Here are the six common and costly errors to avoid:
1. Delaying saving. There are lots of reasons given for putting off saving for retirement, such as low income, unemployment or paying off college loans. But anyone who waits to save misses out on the power of compounding interest over time. For young adults in particular, the difference can be stunning. Someone who saves $3,000 a year starting at age 25 will produce a nest egg of $777,170 by age 65. That’s more than five times the $137,286 balance of someone who starts at age 45. In this example we have assumed an average 8 percent annual return. Even if the person starting at 45 doubles the annual
savings to $6,000, the total by 65 will still be just $274,572, far short of the early starter’s total.
2. Letting emotions guide investing decisions. Plenty of investors have been tempted to buy a hot stock because of the buzz it’s generating, as they get swept up in the market fervor; or to sell a stock or their entire investment portfolio in fear when the market is plunging. Making emotional short-term decisions with long-term money can be disastrous, however. Investors who bought shares of high-flying Krispy Kreme Donuts saw just how quickly things can change – the stock took a freefall from nearly $50 a share in 2003 to less than $5 in less than two years. (There are other examples Nortel and currently RIM). You can also ask those who bailed out of stock funds in their RRSP’s after the meltdown of 2008-09, only to see the market’s value double in the last two years.
We advise our clients to make a plan and have the patience and courage to stick to it. Your objective should be to achieve your goals, not outperform the market, your best friend, or your neighbor with the newest, hottest investment idea.”
3. Skimping on an emergency fund. Emergencies that prompt a quick need for cash can set back your finances for months or years if you haven’t set money aside for anything from car repairs to a layoff. Build an emergency fund that can cover at least three to six months of living expenses. First have a rough idea of what you spend in an average month. Check your records and receipts to get a handle on the total of your monthly non-discretionary expenses – housing, food, utilities, and gasoline. Now work at increasing your
emergency fund to the necessary level, even if you have to temporarily divert other savings in order to do so.
4. Having an unbalanced portfolio. Maintaining a mix of investments is critical for investors to achieve their goals. But being sufficiently diversified is harder than most think. It involves owning a wide variety of stocks and bonds, or the proper mix of funds. People think if they own a couple of stocks and a couple of bonds, they’re diversified and many do just that.
Nearly a third of Charles Schwab’s two million investors hold more than 20 percent of their assets in a single stock, the brokerage reports. That leaves their portfolios vulnerable to a nosedive in the stock because of a slump, scandal or even bankruptcy. Setting and forgetting your allocations within your RRSP plan is another risky oversight, because recent results can tilt your portfolio to be more aggressive, or less, than you intended. You should review your plan at least annually, rebalancing investments and increasing your savings rate if necessary.
5. Paying avoidable or excessive fees. If you’re not careful, it’s possible to rack up hundreds of dollars a year in avoidable bank, airline, credit card and other fees. Using an out-of-network ATM is getting costlier. Free checking is getting harder to find, as banks find ways to charge monthly maintenance fees. Airline fees are ever-higher. Then there are hotel “resort fees,” gift-card activation fees and expensive rental-car insurance fees – one of the most avoidable fees of all, since most auto insurance policies and many credit cards cover your rental.
6. Getting overly conservative with investments in retirement. Many retirees believe they should adjust their portfolios to become much more conservative when they finish working. That overlooks the fact that retirement can last for decades thanks to longer lifespans and improved medical care. It’s essential to continue to seek long-term growth in retirement by investing in stocks and riskier assets than just GIC’s and bonds, the aim is to protect your savings against inflation and minimize the risk of running out of money. We recommend planning for a retirement that could last a full 30 years or more, until age 95. That makes 65 almost the new 35, when it comes to investing.
For more information on how The Wealthgate Group can help you protect your family and help you have a thriving retirement call us at 1-888-507-8944 or email us at email@example.com.
2- Creditor Protection – The bulk of the wealth of most business owners is tied up in their business. As a result, they are at risk of losing their biggest asset if creditors come after the assets of the corporation or sometimes even their personal assets, should they have personally guaranteed the loans of the corporation. Therefore, it is important for business owners to plan to protect their assets from the claims of creditors. This could be achieved by transferring personal assets to the name of their spouse, setting up holding companies, family trusts, or investing in creditor- proof instruments such as segregated funds offered by life insurance companies.
3- Risk Management – Many small businesses depend on key people such as the owner or managers of the business for their successful operation. It is important to make sure that there is sufficient key person insurance in place to cover the risk of losing these key people due to long term disability, premature death or critical illness.
4- Succession Planning – While many entrepreneurs view their businesses as a tool to fund their retirements, few have thought about the tax liabilities of selling that business or how to pass it to the next generation and then derive income. This requires careful advanced planning and consultation with a certified financial planner, as well as an accountant and a lawyer who specialize in succession planning.
5- Shareholder Agreements – If there are several shareholders who own the business or in a partnership situation, it is important to spell out the terms of the arrangement in a shareholder agreement at the beginning of the business or while every one is on good terms. A shareholder agreement should stipulate a method of valuating the business and set out the terms for buying and selling of shares in the business in the event of premature death, long term disability, retirement, early exit, or even in the event of divorce of married shareholders. It is important to ensure that shareholder agreements are properly funded.
6- Use of Capital Dividend Account – Life insurance is a tool that is most frequently used for succession planning as well as for funding of shareholder agreements. If the company owns life insurance on the entrepreneur, the insurance company pays out the death benefit to the firm. Then the CRA allows a tax-free distribution on net proceeds through the company’s capital dividend account, which can pass directly to a spouse or other family member.
7- Universal Life Insurance as a tax shelter - While life insurance is mainly purchased for protection against the risk of pre-mature death, universal life policies allow you to save money on a tax-deferred basis as well. These policies are extremely flexible allowing you to stop and restart your premium payments or to shelter lump sums of money from taxes and are ideal for business owners with fluctuating cash flow and those who need a tax-deferred savings vehicle that allows them to save money over and above their RRSP contribution limit.
8- Individual Pension Plans – Most small and medium sized businesses do not have the luxury of defined benefit pension plans that larger businesses offer their employees. The owners, however, can put into place Individual Pension Plans for themselves and their key employees. These plans are similar to defined benefit pension plans and allow significantly more tax deductible contributions than the RRSP contribution limit.
9- Health Insurance – Business owners can put in place group health and dental benefit plans for themselves, as well as for all or some classes of their employees. The contributions to these plans are tax deductible to the business and are not taxable to the employees.
10- Health Spending Accounts – By setting up a health spending account as a supplement to their group health and dental plan, business owners can pay for medical procedures as varied as elective cosmetic surgery and botox injections to orthodoncy and visits to health practitioners that may not be covered in their health insurance plan or go over and above the limits set in their plan. The contributions to the Health Spending Account are a deductible business expense for the corporation and the benefits are not taxable to the shareholder or employee.
If you or a member of your family is living with a severe and prolonged mental or physical disability that requires ongoing life sustaining therapy and/or restricts the ability to perform basic activities of daily living (eg. walking, speaking, feeding, hearing), a disability tax credit is available. The disability must be certified by a physician, and a special application for the credit must be approved by the Canada Revenue Agency (CRA). If the disabled individual does not have enough income to make use of the disability credit, it can be transferred to a “supporting person” such as a spouse, common-law partner, parent, grandparent, brother, sister or child amongst others.
A claim for medical expenses can also be made for expenses incurred for yourself or other family members provided the expenses total an amount that exceeds 3% of net income or a defined amount ($2,024 in 2010), whichever is less. Among others, eligible expenses generally include payments to doctors, dentists, nurses and other medical professionals, premiums paid to private health services plans, and payments for wheelchairs, crutches, prescription drugs, prescription eyeglasses or contact lenses.
Amounts may also be claimed if you pay for personal attendant care or other disability support expenses that allow you to go to school or earn income from employment or self-employment, or if you care for a disabled adult family member who lives with you and has a low income.
When making claims for disabled individuals, working with a tax professional is suggested. Because some disability claims are permitted only if others are forfeited, working with a tax professional can help maximize available credits.
If you want to save for a disabled individual who is under the age of 59, consider opening a “Registered Disability Savings Plan” (RDSP). RDSPs attract government grants in addition to private contributions, and, in most provinces and territories, provide a way to save for disabled loved ones without affecting provincial and territorial social benefits.
Many business owners set up a trust structure similar to the one seen here to reduce the tax burden stemming from the distribution of profits.
Dividends are paid by the operating company (OPCO) to the trust, which then assigns them to its beneficiaries. Recently, many professionals have used this kind of structure when the opportunity to incorporate arose, as such an approach allows income to be split with a spouse and adult children.
Until 1996, trusts could select a “preferred beneficiary,” allowing beneficiaries’ income to be taxed without actually transferring funds to them. By doing so, beneficiaries could be taxed while the trust retained control of the assets. In short, tax attribution applied to beneficiaries without the funds in question changing hands.
Unfortunately, this choice is now only available in situations in which beneficiaries are physically or mentally handicapped. Under current regulations, if income is attributed to beneficiaries for tax purposes, they must receive and retain the funds (monetary distribution is required) or receive a note payable by the trust.
The Canada Revenue Agency has announced that it would examine these income splitting structures to make sure that the funds truly belong to the beneficiaries, as it appears that certain strategies involve beneficiaries returning the funds received to the main shareholder.
In addition to tax audits, there is a risk that could be referred to as “beneficiary impoverishment.” Take for example a situation in which a child is assigned a $20,000 dividend each year for several years for tax attribution purposes, with all the funds returned to the main shareholder. Obviously, there is a risk that the child will eventually understand the strategy being used and request the funds to which he or she is entitled, which is sure to result in an interesting family conversation!
When a company like OPCO is sold, shareholders can reduce income taxes stemming from the sale of securities by using the $750,000 capital gains deduction. In order to multiply deductions, shares held by the trust are also sold and the capital gains are attributed to the children (minor or adult) for tax purposes with the children also using their $750,000 deduction.
It is important to appreciate that the taxable portion of the capital gains assigned to the beneficiaries must be transferred to them monetarily. Using the $750,000 deduction for capital gains means that $375,000 must be transferred to the children. However, it is possible to issue a note, but this is then an amount payable.
For Quebec residents, another consequence of this strategy is that the public curator must be notified when a minor child has an amount in excess of $25,000.
Lastly, be wary of strategies proposed for tax reasons that could eventually result in unexpected financial or legal consequences.
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If you regularly re-invest profits in your business, consider incorporating. Among others, there are two key benefits to establishing a corporation. First, you may benefit from the limited liability corporations offer (unless you are a professional). This means creditors of your business would not normally have access to your personal assets. Second, a tax deferral is available on the first $500,000 of active business income (ABI). This tax deferral is available when profits can be retained inside the corporation since the first $500,000 of ABI is taxed at roughly 20% instead of approximately 45% when earned as a sole proprietor. However, the tax deferral is eliminated once income is drawn from the corporation and taxed to business owners as a salary or dividend.
Incorporating may be a strategy to consider as your business grows and you retain more earnings in the corporation. Doing so while investing retained earnings tax-efficiently can provide an excellent way to accumulate wealth for retirement or future use. There are costs associated with establishing a corporation (eg. legal and accounting fees), and ongoing accounting fees for the annual filing of corporate tax returns. We suggest working with an accountant and lawyer to determine if incorporating is right for you.
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