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Personal Finance

Individual Pension Plan can boost your nest egg

August 31st, 2016 by

Ideal for professionals, executives, business owners


Looking for ways to enhance your retirement savings beyond a Registered Retirement Savings Plan (RRSP)? If you don’t already have a pension plan through your employer, and you’re a business owner or executive, or an incorporated professional (physician, dentist, lawyer, accountant, and so on), you might consider the benefits of setting up an Individual Pension Plan (IPP). In this era of financial uncertainty, with many businesses increasingly unable to fulfill their group pension funding obligations, and with defined benefit pension plans going the way of the dodo, an IPP can make a lot of sense.

An IPP is basically a defined benefit registered pension plan for a single employee rather than a group. Like any group plan, an IPP pays out benefits based on a percentage of the beneficiary’s prior annual employment income, and payments and funding are governed by the terms of the plan. The plans are regulated by the government and must follow precisely specified rules, like any other pension plan.

Higher limit than RRSP

The beauty of an IPP is that the allowable contribution limit is generally much higher than for an RRSP, allowing planholders who are 15 to 20 years from retirement to accumulate a much larger nest egg than through an RRSP alone.

Like an RRSP, an IPP is an investment account that accumulates over time to provide retirement benefits. But like a pension plan, the IPP provides certain guarantees. In addition, any amounts you contribute are locked in until you retire. And like a regular pension plan, IPP contributions are determined by actuarial calculations to provide sufficient income at retirement.

Not only do contributions accumulate and compound tax-free inside the plan, but IPPs allow for past-service contributions, allowing you to get out of the starting gate with a whole lot more funding. In addition, an IPP must be funded at least 50 percent by the employer to qualify. The beneficiary of the IPP may also make voluntary contributions. And an IPP may provide a guaranteed level of retirement income if, under the terms of the IPP, the employer agrees to cover shortfalls arising from poor investment returns.

Creditor protection

In addition, and of particular interest to business owners, an IPP offers creditor protection should either you or your business face bankruptcy or be forced into bankruptcy protection. Under provincial legislation governing IPPs, your pension plan funding will be insulated from seizure by creditors.

Also of interest to many business professionals is the ability to participate in investment decisions in an IPP. This feature affords a level of flexibility and participation that is generally unavailable in group defined benefit plans.

An IPP also allows for a number of income options at retirement, including payment of an annual pension by the IPP, transfer of amounts to an RRSP, or the purchase of an annuity.

Getting IPP help

IPPs have much appeal for self-employed individuals, professionals, and business owner/managers. By the same token, however, IPPs are legally classified as Registered Pension Plans and are subject to fairly complex and rigorous rules governing set-up, maintenance, and funding. Beyond the actual investments in the plan, this involves things like actuarial estimates, financial statements and disclosure, costs, asset values, and liabilities.

IPPs are definitely not a do-it-yourself type of product. You need the help of a qualified financial professional to set up and administer the plan, to ensure you meet regulatory requirements for contributions, holdings, and reporting.


Where will my retirement income come from?

August 22nd, 2016 by

Start planning now so you don't outlive your nest egg


The retirement planning conundrum never seems to change. It just gets more complicated. Ensuring sufficient income for retirement is now on the radar for every so-called Gen-Xer, and increasingly for Millennials as well. In short, if you’re in your 30s or 40s, it’s time to get serious about retirement saving. If you think “middle age” only starts at 50, think again. As a wise man once pointed out, “I’ll consider middle age to be 50 when I’m guaranteed to live to 100.”

The fact is, however, that Canadians are living longer. As average life spans lengthen to over 80, there’s the distinct possibility of running out of money in retirement. A significant decline in health, sudden critical illness, and a need for quality long-term care are risks we all face as we age.

Unfortunately, government pension plans are becoming increasingly stressed. The average monthly payment for Canada Pension Plan and Old Age Security is less than $1,200 per month. With governments under pressure to curb runaway spending, there’s very little appetite in the workforce to increase public pensions to those who have retired.

In addition, the private pension landscape is changing too. Defined benefit pension plans are going the way of the dodo. Defined contribution plans, which let individuals choose contribution levels and pension management options, are becoming more popular.

And with ever-present inflation and investment risk, building an adequate nest egg has become more of a challenge than ever.

What you’ll really need

A rule of thumb is that in order to maintain your lifestyle during retirement, you will need 60 percent to 70 percent of the average annual income for the last five years of your employment before your retirement.

According to research, only about 39 percent of income replacement at retirement comes from government pensions and plans, such as the Canada Pension Plan and Old Age Security. The remainder must be made up from private employer pensions and personal funds.

Building your retirement income stream

At retirement, creating a stream of stable, reliable income becomes a paramount consideration. After all, you’ve spent perhaps 30 years carefully building a considerable nest-egg that needs to provide a steady income for possibly another 30 years.

To begin with, look at proven income-producing products and potential income streams to create the best cash flow for your retirement needs and to comfortably meet contingencies as you age into retirement.

You’ll also have to plan for tax efficiency to keep the tax take to a minimum and prevent clawbacks of government plans. Consider a combination of sources to produce the most tax-efficient income-portfolio possible, one that’s built for income security, asset growth, and inflation-protection.

Income-producing assets

Here are the top income-producing assets that are likely to form part of your retirement income portfolio, categorized by tax rate payable:

Top-tax assets: bonds; interest income; pensions; employment earnings; registered annuities; GICs; RRSP/RRIF; real estate rental income.

Mid-tax assets: mutual fund distributions; insurance policy cash value; corporate class mutual funds; prescribed annuities; stock dividends.

Low-tax assets: home; personal capital; Tax-Free Savings Account withdrawals; leveraged insurance policy cash value.

Find expert help

The challenge is to turn this stew into a safe, reliable, tax-efficient, long-term income stream that lasts as long as you do. Most of us are too busy with our own lives to become expert portfolio managers and financial planners as well. If you’re in a higher net worth bracket and have already accumulated a sizeable portfolio on your own, it makes sense to hand off some of the money management responsibility to a professional financial planner and money manager, who can objectively assess your financial situation, your needs, objectives, and risk tolerance. The object is to create a sustainable plan that will nail down your financial security in old age.

Stock Market

Brexit? Trump? The Dow? Climbing the wall of worry

August 15th, 2016 by

The market will fluctuate - get used to it!


Stock markets seem to be reaching record highs every day. Toronto’s S&P/TSX Composite Index is the top-performing market in the world so far this year. Yet endless storm clouds seem to be gathering permanently on the horizon: Brexit; the U.S. election; negative interest rates in many developed countries; and on and on. Should you pay attention? Yes, most definitely. But should you start selling off your assets looking for the (probably mythical) “safe haven”? No. Here’s why.

What markets will do

When asked what the market will do next, Gilded Age financier J.P. Morgan reportedly replied, “It will fluctuate.” It’s the only prediction you can make with any certainty. What drives markets is fear and greed. But no one really knows precisely when one force will take over from another in the grand cycle of market ups and downs. As many market veterans are all too aware, calling market tops and bottoms is next to impossible.

Yet astute investors continue to make money in securities markets, generating handsome returns in their portfolios year-in, year-out, regardless of the crisis of the day. That’s because the most successful investors apply three proven principles that never fail.

1. Discipline

When you create a long-term financial plan, you want to see your wealth grow within your risk tolerance level.

If you’re a more defensive investor, but still want to take advantage of the growth potential of equity markets, you might have a broad asset mix of 10 percent cash, 50 percent fixed-income, and 40 percent conservative dividend-paying equities.

That type of portfolio allocation will produce results, but only if you have the discipline to stick with it. The equity portion will naturally be more volatile, but that should be offset by the lower volatility of your fixed-income holdings and the income from your dividend-paying shares. With risk spread across diverse asset classes, your overall portfolio won’t suffer as severely in those inevitable market downturns.

But discipline is critically important. If you succumb to the “fear” part of the fear/greed equation because of Trump or Brexit or Greece or what have you, you’ve made a fatal mistake in your financial planning (just as much as if you start buying all kinds of speculative stocks just as markets reach record highs). If your asset allocation was good before the current crisis, and your security selections made sense then, what’s changed? Have those big blue-chip companies gone out of business? Will governments default on their bonds? Of course not! The discipline lies in making sure you don’t blow up your portfolio at every turn – because you’ll almost certainly do it at the wrong time.

2. Patience

The longer you stick with your plan, the more likely you are to achieve your wealth creation targets, regardless of market fluctuations.

Research has shown that stocks outperform virtually every other asset class over the long term. The Canadian benchmark S&P/TSX Composite Index, for example, has returned an average 8.04 percent compounded annually for 20 years, as of July 31. That means a $10,000 investment 20 years ago in the S&P/TSX Composite, with only $100 added every month, would today be worth $110,827! The important principle here is that you’d have made this small fortune only if you’d stayed in the market. And you’d have done that only by exercising patience.

3. Prudence

When you’ve settled on your financial objectives, risk-tolerance, and an appropriate asset mix, your next step is to select individual assets for your portfolio.

It’s here that you want to have the best professional asset management talent available. You won’t be devoting a lot of time to speculative junior stocks. You’ll want to do your research and know what you’re investing in, including the history and outlook of any company you want to own.

If that sort of analysis isn’t in your wheelhouse (and for most people, it isn’t), hire an expert. Ask your financial advisor who they use for asset management and what their financial management philosophy is. Get the facts and figures and proof of performance. It’s your money. Treat it prudently, and give it the respect it deserves. It’ll pay you back handsomely.


Should you borrow to invest?

August 10th, 2016 by

The lure of low rates can lead to a risk trap


With interest rates so low, and stock markets hovering around all-time highs, many investors are looking to borrow for investment purposes, especially since the interest on an investment loan is tax deductible. While this might look attractive on the surface, borrowing to invest can be a perilous experience – one that you undertake at your own risk.

Borrowing to invest in stocks is certainly seductive when markets are rising and rates are low. And it’s certainly quite popular now. According to monthly statistics from the Investment Industry Regulatory Association of Canada (IIROC), some $21.4 million was invested in Canadian margin accounts as of the end of May.

The promise of gains – with one big proviso

Borrowing money to invest – also known as using leverage – sounds promising. The idea is that you can increase the size of your investment considerably beyond the amount of your own capital. Then you pay off the loan with any gains you may realize from the larger investment. You’ll have to pay interest costs along the way, but provided you can cover this carrying charge, you stand to make the proverbial killing in the market. The proviso – and it’s a big one – is that leverage works both ways.

The fact is, leverage magnifies your gains in a rising market. But it also magnifies your losses when markets head south.

Say you invest $10,000 of your own money (your equity) and borrow $40,000 for a total $50,000 investment in an equity exchange-traded fund. Now suppose the fund gains 10 percent. Your investment is up $5,000. However, in reality, you have made a gain of 50 percent on your original equity, less the interest cost of the $40,000 loan. If the investment falls by 10 percent, you have actually lost a total of 50 percent on your equity. This is why leverage is such a risky proposition.

The dreaded “margin call”

If you’re using a margin account with your brokerage firm, and the value of your investment falls, the brokerage will ask you to put up more cash to restore the equity in your account to the broker’s maintenance margin (a margin call). If you are unable to add cash, the broker may sell your securities to increase your account equity. With a margin account, it is possible to lose your entire investment. Borrowing using a margin account is therefore recommended only for experienced short-term traders with enough cash cushion to meet margin calls.

If you borrow to invest using a bank loan or line of credit, you’ll still get the magnified upside and downside to any stock market investments purchased using the borrowed money. However, you won’t be faced with margin calls if your investments head south. Instead, you’ll have to eat the loss yourself. Basically, you’ll still be on the hook for the entire principal amount of the loan plus ongoing interest for the term of the loan regardless of the value of the investment.

Interest may be tax deductible

Typically, the cost of a loan made for investment purposes is tax deductible, provided it’s a bona fide loan made at reasonable commercial terms and legally documented as a loan obligation. This type of leverage strategy works best over the longer term and only with a principal amount whose payments you can meet comfortably when the value of your investment fluctuates. The objective is to generate a longer-term after-tax return that is greater than the after-tax cost of borrowing.

Because leverage can be both tricky and risky, it’s always prudent to consult your financial advisor before embarking on the strategy.


Stocks at record highs: time to buy?

August 3rd, 2016 by

How to avoid the market timing trap


In a post-Brexit bounce over the past few weeks, the major North American stock markets have touched record highs. That blindsided many small investors who had bought in to the end-of-the-world-style of media hype right after the Brexit vote and jumped out of their equity holdings. Of course, they pretty much missed the almost immediate rally, which recovered the losses and sent markets surging to new highs. So is now the time to buy stocks again? Actually, that’s the wrong question to ask.

The right question

The right question is not whether now is the right time to put money into stocks; rather, it is, “If your portfolio doesn’t already include stocks as part of an asset allocation strategy, why not?”

In fact, anytime is the right time to get into stocks. You should always have some allocation to equities, and if you don’t, you’re doing something wrong. You should also always have bond holdings. And cash. In other words, you should have a plan.

Proper asset allocation is one of the keys to investing success. Basically, this means that you determine what kind of investor you are, what your financial objectives are, how much risk you can really stand, and then create a portfolio of investments that reflects that profile.

You might, for example, be a growth investor with a more aggressive outlook and willingness to take on more risk, and allocate, say, 10% of your portfolio to cash, 25% to fixed income, and 65% to stocks. And you’ll stick to roughly this allocation through thick and thin. You’ll always have a largeish portion of your holdings in equities, but you’ll also have bonds to help mitigate risk and provide income, while your cash gives you flexibility.

What about bear markets and corrections?

The S&P/TSX Composite Index recently went through a correction – that’s when the market falls 10% or more from its recent high before recovering again. It’s bound to happen again. But no one knows exactly when or by how much. Trying to guess market tops and bottoms is called “market timing” and no one ever gets it right, except by sheer accident.

When you have a planned asset allocation strategy that you stick to, you’ll feel more comfortable weathering the inevitable stock market downturns. Yes, the equity portion of your portfolio will plunge right along with the market. But your bond holdings are likely to soar, offsetting losses in equities. That’s called mitigating risk.

And that’s why I tell clients they should be in stocks, bonds, and cash at all times, instead of switching in and out of assets at random based on the headline of the day. It’s a matter of degree – allocating your asset mix according to your objectives and tolerance for risk. The market hits a record high? It plunges 10%? So what? Investing is a long-term business, and you’ll have a much greater chance of success in the long term if you have a plan…and stick to it.