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MANAGING PERSONAL FINANCES

THE NEED FOR PERSONAL FINANCIAL PLANNINGThe secret to success is to have capital, or money. With capital, you can take nice vacations, raise a family, invest in stocks and bonds, buy the goods and services you want, give generously to others, and retire with enough money to see you through. Money management, however, is not easy. Your chances of becoming wealthy are much greater if you choose to become an entrepreneur. That’s one of the reasons why we have put so much emphasis on entrepreneurship throughout the text, including a whole chapter on the subject.

You have to earn the money in the fi rst place. Then you have to learn how to save money, spend money wisely, and insure yourself against the risks of serious acci-dents, illness, or death. We shall discuss each of these issues in this chapter so that you can begin making fi nancial plans for the rest of your life.

FINANCIAL PLANNING BEGINS WITH MAKING MONEYA major reason for studying business is that it prepares you for fi nding and keeping a good job. Today, that usually means learning how to communicate well, how to use a computer, and how to apply some of the skills you have learned in school and in life. It also means staying out of fi nancial trouble.

You already know that one of the secrets to fi nding a well-paying job is to have a good education. Throughout history, an investment in education has paid off regardless of the state of the economy or political ups and downs. Education has become even more important since we entered the information age.

Many people use their education to fi nd successful careers and to improve their earning potential, but at retirement they have little to show for their efforts. Making money is one thing; saving, investing, and spending it wisely is something else. Following the six steps listed in the next section will help you become one of those with enough to live in comfort after retirement.

SIX STEPS IN LEARNING TO CONTROL YOUR ASSETSThe only way to save enough money to do all of the things you want to do in life is to make more than you spend! We know you may fi nd it hard to save today, but saving money is not only possible but also imperative if you want to accumulate enough to be fi nancially secure. The following are six steps you can take today to get control of your fi nances.

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2 Managing Personal Finances

Step 1: Take an Inventory of Your Financial Assets To take inventory, you need to develop a balance sheet for yourself. Remember, a balance sheet starts with the fundamental accounting equation: Assets = Liabilities + Owner’s Equity. You can develop your own balance sheets similar to the one pre-sented in Chapter 16 by listing your assets (e.g., iPod, TV, computer, car, jewellery, clothes, etc.) on one side and liabilities (e.g., rent or mortgage, credit card debt, stu-dent debt, auto loan, etc.) on the other. Assets include anything you own. For our purpose, evaluate your assets on the basis of their current value, not purchase price as required in formal accounting statements. If you have no debts (liabilities), then your assets equal your net worth. (In a corporation, this is called owner’s equity.) If you do have debts, you have to subtract them from your assets to get your net worth. Software programs offer a variety of tools that can easily help you with these calcula-tions. One such example is Quicken (http://quicken.intuit.com/).

If the value of your liabilities exceeds the value of your assets, you aren’t on the path to fi nancial security. You may need more fi nancial discipline in your life.

Since we’re talking about accounting, let’s talk again about an income statement. At the top of the statement is revenue which considers everything you take in from your job, investments, etc. You subtract all your costs and expenses to get net income or profi t. This may also be an excellent time to think about how much money you will need to accomplish all of your goals. The more you visualize your goals, the easier it is to begin saving for them.

Step 2: Keep Track of All Your Expenses You may often fi nd yourself running out of cash, which highlights a cash fl ow prob-lem. In such circumstances, the only way to trace where the money is going is to keep track of every cent you spend. Keeping records of your expenses can be a rather tedious but necessary chore if you want to learn discipline. Actually, it could turn out to be an enjoyable task because it gives you such a feeling of control. Here’s what to do: Carry a notepad with you wherever you go and record what you spend as you go through the day. That notepad is your journal. At the end of the week, record your journal entries into a record book or computerized accounting program.

RBC Royal Bank has developed Spend-o-meter as a way to highlight how some expenses can add up monthly and yearly. For example, if you buy two magazines a week (and based on an average cost), it is estimated that you will spend $624 per year. A tip to save money is to subscribe to your favourite magazine as it is less expensive than buying off the shelf each month. Going to two movies per month will cost you $360. To cut down on this cost, it is suggested that you rent or consider online ser-vices that deliver to your door or stream directly to your TV, computer, or tablet. To estimate some of your expenses, visit http://www.rbcroyalbank.com/savingsspot/spend-o-meter.html. Were you surprised by some of the results?

Develop certain categories (accounts) to make the task easier and more informative. For example, you can have a category called “Food” for all of the food you buy from the grocery store or the convenience store during the week. You might want to have a separate account for meals eaten away from home because you can dramatically cut such costs if you make your lunches at home. Other accounts could include automobile, clothing, utilities, entertainment, donations to charity, and gifts. Most people like to have a category called “Miscellaneous” where they put expenditures for things like banking fees and café lattes. You won’t believe how much you fritter away on miscellaneous items unless you keep a detailed record for at least a couple of months.

You can develop your accounts on the basis of what’s most important to you or where you spend the most money. Once you have recorded all of your expenses, it is relatively easy to see where you are spending too much money and what you have to do to save more money. For examples of expense categories that you can consider



3Managing Personal Finances

when tracking your spending, consider the information at: http://frugalliving.about.com/library/pdfs/BudgetWorksheet.pdf

Step 3: Prepare a Budget Once you know your fi nancial situation and your sources of revenue and expenses, you’re prepared to make a personal budget. Remember, budgets are fi nancial plans. Items that are important in a household budget can include rent or mortgage, utili-ties, food, clothing, vehicles, furniture, life insurance, car insurance, and medical care. You’ll need to make choices regarding how much to allow for such expenses as eating out, entertainment, and so on. Keep in mind that what you spend now reduces what you can save later. For example, spending $3.50 a day for coffee adds up to about $25 a week, $100 a month, and $1,200 a year. If you can save $4 or $5 a day, you’ll have almost $1,800 saved by the end of the year. Keep this up during all four years of school and you’ll have saved more than $7,000 by graduation. And that’s before adding any interest earned.

There are many tools to help you with budgeting. You can take out books on the subject at your local library, buy books on the subject, visit your fi nancial institution’s online site or visit other free (after all, you are on a budget) online sources such as mint.com. What is important is that you get started and fi ne tune the process based on your situation.

You’ll learn that running a household is similar to running a small business. It takes the same careful record keeping, the same budget processes and forecasting, the same control procedures, and often (sadly) the same need to periodically borrow funds. Suddenly, concepts such as credit and interest rates become only too real. This is where some knowledge of fi nance, investments, and budgeting pays off. Thus, the time you spend learning budgeting techniques will benefi t you throughout your life.

Gail Vaz-Oxlade, fi nancial expert and TV host of Til Debt Do Us Part and Prin-cess, recommends the money jar system as a way to manage money. That is, you stop spending when there is no more money in the jar. This is especially helpful for those who need to see their money in order to understand how much they have to spend. Visit http://www.money-saving-ideas.net/money-jar.html#a0 to learn more about this system.

Step 4: Pay Off Your Debts The fi rst thing to do with the money remaining after you pay your monthly bills is to pay off your debts. Start with the debts that carry the highest interest rates. Credit card debt, for example, may be costing you 18 percent or more a year. Merely paying off such debts will set you on a path toward fi nancial freedom. It’s better to pay off a debt that costs 18 percent than to put the money in a bank account that earns, say, 2 percent or less.

Step 5: Start a Savings Plan It is important to save some money each month in a separate account for large pur-chases you’re likely to make (such as a trip, computer, car or house). Then, when it comes time to make that purchase, you’ll have more cash. You should save enough for a signifi cant downpayment on a loan so you can reduce the fi nance charges.

The best way to save money is to pay yourself fi rst. David Chilton, author of The Wealthy Barber, has sold over 2 million copies in Canada (and close to another million in the United States) of his self-published book in Canada reinforcing this advice. His key advice is to invest 10 percent of what you earn for long-term growth by paying yourself fi rst and live within your means.1 You can arrange with your fi nan-cial institution to deduct a certain amount every two weeks or once a month. You will be pleasantly surprised when the money starts accumulating and earning interest over time. With some discipline, you can eventually reach your goal of fi nancial security.




It’s not as diffi cult as you may think. Figure 1 illustrates how $5,000 grows over vari-ous periods at different rates of return. If you start at age 40, you’ll have 25 years in by the time you reach 65.

Step 6: Borrow Money Only to Buy Assets That Have the Potential to Increase in Value or Generate Income Don’t borrow money for ordinary expenses; you’ll only get into more debt that way. If you have budgeted for emergencies, such as car repairs, you should be able to stay fi nancially secure. Financial experts will tell you to save anywhere from three months (if you are single with no dependents) to six months (if you are married with depen-dents) worth of basic living expenses for contingency purposes. That means keeping the money in highly liquid accounts, such as the bank or a money market fund.

Only the most unexpected of expenses should cause you to borrow. It is hard to wait until you have enough money to buy what you want, but learning to wait is a critical part of self-discipline. Of course, you can always try to produce more income by working overtime or by taking on other jobs to generate more income.

If you follow all six of these steps, you’ll not only have money for investment but you’ll have developed most of the fi nancial techniques needed to become fi nancially secure. At fi rst you may fi nd it hard to live within a budget. Nonetheless, the payoff is well worth the pain.

LEARNING TO MANAGE CREDITCredit cards are an important element in a personal fi nancial system, even if they’re rarely used. First, some merchants request credit cards as a form of identifi cation. It may be diffi cult to buy certain goods or even rent a car without owning a credit card because businesses use them for identifi cation and assured payment. Second, credit cards can be used to keep track of purchases. A gasoline credit card, for example, gives you records of purchases over time for income tax returns (if you drive for work) and fi nancial planning purposes. It’s sometimes easier to pay one bill at the end of the month for several purchases than to carry cash around. Third, a credit card is more convenient than cash or cheques. You can carry less cash and easily cancel a stolen card to protect your account.

If you do use a credit card, you should pay the balance in full during the period when no interest is charged. Not having to pay 18 percent interest is as good as earn-ing 18 percent tax free. Also, you may want to choose a card that pays you back in cash (e.g., Scotia Momentum® no-fee VISA credit card) or others that offer pay-backs like credits toward the purchase of gas (e.g., through the use of Canadian Tire Financial Service’s Gas Advantage™ MasterCard®), free long-distance minutes, or frequent-fl ier air miles. The value of these givebacks can vary. Some cards have no annual fees while others offer lower interest rates. To learn more about credit cards

How Money Grows: Time 2% 5% 8% 11%

If you had $5,000 in savings today, how much do you think it would be worth in the future? This chart illustrates how the $5,000 would grow at various rates of return. Recent savings account interest rates are very low (less than 2 percent), but in earlier years, they’ve been over 5 percent.

5 years $5,520 $ 6,381 $ 7,347 $ 8,425

10 years 6,095 8,144 10,795 14,197

15 years 6,729 10,395 15,861 23,923

20 years 7,430 13,266 23,305 40,312

25 years 8,203 16,932 34,242 67,927

Figure 1

Annual Rate of Return




that will best suit your needs, visit the Financial Consumer Agency of Canada’s site at http://www.fcac-acfc.gc.ca/eng/resources/toolCalculator/creditCard/selectorTool/index-eng.asp.

Credit cards are a helpful tool to the fi nancially careful buyer. But, they’re a fi nan-cial disaster to people with little fi nancial restraint and tastes beyond their income. The danger of a credit card is the fl ip side of its convenience. Too often, consumers buy good and services that they wouldn’t normally buy if they had to pay cash or write a cheque on funds in the bank. Using credit cards, consumers often pile up debts to the point where they’re unable to pay. If you aren’t the type who can stick to a fi nancial plan or household budget, it may be better not to have a credit card at all.

An alternative to credit card use is debit card use. Debit cards can be set up so that you cannot spend more than you have saved in your fi nancial institution. This is a great benefi t for those who are not as careful with their spending as they should be.

BUILDING YOUR FINANCIAL BASEThe path to fi nancial success is to have capital (money) to invest, yet the trend today for graduates is to be not only capital-poor but also in debt. Such were the fi ndings of a RateSupermarket.ca survey that showed that the average university student leaves cam-pus with close to $28,000 in debt, and takes an average of 14 years to pay it off based on an average starting salary of $39,523.2 As you’ve read, accumulating capital takes discipline and careful planning. With the money you save, however, you can become an entrepreneur, one of the fastest ways to wealth, but that often means living frugally.

Living frugally is extremely diffi cult for the average person. Most people are eager to spend their money on a new car, furniture, clothes, and the like. They tend to look for a fancy apartment with all the amenities. A capital-generating strategy may require foregoing most (though not all) of these purchases to accumulate investment money. The living style required is similar to the one adopted by most students: a relatively inexpensive apartment furnished in hand-me-downs from parents, friends, and resale shops.

For fi ve or six years, you can manage with the old sound system, a used car and a few nice clothes. The necessary living style is one of sacrifi ce, not luxury. It’s important not to feel burdened by this plan; instead, feel happy knowing that your fi nancial future will be more secure. That’s the way the majority of millionaires got their money. If living frugally seems too restrictive for you, you can still save a little. It’s better to save a smaller amount than none at all.

People are wise to plan their fi nancial future with the same excitement and dedication they bring to other aspects of their lives. If you get married, it is important to discuss fi nancial issues with your spouse. Confl icts over money are a major cause of divorce, so agreeing on a fi nancial strategy before marriage is very important. A great strategy is to try to live on one income and to save the other. The longer you wait before marriage, the more likely it will be that one or the other of you can be earning enough to do that. If the second spouse makes $18,000 a year after taxes, saving that income for fi ve years quickly adds up to $90,000 (plus interest).

Tax-Free Savings Account (TFSA)3What do you do with the money you accumulate? Where do you invest this money? In Chapter 18, some options discussed included depositing money into a savings account or a term deposit (also known as a certifi cate of deposit). Another product to consider is a tax-free savings account (TFSA).

Canadian residents who are 18 years of age or older, and with a valid social insur-ance number, are eligible to contribute up to $5,000 annually to a TFSA. The initial




amount contributed as well as the income earned in the account (e.g., interest income) is tax-free, even when it is withdrawn. Generally, the types of investments that will be permitted in a TFSA include cash, mutual funds, securities listed on a designated stock exchange, term deposits, bonds, and certain shares of small business corporations.

One strategy is to save your money in a TFSA and when you accumulate enough to make a large purchase (e.g., home or a trip), then you withdraw the money and pay for the purchase. Let us look at real estate next as an investment example.

Real EstateYour fi rst major investment might be a low-priced home. You should make this invest-ment as early as possible. The purpose of this investment is to lock in payments for your shelter at a fi xed amount. This is possible by owning a home, but not by renting. Through the years, home ownership has been a wise investment.

The subprime mortgage crisis in the U.S. (discussed in Chapter 4) was a relatively uncommon occurrence. While Canadian fi nancial institutions have not faced the high default rates experienced in the U.S., it did force consumers and investors to look more closely at the risks associated with owning real estate. While there may have been a drop in some home prices, history shows that home prices are likely to rise again and will continue to provide several investment benefi ts.

First, a home is the one investment that you can live in. Second, once you buy a home, the payments are relatively fi xed (although taxes and utilities go up). As your income rises, the house payments get easier and easier to make. Renters, on the other hand, often fi nd that rents tend to go up at least as fast as income. Paying for a home is a good way of forcing yourself to save. Every month you must make the payments. Those payments are an investment that proves very rewarding over time for most people.

Some couples have used the seed money accumulated from saving one income (in the strategy outlined earlier) to buy a duplex home (two attached homes). They live in one part of the duplex and rent out the other. The rent covers a good part of the payments for both homes, so they can be housed very cheaply while their investment in a home appreciates. They learn that it’s quite possible to live comfortably, yet inexpensively, for several years. In this way, they accumulate capital. As they grow older, they see that such a strategy has put them years ahead of their peers in terms of fi nancial security. As capital accumulates and values rise, they can sell and buy an even larger apartment building or a single-family home. Many fortunes have been made in real estate in such a manner. Furthermore, a home is a good asset to use when applying for a loan.

Once you understand the benefi ts of home ownership versus renting, you can decide whether those same principles apply to owning the building if you can set up your own business—or owning versus renting equipment, vehicles, and the like. Fur-thermore, you may start thinking of real estate as a way to earn a living. You could, for example, buy older homes, fi x them up, and sell them—a path many have taken to attain fi nancial security. To calculate the cost differences between renting and buying a house, complete the Rent or Buy? Calculator found at this site: http://www.gen-worth.ca/mi/eng/home_ownership/calculators.html.

Buying a home is likely to be the largest and perhaps the most important investment you’ll make. Experienced real estate investors will tell you that there are three keys to getting the optimum return on a home: location, location, and location. A home in the best part of town, near schools, shopping and work, is usually a sound fi nancial investment. Often young people tend to go farther away from town, where homes are less expensive, but such homes may appreciate in value much more slowly than homes in the town centre. It’s important to learn where the best place to buy is. It’s usually better, from a fi nancial viewpoint, to buy a small home in a great location than a large home in a not-so-great setting.




The Stock MarketYou have learned that one place to invest the money you have saved is in a home. What are some other good places to save your money? For a young person, it is gen-erally not recommended to keep long-term investments in a savings account or term deposit. (This is different for your contingency funds.) One of the best places to invest over time has been the stock market. The stock market does tend to go up and down, but over a longer period of time it has proven to provide a better return on investment.

The future always looks gloomy during a fi nancial crisis, but that doesn’t mean you shouldn’t take risks. Remember the greater the risk, the greater the (potential) return. When stocks are low, that is the time to buy. Actually, when stocks collapse as they did in recent years, this is an opportunity to get into the stock market—not avoid it. The average investor buys when the market is high and sells when it is low. Clearly, that is not a good idea. It takes courage to buy when everyone else is selling. That is called a contrarian approach to investing. In the long run, however, that’s the way the rich get richer.

Chapter 17 introduced you to stocks and bonds. There are tools that track the performance of such investments over time. One such example is the Andex Chart, which summarizes the performance of some key indices such as the S&P/TSX Com-posite (the Canadian stock market), the S&P 500, U.S. small stocks, Canadian bonds, fi xed-term investments, Canadian Treasury bill, and cost of living.4 Bonds have tra-ditionally lagged behind stocks as a long-term investment. Click on http://corporate.morningstar.com/ca/asp/subject.aspx?xmlfi le=6775.xml to see a detailed Andex Wall-chart. Note that you are looking at historical performances that have been impacted by trends in the business environment. No one knows what will happen in the future and this is where doing your homework and knowing your risk tolerance is very important when making fi nancial investments.

PROTECTING YOUR FINANCIAL BASE: BUYING INSURANCEAppendix D introduced you to the topic of risk management. The management of risk is a major issue for businesses. However, it is not just businesses that should be planning for changes. It is also consumers such as you and I. Protecting your fi nancial base should consider different insurance policies to manage and in some instances, reduce your risks. Let us consider some examples in the next few pages.

Life InsuranceOne of the last things people think about is the idea that they may get sick or have an accident and die. It is not a pleasant thought. Even more unpleasant, though, is the reality of young people dying every day in accidents and other unexpected ways. You have to know only one of these families to see the emotional and fi nancial havoc such a loss causes.

Today, with so many partners both working, the loss of a partner means a sudden drop in income. Obviously this is also the case in a single-parent family. To provide protection from such risks, individuals should buy life insurance. Today, the least expensive and simplest form of life insurance is term insurance. It is pure insurance protection for a given number of years that typically costs less the younger you buy it. Every few years, however, you might have to renew the policy, and the premium could go higher. It’s helpful to check out prices for term insurance through a Web-based service. For example, try http://www.insurance-canada.ca/index.php. Be sure to provide as much information as possible to get the best rates.




One of the newer forms of term insurance is something called multi-year level-premium insurance. It guarantees that you’ll pay the same premium for the life of the policy. Some companies allow you to switch your term policy for a more expensive whole or universal life policy

How much insurance do you need? The answer depends on the objectives that you have. For an idea, visit http://www.kanetix.ca/life_cov_calc and complete the Life Insurance Needs Calculator. Figure 2 summarizes why you should buy term insurance.

Whole Life Insurance Is another type of life insurance. Some part of the money you pay for whole life insurance goes toward pure insurance and another part goes toward savings, so you are buying both insurance and a savings plan. This may be a good idea for those people who have trouble saving money. A universal life policy lets you choose how much of your payment should go to insurance and how much to investments. The investments traditionally are very conservative but pay a steady interest rate.

Variable Life Insurance Is a form of whole life insurance that invests the cash value of the policy in stocks or other high-yielding securities. Death benefi ts may thus vary, refl ecting the perfor-mance of the investments. Some people, seeing the stock market go up for so many years, switched out of whole life policies to get the higher potential returns of vari-able life insurance. When the stock market plunged, they were not so certain of the wisdom of their choice. In the long run, however, stocks should rise again.

Life insurance companies recognized the desire that people had for higher returns on their insurance (and for protecting themselves against running out of money before they die) and began selling annuities. An annuity is a contract to make regular payments to a person for life or a fi xed period. With an annuity, you are guaranteed to have an income until you die. There are two kinds of annuities: fi xed and variable. Fixed annuities are investments that pay the policyholder a specifi ed interest rate. They are not as popular as variable annuities, which provide investment choices identical to mutual funds. Such annuities are gaining in popularity relative to term or whole life insurance. Clearly, people have been choosing more risk to get greater returns when they retire. This means, however, that people must be more careful in selecting an insurance company and what investments are made with their money.

Life insurance is getting much more complex. Before buying any insurance, it is wise to consult with both an insurance agent and a fi nancial adviser. They can help you make the wisest decision about insurance based on your overall needs.

Insurance Needs in Early Years are High

Insurance Needs Decline as You Grow Older

1. Children are young and need money for education.

1. Children are grown.

2. Mortgage is high relative to income. 2. Mortgage is low or completely paid off.

3. Often there are auto payments and other bills to pay.

3. Debts are paid off.

4. Loss of income would be disastrous. 4. Insurance needs are few.

5. Retirement income is needed.

Figure 2

Why Buy Term Insurance?




Critical Illness InsuranceIt is a good idea to supplement Canada’s public health coverage with critical illness insurance that pays part of the cost of an accident, or deteriorated mental or physical illness. Sixty-one percent of Canadians admit they have no plan ready in the event they are diagnosed with a critical illness.5 Your chances of becoming disabled at an early age are much higher than your chances of dying from an accident. Therefore, it’s important to have the proper amount of insurance. Call an insurance agent or search the Internet for companies that offer critical illness insurance. The cost is rela-tively low to protect yourself from losing your income for an extended period of time. It is also a good idea to confi rm what protection your employer may offer in case of an accident or illness.

Homeowner’s or Renter’s InsuranceAs you begin to accumulate possessions, you may want to seriously consider getting insurance to cover their loss. You may be surprised to see how much it would cost to replace all the clothes, furniture, pots and pans, appliances, sporting goods, elec-tronic equipment (e.g., computers, blue ray players, and the like), and the other things you own. Apartment insurance or homeowner’s insurance covers such losses. But you must be careful to specify that you want guaranteed replacement cost. That means that the insurance company will give you whatever it costs to buy all of those things new. Such insurance costs a little bit more than a policy without guaranteed replace-ment, but will usually receive a lot more if you claim a loss.

The other option is to buy insurance that covers the depreciated cost of the items. For example, a sofa you bought fi ve years ago for $600 may only be worth $150 now. The current value is what you would get from insurance, not the $700 or more you may need to buy a brand-new sofa. The same is true for a computer you paid $950 for a few years ago. If it were to be stolen, you would get only a few hundred dollars for it rather than the replacement cost.

Most policies don’t cover expensive items like engagement and wedding rings and silver pieces. You can buy a rider to your insurance policy that will cover such items at a very reasonable cost. Ask your agent about such coverage.

Other Insurance: Car and Liability InsuranceYou should buy insurance for your car. Get a large deductible of $1,000 or so to keep the premiums lower, and cover small damage on your own. Be sure to include insur-ance against losses from uninsured motorists.

You’ll also need liability insurance to protect yourself against being sued by someone accidentally injured by you. Often you can get a discount by buying all your insurance (e.g., life, critical illness, homeowners, automobile, etc.) with one company. This is called an umbrella policy.

PLANNING YOUR RETIREMENTIt may seem a bit early to be planning your retirement; however, not doing so would be a big mistake. Successful fi nancial planning means long-range planning, and retire-ment is a critical phase of life. What you do now could make a world of difference in your quality of life when you retire. If you think that it is too early, as a minimum you can start to gather information.

Retirement income may come from what are commonly referred to as the three pillars of retirement income protection. Pillar 1 consists of the federal Old Age




Security (OAS) program. Retirement income from Pillar 2 consists of income from the Canada Pension Plan (CPP) and the Québec Pension Plan (QPP). Pillar 3 consists of income generated from private retirement savings plans with the most common being employer sponsored pension plans (EPPs) and Registered Retirement Savings Plans (RRSPs).6

The retirement income system in Canada is based on both public (Pillars 1 and 2) and private (Pillar 3) retirement savings plans. Almost all of today’s seniors receive income from Canada’s Public Pensions.

Pillar 1: OAS Program7

The OAS program is one of the cornerstones of Canada’s retirement income system. Benefi ts include the basic OAS pension, the Guaranteed Income Supplement, the Allowance, and the Allowance for the Survivor. OAS generates a pension at age 65 if one has lived in Canada for at least 10 years. Measures have been implemented to gradually increase the age of eligibility for the OAS pension between the years 2023 and 2029, from 65 to 67. This program is fi nanced from general tax revenues collected from the Government of Canada. All benefi ts payable under the Old Age Security Act are adjusted four times a year if there are increases in the cost of living, as mea-sured by the CPI. As a point of reference, the maximum monthly benefi t was $544.98 per recipient during the October to December 2012 period. (For updated benefi t information, visit http://www.servicecanada.gc.ca/eng/isp/oas/oasrates.shtml.)

Pillar 2: CPP and QPP8

Established in 1966, the CPP provides basic benefi ts when a contributor to the Plan becomes disabled or retires. At the contributor’s death, the Plan provides benefi ts to his or her survivors. The CPP is a “contributory” plan. This means that all its costs are covered by the fi nancial contributions paid by employees, employers and self-employed workers, and from revenue earned on CPP investments. The CPP, which is designed to replace about 25 percent of the earnings on which a person’s contribu-tions were based, may provide monthly benefi ts starting as early as 60 years of age. As a point of reference, the maximum monthly benefi t per retired recipient (at age 65A) for 2012 was $986.67. Note that this is a higher amount than the OAS maximum monthly benefi t. (For updated benefi t information, visit http://www.servicecanada.gc.ca/eng/isp/pub/factsheets/rates.shtml.)

The QPP is the Québec equivalent of the CPP. It is a compulsory public insurance plan whose purpose is to provide persons who work in Québec (or have worked in Québec) and their families with basic fi nancial protection in the event of retirement, death or disability. The Plan is fi nanced by contributions from Québec workers and employers. These contributions are collected by Revenu Québec and are managed by the Caisse de dépôt et placement du Québec. As with the CPP, the QPP may provide monthly benefi ts starting as early as 60 years of age. As a point of reference, the maximum monthly benefi t per recipient, who began collecting at age 65, for 2012 was $986.67, which mirrors the CPP maximum monthly benefi t.

Pillar 3: EPPs9

Based on the values noted earlier, between OAS and the CPP/QPP, the government will pay out a maximum of approximately $18,380 a year (for 2012) to a 65-year-old. This breaks down to approximately $1,531 a month to cover basic expenses. Financial experts recommend that we need 70 percent of our pre-retirement income in order to have a comfortable retirement. As a result, the third pillar must make up what is not covered by the Public Pensions. EPPs can be one element of Pillar 3.




Private pension plans are employer-specifi c and if applicable, are introduced during an employee’s orientation period at the new place of employment. EPPs include Registered Pension Plans (RPPs) and Deferred Profi t Sharing Plans (DPSPs). In Canada, employer pension plans cover just over 6 million workers, or nearly 34 percent of all employees.

With RPPs, both the employer and employee typically contribute to the plan. A DPSP is an employer-sponsored savings plan in which an employer makes contributions for the employees (who cannot contribute) based on profi ts. The amount accumulated in these plans can be paid out as a lump sum at retirement or termination of employment, transferred to a RRSP, received in installments over a period not to exceed ten years or used to purchase an annuity.

Pillar 3: RRSPs10 As you read above, a minority of working Canadians have access to an EPP. Conse-quently, they need to proactively consider other investment strategies such as RRSPs. An RRSP is a federally-regulated, tax-sheltered savings plan designed to encourage Canadians to save for their retirement. Any earnings from cash or investments held within an RRSP are not taxed until they are withdrawn. An RRSP lets you save for retirement and save taxes at the same time. Not only do you avoid paying income tax on the money you contribute but you postpone paying tax on your investment earnings until you take the money out of your plan later on. And because you’ll earn interest on the interest, the tax-free compounding will make a huge difference in the amount of money you’ll be able to save for retirement. You, your spouse, or a common-law partner can establish and contribute to an RRSP.

The exact amount you’re entitled to contribute for the tax year—which will include any unused contribution room carried forward from previous years—is shown in a separate section of the Notice of Assessment you received from Canada Revenue Agency after you fi led last year’s tax return. The amount you’re allowed to deduct for tax purposes is referred to as your contribution room or deduction room. The dollar limit (or maximum) that you can contribute for any tax year is 18% of your earned income from the previous year (up to a certain limit), minus any “pension adjustment” (if applicable, this refers to the amount of a work pension that you may have built up in the pension plan during the year), plus any unused contributions from previous years.

You may deduct the entire amount from your taxable income when you make the contribution. The amount of tax you save will depend on your marginal tax rate. For tax planning purposes, the marginal tax rate is defi ned as the rate of tax payable on the last dollar earned. This fi gure tells you how much money you get to keep if you make an extra dollar, or how much you save in taxes by reducing your taxable income by a dollar. The marginal tax rate varies from province to province. In other words, the higher your income, the more tax you will save by making a $1,000 contribution to your RRSP. Consider Figure 3 below which lists the marginal tax rate (combined provincial and federal tax rates) for our example.

Marginal Tax Rate Personal Income Range

26% $8,169 to $32,625

32% $32,626 to $65,254

36% $65,255 to $106,090

39% $106,091 and up

Figure 3

Marginal Tax Rate and Personal Income




Your friend has earned $25,000 and you have earned $75,000. A $1,000 investment into an RRSP would save your friend $260 and you would save $360 in tax. Despite investing the same $1,000, everyone derives different tax benefi ts depending on each person’s marginal tax rate.

The RRSP contribution deadline is 60 days after the end of the year (e.g., March 1). You can buy an RRSP at any fi nancial institution or through a broker or fi nancial adviser.

When you start contributing to your RRSP earlier in life, you’ll allow more time for the income earned in your RRSP to compound. You may also fi nd that you can make a smaller total investment in your RRSP, and still be further ahead. While this sounds straight forward, be aware that each year roughly two thirds of Canadians contribute nothing at all to their RRSP. Like any savings program, this requires discipline.

There are other uses for this money, other than for retirement. Two Plans allow you to withdraw money from your RRSP without penalty, assuming that you pay back these funds within a certain period of time. For example, the Home Buyers’ Plan allows you to withdraw up to $25,000 from your RRSP to buy or build a home for yourself or for a related person with a disability. The Lifelong Learning Plan allows you to withdraw money from RRSP to fi nance training or education for you, your spouse, or common-law partner.

Contributing to an RRSP is one of several strategies that Canadian can follow when planning for retirement. There are free programs that will help you determine how much you need to save in your RRSP to achieve your retirement goal. One such example is TD Canada Trust’s RSP Contribution Calculator at http://www.tdcanada trust.com/planning/life-events/rrsp-planning-calc.jsp. Visit the site to determine how much you may have at retirement based on your savings program.

FINANCIAL PLANNERSIf the idea of developing a comprehensive fi nancial plan seems overwhelming, know that help is available. Financial planners assist in developing a comprehensive pro-gram that covers investments, taxes, insurance, and other fi nancial matters. Be care-ful, though. Since fi nancial planning is not regulated in most Canadian provinces, anyone can claim to be a “fi nancial planner” but not everyone is indeed qualifi ed.11 It’s often best to fi nd a person who has earned the distinction of being a certifi ed fi nancial planner (CFP) or a similar designation.

The CFP, for example, is an internationally recognized fi nancial planning designa-tion that is becoming widely regarded as the world standard for fi nancial planning accreditation. There are over 17,500 CFPs in Canada.12 For a list and description of fi nancial designations, as well as advice on fi nding an advisor, visit the Financial Advisors Association of Canada site at http://www.advocis.ca.

In the past few years, there has been an explosion in the number of companies offering fi nancial services. Such companies are sometimes called one-stop fi nancial centres or fi nancial supermarkets because they provide a variety of fi nancial services, ranging from banking service to mutual funds, insurance, tax assistance, stocks, bonds, and real estate. It pays to shop around for fi nancial advice. Ask around among your friends and family. Find someone who understands your situation and is willing to spend some time with you.

Most fi nancial planners begin with life insurance. They feel that most people should have basic term insurance coverage. They also explore your health insurance plans. As discussed earlier, they also consider critical illness coverage, which can include medical expense and disability coverage.




Financial planning covers all aspects of investing, all the way to retirement and death. Financial planners can advise you on the proper mix of RRSPs, stocks, bond, real estate, and so on.

ESTATE PLANNINGIt is never too early to begin thinking about estate planning, although this may be decades away. You may need to contact a lawyer and/or a fi nancial planner to help you prepare the paperwork and do the planning necessary to preserve and protect your investments for your benefi ciaries. Two important documents are a will and a power of attorney.

A will is a document that states how you want your assets distributed, names the executor for your estate, and names the guardian(s) for your children (if applicable). An executor assembles and values your estate, fi les income and other taxes, and distributes assets. This document takes effect when you pass away.

A power of attorney, which can take effect when you are alive, is a written docu-ment in which you appoint someone else to act on your behalf on matters that you specify; this can be made to start immediately, or upon mental incapacity.13 Be aware that the rules regulating powers of attorney tend to vary signifi cantly from province to province.14 To get an idea of what is involved, visit http://www.attorneygeneral.jus.gov.on.ca/english/family/pgt/poa.asp to access a power of attorney kit.

There are hundreds of books on estate planning, so we can only give you a hint as to what is involved. But it all begins with a strong fi nancial base.

ENDNOTES 1. Iris Winston, “David Chilton Returns with a Wealthier Barber,” Fifty-Five Plus

Magazine, 2012, http://www.fi fty-fi ve-plus.com/david_chilton_returns_with_a_wealthier_barber; and Lori Chalmers Morrison, “Dollars & Sense,” Laurier Campus, Winter 2010, 25.

2. Jeff Lagerquist, “Student debt: Average payback takes 14 years,” Finan-cial Post, 4 September 2012, http://business.fi nancialpost.com/2012/09/04/student-debt-average-payback-takes-14-years/.

3. “The Tax-Free Savings Account,” Canada Revenue Agency, 21 March 2012, http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/tfsa-celi/menu-eng.html.

4. “Andex Charts - Key Features,” Morningstar Canada, 2012, http://corporate.morningstar.com/ca/asp/subject.aspx?xmlfi le=6775.xml.

5. “Right Choice Insurance launches online critical illness solution,” Insurance-Canada.ca, 4 March 2009, http://www.insurance-canada.ca/profproducts/health-critical/Right-Choice-Insurance-online-solution-903.php.

6. Karim Moussaly, “Participation in Private Retirement Savings Plans, 1997 to 2008,” Statistics Canada, March 2010, http://www.statcan.gc.ca/pub/13f0026m/13f0026m2010001-eng.pdf.

7. “Old Age Security (OAS) Program,” Service Canada, 16 October 2012, http://www.servicecanada.gc.ca/eng/isp/oas/oastoc.shtml; “Changes to Old Age Secu-rity” Service Canada, 20 July 2012, http://www.servicecanada.gc.ca/eng/isp/oas/changes/index.shtml; “Canada Pension Plan and Old Age Security,” Human Resources and Skills Development Canada, 29 March 2012, http://www.hrsdc.gc.ca/eng/oas-cpp/index.shtml.




8. “Canada Pension Plan Payment Amounts,” Service Canada, 29 August 2012, http://www.servicecanada.gc.ca/eng/isp/pub/factsheets/rates.shtml; “Canada Pension Plan (CPP),” Service Canada, 13 June 2012, http://www.servicecanada.gc.ca/eng/isp/cpp/cpptoc.shtml; “The Québec Pension Plan,” Régie des rentes Québec, 2012, http://www.rrq.gouv.qc.ca/en/programmes/regime_rentes/Pages/regime_rentes.aspx; “Quebec Pension Plan Figures,” Régie des rentes Québec, 2012, http://www.rrq.gouv.qc.ca/en/programmes/regime_rentes/regime_chiffres/Pages/regime_chiffres.aspx; and “Canada Pension Plan and Old Age Security,” Human Resources and Skills Development Canada, World Wide Web.

9. “Employer Pension Plan (trusteed pension funds), First Quarter 2012,” Statistics Canada, 12 September 2012, http://www.statcan.gc.ca/daily-quotidien/120912/dq120912b-eng.htm; Moussaly, “Participation in Private Retirement Savings Plans, 1997 to 2008,” World Wide Web; and Stefania Moretti, “Saving for retire-ment: How much is enough?” Money, 26 February 2010, http://money.canoe.ca/money/mymoney/canada/archives/2010/02/20100226-132437.html.

10. “Registered Retirement Savings Plan (RRSP),” Canada Revenue Agency, 9 May 2012, http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/rrsp-reer/rrsps-eng.html; “Home Buyers’ Plan (HBP),” Canada Revenue Agency, 4 January 2012, http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/rrsp-reer/hbp-rap/menu-eng.html; Sarah Efron and Rob Gerlsbeck, “Top 21 RRSP questions answered,” MoneySense Online, 26 February 2010, http://www.moneysense.ca/2010/02/26/top-21-rrsp-questions-answered/; and Stefania Moretti, “Saving for retirement: How much is enough?” World Wide Web.

11. “Why CFP Certifi cation?” Financial Planning Standards Council, 2012, https://www.fpsc.ca/about-fpsc.

12. Ibid.

13. “Power of Attorney,” LawDepot.com, 2012, http://www.lawdepot.com/contracts/powerattny/?a=t&loc=CA&%20pid=google-pwratt_ca-main_d-s-ggkey_power%20of%20attorney&&s_kwcid=power%20of%20attorney|3522121665.

14. Lloyd Duhaime, “An Introduction to Powers of Attorney in Canada,” Duhaime.Org, 11 November 2011, http://www.duhaime.org/legalresources/elderlawwill-strustsestates/lawarticle-25/introduction-to-powers-of-attorney-in-canada.aspx.


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