The Rule of 72
Written by Sarah Milton
“Compound Interest is the
eighth wonder of the world.” – Albert Einstein
Einstein described compound
interest as the eighth wonder of the world because he felt that those who
understood it, earned it and those who didn’t, paid it. Compounding is what
makes saving early and saving regularly such a powerful part of building wealth
and it’s also what makes it so hard to get out from under the mountain of
consumer debt that so many of us accumulate. In an nutshell, compound interest
is earning (or paying) interest on interest. When you earn interest at a
compounded rate, your money grows faster because you are earning interest on
your total balance (principle + interest) rather than on the principle alone.
Similarly, when you pay interest at a compounded rate (as you do with credit
cards) your interest charges grow much faster and your debt load gets larger.
We can see the power of compounding in
the table below, which shows how $1000 earning 5% annual interest grows
over time. The first column shows how the $1000 would grow earning 5% simple
interest (earned on just the $1000 principle) and the second column shows
how it would grow earning 5% interest compounded annually (earned on the
principle + interest).
5% SIMPLE INTEREST
5% COMPOUND INTEREST
The Rule of 72
The rule of 72 is a simple
way to estimate how long it will take your money to double in value at a given
interest rate. If you divide 72 by the annual interest rate, the answer is the
number of years it will take to double. For example, 72 divided by 5 is 14.4.
This means that, as you can see in the table above, it takes just under 15
years for $1,000 to become $2,000. 15 years later (in year 30) the money has
doubled again to be just over $4,000 and, 15 years after that (in year 45) it
has doubled again to become more than $8,000. In year 60, it will have doubled
yet again and become $16,000. Using this rule, it’s clear to see that both time
and interest rate are two key factors in building wealth. At 8% interest, your
money will double in 9 years (72 divided by 8 = 9) but it will take 36 years to
double earning 2% interest. For a 20 year old, $100 invested at 7% is worth
$2,100 at age 65. For a 30 year old, that same $100 invested at the same rate
is only worth $1,068 at age 65 and for a 40 year old, $100 invested at 7% is
worth just $543 at age 65. This means that, at 40 years old, even though I’m
only twice the age of the 20 year old, I have to save four times as much each
year in order to achieve the same level of wealth at age 65. It’s a concept
that I wish I had understood as a teenager because I’m pretty sure it would
have motivated me to manage my money differently!
At the end of the day,
saving is always a very personal decision: the choices we make about whether to
save, where to save and how much to save, vary enormously from person to
person. However, all too often, I hear people in their twenties saying that
they’ll wait to save until they’re older because then they’ll be earning more.
When you consider how powerful a factor time is in the wealth building
equation, it just doesn’t make sense (especially when you consider that just
because you’re earning more doesn’t mean you have more discretionary income).
If you can do as much with $25 at 20 as you can do with $50 at 30 or with $100
at 40, it makes sense to start the saving habit early.
Even if you feel like you’ve “missed the boat”
because you should have started saving years ago, remember that whatever you
save today has a greater power to grow than money you save next month, next
year or 3 years from now. We can’t change our past choices but we always have
the power to choose to change our financial future by making different choices
Scenario 4: Seniors Without TFSAs
By: Walter Harder
Jackie are contemplating retirement. Robert is 65, earns $55,000 from
employment and also receives a $24,000 pension.
Jackie are contemplating retirement. Robert is 65, earns $55,000 from
employment and also receives a $24,000 pension. He has not started to
receive OAS or CPP but is contemplating retirement at age 67. Jackie is
62 and earns $45,000 employment income. Jackie has accumulated $150,000
in her RRSP. Both Robert and Jackie have no TFSA contribution room.
Will Robert and
Jackie be better off in 2015 than in 2014?
derived no benefit from the Family Tax Cuts announced in October 2014.
the tax brackets and personal amounts will result in slight reductions in taxes
payable by both Robert and Jackie unless their income levels increase. Robert’s
contributions to CPP and his EI premiums will increase due to increases in the
maximum pensionable and insurable earnings.
As the couple
has no TFSA contribution room, they have been making the maximum contributions
under the old limit so they will benefit from being able to contribute
more. In the long term, the increased TFSA contribution room may help
Jackie shelter earnings on RRIF minimum withdrawals if they money is not needed
to fund their lifestyle.
The decrease in
minimum RRIF withdrawals may help Jackie to plan her RRIF melt-down strategy
once she reaches age 72.
If this couple
is philanthropically inclined and have real estate such as a cottage that has
increased in value, they could benefit from the new rules allowing the proceeds
from real estate to be donated to charity in order to reduce capital gains tax.
Robert and Jackie are currently working, they are not likely to be benefit from
the new Home Accessibility Tax Credit in the short term. Should either develop
mobility issues, they may be able to modify their home to accommodate their
mobility issues while getting a 15% tax credit for the first $10,000 of their
Scenario 3: Retired Couple with RRIFs
BY: Karen Milner
Patricia retired a few years ago. Brian is 74 and Patricia is 72. The
couple live in Halifax, NS and have RRIF balances of $300,000 and $400,000
Will Brian and
Patricia be better off in 2015 than in 2014?
derived no benefit from the Family Tax Cuts announced in October 2014.
The reduction in
RRIF minimum withdrawals will affect both Brian and Patricia. Under the
old rules, Brian was required to withdraw at least $23,130 from his RRIF.
Under the new rules, he is only required to withdraw $17,010. If he has
already withdrawn more than $17,010, he will be able to redeposit the excess
(to a maximum of $6,120).
Under the old
rules, Patricia was required to withdraw at least $29,920 from her RRIF. Under
the new rules she is only required to withdraw $21,600. If she has
already withdrawn more than $21,600, she can put back up to $8,320.
less, both Brian and Patricia can reduce their tax bill for 2015. In
addition, Patricia’s age amount could be increased by the reduced withdrawal
(depending on how much other income she has).
This couple may
well be able to benefit from the Home Accessibility Tax Credit if they need to
make renovations to their home to make it more accessible. Under this new
program, 15% percent of the first $10,000 renovation costs could be eligible
for a non-refundable tax credit.
If either Brian
or Patricia has foreign assets with a value between $100,000 and $250,000,
they’ll be happy to learn that the sometimes onerous rules for reporting such
assets will be simplified for 2015.
This couple may
also be able to take advantage of the new rules exempting capital gains on
small business corporation shares or real estate investments if a portion of
the proceeds is donated to charity. If they are selling a family farm,
they will be happy to know that the capital gains exemption on farm property
has been increased to $1,000,000, exempting up to $500,000 taxable capital
gains from tax.
The increase in
TFSA contribution limits may allow for more flexibility in retirement as any
minimum RRIF withdrawals that are not needed to fund lifestyle, can still be
sheltered from tax (after the tax is paid on withdrawal).
Scenario 2: A Young Family
By: Walter Harder
Ashley live in Winnipeg. They have two children, ages 3 and 5. They own
their own home.
Ashley live in Winnipeg. They have two children, ages 3 and 5. They
own their own home. Ashley earns $45,000 annually and has an RPP through
work. Matthew operates a small business (proprietorship) and nets $80,000
annually. He has RRSP savings. Child care costs total $12,000
annually. The couple has no TFSA savings.
Will Matthew and
Ashley be better off in 2015 than in 2014?
This couple were
major beneficiaries of the Family Tax Cuts announced in October 2014.
The Family Tax
Cut (income averaging) saved this couple a few hundred dollars in 2014 because
after claiming Child Care Expenses the two spouses are in different tax
brackets. The couple is likely to continue to benefit from the Family Tax
Cut unless Ashley’s income increases so she moves into the second tax bracket.
UCCB of $60 per month per child will increase Ashley’s income in 2015 by
$1,440. Because the UCCB is taxable, Ashley will have to repay 25.8% of
it in increased income taxes. The increased income will also reduce the
couple’s Family Tax Cut.
As a consequence
of the increased UCCB, Matthew’s claim for the two children will be eliminated
for 2015, increasing his tax bill by just under $700.
If the couple
pays more than $14,000 in Child Care Expenses, their claim will increase in
2015 as the upper limit for children under 7 increased from $7,000 to
$8,000. This will decrease Ashley’s taxable income and increase the
Family Tax Cut.
As a young
couple, Matthew and Ashley could benefit greatly from the increase in TFSA
contribution room. At $80,000, Matthew’s first avenue for retirement
savings should be the TFSA, at least until his income increases.
could have benefitted from the increase in the Amount for Children’s Fitness in
2014 – if their expenditures exceeded $500 per child. The 2015 change to
make the credit refundable will have no effect on this couple as this change
really only effects couples who are not taxable.
Scenario 1: Young Couple No Children
By: Walter Harder
Jessica are a young couple living in their condo in Vancouver. How will
the budget affect them?
Jessica are a young couple living in their condo in Vancouver. Condo fees
are $250 per month. They have no children and both work earning a total of
$100,000. Michael has a registered pension plan at work but Jessica does
not. Jessica has accumulated a small RRSP. The couple has no TFSA
Will Michael and
Jessica be better off in 2015 than in 2014?
This couple is
generally unaffected by changes announced in October 2014 or the 2015 Budget
changes. If income in 2015 is unchanged from 2014, the couple’s taxes
will be reduced slightly as a result of indexation of personal amounts and tax
brackets. Depending on income levels, Michael or Jessica may pay slightly
more in Employment Insurance Premiums and contribute more to CPP in 2015 as a
result of the increase in the maximum insurable and pensionable earnings.
This couple has
the potential to derive major benefits from increase in TFSA contribution
room. As a young couple, they have a significant period to make
contributions to their own TFSAs to generate a significant tax-free retirement
income. If fact, with Michael’s pension plan, their TFSA accumulations
could be more than enough to support a comfortable lifestyle in
retirement. Jessica need not use her RRSP contribution room at all – at
least until her income is in the highest tax bracket.
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6 Costly Pension Mistakes
and How to Avoid Them
Written by Sean Cooper
If you have a pension
plan at work consider yourself fortunate. Only about a third of Canadians have
a workplace pension plan today – a far cry from a couple decades ago.
Workers face a number of retirement challenges today. The low interest
rate environment coupled with longer life expectancy means we need to sock away
even more money for our golden years or face a drop in the standard of life
we’ve become accustomed to.
If you have a decent
pension plan, there are still mistakes you can make along the way. Having worked
as a pension analyst for five years, I’ve seen my fair share of costly pension
mistakes. Here are three costly pension mistakes that can cost you dearly and
how to avoid them.
Not Returning Your
Paperwork on Time
When you decide to retire
or your employment comes to an end, you should receive a pension benefits
statement in the mail shortly. If you’re eligible for an early retirement, the
package will include forms of pension to choose from, such as life only,
guaranteed periods and joint and survivor options. If you’re too young to
retire (and not considered a small benefit), you’ll be able to defer your
pension (start it at a later date) or transfer your commuted value.
Mistake #1: 90 Day
Deadline: Deferred Pension
While you should take the
time to carefully review your package for any errors and carefully consider
your options, it’s important to watch the deadline on your package. You’ll
usually only have 90 days to return your completed paperwork. If you
fail to return your paperwork your pension could be deferred until retirement.
For a 30-something-year-old
this can be a costly mistake. If you’re not going to retire for another 30 years
or longer, your pension will have lost a lot of its purchasing power by then.
Remember the rules of 72 – if inflation only goes up by a modest average of 2
per cent per year, prices will double in 36 years, while your pension will be
frozen. $1,000 per month may seem decent today, but when you go to retire it
may not be a lot. Most private sector pension plans don’t offer indexing in
Mistake #2: 6 Month
Although some pension plans
still allow you to transfer the commuted value after 90 days, there’s another
important deadline you should be aware of. If you fail to return your paperwork
in 6 months (90 days in Quebec), your commuted value will be
recalculated. Depending on current interest rates, your commuted value could go
up or down .
The commuted value
represents a lump sum payment you’ll be able to invest to end up with an
equivalent pension at your normal retirement date (NRD). The commuted value and
interest rates have an inverse relationship. When interest rates go down
your commuted value will increase (you’ll need to invest more
money to end up with an equivalent pension at NRD), but if interest rates go up
your commuted value will decrease (you’ll need to invest less
money to end up with an equivalent pension at NRD).
If interest rates go up by
a lot by the time you return you paperwork, you could see your commuted value
drop by hundreds or thousands of dollars. If you had simply completed it on
time, you would have received your full commuted value with interest. If you’re
transferring your commuted value to a financial institution, it’s important to
follow up to ensure the paperwork is completed. You should phone the pension
administrator to make sure your completed paperwork has been received and is
being processed. It is your responsibility to make sure your financial
institution returns your paperwork on time.
Mistake #3: Quitting Before
You’re Fully Vested
Before you decide to leave
your employer, it’s important to know the date you’ll be fully vested. What’s
vesting? It’s the date you’re entitled to the full value of your accrued
pension when you leave the pension plan. Leaving prior to reaching your vesting
data can result in leaving hundreds or thousands of dollars on the table.
Instead of receiving the commuted value, you’ll only be entitled to your
contributions with interest. If it’s a non-contributory plan you won’t receive
How do you find out your
vesting date? Your vesting date can be found on your annual statement of
pension benefits. Your vesting date depends on your work province, as well as
how generous your pension plan is. In most provinces the legislated
minimum is two years before you became vested. That’s slowing changing as the
provinces look to modernize. Provinces like Ontario and recently Alberta
provide for immediate vesting. That means as soon as you join your company’s
pension plan you’re vested.
To get around the new vesting rules, some employers
may look to extend the eligibility for joining the plan. Instead of being able to
join immediately, you may have to wait two years to be enrolled. If you’re a
new employee, it’s important to ask if you’ll be enrolled in the pension plan
right away. If you’re unsure, be sure to ask human resources or your pension
3 More Costly Pension
Mistakes and How to Avoid Them
Written by Sean Cooper •
Last month we looked at three costly pension mistakes to
. Common pension mistakes include not returning your paperwork
on time and quitting before you’re vested. This month we look at three more
pension mistakes that can cost you dearly. Although it may not seem like a big
deal, simple things like not updating your spouse and beneficiary and not
joining your pension plan right away can come back to haunt you. Here are three
more costly pension mistakes and how to avoid them.
Mistake #4: Not Updating
Your Spouse and Beneficiary
It’s important to keep your
spouse and beneficiary on file up to date. If you pass away in retirement and
elected a pension with a guarantee period (i.e. 5, 10 or 15 year guarantee),
you’ll want to make sure the remainder of the guarantee payments goes to the
person you want. Just because you chose your daughter to be your beneficiary
when you retired, doesn’t you won’t want to change it. What if you get
remarried and decide to make your new spouse your beneficiary? Unless you
complete a new beneficiary form, your beneficiary will stay the same. That
means your daughter will still be entitled to your pension death benefit when
you pass away, leaving your new spouse with nothing.
Things get even more
complicated if you pass away before retirement. The pension death benefits for
a pre-retirement death (or active death) depend on your pension plan and
province of employment. Your spouse is usually entitled to the death benefit
even if you beneficiaries on file. Even if you have a spouse, it’s still a good
idea to name beneficiaries; if your spouse and you were to pass away at the
same time (for example in a car crash), your beneficiaries would receive the
death benefit instead of your estate. Again, it’s a good idea to complete a new
Mistake #5: Not Joining
Your Company’s Pension Plan Right Away
While a lot of employers
enroll their employees in the pension plan right away, some employers leave it
up to their employees to enroll. If you have a defined contribution plan
sometimes your employer will only deduct the minimum contributions off your pay
cheque (for example, 2 per cent instead of the maximum 5 percent of your earnings).
As soon as you’re eligible
to join your company’s pension plan, you should walk, no run, to your company’s
human resources department to sign up. By not joining right away, you’re
leaving free money on the table. You may prefer to invest your own money in
your RRSP, but if you’re one of the lucky few with a non-contributory
gold-plated defined benefit pension plan, there’s no good reason not to join.
Mistake #6: Not Starting
Your Pension When You’re Entitled to An Unreduced Pension
If you choose to defer your
pension (leave it in the pension plan) instead of transferring it to your RRSP,
it’s important to make sure you keep your address up to date with your former
employer. When you’re approaching your normal retirement date, your former
employer will usually try to contact you, but only if they have your most
recent address on file.
If you’re approaching age 65, it doesn’t hurt to
take the initiative and contact your former employer about starting your
pension. You’ll want to make sure you start your pension on time; although you
may still be able to collect your pension retroactively to age 65 if you
commence it later on, in most cases you won’t receive interest.
Financial spring cleaning
Written by Sarah Milton
Rearrange Your Goals
Given that research
suggests that most of us will have abandoned our new year’s resolutions
by mid-February, spring is a great time to revisit our financial goals and get
back on track. One of the key components of successful goal setting is having a
strong motivator; too often we set goals because we think we “should” do
something rather than because we actually want to. Without a definite reason to
save or to eliminate debt or to learn more about investing, it’s unlikely that
we’ll stick at working on our goal long enough to achieve it. If you find that
you keep setting the same goal over and over again and never making any
significant progress towards it, it might be time to either give up on it
completely or to find a solid reason to work towards it that actually motivates
and inspires you to keep going.
Declutter Your Payments
Often when I meet with
clients and we go through their statements, there’s at least one monthly
payment that they’ve been meaning to cancel and never got around to. It might
be a subscription to a magazine that you never have time to read, a monthly
membership fee for a gym that you aren’t taking full advantage of, or one of
those insurance policies that your financial institution persuaded you to take
on a 30 day free trial and you forgot to cancel. Whatever it is, taking 15
minutes to review your statements and another 30 minutes to make some phone
calls could save you a significant amount of money each month; money that could
be “repurposed” towards a financial goal or that could be used for something
that you’ll actually use and/or enjoy.
Tidy Up Your Spending
A spending clean up can be
a powerful way to channel more of your money towards the things that matter
most to you. Doing a clean-up of your spending means taking a look over your
statements and finding all the places where your money is “drifting”. This
drift might be the result of any number of things. For example: overspending at
the grocery store, picking up lunch or coffee on a too-regular basis, random
purchases of things you didn’t really need or too many cash withdrawals from
the ATM. David Bach coined the phrase, “latte factor” to describe these small
purchases that can add up to hundreds of dollars each month if we don’t pay
attention to them. It’s not that treating yourself or indulging in the odd
splurge is a terrible thing but the trick is to make sure that you’re using
your “fun money” to pay for those things and not money that you might have
intended to use for something else.
Try a Money Cleanse
If you find that you’ve got
too much money drifting away each month, why not try a 28 day financial
cleanse? Science suggests that it takes 28 days of consistent action to create
a habit (good or bad) so taking four weeks off from random spending and trying
really hard to develop (and stick to) a consistent spending/saving pattern can
be a really powerful tool when it comes to taking your finances to the next
level. The first few days are the hardest but if you can make it through the
first week there’s a good chance you’ll be able to see it through all 28 days.
Remember that the point isn’t to deprive yourself of everything that’s fun;
that’s a sure-fire recipe for disaster in my experience! Rather, it’s about
creating a balanced approach to spending and saving so that you can enjoy your
money without overspending and ensure there’s enough left over for the future.
Effective money management hinges on building your
understanding of basic money principles and creating simple systems that help
you live within your means and pay yourself first. Taking a few hours every few
months to check-in on those systems and make sure your spending habits aren’t
slowing you down is a time investment that’s definitely worth making. If making
some changes to your finances is something you’ve been meaning to do for a
while, then why not take some time this week to think about what you could do
to help spring clean your finances?
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