Q – Last week you answered a question about fighting a Notice of Assessment from the Canada Revenue Agency. My question relates to another comment made on my Notice regarding instalment payments. I have a business on the side, apart from my regular employment, and every year I’ve paid tax on income from that business. Now the CRA says that I “will receive an instalment reminder in August” and that I may have to start making instalment payments on September 15. I’m not sure what this means. Can you explain? – Shirley B., Toronto, Ontario
A – Around this time of year, we get plenty of questions about both Notices of Assessment demanding more tax and instalment payments. Both issues can get complicated, as you might expect in dealing with the CRA, so it pays to take a few minutes to try to sort out what’s going on.
In your case, the CRA has determined that the annual tax you owe, less any withholding, for the current year and either of the two previous years is more than $3,000. Very simply, if you owe more than $3,000, they want you to pay in instalments, typically payable quarterly.
Unlike quarterly instalment payments for GST/HST, which are mandatory whether or not you receive a notice or voucher, you don’t have to cough up instalments on income tax payable until you receive a “reminder notice” from the CRA. You’ll get a reminder notice twice a year – one in February reminding you to pay up on March 15 and June 15, and one in August, reminding you that instalments are due on September 15 and December 15.
It sounds like you’ve recently exceeded the $3,000 threshold, and that the CRA therefore wants you to pay your 2013 tax bill in two instalments starting on September 15. The CRA has to receive these payments by the due dates so that you will be deemed to have paid on time – no “postmarks” allowed. You’ll then receive reminder notices for regular quarterly payments beginning in March 2014.
If you are sure your tax liability for 2013 will not exceed the $3,000 threshold, you can ignore the instalment reminder notices. If you’re not sure or you think you’re borderline, it makes sense to go ahead and pay the instalments to avoid various penalties and interest charges, which can be hefty, as instalment interest is compounded daily. The banks and credit card companies have nothing on the CRA for usury!
A CRA demand for instalment payments can also put a monkey wrench in your cash flow planning if you’re not prepared for it. Instalment payments can be tricky, and can get complicated. To avoid running afoul of CRA regulations and incurring penalties and interest, it makes sense to consult a qualified financial advisor if you’re unsure about your tax situation. But make sure you do so well before any due dates set by the CRA. – Robyn
Q – I recently received a Notice of Assessment from the Canada Revenue Agency, saying that I owe several thousand dollars more in taxes. I disagree. But I’m at a loss about what to do next. Should I call the CRA directly? What would be the best course of action? – Stephen B., North York, Ontario
A – It’s around this time of year that taxpayers get tax refunds and Notices of Assessment from the CRA. Sometimes those Notices of Assessment can contain a nasty surprise, as in your case.
Your first step is to look closely at the Notice of Assessment and determine exactly why the CRA says you owe more. Did you miscalculate an entry? Did you make a data entry error when you filed your return? Sometimes the problem is as simple as that, and you’ll just have to swallow your embarrassment and pay up. Other times, the CRA may be disallowing tax credits or deductions. If you’re not sure what the problem is, your next step is to call the CRA to find out. Sometimes, it can be cleared up by speaking with someone directly.
If calling the CRA doesn’t resolve things, you may have a good reason to object to the CRA’s Assessment. And, as you’d expect, there’s a form for that. It’s called the T400A Objection – Income Tax Act, or more commonly, a Notice of Objection.
If you plan to go down this route, it’s really important to note that you have only 90 days from the date the CRA mailed you your Notice of Assessment to file a Notice of Objection, whether you actually received your Assessment or not. Your Notice of Objection should include chapter and verse about why you believe the CRA’s Assessment is incorrect. That includes evidence that the CRA has made an error either in fact or in law. And yes, if this sounds as if you are considered “guilty” until you can prove your innocence, you’re right. The CRA is considered to be in the right until proven wrong, and that means that any you still must pay any assessed amounts or face interest on overdue amounts (at an annual 5% rate for the second quarter of 2013, which compounds daily).
In general, it makes sense to pay what the CRA says you owe, if only to avoid that penalty interest from mounting up. The reason is simple. If your Notice of Objection deals with tax deductions, GST/HST, or withholding tax, the CRA can continue to take steps to collect any balance owing, including seizing assets or garnisheeing wages. If you pay now and fight the assessment, which could take as long as a year to sort out, and subsequently win, you’ll get your money back, with a little bit of interest.
Filing a Notice of Objection can be a perilous enterprise, with various time limits and conditions attached. Doing it wrong can end up costing you not only your original assessment but also other hefty penalties and interest. Your best course of action is seek the advice of a tax lawyer or other qualified financial or tax advisor to help you with the procedures involved for filing a Notice of Objection. – Robyn
Q – My husband and I are thinking of starting a family and we feel we need more space. We are currently renting a downtown condo unit, but we’re wondering whether we can afford to borrow to buy a home. Is there some rule of thumb we can use to calculate the type of house we can afford so we don’t fall into the “money pit”? – Sue T., Toronto, Ontario
A – The answer to this sounds simple, but it’s not really. Buying a home is probably the biggest financial undertaking most Canadian make in their lifetimes. So it’s not something you want to treat lightly from a financial planning perspective. Most of us have to arrange for a mortgage to finance the purchase of a home. The real question then becomes, how much mortgage debt can you really afford to carry?
When you figure your monthly budget and take it to a bank loan officer or mortgage broker, they’ll apply a couple of tests to determine how much mortgage you can afford. And that in turn determines how much house you can afford to buy.
The debt service ratios
When you apply for a mortgage, your bank or other lender will look at something called the Gross Debt Service (GDS) ratio and Total Debt Service (TDS) ratio. These are calculated using factors such as your annual income, overall debt load, and how much you pay every month for housing costs.
The Canada Mortgage and Housing Corporation (CMHC), which governs the mortgage market in Canada has a rule that your monthly housing expense – which is the total of your mortgage principal and interest, tax, and heating expenses – can be no more than 32% of your gross household monthly income. Your GDS is the ratio of your total housing costs to your gross monthly income.
In addition, the CMHC rules state that your total monthly debt load (which includes credit card interest, consumer loans, and car payments), including housing costs, can be no more than 40% of your gross monthly income. Your TDS is the ratio of your total of your monthly debt load to your gross household income.
Working from these ratios, you’ll be able to determine how much mortgage you can afford to carry. But the story doesn’t end there.
Costs can mount up
Based on the debt load you can comfortably carry, you’ll then have to decide on the type of home you want to go hunting for. Most younger couples just starting out will not be able to afford a single-standing home in the downtown areas of Toronto’s larger urban centres, like Vancouver, Calgary, Toronto, or Montreal. That means you’ll be looking at suburban areas, or areas even further afield – the so called “exurbs” or “bedroom communities.” Keep in mind that while prices may be marginally lower in these areas, you’ll be adding higher commuting costs to your monthly budget.
In addition, you’ll have to budget for monthly maintenance and upkeep costs of your home – costs which were buried in your monthly rental payment, but which will now come out of your own pocket – in addition to your mortgage payment.
The offset to the tidal wave of costs involved in buying and owning your own home is that property values tend to increase over the longer term, at least by the rate of inflation, and often by quite a bit more depending on the location of your home. And with every principal payment, you’ll be adding to your equity, which means that each month, the bank owns less and you own more of your home.
The buy-or-rent debate can quickly become complicated. Throw in the various types of mortgages and payment options available (e.g., fixed term, variable rate), and your head will soon be spinning. If so, get the help of a qualified financial advisor to help you decide what’s really affordable for you, and help you avoid the proverbial “money pit.” – Robyn
Q – For the past few years, I admit I’ve been just too nervous about investing in the stock market, because I’ve heard various market experts say that the economy is still weak and the stock market will not outperform. As a result, I’ve been holding mostly bond mutual funds and cash. Luckily, they’ve done okay. But now, with the big U.S. stock indexes like the Dow Jones Industrial Average climbing to record highs, I’m starting to wonder if I’ve made a mistake. Do you think I should switch out of bonds and invest in some good equity mutual funds? – Raj S., Georgetown, Ontario
A – The paradox here is that since its low back in March 2009, at the depths of the global financial crisis, the Dow Jones Industrial Average has advanced about 125%, crossing the record 15,000 mark recently. That record has been four full years in the making! Even Toronto’s resource-heavy S&P/TSX Composite is up 64% in the same period. Where have all the small investors been? In fact, they’ve missed another cyclical post-recession bull market.
The real question to answer here is not whether now is the right time to put money into stocks; rather, it is, “If you haven’t had exposure to the stock market over the past four years, why not?”
When clients ask me whether now is the right time to get into the stock market, I usually tell them thatanytime is the right time to get into stocks. In fact, you should always be in stocks. If you’re not, you’re doing something wrong. This usually gets some raised eyebrows and quizzical looks. Then I go on to say that you should also always be in bonds. And in cash. In other words, you should have a plan.
I’m talking here about proper asset allocation, one of the keys to success in personal money management. Basically, this means that you determine what kind of investor you are, what your financial objectives are, how much risk you can really withstand, and then create a portfolio of investments that reflects that profile.
You might, for example, be a growth investor – a little more aggressive in your outlook – 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. Over the past four years, you’d have done pretty well with this kind of portfolio. And you wouldn’t now be wondering whether it’s time to “get into stocks.” You’ll already have been in stocks, reaping the gains along the way.
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. 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. – Robyn
Q – I manage my own investment portfolio, and I’m an active trader with an online account. However, I just paid my tax bill for 2012, and it was a doozy! A large part of it was due to tax on investments, particularly on income on distributions and sales of some mutual funds, and capital gains on various stock transactions that I thought had worked out well. I was surprised at the size of the chunk the taxman took out of my total returns. Am I doing something wrong? – Stephen L., East York, Ontario
A – You’re not necessarily doing anything wrong. But you may have fallen into the trap that so many do-it-yourself investors do. You’re looking at your investments the wrong way around.
While the asset mix of your portfolio is important, and your individual security selection might be exciting, you may be ignoring one of the biggest factors in wealth creation: tax efficiency.
Research has shown that creating tax efficiency in your portfolio accounts on average for about 28% of overall long-term investment return. Surprisingly, the factors with the next largest influence on your portfolio returns are the time you spend on management, which has a 26% importance ranking in portfolio returns, and managing your emotions, which adds up to about 20% ranking.
Believe it or not, asset mix accounts for only 17% of what goes into total return, while security selection – the item that most investors spend most time on – has only a 2% importance ranking in determining portfolio outcomes.
These are fascinating numbers, because they tell us why so many do-it-yourself investors get into trouble: They place outsized importance on the aspect of portfolio management that contributes the least impact to long-term portfolio growth – security selection. And I suspect this is what has happened to you.
It’s easy to get carried away with online trading, but in the process, you’re not only generating costs in the form of brokerage commissions, but you may very well be inadvertently accumulating a hefty tax bill on the various buys and sells of your investments through the year. It all takes a sizeable chunk out of your investment returns and puts it in someone else’s pocket. There’s probably no other activity in the world where individuals will so eagerly perform a robbery on themselves.
The key is to step back from the trading screen for long enough to take a look at your whole portfolio. And then ask yourself:
* Is it tax efficient? Am I attracting maximum tax with every transaction or am I minimizing the tax hit? Am I maximizing my use of Tax-Free Savings Accounts (TFSAs) and Registered Retirement Savings Plans?
* Is it low cost? Am I using investment strategies that reduce my overall trading, transaction, and management costs, such as allocating at least some portion of my asset mix to low-cost exchange-traded funds. In the case of mutual funds, have I looked at corporate class shares?
* Am I mitigating risk? Am I diversifying my portfolio with enough non-correlated asset classes to suit my tolerance for risk. Am I using hedging or income-generating strategies with options? Or am I essentially “throwing darts” every day, and hoping for the best?
Granted, these are not particularly easy questions to answer, and you might just have to break down and talk to a financial advisor. As a self-directed investor, this probably goes right against the grain. But you sound as if you’re in a bit of trouble sorting out how your various investment activities are affecting your overall returns. An objective study by an independent fee-only advisor (not one affiliated with a bank, brokerage, or other financial institution) could go a long way to helping you get your investments back on the right – tax efficient – track. – Robyn
’Tis the season…for tips. Year-end is a great time for advisors, investment counsellors, pundits, and other financial experts. They can fire off opinions and advice, filling websites, YouTube videos, and newspapers with reams of predictions, analysis, advice, and commentary…that most people won’t pay the least bit of attention to. And who that do will soon forget what they heard, in the hustle and bustle of the holiday season. But there is, in fact, a handful of year-end investment and tax tips that make a lot of sense. Mainly because they could save you a bundle of dough – and maybe even get you a tax refund.
Avoid buying mutual funds in December
For example, you should not buy a mutual fund in December in a non-registered account. If you do, you could end up paying tax without ever having made a buck in gains. It all has to do with year-end distributions made by mutual funds, which impact net asset value. Why pay for someone else’s distribution? Wait, and invest in January.
Then, if you’re an investor, and you’ve got some losing stocks in your portfolio, you might want to consider selling before year-end. That’s because you can use losses to offset any gains you might have made earlier in the year on other investments. To qualify for 2012, the settlement must take place in 2012.You still have time – barely. The last possible day to sell securities to be eligible for a capital loss in 2012 is Monday Dec. 24, to settle on Dec. 31, 2012. For U.S. exchange-traded stocks, the last day to trade is Dec. 26, for settlement on Dec. 31.
There are also a number of payments that you can make before year-end to get a tax benefit for 2012. These include such things as charitable donations (you can still do it online to ensure your donation is processed for 2012), interest payments on money borrowed for investment purposes, investment counseling fees, even safe-deposit box rental fees.
While not strictly investment-related, ensure you make any necessary medical or dental payments for items not covered by provincial health plans. These include such things as glasses, prescription drugs, and hearing aids. Pay before year-end and you can add them to your medical expense deduction for the year.
Defer RRSP/RRIF withdrawals
And if you’re planning a withdrawal from your RRSP or RRIF, wait until January if you can. That way, you’ll defer the tax hit for another year.
I’d like to take this opportunity to wish everyone a very happy holiday season and a healthy and prosperous New Year.
Catch Robyn on CityNews Channel next Friday, Dec. 28, between 8:15 pm and 8:30 pm, when she’ll talk about financial New Year’s resolutions you might actually be able to keep!
Q – My husband and I have just had our first child. We are in our early 30s and have a very large mortgage and substantial credit card debt. My husband was recently laid off, and we are strapped for cash. We know we need insurance, but permanent insurance is very expensive. What do you think of term insurance? – Olivia D., Niagara Falls, Ontario
A – Life insurance is a very important investment, especially if you have a growing family. There are many benefits to term insurance, but you must keep in mind that this type of insurance covers a specific “term” as specified in the insurance contract, say 10 years, after which it may be renewable, typically at a higher premium. It does not last for your lifetime, as “permanent” insurance does.
Term life insurance is the most basic and least expensive (at least in the early years) of insurance policies. It ensures that a specified sum of money will be paid out to your beneficiaries if you die during the term of the policy. This money can be used to pay off the mortgage, credit card bills, children’s education, or for whatever you need. The term can range from 5 to 30 years, and the premium will remain the same for the term you have specified. If you or your beneficiaries do not make any claims during the term of the policy, in most cases, the policy will expire worthless.
In my opinion, term life insurance is appropriate for the average person looking to insure themselves against unforeseen events. It is similar to car insurance. You pay car insurance to protect yourself in the event of an accident, but if you don’t have an accident, the insurance company is not going to give you your money back.
Most term polices can be converted into permanent life insurance policies later in life without proof of medical insurability, but you will be paying the premiums at the attained age. Providing you qualify, term insurance will give you the coverage you need now. In the future, when your cash flow is more substantial, you can look at converting to a permanent policy, such as whole life or universal life, if it suits your needs. – Robyn
Q – Like many investors, I am yet another person disappointed with my investment returns. My advisor tells me I have done well against the benchmark. What benchmark should I be looking at? I am a balanced-risk investor. Thank you. – Chris S., Vancouver, BC
A – One of the most important things to look at when comparing your portfolio with a benchmark is to make sure that the benchmark is made up of the same asset mix as your portfolio. In other words, if you have, say, 50% in Canadian bonds and 50% in Canadian equity, you would use a weighted fixed-income/equity benchmark to make your comparison.
One of the most commonly used benchmarks for fixed income in Canada is the DEX Universe Bond Index or the ETF that tracks it, the iShares DEX Universe Bond Index (TSX: XBB). You would use this benchmark for the bond portion of your portfolio. One of the most widely used Canadian equity indexes is the S&P/TSX Composite Index or the ETF that tracks it, the iShares S&P/TSX Index (TSX: XIU). You would compare the 50% Canadian equity holding against this benchmark.
It is the role of an active portfolio manager to beat the benchmark index more often then they miss it. If your returns consistently do not match or exceed the benchmark, then you are in effect paying a manager for poor performance. The argument is that in the case of persistent underperformance, you could just buy the benchmark index ETFs yourself and not pay the manager at all.
However, before jumping the gun, it’s important to do your research, comparing your portfolio performance against the benchmark over various time periods. That way you’ll have a clearer picture of your true performance. If you still have concerns, then speak to your advisor. – Robyn
Let’s say you’re a professional woman with a nice little nest-egg put aside. You’re perhaps juggling a career and a family. Maybe you’ve got a house and a mortgage. You’re crazy busy. But your nest-egg? Not so much. It’s just sitting there. It could be in what banks laughably call a “high interest” savings account, which might be giving you the princely sum of 1% a year…if you’re lucky. Or, worse, it could be in a bank money market fund, which yields something close to 0%. Maybe awhile ago you took a chance and hastily bought some units in a stock market mutual fund that your bank teller or insurance agent suggested. That’s probably gone nowhere, too. The bank teller has moved on. And your insurance agent’s forgotten about you.
So what do you do? Clearly, things can’t go on like this for too long. Sadly, though, they do. Very often, your busy lifestyle just simply pushes any thought of investments right to the bottom of that ever-growing to-do list. And so inertia kicks in, and your money just stays where it is…being lazy, and making other people (usually banks) very rich.
I want to turn that around, and show you how to use your money to make you very rich. And that starts with some basic decisions about where to put it. Financial planners and investment advisers have a fancy term for that: “asset allocation,” or choosing the right mix of investment types. And research has shown that choosing the right mix can be even more important in building wealth than choosing the individual investments themselves.
So instead of, say, just jamming your nest-egg at the bank teller and asking her to put it somewhere “safe,” it’s a lot smarter to first ask yourself how you want to divide that money up. The principle here is that if you put some of your funds into risk-free investments, some into income-producing investments, and some into growth investments, your overall portfolio (and now you really can call it a “portfolio”) will be a lot more effective in achieving your financial goals (and I hope that includes true financial independence). That’s because your money is working hard to make more money for you, and paradoxically, with not much more overall “risk” than you had keeping it in a savings account (which actually is pretty risky, because you’re really losing money from taxes and inflation).
Q – How do I figure out how much life insurance I need and what type of insurance to buy? – Ralph J., Ajax, Ontario
A – To estimate how much life insurance you need, consider the following: The amount needed to pay off your debts; any final expenses and taxes that will be owing on your death; the amount your family will need to maintain its lifestyle; and education costs for children.
There are two main types of life insurance, term and permanent insurance.
Term insurance provides protection for a specified number of years for a specific purpose, for example, to pay off your mortgage in the event of your death or pay for children’s education. It is the cheapest insurance you can buy.
Permanent insurance provides protection for your lifetime and will be paid to your beneficiary or estate upon death. There are three types of permanent insurance: whole life; universal life; and term to 100 insurance. The type of insurance you need will depend on what your objectives are and in most case will be a combination of both term insurance for short term obligations and permanent insurance which is ideal for longer-term insurance needs, such as estate planning.
Insurance policies are complex and each type carries different benefits and cost structures. Your best bet is to speak to a licensed insurance agent to ensure you get the right amount of insurance and the right type to suit your needs. – R.T.