given that this particular generation has forego the classic bricks and mortar bank and gone online.  But in general, most Canadians will use a bank, it is most likely where your pay cheque will go.

That being said, since most pay cheques go to the bank, it makes it easy to setup your RRSP using a pre-authorized checking arrangement (PAC) - transferring funds directly from your main account into your chosen investment vehicle inside your RRSP.

But what exactly is an RRSP, you ask.  For starters, RRSP is an acronym that stands for registered retirement savings plan.  RRSPs were started in 1957 by Liberal Prime Minister Louis St. Laurent to encourage Canadians to save money for retirement.  People by nature, wanted to spend money as soon as they earned it.  Ottawa need to give an incentive to Canadians to save for the future.  That first year in 1957, the maximum you could contribute was only $2,500 or 10 percent of your taxable income, whichever was less.  Today it's the lesser of the $24,930 or 18% of taxable income.

An example with calculations would best show exactly what an RRSP does.  Say for example, you earned $40,000 in 2015, putting you in the lowest federal tax bracket of 15%.  Also for this example, assume that you are an Ontario resident, which means you will pay an additional 5.05% in provincial income tax.  Now comes the RRSP magic.  Also in this example, you will have contributed $5,000 before the RRSP deadline for 2015.

Now it is April and you need to file your income tax for the calendar year 2015.  That $5,000 is deducted straight from your taxable income.  So if your taxable income before the RRSP was $40,000 you can now tell the government your taxable income is now $35,000.  If you combine the federal and provincial income tax rates (15%+5.05%=20.05%), you'd get a refund of 20.05% of $5,000 which is $1,002.50

That is correct, Ottawa will send you a cheque for $1,002.50 if you contribute $5,000 to your RRRP in this example.  (The effect is more dramatic if you are in a higher tax bracket).  Where does this money come from you ask?  Basically your employer will tax you every 2 weeks using the $40,000 income.  Come tax filing time, you tell the government that the $40,000 was actually $35,000 so the taxes my employer deducted, some of it will need to be returned to me.  Viola refund.

Sounds pretty good to a young person, but remember Ottawa's generosity is reversed when you retire, as soon as you start taking money out of your RRSP, tax will come off.  But by that time, you will be in a lower tax bracket.  It's a fair trade off for all those years of working.

I suggest to the millennial reading this, that $1,000 cheque would best be used to fund next year's RRSP amount.  This way instead of paying $5,000 in RRSP contribution, you will only need to find $4,000.  This is compounding at it's basic.  Yes, there is the temptation to spend it on a new tv or something else but compounding it this way, just makes it easier to save and isn't that the intent of all of this.

Is the Costco Executive Membership worth $110?

A lot of us have a Costco Membership.  This membership cost $55 a year for the Gold Star card.  There is no doubt that the Gold Star Membership is well worth the $55 a year for any type of household, family of 4, family of 2 (husband and wife), single household.

But is the upgrade to the Executive Membership for $110 a year, basically doubling the gold star amount, worth it?

First off, we start off by listing the Pros and Cons Costco shopping.  The next section will then discuss what the upgrade can offer and how we can answer if it is worth it?

Pros

• Food quality.  Most of us who have visited Costco have seen the cost of meats at Costco.  The prices are higher than most of your standard grocery store.  Everything is sold in bulk making it more expensive than say if you wanted to buy only 2 steaks or only 1 pound of ground beef.  Once you experience the price and quality of their meats, and then go to your local grocery store, you will feel that you are paying too much there.  A curious thing about their ground beef, if you look at the expiry date, for some reason, it is always the next day.  I've asked a few costco staff about the best before date.  They inform that hey ground their beef every morning and nothing is added, no fillers, no bones, nothing but beef.  I asked but what if you don't sell all of this meat, after all it is a lot.  The staff at the end of the day sells it to other departments, example the prepared Shepard's pie is made using this ground beef.  The meat may be overwhelming to some, but it is very common to buy in bulk and cook what you need today and portion the rest out into freezer bags and put them in the freezer.  Staples like milk, eggs, bananas, coffee are priced well at Costco.  The $1.50 hot dogs at the snack bar is also worth mentioning, this comes with a re-fillable drink.  Great value there.

• Return Policy.  The Costco return policy is legendary.  Complete satisfaction.  You can even buy the membership, use and shop with for 9 months and then say you are not happy, they will refund your membership.  All food and products are returned with no questions asked.  The beauty of Costco is you do not need a receipt as they look up the product and ask for your membership card and then refund your monies.  To test this policy, we once bought the Kirkland energy drinks pack of 28.  We drank about 7 of them and finally my wife said, something doesn't taste right about it, go return it.  Took the remaining drinks and returned it, simply said it didn't taste what expected.  Most pleasant return on used product I ever experienced.

• Pharmacy dispensing fees.  Most of us have insurance at work which covers anywhere from 80% to 100% coverage.  Fortune for my family, my work covers 100% of the cost of prescriptions but dispensing fees are only covered up to $7.  Now this situation does not work if we go to our local drug store which is a chain and has a $12 fee.  How many of us have gotten a prescription and had to pay 20% of the cost of drugs but then the dispensing fee made the bill seem too high.  No problem here, Costco charges a fee of $3.89 so I have never had to pay a penny for any prescription.  The best thing about the Pharmacy at Costco, you do not need a membership to use it.  I asked a cashier and she said something along the lines of "not refusing the public access to prescription drugs".  So if you are bummed about the cost of dispensing fees for drugs, try the Costco Pharmacy, you don't even need a membership.

• Products I enjoy.  If you live near a Costco that has a gas bar, you can save almost $0.06 to $0.10 per litre versus the surrounding gas stations.  Amazing value.

• Another product that I enjoy.  The dress shirts, dress pants both brand name and the Kirkland brand.  A lot of us work in an office, the work clothes you can get from Costco will save you quite a bit versus other retailers.

• Samples.  No explanation needed here.

Cons

• Lineups to pay.  On busy weekends, the lineups stretch as far as the eye can see sometimes.  The gas bar is no different.  Generally the lines move well but if you have kids that are restless with you, you will need to pack your patience.

• Some prices are not that great, they make it hard to calculate if you are getting a good deal or not as unit prices are changed a lot.  One item you can calculate is a can of soda.  The quality does not change, and the unit price is set once you divide the price of the case by the number of cans.  Try the calculation next time, and you will understand why you don't see cases of coke cola in shopping carts at Costco.

• It is hard to leave Costco without spending a minimum $100 (unless you are disciplined)

• Impulse buys.  There are lot of impulse buys at the end of isles.  Again discipline is needed here.

• Bulk can be bad.  Even with a family to feed, some items can go bad due to there being too much.  

Executive Membership

You get all of the above plus 2% on almost all your purchases as cash back.  So there is a possibility of getting a free membership or even a heavily discounted membership.

To receive $55 in cash back, you would need to spend $2750 a year or $229.17 a month

To receive $110 in cash back, you would need to spend $5,500 a year or $458.33 a month

You get the Costco Magazine mailed to you.

You get Executive only discounts mailed to you.

Now we all know what we spend on gas for the car, staples like milk and eggs, we buy work clothes, we buy meat, etc.  Everyone's situation is different but you can use these calculations to justify upgrading or even purchasing the gold star membership.  For us, it's a no brainer, the Executive membership is worth it.

If there are any other items that I have not mentioned, feel free to comment.

Top 5 ways to maximizing your finances and minimize your tax burden for 2016

As we begin a new year, here are my top 5 ways to maximize your finances and minimize your tax situation.  After all, this blog was created for these 2 top reasons, if these 2 reasons are realized, you generally feel better with yourself and this in turns reduces those sleepless nights.

1.  If you have it, contribute $5,500 to your 2016 TFSA as soon the calendar changes to January 1st.  You will have the entire amount working for 12 months as opposed to putting in small amounts.  Last years limit of $10,000 is still available if you have not contributed to your 2015 limit.  Previous years are also still there.  Once again, this is a self directed TFSA, no savings accounts, no mutual funds.  You pick the dividend stocks.  

2.  If you expect to be in a lower tax bracket when you retire (which a lot of us will be).  Consider contributions to your RRSP.  While much of the focus in the next 60 days leading up to the contribution deadline of Feb 29, 2016.  Why not consider contributing to your 2016 RRSP.  Exact same reason as in number 1 above for contributing early.  Again, this is a self directed account.

3. If you got kids under 18, be sure to contribute at least $2,500 to each child's registered education savings plan (RESP) to take advantage of the 20% matching from the government.  You may be able to catch up from previous years.  Again, a lot of people maybe unaware, RESP accounts can be self directed, I would prefer it to be.  Who wants to pay fees for the first 18 years of a child's life when you should be saving for the first 18 years.

4. While income splitting for families, known formally as the Family Tax Cut, was eliminated for 2016, you may still be able to do some income splitting by taking advantage of the historically low prescribed rate.  If you have a spouse, partner, or kids in a lower tax bracket than you, consider a prescribed rate loan strategy whereby the higer-income spouse or partner loans funds to the lower income spouse or partner to invest at the record low prescribed rate, which is at one per cent until at least March 31.  Here is the CRA website link http://www.cra-arc.gc.ca/tx/fq/ntrst_rts/menu-eng.html

5.  Plan now to avoid a tax refund next spring.  If you regularly get a large tax refund each spring, consider applying for a reduction of tax at source use the CRA form T1213.  This form needs to be updated annually.  Getting a large tax refund sounds good but in reality, you are hurting yourself, you are giving the government an interest free loan for 12 months.  If you use the reduction at source, your refund will be split evenly by the number of times you get paid by your employer which will increase your take home pay a little.  That is basically what your large tax refund is, all those little amounts of additional take home pay added into one amount.

Hope some of these ideas generate conversation or ideas for you.

Happy New year.