Module 4: Mid-Life
AFM 321 Personal Financial Planning
Learning Goals
By the end of this module you will, from a mid-life perspective, be able
to:
Organize your financial plan and cash flows to and from various
sources, including rental property, mortgages and investments, and
family members
Assess your savings and their risk profiles, including consideration of
RESPs, spousal RRSPs, and other funds
Identify relevant spending categories and their implications, including
home ownership, insurance (e.g., home, auto, life), and children
Create and report a budget and other schedules, including a will, and
document information relevant for these schedules and your taxes
Financial Goals
Your financial goals will likely transition beyond just you as you reach
mid-life
Marriage and children are common, and they change your perspectives
Record some goals that you can work towards in your budget
Plan for a second job
Save for kids’ education
Save for your and your spouse’s retirement
Cash Flows from Rental Property
Could renting property be a solid investment for you?
Home price increases and conventional wisdom suggest the potential gains are
good
Are you prepared to manage tenants, repairs, reporting (budgets and tax), etc.?
Rental property introduces more complex tax implications than other
investments
Annual net income (rents less deductible expenses) is taxable now at ordinary
rates; increase in property value is taxable in the future at capital gains rates
Net rental income contributes to RRSP contribution room (part of earned income)
Requires a separate schedule on your tax return to report rental activity
Requires capital cost allowance (CCA) and related calculations
CCA on Rental Property
CCA is a deduction for using up the value of an asset (tax depreciation)
As CCA is just an estimate, you settle up those deductions when you sell, which
can create income (recapture of too much CCA) or deduction (terminal loss of not
enough CCA)
Rental buildings that cost more than $50,000 are depreciated
separately
Other rental assets, like furniture, can be pooled together
Canadian legislation allows “accelerated investment” and higher 1st-
year CCA
Essentially 1.5 times normal CCA; traditionally, 1st-year CCA was half of normal
CCA
On any rental property, you cannot use CCA to increase or create a net
Pay Down Mortgage or Invest?
Choosing whether to pay down/off your mortgage early or invest can
inv0lve at least a few considerations
What are the rates of debt (pre-tax) and investment return (after-tax)?
Are you investing in a tax-advantaged plan?
What will you do when the mortgage is paid off?
Can you afford the interest rate risk?
You can build a schedule comparing the cash flows over time to see,
economically, which option is best
Family Members and Income Splitting
In Canada’s individual tax filing system, each taxpayer has an incentive to lower
their tax liability by shifting money to someone else – called income splitting
Attribution rules prevent an individual from splitting income with their spouse
or minor children
Attribution results in property income taxed in the hands of the person shifting (and also
capital gains in the case of a transfer to a spouse)
Adult children aren’t subject to the rules; neither is non-property or capital gain income
TFSAs, RESPs, and spousal RRSPs offer legal income splitting opportunities
You can also have the family member provide FMV consideration; spouses must also elect
out of default rules that transfer property between them at cost
(Re)Assess Your Savings
Future value calculations are great for estimating savings that we can
accumulate
They also help you understand the power of compounding and early vs. late
saving!
In addition to estimates, you have to make real choices about risk
when investing
How much risk can you tolerate? How often should you update those preferences?
You can simplify using an allocation between stock index fund(s) and bond index
fund(s)
You could follow risk allocations in target-date funds or the age rule of thumb
Document your choices
RESP Saving
RESPs help kids pay for Feature Explanation
expenses associated with Contributions After-tax
attending university, college, or Earnings and Taxed deferred (in hands
grant of recipient)
an apprenticeship
Withdrawals Taxed in hands of
Can have individual plans, or a recipient
Annual No limit; lifetime limit
family plan to share among contribution instead
children Carryover Use up to lifetime limit
If you don’t/can’t use (all) the Grant (CESG) Government top-ups,
subject to annual and
RESP, you pay back the CESG, lifetime limit
can transfer some to your RRSP Contributors Anyone (including future
recipient)
You can estimate its future value
Age From birth until age 31
Spousal RRSP
You can use some of your RRSP deduction room to contribute to a
separate RRSP set up for your spouse
You get the same deduction as if contributing to your own RRSP; spouse gets
future income
More advantageous to use when the difference between spouses’ current tax
rates is large
Allows income splitting, subject to two caveats
Attribution can still occur when a spouse withdraws within 3 years of your
contribution
With retirement income splitting rules, a spousal RRSP has less appeal unless you
expect significant non-pension income
Emergency Funds
Another common financial planning recommendation is to set aside 2-3
months expenses in case of emergency
The more monthly expenses you have, the more you need to set aside
Can use this amount for various unexpected costs
Could also use this amount for paying down a mortgage, or planned spending
(e.g., travel)
Be considerate about how you invest this money
Do you want it in riskier assets or something safer?
Do you want it stashed in a registered account or a non-registered account?
Home Ownership – Mortgage Structure
Most people can’t afford a home without a mortgage, so choosing
features of a mortgage is an important decision
Fixed or variable interest rate?
How long of an amortization period?
How long of a renewal term?
Prepayment options and open or closed mortgage?
How frequent are mortgage payments?
You can use a mortgage calculator, or build your own schedule, to
compare options
Home Ownership – Mortgage Affordability
In order to be approved for a mortgage, a lender will assess what you can afford
In addition to your income, lenders use Gross Debt Service (GDS) and/or Total Debt Service
(TDS) ratios to help assess
Standard practice is GDS less than 35%, TDS less than 42%
You should always assess what you think you can afford
Is your down payment sufficient and/or will you use the home-buyer’s plan (HBP) to withdraw
some of the down payment from your RRSP?
Does the regular payment you determined when looking at mortgage structure fit your
budget?
Beware of banks offering you a bigger debt than you (or ratios) think you can afford
Home Ownership – Closing and On-going Costs
Buying your home involves certain costs paid at the time of purchase
You give your down payment, and pay land transfer tax, legal fees of 2-4% of
purchase price
In finding a home, you should have a home inspection; in moving to the home, you
may incur moving costs (packing, shipping, storing, etc.)
Owning your home involves certain on-going costs over time
Like with renting, you have utilities and technology (likely internet, maybe
cable/phone)
Regular mortgage payments, property tax, insurance, landscaping, maintenance
Furniture and appliances (initial and replacement) and possible renovations
Home, Automobile, and Other Insurance
Home insurance protects against damage to home, damage or theft of personal
property, liability for third party harm
Risk coverage can be comprehensive (all but excluded) or standard (only those named)
Auto insurance protects against harm to you or your passengers (benefit), damage
to car (collision), harm to others or their property caused by you (liability)
Collision coverage typically not mandatory
Home and auto premiums affected by location, age, type, size of coverage and
deductible
Other insurance needs include health, disability, and critical illness
Life Insurance Considerations
Life insurance protects financial obligations that continue after you die
Term pays out a lump sum if you die during specified time; permanent pays out a lump
sum if you die while holding or a cash surrender value if you cancel or coverage expires
Factors to consider
Term has lower premiums than permanent because no cash surrender value
Lump sum is not taxable; cash surrender value is taxable
Premiums are lower the younger (and healthier) you are, and can get very expensive as
you age
Insurance can vary with age (cheaper earlier, costlier later) or be fixed over time
Purchase in increments that represent the amount of coverage (payout) if you die; more
increments, higher premiums
Determining Life Insurance Coverage
How much coverage to buy varies by individual and stage of life
Generally, coverage is gap between accumulated savings and financial obligations
Laddering is the process of adjusting your coverage, up or down, as life changes
Build a schedule that accounts for savings and what your lump sum must
pay for
Income replacement (e.g., 10 times your net income)
Debt/mortgages to be paid off
Cost of kids, including RESP contributions
Savings includes TFSA, RRSP, pension, etc.
Other Spending
Changes in life may lead you to take on more debt/loans
Cars, trips, furniture, renovations – be careful, and never use without budgeting
the pay back
Credit cards – use to develop good credit history (each spouse should have their
own)
One big, costly change is children
Some estimates suggest $10,000-15,000 annually, per kid
Plan in the budget for the expected: reduced income (early), childcare, school,
activities, clothes, medical expenses, bigger stuff (car, house, travel, etc.)
Leave room for the unexpected
Reporting – Wills and Beneficiaries
You need a plan of who you will leave your assets too
Some assets, like pensions and insurance policies, name beneficiaries
Other assets (e.g., houses, cars, non-registered accounts), require a will to specify
beneficiaries
Considerations for a will
Pay a lawyer to set up or do it yourself?
If married, leave to surviving spouse (tax advantaged) and/or to non-spouse
family?
Updates to your will over time as life changes
Reporting – Tax Considerations
Be ready for additional tax schedules and forms in mid-life
Rental income (T776) and CCA, business/consulting (T2125), multiple T4s and/or
multiple reporting boxes on a T4, T5s and/or T3s for non-registered savings
You may need to pay instalments if income sources don’t require
withholding
Spouses still file their own returns, but they can share certain credits
Medical expenses can be grouped for the entire family
Childcare for children can be deducted by the lower-income spouse
Canada Child Benefit program also provides a tax-free, income-adjusted cash flow
for couples with kids
Lesson Review
What different goals might someone in mid-life plan for?
How does rental property affect your budget and your taxes?
What are different saving options, and what are the tax implications of using
these options and/or splitting income with family?
What are your risk preferences and how does that affect your investments?
What factors should you consider when determining mortgage approval,
affordability, and owning a home?
What types of insurance can you buy, and how much life insurance do you
need?
What new reports and tax forms/items should you consider in mid-life?
