Last week we discussed our sustainable personal financial plan: the base and how we hope this plan can be sustainable for today but also to set the ground work for tomorrow. Today I will discuss “the tomorrow”, or, the future of our personal financial plan. For purposes of this article the “future” means we plan to have the remainder of our plan to be in full affect by the end of 2012. We gotten started on a lot of the plan already but there are other areas we need to kick start.
I will take a look at our investing strategies - what we have decided to utilize now and in the near future in addition to parts of the investing and personal finance world we are not focusing on. I will also touch on some of our own personal investment ideas regarding community. When we discussed the base of our personal financial plan a lot of the variables were established for us – things we have to do. How we approach the future of our personal financial plan is by choice, or design, and we hope our readers have some great input into our approach both the pros and the cons.
The Smith Manoeuvre
After buying a home and selling our house fast last summer we decided to employ the Smith Manoeuvre with our new house. I will detail the ins and outs of the Smith Manoeuvre (SM) at a later date but to explain this investing strategy in the terms I used to explain the strategy to Mrs. SPF the SM is a method for Canadians to turn their non-tax deductible mortgage into a tax deductible mortgage. This is already the case for our U.S. readers but here in Canada we can’t deduct our mortgage.
The SM requires the use of a Home Equity Line of Credit (HELOC) which is used to purchase income producing stocks – our preference is to buy Canadian dividend-paying companies. The interest paid on the loan is tax deductible and the return from this tax credit, coupled with the dividends earned from the investments are applied to the mortgage which results in the mortgage being paid off more quickly and an investment portfolio being established.
We choose the major Canadian dividend-paying companies because they are well established major players in our economy that we trust will retain value even if their growth isn’t other-worldly. The SM is a leveraging investing strategy so we look to keep our investments low-risk. The analogy I told Mrs. SPF was “who do you think is better off?”
- Person A who owns their $300,000 home and paid full interest over 25 years but has no debt
- Person B who owns their $300,000 home, paid less interest as they were able to reduce their amortization by 9 years, has a $1,350,000 portfolio and has $240,000 in debt but the interest on the debt is tax deductible (in 25 years time)
Mrs. SPF immediately answered Person B and we were on our way to add some risk to our otherwise conservative personal financial plan.
As we’ve discussed, we give to believe in donating to charity. We get some pretty hefty benefits, tax wise, from charitable donations. We get 20% back from the government on the first $200 then we get our marginal tax rate (over 40%!) back on everything about $200.
But tax returns are not the reason we give. We’re still out of pocket after all. What we find important is that we are investing in our community. We believe that by investing in organizations that support our city and region we strengthen the community. A stronger community means stronger economics and quality of life. We can afford to give back to the community that enables us to have good jobs and a nice home – so we give back as a part of our personal financial plan.
Lastly, there are some organizations that we feel strongly about for a variety of reasons and experiences. We think we should give to these organizations as they have played a role in our lives or the lives of those we love. I can’t be certain karma has any affect on our ability to execute our personal financial plan but i’m not going to chance that it does not.
The Tax Free Savings Account (TFSA)
The Tax Free Savings Account is a pretty great way to stash money or investments. The basics? Save up to $5000 each year and it grows tax free and when you “withdraw” from the account you don’t pay any tax. Mrs. SPF and I plan to fully leverage these accounts – who wouldn’t? The TFSA is a critical part of our personal financial plan. In one of our accounts we plan to invest, likely in Exchange Traded Funds (ETFs) that hold national and international companies as we loathe excessive Management Expense Ratio (MER) on mutual funds and we are already investing in stocks with the Smith Manouevre.
In the other TFSA we will stash our modest emergency fund and ETFs that hold bonds. This will be our safety account. In our personal financial plan this account is pretty hands off. I use terms like will and plan as we are still implementing our plan.
Registered Retirements Savings Plan (RRSP)
Ah, the good ol’ RRSP. The investment account that grows tax free and helps reduce income taxes today. For many Canadians maxing out their Registered Retirements Savings Plan (RRSP) year in and year out makes a lot of sense. For Mrs. SPF and I? Not so much.
You’re probably thinking “whoa there Sustainable PF! So far you have made sense but now you ignore the most popular means by which Canadians invest for retirement?”. Yup! The RRSP just doesn’t, at least to me, appear to be our best choice in our personal financial plan. I assume you would like an answer why …
- Our Defined Benefits Pensions (DBP) affect us in a few ways. First, our income at retirement will be pretty good due to the DBP. When funds are withdrawn from an RRSP they are taxed at the marginal tax rate of the RRSP owner. Since we’ll have pension income we will be in a lower tax bracket than pre-retirement but we’ll earn 67% of our pre-retirement income and that means we’ll be taxed more than someone who does not have a DBP.
- Still along the lines of the DBP, our pension reduces how much we can invest in our RRSP by quite a bit. Not only is our contribution room reduced our pension contributions already help reduce our annual income tax payable.
- Our DBP means that our contributions to the DBP are automatically deducted from our pay cheques. We’re already forced to save 9% of our gross pay to secure the “gold plated pension” that anchors our personal financial plan.
I did withdraw from my RRSP when I bought my first house so I continue to buy back the minimum RRSP as part of that plan. We also plan to look at RRSPs each year to determine whether or not contributing to the RRSP will lower our tax rate. Hey, if we can save $3,000 in taxes by making a $3000 investment then I think we need to consider the RRSP as part of our personal financial plan in that given year. Other than these mandatory and mainly minimal contributions, we feel our money is much better spent on paying down student loan debt, mortgage debt, investing in the TFSA and contributing to the next topic: Registered Education Savings Plan (RESP).
Registered Education Savings Plan (RESP)
I’ll be the first to admit that I don’t know a whole lot about the RESP program. What I do know is that up to $2,500 can be contributed to this plan for each child under the age of 18, and, that the government gives an automatic 20% rate on return (up to $500). I may have some this wrong but I think we can start putting $3,000 a year away for lil’ SPFs education.
As part of our personal financial plan we will be learning about the RESP and i’ll likely start @ Money Smarts Blog where Mike Holman has written at length on the topic of RESPs.
Our emergency fund is one area Mrs. SPF and I differ in terms of our risk tolerance in keeping a set amount of expenses covered by an emergency fund. Nonetheless, we need to get on common ground regarding the emergency fund as we put together our personal financial plan. After reading about personal finances for a few years now i’ve read a lot of financial advice ranging from “my line of credit is my emergency fund” all the way to “I feel I need 12 months of expenses”.
This is where i’d like to ask our readers, given what they know about the base and the future parts of our personal financial plan and our employment circumstances. How much of an emergency fund should we have? Some notes …
- We have good stable jobs but we are in a unionized environment and theoretically could go on strike or be locked out at the end of 2012.
- We have a little one on the way. Mrs. SPF will receive 93% of her salary for about 60% of her maternity leave and $1700 per month for the remainder of the year while she stays home with the baby.
- We could pay off all of our non-mortgage debt with our current savings.
Wills and Financial Data Sheet
We know we need to get wills written. We were set to do so in the spring but upon learning lil’ SPF was on his way we decided to get the wills done after he arrives. We figured we’d have to get the wills adjusted once he arrived so it was better to just make one trip in getting these important documents created. The last part of our personal financial plan is a financial data sheet. Since I manage most of the finances, if something were to happen to me, Mrs. SPF needs access to all of the account numbers and passwords for our financial plan information. This is on my to do list.