Saving for a rainy day

It’s been a little longer between posts than I would have liked, but I spent some time with the family before the summer winds down.  I’m also switching jobs for the second time this year, so I’ve been working out some details on that end as well.  In keeping with the topic of employment changes, I want to talk about emergency funds.

I don’t know about you, but I’ve always been told to save money for a “rainy day.”  Now, I live in St. John’s, NL, so we have a lot of those.  But the rainy day fund is meant to cover us in the event that something unexpected happens.  It’s not really aptly named.  I expect a rainy day 3 days a week.  So I prefer to call it an emergency fund.

Financial experts have different opinions on emergency funds.  A large consensus would tell you to have at least 3 months’ expenses in a safe place that’s easily accessible.  Others will go as far as 6 months to one year.  Some suggest at least a bare minimum of your insurance deductible tucked away.  It all depends on your level of comfort and risk.

There is a problem with following this advice.  Friends recently confided in me that they have a sum of money sitting in their bank account for emergencies.  They are both employed and have been for some time, and like a lot of us, are paying off a mortgage, vehicles, student loans, and consumer debt.  I asked why they do it this way, and the “rainy day” scenario was raised.

I understand that emergencies happen and they can be very expensive.  However, I also believe that having debt hinders your ability to respond to that emergency.  The debt doesn’t disappear if you lose your job or a family member falls ill.  You are still accumulating interest and making payments during an emergency.  It’s one more burden to bear while you’re dealing with a crisis.

The other issue I see is that we don’t really identify emergencies.  Some dip into the emergency fund because they have to go on vacation or must buy a brand new truck.  Once we get down to the fundamentals, an emergency has to be:

1. Serious,
2. Unexpected,
3. Significant, and
4. Actioned immediately.

My suggestion to my friends was to use the amount sitting idle in their bank accounts to pay down their line of credit.  Once it is paid off, they should keep the line of credit open with a $0 balance and the same limit (more on that in a bit).  That way it’s one less thing to worry about in an emergency.

Focus on saving after your debt is paid off.  If you need an emergency fund (it’s your money, so it’s your decision), start contributing after your debt is paid down.  And please don’t leave it in your bank account.  It’s not helping you there.  If you have contribution room (which most Canadians do) put it into a TFSA which is appropriate for your risk appetite.  That way, at least you are earning something by having it sit somewhere.

Of course, not everyone will agree with the TFSA approach.  Some like to have their money at their fingertips in an emergency situation.  But here’s the thing, you won’t be immediately broke if a crisis happens.  If you lose your job, your employer may pay severance or you may be eligible for Employment Insurance.  If you have a family illness, your employer may provide paid time off or you may qualify for government benefits again.  If your roof needs to be replaced, your homeowner’s insurance may cover most of the damage.  Your friends and family can help as well.  You’re not 100% accountable to pay for all emergencies.

Further, the only situation I can think of that would require immediate, upfront cash is if someone close to you is kidnapped for ransom.   And, let’s face it, none of us would ever be prepared for that emergency anyway.  Most other situations would allow you to use your credit card or line of credit in the short term, provided you don’t have them maxed out when the emergency happens.  The other thing to remember is that your bank won’t grant you access to all of your money at once, either. 

Your credit card has an interest free grace period, normally meaning you won’t accumulate interest on purchases until a number of days have passed (usually 21 days after your bill date).  This is critical if you are using a TFSA as an emergency fund, as it may take 5-8 days to access your money.  There is still plenty of time to get your money before you need it.

My friends asked if I believe in using emergency funds.  I do think it comes back to your personal risk tolerance and preferences.  We don’t have an emergency fund.  We may start a small one in the future, but our immediate goal is to pay down debt.  Once the debt is paid down, our plan is to have a line of credit with a limit of 6 months’ living expenses.  That line of credit will have a $0 balance and will only be accessed in the case of an emergency.  A real emergency.  Once the emergency is over, we will have to pay it off again. 

Instead of contributing straight to an emergency fund or keeping money in the bank, we have a general TFSA that we will contribute to regularly when our debt is paid off.  It is a low-medium risk profile and we are comfortable that money will be available when needed.  So if we get stuck, we will use it to pay off the emergency line of credit.  If we never have an emergency or we never have one that fully exhausts our TFSA, we have that money and its growth for our retirement.

So there you have it, I’m preaching to pay off debt so you can go into debt in an emergency.  It might sound silly to some, but I’ve classified an emergency as an acceptable reason to build debt. You won’t hear me say that very often.

Finally, I’d like to recommend David Chilton’s The Wealthy Barber Returns for further reading.  He has an excellent chapter about emergency funds in there.

Reduce the Taxes Coming Out of Your Paycheque

We are all looking for creative ways to increase our cash flows and either pay down debt, put more money away for retirement, have more buying power, or any combination of these three.  There are a number of ways to do this, but I’m not sure how familiar people are with the strategy I’m about to share because:

1. Everyone hates anything to do with taxes,
2. It requires a little bit of work,
3. It’s not well advertised, and
4. We all love tax refunds.

This is a strategy I used back in 2008 and 2009.  In 2010 my employer made it a little more challenging to implement, so I let it go.  Then life got in the way and I never gave it much thought afterwards.  I also liked getting a lump sum of cash in March (yes I file my taxes early) right around my birthday.  In any event, I started noticing a bit of a cash flow issue in our house as we pay for childcare and try to save for retirement.  That March lump sum was being used to pay off some debt accumulated while Deanne was on maternity leave and taking home less than half her regular salary.  So we decided to implement the strategy once again and will continue to use it going forward.

Basically, what I am rambling on about is Form T1213 – Request to Reduce Income Tax at Source.  I’m not sure if anyone without business education has much information about it (I remember learning about it in the Introduction to Tax class at MUN many years ago) but it’s something that is quite underutilized.  It’s a form that you can fill out and send to the Canada Revenue Agency (CRA).  If you fill it out correctly, you should receive a letter back from CRA in 8 to 12 weeks.  You then send it to your employer and they will reduce the amount of income tax they withhold from your paycheque.  Sounds simple enough, right?  It actually is pretty simple.  If you send it to CRA by November 1st, you can maximize the benefit to you as you would have it back to your employer in time for your first payroll run for the following year.

The types of things you can include are the expected annual amounts for:

1. Childcare expenses.  This one is huge for us right now.
2. Contributions to an RRSP (outside of employer plans that have a deduction on your regular payroll)
3. Child support
4. Employment expenses
5. Medical expenses
6. Donations

A number of these expenses are regularly occurring expenses.  Childcare is a great example here; we pay the same amount per child per week.  It doesn’t change.  So we can tell the government what we expect to pay for the entire year.  Others, like medical expenses, are more variable in our case, so we leave those out of the equation.

The key is, these are estimates.  If you overestimate your expenses, you’ll pay at tax time.  If you underestimate, you get a refund.

I like this strategy because of the impact on biweekly cash flows.  I was late getting my paperwork to payroll this year.  It’s finally implemented for this pay run and I’m actually clearing more than $1100/month vs. what I was before!  $1100/month for 4 1/2 months makes quite a difference.  It would probably be closer to $400/month for a full year, but that still makes a difference in our lives.  That’s $400 we have to put toward paying down debt and our savings per month.  Mind you, we’re giving up a lump sum tax refund to get that.  But we like it because:

1. We are accumulating less interest on our debt if we pay it off now vs. waiting until next March,
2. We are accumulating more growth over contributing to our savings over a 12 month period vs. waiting until next March, and
3. We’d rather have our own money to reduce debt and increase our own wealth than give the Canadian government an interest-free loan over 14 months.

I think number 3 is a selling feature we’ve been told about by financial experts that doesn’t really get much thought.  If you get a lump sum tax refund, you’ve loaned money to the government.  Plain and simple.  If you pay in at tax time, the government loaned you the money.  That’s all fun and games, but what happens when you have debt or you need to save money?

Here’s an example:  If you loan the government $400/month over the course of 2017, you’ll get $4,800 back in March 2018 (or April or May if you don’t file your taxes right away).  Let’s say you have $5,000 on a 5% Line of Credit (LOC) starting on January 1, 2017.  If you make regular monthly payments of $400/month, you’ll have it fully paid off by January 2018.  However, if you wait until March 2018 for your refund, your LOC will be worth $5,300 (due to the compounding nature of interest) and you’ll only have $4,800 to pay.  See the problem?  You still have to find $500 from somewhere else to cover your loan, or let it grow again until tax time in 2019.  Savings work the same way, only we’d treat that $500 as a lost investment opportunity.

Of course, the strategy only works if you’re disciplined enough with the extra money coming in.  I found with the large refund, we were more inclined to use it toward buying things we didn’t really need or catching up on debt accumulated over the prior year.  Now, we’ve got the additional cash flow automatically going toward our debt and savings, so we don’t really the same opportunity to waste it.

If I have you convinced, I’d like to offer some tips in preparing and submitting the T1213 form:

1. Make sure you provide a separate sheet summarizing all of your calculations.  The CRA is full of accountants and accountants love to see calculations.  It also helps them process the request more promptly.  I did mine on an Excel spreadsheet and summarized the amounts I expect to spend on each expense.
2. Provide some documentation for each expense.  It may be as simple as your childcare contract showing the price per day or week, or getting a copy of your pre-authorized payment plan for your RRSP.  You don’t need to document everything (e.g., I don’t have any pre-authorized payment plan for donations, but I do contribute a regular amount every week), but at least try and summarize expenses as best you can.
3. If anything changes from your prior tax year, include your assumptions and calculations.  This one caught me up.  This year I am claiming childcare expenses as I expect Deanne to make more than me.  In prior years Deanne got to claim it.  So the CRA initially denied my request.  I had to resubmit showing what I estimated as both our taxable incomes for 2017 and how I got there.  It took another 8 weeks, but I was finally approved.
4. Don’t be afraid of the math, you don’t need to do complex calculations.  I estimated my taxable income for 2017 as my gross pay per paycheque x 26 pay periods minus my scheduled RRSP contributions and professional fees.  Simple enough.
5. It may take some time to do it the first time.  I built an Excel spreadsheet.  It took me a few hours to get it the way I liked it, but next year I just need to update my sheet.  That should take me no more than a few minutes.
6. Fax it in.  I’m lazy to the point of efficiency.  I have access to a fax machine, so I sent it that way.  I didn’t need to bring all of my papers to the post office and find out how many stamps I needed.

So there you have it.  It’s a bit of work, but you can actually make some material changes to cash flows in your house just by doing a bit of upfront work and keeping more of your own money.

 

Rent vs. Buy: The Realities of Real Estate

This post started off being about debt in general.  However, as I started writing, I saw things begin to emerge about home ownership.  Bear in mind, these are my views and your own circumstances may be different, but you may want to think about the implications before jumping into home ownership.  Also, if you are a real estate agent or mortgage broker, you may wish to skip this post.

Is it really worth it to own your own home?  Traditional financial experts would say yes, but that is assuming that a home is an appreciating asset and can be treated as an investment in your portfolio.  However, home ownership also contributes to household debt and if not carefully considered, will impact your spending power for years to come.

Is a mortgage debt?

A mortgage is absolutely debt.  A debt is money you were lent that and owe an obligation to pay back.  That’s all it is.  While you may be building equity in an investment, the amount of money you owe on a mortgage is debt.  So if my house can sell for $350,000 and I owe $300,000 on it, I have a debt of $300,000 and equity of $50,000.  That’s a relatively simplified calculation, but you should know that your mortgage is debt.

Did you buy your home for financial reasons?

Home ownership is a goal that many young people have as they enter the workforce.  I remember saying “I’ll rent for now, but when I have $X saved up, I’m buying a house.”  Why is that?  Maybe it’s pride.  Maybe it’s our upbringing.  We don’t really consider the financial implications of home ownership. I’ll give a real example; in 2011 Deanne and I were renting a 3 bedroom basement apartment for $1000 a month and we paid tenant’s insurance of about $400 a year.  That’s $12,400 a year in living expenses.  We had enough space for us and the cat, and if we wanted to have company, there was room.    If everything stayed flat, we’d pay $248,000 over 20 years to live there if we decided not to buy a house.  I’ll push it closer to $350,000 assuming our rent and insurance increased each year.

We bought our house for just a little less than that and opted for a mortgage.  Now we have a house that’s costing us $2000 a month in a mortgage and taxes (we opted to accelerate and combine payments) and about $1500 a year in insurance.  And we had a downpayment.  And closing costs.  And a lot of renovation costs.  Plus property upkeep expenses and maintenance.  Plus more furniture and appliances.  Plus the added electrical.  It’s costing us roughly $30,000 a year.  After 20 years, that’s $600,000 if flat.  If we account for the same level of inflation on that, it’s $845,000.  That’s $495,000 more than what we would pay as renters.

If we didn’t become homeowners, we could have invested $495,000 over 20 years and used that principal plus growth to buy a brand new house as a 47th birthday present to one another!  Instead at 47 we’ll be celebrating going mortgage free in a 20 year old house.

I know it’s a bit of an oversimplified, exaggerated example, but the numbers aren’t actually that far out to lunch.  Home ownership is a big contributor to why so many people are in financial trouble (more on that later).  If you want to play around with your own numbers, David Trahair, CPA, CA has a wonderful template you can use.  Check the links under Spreadsheets > Cash Cows, Pigs, and Jackpots on his website.  I highly recommend checking out his books or attending one of his seminars.  I had the opportunity to do both back in December.

You don’t have a mortgage because it makes financial sense.  Someone may have told you somewhere along the line to own a home to build equity and that “you’re paying yourself” or some other line that doesn’t really make sense.  The only time it sort of makes sense is if you decide to be a landlord and rent out part of your space.  Then you are giving up some of your privacy and security.

You have a mortgage because you want to own house

I don’t know why you wanted a house, but you wanted it.  We wanted a private place to raise our family.  Rentals don’t offer that, unless you rent an entire house.  Then you’re walking on eggshells every time your kids move in the house, afraid they’ll dent the floor or throw a toy through the wall.  What if they clog the basement toilet and it floods the whole place?

Well, renting keeps you safe there too.  You might lose your damage deposit, which could be as much as 6 month’s rent.  Well flood a basement in your house and you’re out a lot more than $6,000 if your insurance doesn’t cover it.  Renting a home is actually much less financially risky.

Why did we buy a house again?  Maybe it’s security of location and knowing we won’t get evicted.  Maybe we want a place that we can renovate and call our own.  Maybe we wanted a backyard.  Maybe at the time we thought we were making a financially responsible decision, but a quick look at the numbers 5 years later tells us otherwise.

In any event, we have a house, a mortgage, all of those creeping expenses associated with home ownership, and our land.  It’s not much, and there are days we might wish we spent our money differently, but it’s ours.  We’re spending our money on it and we enjoy it.  That’s what matters, after all.

I’d love to hear some of your thoughts on home ownership.

 

 

Welcome to the Cash Matters Blog

I’ve been reading blogs for quite some time and have finally decided to join in on the action.  I don’t really know what to tell you to expect at this point as I’m learning as I go, but I am quite interested in helping others find simple and practical ways to solve personal financial problems.  So please join me in this adventure and we’ll journey together.

The truth is, money scares a lot of people.  Our society is constantly reminding us that none of us have enough.  If you watch the news, financial experts constantly tell us that we aren’t saving enough and spending too much.  Bloggers do the same.  Meanwhile, governments are increasing taxes and consumer prices keep rising.  Our friends are posting pictures of lavish holidays on Facebook and Instagram.  Others are bragging about getting X% off items on Black Friday they didn’t really need in the first place.  It’s enough to give anyone a migraine.

We live in a society where cash is needed to buy goods and services.  That’s it.  Full stop.  It doesn’t have to be scary.   You don’t need to max out your RRSP and TFSA contributions every year if you can’t afford to.  You don’t need to buy the latest gadget just because it’s on sale.  And you probably don’t need that family holiday every single year.

OK, OK, here I am, alienating the financial planning crowd and anyone who wants to have fun.  Of course you need to plan for the future.  And you obviously need to use money to buy things you need and enjoy.  It’s just that everyone is different and has unique circumstances.  So, you have to use the tools and education you have to make informed decisions about your money.

When we aren’t fully engaged with our finances, we tend to underestimate our spending and overestimate our wealth.  I’ll be the first to admit, I was guilty here.  It’s no different than diet and exercise.  Our brains are programmed to do that to make us feel better and help us survive.  It’s bad enough that the media, the government, and your friends are stressing you out about money.  Now your brain is working against you as well!

My goal in all of this is to share some of the ways I’ve learned to manage money more effectively.  That will hopefully help alleviate some of your fears and keep the blue, purple, green, red, and (if you’re lucky) brown bills in your wallets.  If not, at least it’s an opportunity for me to document my own strategies and philosophies about money for future generations to laugh about many years down the road.

Thanks for reading to this point.  Leave a comment if there’s anything in particular I should write about in an upcoming entry.  If you have your own tips and tricks, I’d love to hear about them too.