November/December - 2013
Three Steps to a Financial Plan - Though it definitely seems more complicated, LIFE LETTER for November tells us that there's really only 3 steps to a successful financial plan.
Three Steps to a Financial Plan
Though it may seem otherwise, financial planning actually consists of only three steps:
The first step plans for the unpredictable - events that can occur at any time, without warning, and can wipe out earning ability or assets, such as death, disability, critical illness or property destruction.
The second step is planning for events that are expected to happen at some future date, such as retirement.
And the third step is planning for the things you hope for - your ‘bucket list’ - such as having more money than you can ever hope to spend, or perhaps total financial independence.
Too many people get the order of these steps mixed up and devote too much energy and money to step three, and fail to give enough attention to the first two. Their plans, if you can call them that, often rely on luck in the lottery or stock market. Sadly, by the time they realize these methods don't work, it's either too expensive or too late to recover by going back to the first two steps. As the Dutch farmer said, "We grow too soon old and too late smart."
Planning for the unpredictable is the first step because unforeseen events can wipe out assets or earning ability, leaving destitution in its wake. An oft seen TV-news item is the family whose home is destroyed by fire or flood, and is wiped out because it was not insured.
Rarely seen on TV, perhaps because it happens too often to even be news, is the family left destitute because a breadwinner, destroyed by critical illness, disability or death, was not adequately insured.
Steps one and two have a common goal - income replacement. The most valuable family asset is actually the income-earning ability of its breadwinners. How much income will be needed if or when this ability no longer exists, if an income earner becomes seriously ill, dies, or is forced to retire?
The common aim in each step, therefore, is to determine how much income is needed when such earnings are no longer available. The method of replacing that income then differs for step one and step two.
In step one, the income of an income earner is replaced through insurance against the unpredictable possibility of death, disability or critical illness. In step two, wages or salary are replaced after retirement by pensions and other assets.
Only after the first two steps are planned and the plans put into action can step three be properly considered. Achieving financial independence prior to retirement, for example, is best approached when you know that if all else fails, you will at least have achieved it at retirement.
But first things first. Have you taken the first step? If not, what are you waiting for?
Copyright © 2013 Life Letter. All rights reserved
Establish a financial plan - because it's the right thing to do!
Registered Retirement Savings Plans (RRSP) Basics?
The Registered Retirement Savings Plan (RRSP) was created by federal legislation in 1957 as an incentive for Canadians to save for their retirement income needs. Many changes have been made over the years, but the basic mechanics of RRSPs are quite simple. Some basic RRSP strategies are:
Delaying taxes - Canada Revenue Agency (CRA) enforces the rules as to how much we can contribute to RRSPs. For the 2013 tax year, it's 18% of 2012 income to a maximum of $23,820, plus any unused contribution room from previous years, minus any other adjustments. CRA reports to each tax payer the amount they can contribute to an RRSP on their Notice of Assessment a few weeks after filing a tax return. Deposits made to an RRSP within the above limits are deductible from income. Deductions can actually be delayed to a future year when income is greater, thereby making the tax savings larger.
Income taxes on the RRSP deposit and growth are postponed until money is actually withdrawn. For example, John commits to saving $18,000 of his income each year. Because an RRSP deposit is tax deductible, the full amount is invested. If John were to deposit instead to a non-RRSP account, he would only be able to invest $11,700 (assumes a 35% marginal tax bracket) which is what he would have left over after paying taxes. As taxes on growth are also postponed inside an RRSP, his $18,000 per year would grow to about $1,625,766 in 35 years at 5%. His non-RRSP account would only grow to about $861,731 over the same period because John's growth will be taxed along the way.
Use an RRSP to Purchase a Home - Federal legislation allows qualifying home buyers to withdraw up to $25,000 per person of existing RRSP funds towards the purchase of a home under the Home Buyers Plan (HBP). Income tax will not be withheld on this withdrawal. In essence, this is a tax free loan from an RRSP.
Over a period of up to 15 years, you have to repay to your RRSPs the amounts you withdrew under the HBP. Generally, for each year of your repayment period, you have to repay 1/15 of the total amount you withdrew, until the full amount is repaid to your RRSPs. The repayment period starts the second year following the year of withdrawals and ends when the HBP balance is zero. If a repayment is missed in any year, regardless of previous repayments, it will be considered a taxable RRSP withdrawal.
Contribute to a Payroll Deduction RRSP – Many forward thinking employers have set up Group RRSP plans for their employees. In some cases, the employer will match a certain portion of the employees deposits. If you have one available where you work, you should take advantage of it.
They are convenient and effective. You choose an amount to be deposited to your RRSP per pay period and it's automatic. That way, the money doesn't have a chance to trickle through your fingers. A Group RRSP can provide an instant tax break. The deposit can be subtracted from income before taxes are calculated. Do you really want to wait for the CRA to send you a refund?
Copyright © 2013 Life Letter. All rights reserved
Save for Retirement - because it's the right thing to do.!
Mutual confidence is the power that binds together all harmonious human relationships.