Reader Question:Do I Have To Share My RRSP With My Spouse When I Get Divorced?

Another reader of the Canadian Budget Binder blog asked the question, Do I have to Share my RRSP with my Spouse When I get Divorced”?

In Ontario there is the Family Law Act. In simple terms all property acquired after the date of marriage, up until the time of marriage breakdown is deemed to be the property of both parties. The ownership of the property is not a factor. So in short each person is entitled to 50% of the total family property.

There are certain exceptions like the family home that was brought into the relationship or received as a gift or inheritance. However to keep things simple we will ignore this.

RRSP’s, Stocks, Bonds, Pensions, are all subject to being included under Family Law. So if one spouse had a significant RRSP and the other nothing then the spouse with nothing would be entitled to 50% of the spouse’s RRSP.

Note: the courts adjust the value of the RRSP down, by the amount of withholding tax that would be payable if the RRSP were cashed in. So the figure used is less than fair market value of the RRSP.

To understand this fully the courts ask each person for a statement of assets and liabilities at time of marriage and time of marriage breakdown.

In effect they are doing a net worth statement at two points in time. This is known as net family property (NFP) and the spouse with the RRSP would include it as part of their NFP.

The spouse with the higher NFP would then be required to make an equalization payment to the other spouse so that both share 50-50.

This payment does not have to come from the RRSP or a transfer of the RRSP to settle the payment obligations. It can actually come from any assets owned by the individual with the higher NFP.

Hopefully this gives you some insight on your question about an RRSP and Divorce. To learn more about Family Law, Division of Assets and calculation equalization payments visit Feldstein Family Law Group .

Every attempt has been made to be accurate but Errors and Omissions Excepted.

Have you been through this experience? What did you learn?-Mr.CBB

 Gary Gorr

Guest Post: About Gary Gorr: What kind of written plan do you have for retirement that ensures you won’t outlive your money? I help people answer that question Contact Information: (905) 202-8430 ext.626 ggorr@ifcg.com or you can follow my blog at Gary’s $$$ and Sense 

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Reader Question:Is It Savvy To Cash In My RRSP’s To Pay Off Debt?

A Reader Question about whether it was savvy to cash in an RRSP to pay off Debt was submitted to Canadian Budget Binders Ask Mr.CBB. He forwarded it to me to share my opinion on this topic with all of you.

My short answer is that it depends.

There are several factors to consider:

  • The age of the person
  • The withholding tax on the funds withdrawn on the RRSP
  • The amount of debt and its’ interest rate
  • The type of investment held in the RRSP
  • The opportunity cost of the withdrawal

To keep things simple let me say if you are doing this and are under 30 then it might not be a bad thing. At older ages you have a shorter accumulation period and time and the magic of compound interest work against you.

I have always maintained that paying off debt is one of the best investments someone can make.

Let’s say you’re carrying a credit-card balance of $1,000 with 18 percent simple annual interest. That’s $180 a year in charges. Pay off that debt and you’ve saved $180. That’s the same as investing $1,000 in something that earns an 18 percent return after tax.

Tax Withholding Rates

When you withdraw funds from an RRSP there is a tax withholding. This is a credit due for taxes payable on 100% of the withdrawal and is to be paid by April 30th in the year following the withdrawal. You may indeed owe more than the rate withheld if you have a high income.

Withdrawal Amount Tax Withholding
From $0 to $5,000 10%
From $5,001 to $15,000 20%
Greater than $15,000 30%

So let’s assume you have $10,000 in debt. You are paying the minimum of 3% per month to carry the debt or $300 per month. The debt carries an interest rate of 18%.

Approximately $14,300 needs to be withdrawn to net the $10,000 to pay off the debt. Your savings, the cash flow of $300 per month after the debt is eliminated.

However the real cost may be much greater.

What would the $14,300 be worth at age 65 at 6% yield if it had never been withdrawn?

If you were 35 when you did this, the monies would be worth at 65, $83,281 so you are giving up potential growth on this money in addition to the withholding tax.

Ok, I hear the question already: What if we withdraw, pay off the debt, and invest the $300 a month every month to age 65?

If you indeed did do this, your deposits would be worth $294,354. In this example provided you have the discipline to save the $300/mo. it indeed might work out to eliminate the debt first.

What if our client was able to find savings through budgeting etc. and find an additional $300 per month?

In 19 months he/she would be debt free, their RRSP would be intact, and now they can save even more toward their future.

This Calculator is a handy tool. First enter $10,000, then 18%, then monthly payment of $300.

Under step 2, choose minimum payments. This shows the real cost of paying credit cards on a minimum payment basis.

On page 2, change the monthly payment to $600. See the result? You may want to bookmark this calculator.

Ideally this would be the preferred course of action.

If your RRSP’s are earning low rates of return, such as 2% or 3% it makes it easier to withdraw monies and eliminate the debt.

Your opportunity cost (Put another way, the benefits you could have received by taking an alternative action.) is not very great because of the low yield on the investment.

So there you have my analysis on whether you should cash in your RRSP’s to Pay Off Debt!

What is your opinion?

Would you pay off the debt first?

Look for the savings through budgeting and keep the RRSP intact?

Comments and opinions are welcomed below.

Gary B. Gorr, CHFC

About Gary Gorr: What kind of written plan do you have for retirement that ensures you won’t outlive your money? I help people answer that question CONTACT INFORMATION: (905) 202-8430 ext.626 ggorr@ifcg.com or you can follow my blog at Gary’s $$$ and Sense 

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Straight Talk About Fees and Penalties on Mutual Funds

Mr. Canadian Budget Binder received a question from one of his readers and asked me to craft a guest post to answer it.

QuestionCan you explain MER Fees and Penalties regarding investments?

 What Does MER stand for?

MER means Management Expense Ratio. There are a variety of expenses that make up MER.

Some are:

  • The fee paid to the fund managers for managing and investing your money
  • Legal and audit fees of the fund
  • Advisor sales compensation and trailer fees (ongoing service fees)
  • Advertising expenses that promote the fund
  • The cost of buying and selling the stocks the fund holds

How does this impact my investing return?

All published returns for a fund are net returns, after the MER has been deducted. In simple terms Fund A has a return of 10%. Its MER is 2.5%. The net return to the investor is 7.5% Fund B has the same 10% return but has an MER of 2%. The net is now 8%.

The lesson we can learn from this is that lower MER’s usually mean more money for the investor all other things being equal.

Some investors have focused exclusively on buying investments with the lowest cost. There are investments like ETF’s (exchange traded funds) that have very low-cost factors. Some range from 0.15% to 1.40%.  I will comment more on this later.

Sales Commissions, Fees and You

 There are three main ways advisor’s are compensated.

  1. Commission based
  2. Fee- Based
  3. Fee Only

Commission Based

Sales commissions are embedded in the MER to compensate advisors. This can take one of three forms and each has an impact on the investor.

The three commission based options are:

  1. Front End Load
  2. Deferred Sales Charge (DSC)
  3. Low Load Sales Charge (LL)

In the Front-End Load option, the client and the advisor negotiate a percentage of the deposits as a sale commission, usually from 0% to 5%. This percentage is deducted from the investment right upfront. In the long run this is not a good thing for the investor. In addition the advisor would receive a portion of an ongoing trailer fee of 1%. The other portion belongs to the dealer where the advisor does business.

The client, however, can move his/her funds to another fund company at any time without any sales penalties or charges.

In the Deferred Sales Charge (DSC) option, nothing is deducted from the investment. The Mutual fund company pays the Dealer/Advisor an upfront commission. Because they advance the commission they have a penalty if the client leaves the funds from the current company to another company. This is based upon a percentage of the original deposit not the current fair Market Value.

The percentage is on a declining scale and lasts for 6 or 7 years depending upon the fund company. After this time period the investor is free to do what he/she wants without any penalty.

Here is a sample of the Deferred Sales Charge:

An advisor will receive an ongoing trailer commission of 0.5% under this fee option. Again this is shared with the advisor’s dealer.

An investor purchasing funds under this option has 2 relief options. One is he/she can withdraw 10% of the funds value in a given year. The 10% is non-cumulative. In essence if you didn’t use it in years 1 and 2, you can’t withdraw 30% in year 3, just 10%.

Some clients annually move the 10% fee free amount to the same mutual fund but on a zero commission basis. In this way you can indeed accumulate the 10% over time.

The sales charge only applies if you sell some or all of your funds and purchase with another mutual fund company other funds.

The second relief option to the DSC charge is that many fund companies have large numbers of fund options and a move or switch from one fund to another within the same fund family does not incur the DSC penalty.

The low-load sales charge  (LLSC) works similar to the DSC option. However the restriction is limited to 3 years versus the 6 or 7 on the DSC option and the penalty percentages for withdrawals are roughly half of the DSC option.

Traditionally the commission option has been the main way advisors have been paid for their efforts.

Many people argue that the advisor’s compensation should be upfront, known, and factored out of the MER. It should be transparent versus embedded.

This has led to some advisors who charge a fixed percentage of your assets like 1.5% to 2% for smaller amounts of money and a lower percentage for bigger amounts (usually over $250,000) These advisors are known as Fee-Based Advisors.

The cost of advisor compensation is stripped out of the MER and the investor will have MER’s that are about 1% less than before. The investor in turn pays the advisor the fee, which in the past has been paid by the mutual fund company.

Using this type of advisor allows a client to freely move monies from one company to another as they are sold on a 0% front-end load. (A note of caution, this freedom to move at anytime isn’t always a good thing). The only compensation besides the upfront fee they charge is the ongoing trailer fee paid by the fund company.

There are no penalties or charges if a client moves their money to another fund company, other than maybe an account closeout fee that is fairly nominal, usually less than $125.

Fee based advisors if they are licensed for other products such as life insurance etc. can still earn commissions from the sale of those products. The fee-based refers to the investment component.

Fee-Only Advisors

Another variation is that some advisors charge a fee for doing the planning and advising on investments and perhaps life insurance, estate planning etc. This fee can be based upon the nature of work being performed. Some charge hourly, work on an annual retainer, or again as a percentage of your account size. They receive no compensation on the products being purchased. These advisors are known as fee-only.

The investor pays the fee and a client has no penalties if they move their funds to another institution, except for the closeout fee.

Which Option Is Right For You?

I am sure by now you all have an opinion. Let me say there is no perfect answer.

If you have less than $100,000 many advisors will not work with you on a fee only or fee based option, as the earnings don’t properly compensate them for their time and effort. That is why many advisors have an advertised account minimum.

Many investors don’t like the thought of writing a cheque for the fee. If they have $200,000 and the fee is 2% then the cost is $4,000. They could buy under the LLSC and the advisor is properly compensated and there is no fee payable by the client.

All advisors worth their salt will explain in simple English the various compensation options a client has. Then the advisor and client can settle on a mutually acceptable basis of dealing.

What Is More Important Than Costs and Commissions?

MER is important!  Understanding how an advisor is paid and its impact on your investment is important!

However in my 37 years of advising Canadians I think there are two more important factors.

  1. The absence of a financial plan
  2. The biggest determinant of financial failure is behaviour, specifically bad behaviour. It is not the cost of an investment, the commission or fee option being chosen, or the products selected.

Products like Mutual Funds, ETF’s, etc. are just tools to accomplish a goal. In 37 years I find people don’t plan to fail, they fail to plan.

What product solutions you buy should be in the context of an overall plan. However, I have too often seen Canadians buying the product of the month, or the one with the latest high returns published in the newspaper.

The axiom we have all heard is buy low, sell high but because of our own behaviour we buy high and sell low.

 Our behaviour looks like this:

 

Dalbar every year does a survey on Investor Behaviour. There are many factors they discuss in their Quantitative Assessment of Investor Behaviour (QAIB).

The results consistently show that the average investor earns less – in many cases, much less – than mutual fund performance reports would suggest.

  • Fact: Since 1991 to the end of 2010 the S&P 500 index had increased by 9.14% annually.
  • Fact: The average investor only made 3.83% ignoring taxes and inflation in the same time period.

One point that caught my attention was the average length of time an investor held an investment fund. (This is a 20-year study)

  • For equity funds it was 3.27 years
  • For fixed income it was 3.17 years
  • For asset allocation funds it was 4.29 years

Implicit in these numbers is the investor chasing the next new big thing.

Email me at ggorr@ifcg.com if you want the Full Report-It’s Free

I point out these factors to show that yes costs matter but what matters more is managing you own bad behaviour.

My one true value as an advisor to my clients is to prevent them from making emotional decisions that are very costly. I have lived and advised through a long arc of history and I have witnessed many clients make emotionally based investment decisions to their financial detriment.

My job is to act as a sober second opinion and help them take a more reasoned approached to what they do, remind them of history, and that this too shall pass. This is what clients pay me for, to help prevent them from making costly emotional mistakes.

So now you know about MER’s, Costs, How Advisors are paid. I hope you focus on the more important factor in your financial success, Managing Your Own Behaviour.

I am an investment advisor employing behavioural finance principles in my advice giving and a licensed life insurance broker with 36 years of experience helping Canadians achieve financial security. CONTACT INFORMATION: (905) 202-8430 ext.626 ggorr@ifcg.com

You can read more about personal finance at my blog at Gary’s $$$ and Sense

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Reader Question: RRSP’s-The Need To Know Basics

RRSP’s-The Need to Know Basics

Reader Question: I want to save for retirement. Where is the best place to save for this? I have been told NOT to use RRSP. Can you help?

Saving for retirement is a good thing and RRSP’s (Registered Retirement Savings Plans) are a popular tool for doing so.

I don’t know the client’s age or his/her income so this answer is predicated on the fact that the client has several months of income in an emergency fund.  An emergency fund is a base component of proper planning and should be done before making any RRSP contributions.

Also, it assumes the client is making more than $40,000 in income per year, as incomes under $40,000 don’t benefit much from tax savings on RRSP contributions.

Below I will try to define some of the Basics of RRSP’s and also illustrate some of the long-term advantages.

When Did RRSP’s Begin?

RRSP’s first came into existence in 1957 as a government supported effort to help Canadians save for their retirement.

Types of RRSP’s

There are broadly speaking three main types of RRSP’s

  1. Individual RRSP-where the contribution is made in your name and held in your name.
  2. Spousal RRSP- The contribution is made by you, deducted by you, but held in the name of your spouse.

This strategy would be employed when you are the higher income earner now and likely in retirement. The payout would be taxed in spouse’s hands and result in less tax payable.

  1. A Group RRSP-The contributions are payroll deducted and forwarded to the investment manager of the group RRSP and invested as per your directions in your individual account.

One key difference is that tax savings can be realized immediately if documented properly rather than waiting until the end of the tax year.

How Much Can I Invest?

You Can Invest 18% of prior years “earned income” minus any pension adjustments (P.A) up to a yearly maximum. Contributions made to a Pension Plan where you work, by you and your employer would be an example of a P.A. and would reduce your RRSP contribution amount. The maximum for 2012 is $23,280. This maximum will be indexed annually by the annual increase in the average wage.

Canada Revenue shows how much you can contribute annually on your Notice of Assessment.

What if I can’t contribute the maximum I am allowed?

Good news! The unused amount not claimed is carried forward and never lost. CRA keeps track and shows the unused amount that can be claimed in future years, either in whole or in part, on your Notice of Assessment and is not limited to 18% of your current income.

What Kind of Investments Can I have in my RRSP?

People often say I am going to buy an RRSP as if it were itself an investment. It is just a holding vehicle for certain types of investments.

Some of the most common types are:

  • Cash
  • Guaranteed Investment Certificates (GIC’s)
  • Savings Bonds
  • Treasury Bills
  • Bonds
  • Mutual Funds
  • ETFs (Exchange Traded Funds)
  • Canadian Mortgages
  • Equities
  • Income Trusts

The type you choose for your RRSP depends upon many things. One should consider your level of risk, your investment time horizon and the return you might require to achieve your financial objectives for retirement.

A good planner can help you build a retirement plan for you and answer these questions and help decide the right investments for you.

The Main Advantages of RRSP’s

  1. Contributions are tax deductible, resulting in less current taxable income
  2. Investment earnings grow on a tax deferred basis

How important is the tax deferral aspect of RRSP’s?

To see how important it is let us compare a 35 year old saving $7,000 per year into an RRSP versus the same $7,000 being saved in a taxable investment and being taxed annually at 40%, both investments earning 7%.

After 30 years the Registered Investment has a value of $707,511. The non-registered investment is worth $423,022. Every year the non-registered investment was worth less, as 40% of the investment earnings were lost to taxes.

Granted the registered investment has had zero taxation in the accumulation period, this is the real magic of tax -sheltered growth, and will be subject to taxes when income is withdrawn.  Usually in retirement most Canadians will be in a lower tax bracket than during their peak earning years and the income will be taxed at a lower tax rate.

Even if we assume the client took the money in 1 lump sum at 65, not likely or recommended, and paid tax at 40%, the net after taxes would be $424,507, effectively the same as the non-registered plan.

What if the Investor Reinvested their Tax Savings every year?

This has a profound impact on the size of your accumulation! The tax savings on a $7,000 deposit produces an annual refund of $2,800 ($7,000 times 40%). If this were invested outside an RRSP it would produce an additional $169,209 of capital. The combined capital total at 65 would be $876,720.

All investors should seriously think about reinvesting the tax savings to magnify the accumulation.

The Benefits of Starting Early

If the client waits five years to begin investing and starts at 40 versus 35, he/she will accumulate only $598,567 (assuming he/she reinvests tax saving). A significant difference and proves the old axiom that starting early has significant advantages.

Your RRSP is Not an Emergency Fund 

Yes, investors can withdraw funds from their RRSP and sometimes do, but seriously the consequences are more severe than you might imagine.

If you withdraw there is a withholding tax levied and is based upon the size of the withdrawal. This is applied to income tax owing, as the withdrawal is 100% added to other income in the year of withdrawal

Withholding Tax Rates on Withdrawals
Withdrawal Amount Rate
0 to $5000

10%

$5,001 to $15,000

20%

$15,000 and over

30%

The real cost is the long-term cost.

A male age 35, investing 7,000 per year at 7%, and wanting to retire at age 65 and currently has $50,000 of accrued RRSP savings. After 10 years he withdraws $25,000 to deal with a critical illness. What impact will this have on his future savings?

Impact of a withdrawal from RRSP Withdrawal Calculator The result is very significant as you can see.

To answer the final piece of this investor’s question where he/she has been advised not to use RRSP’s. I find there are few circumstances where an RRSP doesn’t make sense.

However low-income Canadians, or Canadians with expensive debt, or those without an emergency fund would be advised to tackle debt first, build an emergency fund, before investing in an RRSP.

This is not a comprehensive overview of RRSP’s but focuses on the Need to Know information. Every attempt has been made to be accurate but Errors and Omissions are Excepted (E&OE)

Now that your literacy has improved the next step is to find an advisor to help you begin the process of retirement planning.

Do you have RRSP’s and how old were you when you started to invest? – Mr.CBB

About Gary Gorr

I am an investment advisor employing behavioral finance principles in my advice giving and a licensed life insurance broker with 36 years of experience helping Canadians achieve financial security. CONTACT INFORMATION: (905) 202-8430 ext.626 ggorr@ifcg.com

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