Thursday, February 28, 2013

RBC Advertised Mortgage Rates Bake in a Processing Fee

An RBC mortgage ad in a newspaper drew my attention. It offered a 3-year mortgage at 2.99% and a 7-year mortgage at 3.59%. However, what really caught my eye were some percentages in large font in the fine print. It turns out the advertised rates assume a $250 processing fee, and the actual rates when this fee is accounted for are higher than the advertised rates.

The fine print says that the advertised rates are “based on a $200,000 mortgage and a mortgage processing fee of $250.” The fine print goes on to say that the 3-year 2.99% offer is really 3.04%, and the 7-year 3.59% offer is really 3.61%. To RBC’s credit, the real rates were in a huge font compared to the rest of the fine print. However, it would be better if they just advertise the real rates in the first place.

Being a math guy I wondered how RBC came up with the real rates. I used a spreadsheet to try one method that matches RBC’s numbers, so it may be how they did it. For starters, I assumed a 25-year mortgage.

A $200,250 mortgage amortized over 25 years at 2.99% gives a payment of $946.65 per month. The mortgage balance after 3 years is $183,298.88. The next step was to find the interest rate that makes a $200,000 mortgage with the same payments end up with the same mortgage balance after 3 years. The result was 3.036%, which rounds to the 3.04% in RBC’s fine print. Repeating this process for the 7-year mortgage gave an interest rate of 3.613%, which rounds to the rate in the fine print.

But why stop here? Why not bake in a $10,000 fee? Then the advertised rates can be 1.25% for 3 years and 2.74% for 7 years. I suspect RBC’s response to this is that the $250 fee represents a real cost they have for processing a mortgage. However, baking in a processing fee just makes it harder for Canadians to properly compare mortgage rates.

Wednesday, February 27, 2013

Handling RRSPs and RRIFs for Low-Income Seniors

I spent some time recently helping a low-income retired couple, the Wilsons, figure out what to do with their RRSPs now that they are on the verge of having to convert them into RRIFs. They know that because they collect the Guaranteed Income Supplement (GIS), the minimum RRIF withdrawals will reduce their GIS benefits. The question is whether there is anything they can do about this.

To protect their privacy, I’m not using the Wilsons’ real names and I won’t reveal their exact incomes or amount of savings. The fact that they collect GIS puts their income into a range, and I’ll reveal that their savings are shy of 6 figures.

I took a detailed look at how RRIF income affects the Wilsons’ finances, and one observation is that this is a complex undertaking. Low-income retirees don’t pay income tax, but they do receive a number of different types of benefits that are income-tested. This means that each dollar of RRIF income can reduce their benefits.

Not only is the GIS clawed back at either 50% or 75%, but GST/HST benefits can be reduced as well. The Wilsons live in Ontario and receive Ontario Trillium Benefits (OTB). Because they pay property taxes, they get the Ontario Senior Homeowners’ Property Tax Grant (OSHPTG). These benefits get reduced as income rises. There can be other types of income-tested benefits as well, but I’ve covered the 4 types that the Wilsons receive.

The default course for the Wilsons is to just take the minimum RRIF withdrawal amount each year. At their income level, the entire withdrawal amount causes their GIS to be clawed back at 50%. So, their net income (income tax return line 236) will rise only 50 cents for each dollar of RRIF income. Their OTB gets clawed back at 4% of this 50 cents, or another 2 cents. At the Wilsons’ income level, GST/HST benefits and the OSHPTG are not affected by minimum RRIF withdrawals. Accounting for all factors, the Wilsons only benefit by 48 cents for each dollar of RRIF income.

Another way to look at this is that only 48% of the Wilsons’ savings is really theirs if they follow the standard path. The remaining 52% will be lost due to reduced benefits. The question now is what can they do about this?

Surprisingly, the right answer may be to withdraw all of the RRSP/RRIF savings. I first looked at what would happen if the Wilsons were to withdraw the entire amount in 2013. This would trigger some income taxes and would completely eliminate their benefits for a year. The total tax bill plus benefits loss works out to 32% of their savings. This is a big blow for a couple who currently don’t pay any income taxes, but it is better than losing 52% with the standard RRIF minimum withdrawal path. Rescuing 20% of their savings is a big deal for the Wilsons.

Another scenario I looked at was to split the RRSP/RRIF withdrawals across 2013 and 2014. This reduced the total tax paid significantly, but creates 2 years of benefits reductions. In this scenario, the benefits don’t quite go to zero for 2 years, but they are almost zero. Totaling the income taxes and two years of benefit reductions works out to 33% of the Wilsons’ savings. So, this scenario is not quite as good as withdrawing the entire amount in 2013. Increasing the number of years of large RRSP/RRIF withdrawals just makes things worse.

As strange as it seems, the Wilsons’ best approach is to withdraw all their savings in 2013. A complication here is what they will do with the withdrawn money. The best answer is to put it in a TFSA. In the Wilsons’ case, once they pay their income taxes and hold back enough money to live on that makes up for the one year of lost benefits, the remaining savings just barely fit into their available TFSA room as of the beginning of 2014. They can even invest the remaining money in exactly the same investments that they had in the RRSP/RRIF.

So the Wilsons’ plan is to make a complete withdrawal near the end of 2013 (but not too close to the year-end that some kind of error would delay it until 2014). The brokerage will withhold 30% of the withdrawn amount for income taxes, but this will be more than the Wilsons will actually owe. Most of the remaining withdrawal will be made “in-kind” and placed in their TFSA. Part of this TFSA contribution will sit in a taxable account for a short time until the Wilsons have more TFSA room at the start of 2014. The Wilsons will take the small amount of the remaining withdrawal in cash. This cash combined with their 2013 tax refund will be used for living expenses to make up for the lost benefits from the middle of 2014 to the middle of 2015.

There are a couple of emotional issues with a complete withdrawal. One is that it just feels wrong to spend a working life building an RRSP and then just collapse it entirely in one shot. Another is that the TFSA account balance will be smaller than the RRSP/RRIF account balance. However, the entire TFSA account balance will belong to the Wilsons. Sticking with a RRIF means that 52% of the RRIF balance belongs to the government.

A caveat here is that I assumed the Wilsons will not earn any significant income in the future. If this is not the case, the entire analysis changes. Another possibility is that government rules for taxes and benefits may change in the future. But this seems like a reasonable chance for the Wilsons to take to save 20% of their money. This analysis was specific to the Wilson’s situation. Your mileage may vary.

Tuesday, February 26, 2013

Adding Commodities to a Portfolio

Larry Swedroe has long advocated adding a small amount of commodities to a portfolio to boost risk-adjusted returns. The theory says that while the commodities lower the overall expected return, they more than make up for this with their lowering of the portfolio risk (standard deviation). I’ve been resistant to this idea despite Swedroe’s numerical examples of improved risk-adjusted return. I think I can finally explain my reluctance when it comes to commodities.

In Swedroe’s most recent book (see my review here), he gives a clear example showing the effect of adding some commodities to a particular portfolio based on historical returns from 1975-2011. The portfolio begins with a 60/40 split between various equities and 5-year treasury notes, and has the following characteristics.

Before Commodities

Annualized Return: 12.4%
Annual Standard Deviation: 11.8%

He then replaces part of the equities to give the portfolio a 4% exposure to commodities.

After Commodities

Annualized Return: 12.1%
Annual Standard Deviation: 11.2%

So, the question is whether it is worth it to reduce expected returns by 0.3% to get a 0.6% reduction in volatility. Let’s first look at this in terms of relative risk aversion (RRA). A rough calculation of RRA is the change in expected return divided by the change in half the square of the standard deviation. Half the square of standard deviation dropped by

(1/2)(11.8% x 11.8% - 11.2% x 11.2%) = 0.069%

The expected return dropped by 0.3% which gives RRA = 0.3/0.069 = 4.3. In fact, the real figure is closer to 5.3 because I think Swedroe gave compounded returns rather than arithmetic average returns. This is an extremely high level of risk aversion, well beyond my own fear of risk.

On the other hand, if we look at the numbers another way, the commodities make sense. Let’s project this risk reduction to see what would happen if we were able to extend it further. If we repeatedly reduce expected return by 0.3% and volatility by 0.6%, we get to a risk-free return at 6.5%. This is clearly higher than the real risk-free return. So, mixing in some commodities is more efficient at reducing volatility than mixing in risk-free investments.

This means that if we want lower volatility than we would get from an all-equities portfolio, then it makes sense to add some commodities first, and then add in some risk-free (or very low-risk) investments.

This is great for most investors, but I don’t seek lower volatility. I’m happy to take on volatility as long as it comes with sufficiently higher expected return. So, I don’t want government debt for my long-term savings, and I don’t want commodities either.

A counterargument to this reasoning that Modern Portfolio Theory would spit out is that I should mix in commodities and then leverage my portfolio a little. The theory says this approach would give me a slightly higher expected return than an all-stock portfolio with the same volatility.

The problem with this result is that it is based on the baked-in assumption that I can borrow at the risk-free rate. I can’t. Borrowing always costs me more than I can get from a risk-free investment. If I back the loan against my house, I can make the difference between my borrowing rate and the risk-free rate quite small, but this gap is still enough to kill the idea of using commodities. So, my portfolio will remain commodity-free.

Monday, February 25, 2013

Think, Act, and Invest Like Warren Buffett

Larry Swedroe is well-known for explaining the science of investing, but his latest excellent book Think, Act, and Invest Like Warren Buffett is decidedly less technical and much more accessible to a broad range of readers. The title suggests that the book is about beating the markets with superior stock selection, but it’s really about following Buffett’s advice rather than his actions.

The first couple of chapters contain numerous Buffett quotes that make it quite clear that he thinks most investors would be best off investing passively in low-cost index funds rather than attempting to beat the market. With this approach as a starting point, Swedroe uses the rest of the book to explain how to execute this plan. The focus on concepts rather than technical detail makes this book an easy read while still being very useful.

One thing that prevents investors from improving is that most have no idea how badly they are performing. A study by Glaser and Weber “found investors overestimated their own performance by an astounding 11.5 percent a year.”

Swedroe is big on having a plan in the form of “an investment policy statement (IPS) laying out the plan’s objectives and the road map to achieving them.” He thinks that you should even sign your plan as a kind of contract with yourself. The idea is to prevent you from deviating from the plan in a moment of fear or overconfidence. I’ve definitely seen many investors desperately searching for rational-sounding justifications for their emotional desire to change their plans.

Swedroe gives some simple examples to show how mixing different investments together can increase expected returns and lower volatility. He even suggests that lowering expected returns can be justified if volatility is also reduced. This is what happens when he mixes commodities into a portfolio. I’m not sold on the virtues of mixing in commodities, but that discussion will need more space.

The book contains a section on rebalancing portfolios based on some rules of thumb for how far a portfolio can get away from its targets before it’s time to rebalance. I find these hand-wavy rules unsatisfying. Some time ago I worked out a sensible set of thresholds based on trading costs and expected rebalancing profits and coded them into a spreadsheet I use to track my portfolio.

With the current debate in Canada about whether financial advisors should be held to a fiduciary standard, it’s interesting that the top of Swedroe’s list for what to look for in an advisor is one who meets “a fiduciary standard of care.”

Swedroe closes his book with a point that has meaning for me: “the truly great tragedy is that [active investors] miss out on the important things in life in pursuit of what I call the ‘Holy Grail of Outperformance.’” I used to waste hours each week poring over company financials. Now I have more time for other things I enjoy far more.

Friday, February 22, 2013

Short Takes: Ally Fading, Brevity in CRA Communications, and more

Royal Bank has begun dismantling Ally, the online bank they acquired a few months ago. Customers can’t open any new Ally accounts, and RBC will close existing Ally high-interest savings accounts on April 30.

The Blunt Bean Counter says that it is usually a mistake to offer extra information to CRA beyond what is necessary.

Larry MacDonald looks at what it takes to eventually save up a million dollars in your RRSP.

Million Dollar Journey explains how you might get hit with taxes when transferring the commuted value of a pension into a Lock-In Retirement Account (LIRA) if you go over the Maximum Transfer Value.

Canadian Couch Potato points out that while there are problems in the mutual fund industry, not all ETFs are better than all mutual funds. In some cases, the best mutual funds are a cheaper option than ETFs.

Money Smarts shows that deciding between an RRSP and a TFSA is a little more subtle than just comparing marginal tax rates before and after retirement.

Big Cajun Man chokes on an article that defends the Pay Day Loan industry.


Thursday, February 21, 2013

Stress-Testing your Personal Finances

At the prodding of The Blunt Bean Counter, My Own Advisor recently answered a series of questions designed to test how well his personal finances would stand up to different types of stress. I liked the list and decided to give it a shot myself.

I like to think that I’m very well-prepared financially, but let’s put it to a test. Here are the questions and my answers.

Are you spending more than you earn today?
No. My family spends only about half my take-home pay.

If your income dropped by 50% for 6 months what would you do?
Not much. I would probably delay RRSP contributions until after the 6 months were up.

If you needed more income what would you do?
I would take one of the job offers I get to do work I don’t really want to do, but pays more than I make now. However, I’d rather just live modestly than spend all my time working.

Do you have enough insurance to pay off debts in the case of a death?
I have no debts.

Do you have a Will? Do both spouses know where to find it? Is it up to date?
Yes, yes, and not really. My current will has provisions for what will happen to my children in the event that both my wife and I die, but my children are adults now.

Do you have a list of assets (investments, real estate, other) you own? Do both spouses know where to find it? Is it up to date?
It’s not exactly a list, but it’s all in a spreadsheet.

Do you know you have access to money if you needed it in an emergency (line of credit, savings account)? Do you know what accounts you’d withdrawn from first to avoid more debt? Is the money readily accessible within one day?
Yes to all questions.

Do you know you have a list of emergency contact information for professionals in an emergency situation (doctor, lawyer, and accountant)?
Yes for the doctor and lawyer, but not the accountant. I’ve always spent the time to understand my tax situation, so I haven’t used an accountant. I might do well to have an accountant in mind in case of tax troubles.

My results are reasonably good but not perfect. How did you fare with these questions?


Wednesday, February 20, 2013

The Importance of Benchmarks

I’m a big believer in comparing your portfolio returns to appropriate benchmarks each year. Passive investors need to know if their investments are really tracking the indexes they are supposed to track. Active investors need to know whether their strategies are winning or losing.

I was throwing out some old papers and came across an article in a BMO Investorline “Best of the Best” magazine that mentioned both benchmarks and the importance of controlling costs. I was a little surprised by this because a focus on costs and benchmarks would push most investors to cheap indexing strategies that would lower BMO profits.

The article discussed “minimizing the costs―management expense ratios (MERs), commissions, etc.―associated with investment selections.” I’m impressed with Investorline for highlighting costs as an important factor in choosing investments.

Comparing portfolio returns to the right benchmarks is important as well. If you’re losing to a simple indexing approach year after year, maybe it’s time to give up on trying to beat the index. Unfortunately, few investors compute their returns and compare them to indexes. A study by Glaser and Weber showed that investors overestimated their own past returns by over 11%, on average. So, if you don’t measure your returns but you’re pretty sure you’re doing well, maybe you should knock 11% off your estimate of your portfolio’s yearly return. Or better yet, start measuring your returns.

The Investorline article had a sidebar titled “The Importance of Benchmarks.” Based on the title alone, I thought this was another example of their willingness to give investors useful information, even at the expense of their own profits. After all, if more investors knew just how badly their portfolios were performing, many would find their way to low-cost indexing.

Unfortunately, the article used a definition of “benchmark” that I hadn’t seen before in connection with investing. Apparently, benchmarks are measures of allocation to stocks vs. bonds, concentration in geographies, allocation to growth vs. value, and other measures of diversification. These are important things to consider, but when it comes to investing, I prefer to reserve the word “benchmark” to mean a measure of how a passive portfolio with a given mix of assets performs. Then active investors can see whether their investing strategy is winning or losing against a passive do-nothing strategy.

Tuesday, February 19, 2013

“Real Wealth is Built Through Innovation”

I’m getting to like Mark Carney more and more. He was recently quoted as saying “Real wealth is built through innovation, and it’s gained through hard work.”. He’s spot on with the real source of improvements to our lives over long periods of time. Commenting on Canadian housing prices, he continued “It’s not through some magical asset inflation.”

On a macroeconomic scale, the wealth gains we’ve had over the decades have been driven by hard work and innovations that make our lives easier and better. These innovations destroy some jobs and create others. The net effect is that we collectively get more for less effort.

When governments create jobs through make-work projects or financial stimulus, we are getting short-term solutions. True long-term improvements come from innovation. When it comes to promoting or thwarting innovation there are no purely good actors or bad actors, but generally speaking, the enemies of innovation are large organizations that fight to maintain the status quo such as governments, large unions, and the largest businesses in Canada.

Carney’s concern with his remarks was that Canadians are building debt backed against inflated housing prices. He predicts that we will see more downward adjustments to house prices. I have no opinion on the direction of house prices, but I agree with him that “Canadians shouldn’t count on home prices to be their main source of wealth gains.”

It wouldn’t be so bad if Canadians were selling their homes and going on spending sprees with the resulting cash. The problem is that too many Canadians are borrowing against their homes to spend. If these homes do go down in value, the debts still need to be repaid in full.

Friday, February 15, 2013

Short Takes: Readers Vote, Hating Debt, Improving Pensions, and more

top Canadian finance blogsJeremy at Modest Money is hosting a poll of the best Canadian financial blogs. A vote for my blog will improve your sex life :-)

Preet Banerjee did a very interesting TED Talk about changing the way we think about debt.

Malcolm Hamilton offers his thoughts on how to best provide pensions to Canadians in this short video interview. I agree with him that efforts to improve financial literacy are unlikely to make us all rational retirement savers. Hamilton has a good prescription for pensions but says he doesn’t have any good answers for containing the growth of personal debt. Hat tip to the Stingy Investor for pointing me to this one.

Tom Bradley at Steadyhand sees risk and valuation problems with dividend-based portfolios.

Money Smarts believes open houses are useful for selling your home even if some real estate agents don’t think so.

Squawkfox says to beware of inactivity fees on your credit cards.

My Own Advisor tackles the question of how big a portfolio needs to be before it makes sense to go from mutual funds to ETFs. The answer depends on your costs and trading patterns. The time to switch is when ETF MERs and trading costs add up to less than the MER costs of the mutual funds. This will depend on how much you pay for trades, how often you trade, and other factors.

Big Cajun Man has been writing about his TD RDSP troubles long enough that TD tracked him down to talk about it.

Million Dollar Journey takes a look at how to optimize your split between RRSP and TFSA contributions. A good starting point is to just save something somewhere. Once you get the saving habit you can worry about optimizing where you’re saving the money.

Wednesday, February 13, 2013

Broken Retirement Calculator

The Globe and Mail offers a number of free retirement and investing calculators including their pay yourself first calculator. I tried poking around with it but couldn’t get it to spit out numbers that matched my own calculations. I’m convinced now that it is broken.

This calculator takes in 5 numbers:

– Annual salary
– Salary increases
– Pay yourself percentage each year
– Number of years of saving
– Rate of return

Then the calculator spits out

– Total earnings
– Retirement fund

To narrow down the problem, I tried simple scenarios with 0% salary increases, a 0% rate of return, and a $100,000 income. I set the saving rate to 12% ($1000 per month). Sticking in just 1 year of saving, I get the expected result:

– $100,000 in total earnings
– $12,000 retirement fund

But when I go to 2 years of saving, I get

– $200,000 in total earnings
– $23,000 retirement fund

Exactly 1 month of savings is missing. Going to 3 years of saving, the retirement fund goes to $34,000. Now 2 months of savings are missing. This pattern continues. After 20 years, 19 months of savings are missing.

This seems like a pretty simple mistake that should have been caught. I haven’t investigated whether this calculator makes any other types of mistakes. I sure hope there haven’t been too many people relying on this calculator.

Tuesday, February 12, 2013

Passive Income Goals

A common goal for investors, particularly dividend investors, is to build savings to the point where they can replace their salary income with dividend income. I have this goal as well, although I’m happy to generate this income from a combination of dividends, capital gains and interest.

A critical factor in determining whether you’ve truly reached your goal is whether your capital is still expected to grow at least as fast as inflation after you take your income each year. Some investors say they don’t care about the amount of capital they have saved as long as they hit their income targets. This is fine if the capital isn’t shrinking, but could be a disaster if the capital can’t keep pace with inflation.

An investor with the wrong focus could hit an income target quite easily – just find a few stocks with ultra-high dividend yields. I did a simple screen of Canadian stocks that showed 21 stocks with dividend yields between 10% and 20%, with an average dividend yield of 14%. So, a $500,000 portfolio invested in these stocks would earn an income of $70,000 per year. Many people would be happy to retire permanently on this income. But the important question is whether the income will stay this high. High dividends are often unsustainable. If a company consistently pays out more in dividends than it earns in business profits, eventually it will have to cut its dividend, perhaps drastically.

The iShares Dividend Aristocrats ETF (ticker: CDZ) has a dividend yield just over 3%. On a $500,000 portfolio, this is just $15,000 per year. This income level is depressingly low compared to $70,000. But what is the point of the $70,000 income if it drops drastically in future years? You’re effectively spending your capital even if you own the same number of shares from year to year. With dividend aristocrats, at least there is a reasonable hope that the income will continue and even rise over time.

In my opinion, an even better strategy than investing in dividend aristocrats is to be more broadly diversified. This drops the dividend yield to a little over 2%, but the possibility of higher capital gains makes up the difference.

Dreaming of leaving a hated job is understandable, but reaching too far for yield is dangerous. Investors are better off focusing on the profitability of the businesses they own rather than the dividend yield. This is true whether you buy individual stocks or buy funds that hold many stocks. Not all income streams are sustainable.

Monday, February 11, 2013

Free Credit Reports

It’s a good idea to check your credit report occasionally to make sure the information is accurate and that your identity hasn’t been stolen to borrow in your name. Online credit report services with fees are heavily advertised, but you can get your reports for free as well.

Free reports are available to Canadians by calling both Equifax (800-465-7166) and TransUnion (800-663-9980 (outside Quebec) or 877-713-3393 (within Quebec)). You have to answer a series of questions to authenticate your identity, which involves a lot of punching in numbers on your keypad or saying the answers. I did this recently and it went quite smoothly.

My experience with Equifax was better because it repeats your answers back to you before you confirm that they are right. TransUnion said “if you are satisfied with your entry, press 1” after each piece of information I entered, but didn’t tell me what I had entered. In one case I incorrectly entered a date with only two digits for the year instead of four. Fortunately I realized the mistake and corrected it before moving on.

I placed my order recently with both Equifax and TransUnion on a Wednesday and got both reports by snail mail the following week (Equifax on Tuesday and TransUnion on Friday). This was better than my experience two years ago.

My reports were fairly accurate. One listed me as having lived at my brother’s house. The other listed a funny phonetic spelling of a former employer’s name that was off by 6 of 13 letters.

One thing you don’t get with a free report is your credit score. But I’m more concerned with ensuring that all the detailed information about my accounts is correct.

Thursday, February 7, 2013

Aeroplan Miles and CostCo Gift Cards

For many years now I couldn’t see what benefit I was getting from Aeroplan miles. Every time I tried to use the miles to book a flight I wasn’t offered any decent connections, and I ended up just paying for flights that suited me better. Even having Air Canada elite status doesn’t seem to help. But, I found a way to deal with the problem that involves CostCo.

Years ago the situation was different. I was actually able to use Aeroplan miles for free flights. And this was back when the flight was actually free instead of having to pay various taxes and surcharges when redeeming miles. But I haven’t been able to use my miles for a flight for a long time now. I even let over 30,000 miles expire at one point because they seemed worthless.

Fortunately, there are options for using Aeroplan miles other than reduced-cost flights. Aeroplan offers a large number of goods and services in exchange for miles. Looking through the selection, I despaired of finding anything I wanted until I came across $100 CostCo gift cards for 13,500 miles.

I’ve already ordered 3 gift cards and they worked just fine at CostCo. So, now I can say that to me Aeroplan miles are worth about $7.40 per 1000 miles. And now I just pay for any flights I take, frequently on airlines other than Air Canada.

Wednesday, February 6, 2013

Why Does CRA Limit Us to 20 Tax Returns Per Computer?

Vendors of personal income tax software impose various limits on the number of returns you can file. However, CRA imposes a hard limit of 20 returns per computer. Why?

The seventh entry in CRA’s NETFILE FAQ answers this question. The explanation begins with “The CRA's primary interest is always to protect the taxpayer.” This gave me a chuckle. I can believe that protecting taxpayers is high on their list, but their primary interest is to suck up giant piles of money. OK, moving on.

The rest of the explanation is a little vague, but the concern seems to be identity theft. I guess an identity thief with personal information on many Canadians could cause trouble on a large scale with unauthorized use of NETFILE.

So there you have it. Anyone who wants to file more than 20 returns needs to NETFILE with multiple computers or could use EFILE which is intended for tax preparers.

Tuesday, February 5, 2013

EI Clawback Exemption

Looking at my first paycheque of the year, I feel the sting of Canada Pension Plan (CPP) and Employment Insurance (EI) deductions starting again. I don’t really mind contributing to my future income in the form of CPP, but calling EI “insurance” always irked me because I thought my income level made it nearly impossible for me to ever collect.

There are clawback provisions for any EI benefits you receive over and above paying normal income taxes on the benefits. I had assumed that if my year’s pay was too much above $60,000, any EI benefits would be clawed back anyway.

It turns out that there is an exemption for anyone who hasn’t collected any EI benefits in the preceding 10 taxation years. So, while I don’t expect to be involuntarily unemployed, in principle I could collect EI benefits for a while and not have them entirely taxed back. This could only happen once every 11 years, but at least this insurance has modest value to me. So, instead of viewing EI deductions entirely as a tax, I now see them as mostly tax and a little bit of insurance.

Don’t get the wrong idea about my view of EI. I don’t mind paying into a fund that helps people who lose their jobs. And I think it makes sense to claw back benefits from high-income earners. I just question whether we should call it insurance or just another tax. At least the first year you collect EI you aren’t subject to clawback.

Monday, February 4, 2013

Bye-Bye Penny

The Royal Canadian Mint will no longer distribute pennies as of today. I say good riddance. It’s been decades since a penny was worth enough to matter.

It seems that one of the most convincing arguments for getting rid of the penny is that they cost more than a penny to make. I don’t see why this has anything to do with it. If the government could make $1 million worth of pennies for $800,000 in costs, should we say that they have made a $200,000 profit? They could just as easily make $1 million worth of $100 bills for far less than $800,000 in costs. For that matter, they could just create money that only exists in bank computers for next to no cost.

Suppose the government could make coins out of a very cheap metal with face value 1/10 of a cent at a cost of 1/20 of a cent each. Should they do this to make a 50% profit? The answer is obviously no. What is the point of a coin worth only 1/10 of a cent? Whether the coin is “profitable” is irrelevant. What matters is the usefulness of the coin. Pennies are almost completely useless for practical purposes.

The real test for getting rid of the smallest denomination coin is whether it represents an amount of money that makes a difference in a physical money transaction. Based on this test, we could certainly live without nickels and dimes as well. I’d be happy if retailers just rounded my change to the nearest quarter.

Friday, February 1, 2013

Short Takes: Bad Company Retirement Savings Plans, Collateral Mortgages, and more

MoneyNing has a great infographic illustrating the best and worst company retirement savings plans in the U.S. The difference between the best and worst plans is more than enough for a Virgin Galactic flight to the moon.

Canadian Mortgage Trends explains the pros and cons of collateral mortgages. One thing I would add is that because a collateral mortgage is more expensive to transfer to another lender, it allows your existing lender to charge you a higher interest rate when you renew.

Rob Carrick takes on the question of whether you should pay down debt, save for retirement, or some of each. The important part of his analysis is that he takes into account human nature in making the decision.

Potato continues the housing debate arguing that an improving economy will bring both higher wages and higher interest rates, but that mortgage payments will rise faster than wages.

The Blunt Bean Counter finds estimates of the cost of owning a dog to be low. I always tell people I have the perfect dog. It costs me nothing, I see as much of it as I want, and it lives the rest of the time next door. (My neighbour might experience higher costs than I do.)

Retire Happy Blog explains the rules for getting money out of a Lock-In Retirement Account (LIRA). When I first got a LIRA, I thought that when I hit 55 I’d be able to just dump the money into an RRSP. But the rules are more complicated than this. The government wants you to get lifetime income from your LIRA rather than blowing it all in a weekend in Las Vegas.

Preet Banerjee interviews Ellen Roseman in his latest podcast.

Canadian Capitalist updates his sleepy portfolio report card.

Big Cajun Man says “Don’t BITCH about [your debt], DO something about it!”

Gail Vaz-Oxlade brings us several surprising uses for newspaper.