Rules to Financial Planning
Many people ask us what they should do to create wealth for themselves and their children. Here are four rules that we have come across that are essential to Financial Planning, regardless of someone’s income:
1. Get rid of Non-deductible Debt
2. Accumulate Assets for Retirement
3. Find opportunities to split income with your spouse or children
4. Prepare for the Unexpected
Now that you know the rules here is a brief insight into what they mean:
Rule #1 – Get Rid of Non-Deductible Debt
No matter who you are, you have debt in some way, shape or form. There is good debt and bad debt and getting into a lot of bad debt may be bad for your finances. Debt is a fact of life, but how you manage debt and what type of debt you carry directs your lifestyle.
The cost of debt should be your first consideration in planning. Having bad debt means you are paying for it using after tax dollars. For example, an interest charge of $100 might have a “real” cost of $130, because you have to earn $130 just to have $100 after tax to pay your interest.
1. The best way to reduce your debt is to go after the high interest debt first, which is generally your credit card debt. Our suggestion is to go to the bank and get a credit line to consolidate all your credit card debt in one place and replace your credit card debt with a lower interest rate debt. This will make your debt payments smaller and more manageable. Make sure you don’t max out those credit cards again once you have consolidated your debt!
2. You should make a plan to slowly chip away at your highest interest rate debt first while making any minimum payments on other debt.
3. If you have spare money sitting around consider accelerating your bank loan repayments, this will reduce the total interest you have to pay over the life of the loan!
Rule #2 – Accumulate Assets for Retirement
The most effective and tax efficient way to build assets for retirement is to join your company’s pension plan and/or contributing to an RRSP.
The advantages of putting money into an RRSP are as follows:
1. You get a tax break on any contributions you make. See our blog on RRSP vs TFSA here: http://www.diyapc.ca/blog/ever-wonder-what-difference-between-rrsp-and-tfsa
2. The investment income earned on the contributions grows without being taxed inside the RRSP account
3. When you withdraw the money in your retirement, you will probably do so at a lower tax rate
A wise man once said “Pay yourself first”. You can attack Rule #1 and Rule #2 by following this golden rule to Pay Yourself First. Take money during the year and put it into your RRSP’s and continue to make your minimum payments on your debt. The rate of return on your RRSP is most likely higher than interest charges on your debt. Once you get your tax refund, use it to pay down your debt. In this way you have saved for retirement and paid down your debt!
Rule #3 Find Opportunities to Split Income with your spouse and/or children
The idea behind “Income Splitting” is to shift income from the higher income spouse to the lower income spouse in order to reduce the overall tax burden on the family as a whole. Some simple examples on income splitting are as follows:
1. Use the higher income earner’s RRSP contribution room to make a spousal RRSP contribution. The contributor will get the tax deduction, and later in retirement when the money is withdrawn it will be taxed in to lower income spouse’s hands. Example if you had $1,000,000 in your RRSP’s and your spouse had no money in their RRSP’s and upon retirement you need to withdraw $100,000 to survive in a given year, if you withdrew $10,000 the tax rate would be in the third tax bracket however if your spouse took out $50,000 and you took out $50,000 you both would reduce your tax rates and pay a lower amount of tax!
2. If both partners have income, have the higher paid spouse pay all the household bills. The income of the lower paid spouse should be used to buy investments for the family. The assets should be in the name of the lower income spouse so that any resulting investment income is taxed at the lower income spouse’s tax rate.
3. The Federal Government has recently announced the Family Tax Credit which allows the higher income spouse to allocate up to $50,000 of income from themselves to their lower income spouse effectively reducing the tax on that $50,000 of income. This tax credit could save you up to $2,000 on your taxes.
Rule #4 – Prepare for the Unexpected
No financial plan is complete without an estate plan. You should periodically review your plan to ensure that it is meeting your requirements as your life changes.
1. Evaluate your life insurance needs. Carry adequate life insurance at all times
2. Prepare a will, a power of attorney and a mandate
3. Name beneficiaries on registered plans, TFSAs and life insurance to ensure that your dependents are taken care of just in case something should happen.
We believe that if you follow these four simple rules, and ensure that you spend less than you make, you will become financially independent! Come in and talk to us or email firstname.lastname@example.org for further guidance, we can help you make a financial plan that is tailored to your situation!