Six financial literacy principles

1. Budget your money

“Pay yourself first”

In general, there are four main uses for money: Spending, Investing, Saving, Giving Away. Finding the right balance among these four categories is essential, and a budget can be a very useful tool to help you accomplish this.

Get going

An important starting point in creating a budget is thinking about and recording your short- and long-term financial goals (e.g. a new electronic device, vacation, vehicle, house, further education). Doing so will help generate a baseline for mapping out and putting concrete plans in place.

Many use this formula in their budgeting: Income – Expenses = Savings…

But, this is the formula to help you achieve money success: Income – Savings = Expenses. In other words, savings should be prioritized and built into your budget plan, and expenses should be planned and paid from the remaining money after savings have been factored in.

Five key benefits of a detailed budget

1. Tracks cash in vs. cash out


2. Determines savings needed for short- and long-term goals


3. Helps you manage monthly bills and expenses


4. Prepares for unexpected expenses


5. Decreases likelihood of overspending or unnecessary spending

Structure your savings

To help prioritize savings in your budget, consider setting aside a specific amount on a regular basis, such as through a pre-authorized contribution plan where funds are taken from a paycheque and deposited in an investment vehicle or savings plan.

In creating a budget, it’s important to include and track: Income, savings goals, fixed expenses and flexible expenses (needed and wanted)

For a budget to be most effective, it’s important to factor in all lifestyle expenses and other financial components, and ensure they’re logged appropriately. 

2. Taxation – it’s not all yours

“Understand your true earnings and how they are taxed”

Four main sources of income: Employment, Investments, Inheritance and Unexpected (such as a lottery win). Each of these sources may be taxed in different ways and at different levels.

Canada’s federal tax rates for 2022 are based on income level:

* The federal basic personal amount for 2022 is $14,398. This amount is gradually reduced if your income is over $155,625.

… BUT, it’s important to distinguish between marginal tax rates and average tax rates. Your marginal tax rate is the rate of income tax that you will pay on your next dollar of income earned. Your average tax rate is calculated considering your total income tax payable as compared with your total income. Further to federal tax rates, there are also varying provincial and territorial tax rates.

Tax by income type

• Employment — Taxed at your marginal tax rate


• Inheritance — Receiving an inheritance is usually tax-free


• Unexpected Income — Lottery winnings and gifts are not taxed when received


• Investment — Taxes vary depending on investment/investment income type:
  
  
  
  • Interest — Taxed at your marginal tax rate
  
  
  • Dividends — Taxed at lower rates than any other investment type
  
  
  • Capital gains — 50% of your capital gain is taxed at your marginal tax rate
  
  
  • Rental income — Taxed at your marginal tax rate
  
  
  
  

Remember…

Tax considerations exist in various areas of wealth planning. There may be opportunities to incorporate potential tax benefits into your plans and there may also be negative tax consequences associated with certain decisions. Additionally, when choosing the best investments for your circumstances, taxes should not be the only consideration, and it’s important to factor in the after-tax rate of return in determining tax-efficient investments. For these reasons, it’s crucial to consult with a qualified tax advisor to ensure your circumstances and needs are appropriately accounted for.

3. Borrowing

“Not all money is created equal”

What is credit?

A form of borrowing that gives a customer the ability to obtain something on a promise to repay in the future.

Credit and credit scores

When you borrow, certain information is shared with a credit bureau. Over time, additional information, such as whether you’ve paid your bills on time, whether you’ve missed payments and how much debt is outstanding, will get shared with the credit bureau. These factors go into calculating your credit score — a number assigned that indicates to lenders your capacity to repay a loan — as reported on your credit rating report.

Credit score range

300 (just getting started) to 900 (the best score you can achieve)

The “magic middle number” is 650. A score above will likely qualify you for a standard loan; a score below would likely create difficulty in getting new credit.

Why do we borrow?

• To help build credit history for future needs (such as a mortgage)


• To satisfy short-term purchasing needs or online payments (vacations, gifts, personal and household items)


• To facilitate longer-term goals (purchasing a car or house or paying for education)

#1 tip for maintaining credit score…

Pay all bills on time, even if it’s just the minimum payment. Missing even one payment can negatively impact your credit score.

3 main types of credit: Credit cards, personal/term loans, line of credit.

Regardless of type, remember that all forms of credit come with a cost — i.e. interest, usually monthly, and fees (the amounts lenders charge for use of their money).

Fast facts

• Credit card — Great way of establishing credit and credit score at an early age; typically charge higher interest rates, so should be paid off monthly when possible.


• Personal/term loan — Suitable when there’s a need to borrow money for a specific purpose and the repayment term is longer than a year; interest rates are more moderate.


• Line of credit— Most flexible way of borrowing money, whereby a certain amount of money is requested but doesn’t need to be used all at once; can usually repay the loan and re-borrow; tends to carry the lowest interest rate.

Other options for borrowing

• Lease/finance (a car, for example)


• Mortgage loans (to finance the purchase of a property)

Tips to manage debt

To avoid over-indebtedness, it’s crucial to ensure funds are available to pay your bills. Planning goes a long way to help stay on top of debt. Try creating a list of all your outstanding credit and write down when payments are due and what the interest rate is for each. A good general rule is to repay the debt with the highest interest rate first, and always try to determine where you can make more than the minimum monthly payment.

4. Plan before investing

“Think about and map your goals”

Identifying your short- and long-term financial goals will help determine which types of investments and planning approaches may be most suitable and effective to help you save for your needs. In doing so, it’s crucial to first distinguish between what you actually need versus what is a “nice-to-have.” Going through this process allows you to set realistic goals that you can confidently work towards achieving.

Two approaches to planning finances

Simple projection

A simple cash-flow analysis that looks at short- and long-term goals

Detailed plan

A comprehensive wealth plan, also referred to as a financial plan, which helps guide individuals towards achieving more complex financial goals throughout their lifetimes and beyond

Six benefits of wealth planning

• Peace of mind


• Increased control over the unexpected


• More money in your pocket

• Minimized financial risk


• Sustainability


• Easy to update

Wealth stage matters

Your stage of life will greatly impact your financial picture now and in the future, and the financial and investment decisions you make. In general, there are three main wealth stages that individuals move through and between over the course of life:

• Early Savers– Establishing career, perhaps buying a home, getting married or starting a family
  
  Main objectives: Earning, saving and growing assets


• Mid-Life Accumulators– Stable career, homeowner, starting to think about retirement and estate planning and transferring wealth to children
  
  Main objectives: Creating a balanced portfolio of preservation and growth


• Preservers/Spenders– Retired or working less, using accumulated wealth to generate income as a salary replacement, keen on protecting assets, estate and wealth transfer planning is a priority
  
  Main objectives: Minimizing risk, generating income to replace salary and managing wealth wisely in regards to income tax

Whether you develop a simple wealth projection or a more detailed wealth plan, the process involves analyzing and interpreting all of your financial information. From there, results are generated, and those results are modified and tweaked until desired goals become feasible. Your current stage in life may impact what type of recommendations are made, as well as how you implement the recommendations to pursue your financial goals, and will differ by individual (e.g. increase savings towards your retirement goal by opening a Tax-Free Savings Account (TFSA) or a Registered Retirement Savings Plan (RRSP)).

Don’t forget to monitor!

Wealth plans and projections should be treated as living, breathing documents. To make sure they continue to work for your personal situation, they need to be reviewed on a regular basis. A good rule of thumb is to revisit it annually — unless you experience an unexpected life event, your goals change or there’s a material change in your financial picture. One of the best ways to ensure you revisit it regularly is to simply schedule the time in advance on your calendar.

5. Invest to achieve your goals

“Match your financial vision with the right investments”

While there is a wide variety of investment options available, the two primary types of accounts in which they are held — Registered and Non-Registered — can have implications for investors.

Registered: Accounts and plans that are registered with the government for income tax purposes and that provide tax-deferral opportunities (e.g. RRSP, Registered Retirement Income Fund (RRIF), Registered Education Savings Plan (RESP), Registered Disability Savings Plan (RDSP), other pension plans) or are non-taxable (TFSA)

Non-registered: Accounts that are not registered with the federal government, do not have limits, and earn income that must be included as taxable income each year (e.g. Investment accounts with corporate stocks, bonds, mutual funds, exchange traded funds (ETFs) or guaranteed income certificates, to name a few)

What’s the difference between an asset class and an investment vehicle?

An asset class is a broad category of investments (e.g. cash, bonds or stocks) that have a distinct risk/return relationship. An investment vehicle is the financial product that enables investors to buy and sell the underlying asset class (e.g. a mutual fund or an ETF).

Understanding the risk/return relationship

In the investing world, there is a strong relationship (correlation) between risk and return. Generally speaking, the higher the potential return, the more risk an investor should be willing to accept. Keep in mind, for most types of investments, returns are not guaranteed.

“Don’t put all your eggs in one basket”

With investing, it’s important to diversify, which means finding the right balance of investments and creating a portfolio that includes different types of investments to reduce overall risk and volatility.

What type of investor are you?

When building your investment portfolio, it’s important to first gauge your risk tolerance, which is the amount of market volatility, specifically the ups and downs, that are reasonable to expect during your time horizon. Defining your risk tolerance will help you determine the type of portfolio that best suits your needs and also help you manage expectations during down markets. Once you have a sense of where you are on the risk tolerance spectrum (risk-averse versus risk-tolerant, or somewhere between), you are in a better position to invest in a portfolio that aligns with your overall goals and objectives as an investor.

Main components in determining risk tolerance and investor risk profile

• Your investment time horizon


• Level of comfort with fluctuating markets


• Your other sources of income/overall financial situation


• Your liquidity or cash flow needs

6. Preparing your estate

“Protect yourself, your family and all of your assets”

Your “estate” is all of the property that you own — from your car, home or other real estate to bank and investment accounts and personal possessions.

What is estate planning?

While creating a Will is an important step in the estate planning process, estate planning is the broader process of creating a detailed plan, in advance, that includes tasks and decisions for the management and disposal/transfer of a person’s assets during their lifetime and after death. It can, together with your Will, serve to help assure that your wishes and intentions are carried out and that your assets can be passed down to your heirs in the most tax-efficient ways.

Key documents in estate planning

Will

This is a guiding legal document in the administration of an estate where you outline your decisions for how property and possessions are to be distributed at death. If an individual passes away without a valid Will, they are said to have died “intestate” and, simply put, this means the provincial laws determine how the estate will be administered and divided. In other words, individuals lose all choice as to who receives what, and it may also create extra fees, taxes, and delays in administering the estate.

Power of Attorney (POA)*

This is a written document that legally authorizes another party to act on an individual’s behalf during their lifetime. It may help to provide personal and financial comfort should you become incapable of making these decisions (due to an accident, significant illness, cognitive condition, etc.).

*In Quebec, this is called a Mandate.

Creating an inventory

A beneficial first step in estate planning is building an inventory of what you own and what you owe, as well as other important financial information (e.g. location of your Will, POA/Mandate, insurance policies, digital passwords, etc.). 

Key questions in estate planning

1. Who will act as executor and administer my estate after my death?


2. Who are my beneficiaries?


3. How do I want to support them?


4. What charities do I want to support?


5. Am I transferring assets in a tax-efficient way?


6. Which assets will make up my estate?


7. Who will act as my power of attorney for property or personal care should I become incapable?

Main wealth transfer options

• Through your Will


• Registered accounts with named beneficiaries or joint ownership accounts


• Gifting assets before death


• Through inter-vivos (living) trusts

Death and taxes

In Canada, there is no true estate tax…BUT, there are three potential taxes that may apply at death:

• Income tax – Because individuals are deemed to have disposed of all of their assets at death, meaning capital gains are automatically triggered and registered accounts are generally collapsed


• Provincial/territorial probate fees – Applicable fees associated with probating a Will, which vary greatly by province/territory


• U.S. estate tax – For U.S. sourced assets, such as U.S. corporate stocks and U.S. real estate

Did you know?

Insurance may be an estate planning option to consider. Why?

• It can provide a tax-free lump-sum death benefit.


• It can provide liquidity in an estate to pay taxes and debt.


• It can provide funds when they are needed the most.

Remember…

Over the course of life, your priorities and circumstances can change, so it’s important to review and revisit your estate plans every few years or after a significant event (e.g. a change in marital status, birth or death of a loved one, etc.).