In my last few columns I have discussed step 2 of Dave Ramsey's 7 Baby Steps (see http://www.daveramsey.com/new/baby-steps/). I love talking about getting out of and avoiding debt because it is an essential prerequisite for financial success. Now I think it's time to move on to other topics that cover what should happen after getting out of debt. Baby Step 3 is to build 3 to 6 months of expenses in savings, but I have discussed this step in previous columns.
In this column I will address 3 questions regarding Baby Step 4, which is to save 15% of income toward retirement.
Why should I wait until I'm out of debt with an emergency fund before saving for retirement? The answer is simple: FOCUS! You're not going to gain traction if you try to do too much at once. It is true that saving for retirement is very important, and the earlier you start the better, but I am only recommending that you put off retirement savings temporarily. With focus and discipline, the average family takes 18 to 24 months to complete Baby Steps 1 through 3. Once you are free from income-eating debt payments and have an emergency fund to prevent you from going back into debt, you will be in a great position to contribute to retirement.
Why 15%? 15% is not a magic number, but it's enough to make good progress toward retirement but not so much that it's a huge burden. Some of you will want to save less, but I encourage you to stretch yourself to reach this goal. Some of you will want to save more, but I encourage you to dial back unless you have a lot of extra money. Take anything extra you have above 15% and apply it to the next baby steps - fund kids' college, pay off your house early, build wealth in other ways (i.e. real estate), give money away, and yes, even spend some of it!
Where should I put the money? Definitely use a Registered Retirement Savings Plan (RRSP) and/or a Tax-Free Savings Account (TFSA). Both of these provide significant tax advantages. An RRSP allows you to invest pre-tax dollars (what you contribute is a tax deduction) but you are taxed on any withdrawals. A TFSA allows you to invest after-tax dollars (no tax deduction), but the withdrawals in retirement are tax free. If you have the same tax rate now as in retirement, the end result is exactly the same. Of course, we have no idea what our tax rate will be in retirement, so it's best to talk through your options with an advisor. You can think of an RRSP or TFSA as a blanket that protects your investments from taxes, but they are not the investments themselves. Even if you use an investment advisor, such as at a bank, make sure you understand what your RRSP or TFSA is invested in.
There is much to talk about on the subject of retirement planning, but I will leave it at that for this column. If you have any questions or topics you want me to address, please email me
Thursday, May 27, 2010
Thursday, May 13, 2010
Baby Step 2 - School Without Student Loans (Part 2)
In my last few columns I have discussed step 2 of Dave Ramsey's Seven Baby Steps (see http://www.daveramsey.com/new/baby-steps/), and last time I made the case that it's actually possibly to get through school without student loans. This week I will continue on that theme in answer to the question, “what's wrong with student loans?” Two principles I would like to discuss are (1) student loans, like any debt, can take the place of creativity and sacrifice, and (2) students loans for most people are NOT easy to pay off.
Simply put, students loans make it too easy. That may not sound like a bad thing, but it is bad when you're trading short-term ease for long-term pain (refer to principle number 2). There's nothing wrong with being a starving student living in a small apartment getting around in an old car. In fact, learning financial discipline and sacrifice as a student will prepare your character to handle prosperity in the future.
For some people the only possible way to get an education might be to take out a minimal loan and use it for the bare necessities. However, few of us have that kind of discipline. If you need $5000 to cover the bare necessities, why not take out $5500 and eat out a little more often? Why not take out $7500 and live in a little nicer apartment? Why not take out $10,000 and buy a big-screen TV and nice couch? Someone I talked to recently admitted that he spent more student loan money on CD's and stereo equipment (you can tell he went to school a few years ago) than he did on his education.
The second principle is that student loans are NOT easy to pay off. The average university student graduates with around $20,000 in debt. Starting salaries vary widely by profession and location, but somewhere around $45,000 is probably somewhere in the middle of the range for a bachelor degree. That might sound like decent money, but a typical one-income family will have trouble finding extra money for student loan payments after taxes and the many other expenses of life.
If the average student loan is $20,000, and a typical interest rate is around 6%, here are some examples of how long it would take to pay it off. $150/month: 18 years. $250/month: 8 years. $750/month: 2.5 years. $1000/month: almost 2 years. You might think that 2 years doesn't sound too bad, but even if you could spare $1000/month right out of college (not very likely), think of what else you could do with that $1000/month.
You could save for a $24,000 down payment on a house, you could buy a nice vehicle, or my personal favorite, you could invest it for 2 years. If you invested at a 10% return (if you starting investing a year ago, your return would have been more like 50-80%), it would become $26,500 in 2 years. If you just left that $26,500 in investments at 10%/year (the average stock market return over a long period of time) and did no other investing for the rest of your life, you would be a millionaire when you retire in 40 years ($1.2 million to be exact).
Are those extra comforts while attending school worth $1.2 million? I'll leave that up to you to decide.
If you have any questions or topics you want me to address, please email me!
Simply put, students loans make it too easy. That may not sound like a bad thing, but it is bad when you're trading short-term ease for long-term pain (refer to principle number 2). There's nothing wrong with being a starving student living in a small apartment getting around in an old car. In fact, learning financial discipline and sacrifice as a student will prepare your character to handle prosperity in the future.
For some people the only possible way to get an education might be to take out a minimal loan and use it for the bare necessities. However, few of us have that kind of discipline. If you need $5000 to cover the bare necessities, why not take out $5500 and eat out a little more often? Why not take out $7500 and live in a little nicer apartment? Why not take out $10,000 and buy a big-screen TV and nice couch? Someone I talked to recently admitted that he spent more student loan money on CD's and stereo equipment (you can tell he went to school a few years ago) than he did on his education.
The second principle is that student loans are NOT easy to pay off. The average university student graduates with around $20,000 in debt. Starting salaries vary widely by profession and location, but somewhere around $45,000 is probably somewhere in the middle of the range for a bachelor degree. That might sound like decent money, but a typical one-income family will have trouble finding extra money for student loan payments after taxes and the many other expenses of life.
If the average student loan is $20,000, and a typical interest rate is around 6%, here are some examples of how long it would take to pay it off. $150/month: 18 years. $250/month: 8 years. $750/month: 2.5 years. $1000/month: almost 2 years. You might think that 2 years doesn't sound too bad, but even if you could spare $1000/month right out of college (not very likely), think of what else you could do with that $1000/month.
You could save for a $24,000 down payment on a house, you could buy a nice vehicle, or my personal favorite, you could invest it for 2 years. If you invested at a 10% return (if you starting investing a year ago, your return would have been more like 50-80%), it would become $26,500 in 2 years. If you just left that $26,500 in investments at 10%/year (the average stock market return over a long period of time) and did no other investing for the rest of your life, you would be a millionaire when you retire in 40 years ($1.2 million to be exact).
Are those extra comforts while attending school worth $1.2 million? I'll leave that up to you to decide.
If you have any questions or topics you want me to address, please email me!
Tuesday, May 4, 2010
Canada-US Differences
An FPU class member requested a summary of main differences between Canada and the US as covered in FPU. I thought this was a great idea, so I am sending it to everyone who is taking or has taken the class.
All of the underlying financial principles are the same, but there are some differences in applying these principles. I'm not an expert in any of these areas, so please correct me if anything I've mentioned is not accurate.
Dumping Debt
- Visa and Mastercard debit cards are not offered by every Canadian bank. 1st Choice Savings Credit Union is the only bank in Cardston that offers one (Global Payment Mastercard)
Credit Bureaus
- It's not quite as easy to get a free annual credit report from credit bureaus in Canada, but it is possible by following instructions on the credit bureau websites (www.Transunion.ca and www.Experian.ca)
- Unlike the federal Fair Debt Collections Practices Act in the US, debt collection practices are governed by each province in Canada. Information about Alberta can be found here: http://www.
Retirement Planning
- IRA, SEPP, 401(k), 403(b), 457 (US) = RRSP (much simpler in Canada!)
- No penalty for withdrawing from an RRSP (10% penalty on most US plans) unless the underlying investment has a withdrawal penalty (such as a GIC), but withdrawal is taxed as income
- One spouse can contribute to the others RRSP and still get the tax break (spousal RRSP)
- Roth IRA, Roth 401(k) (US) = Tax-free Savings Account (TFSA) (Canada)
College Savings
- ESA, UTMA, 529 (US) = RESP (Canada)
- Unlike ESA's, RESP's are not tax free, but the government does match 20% of contributions up to $2500 per year (contribute $2500, get $500 for free)
Real Estate and Mortgages
- Mortgage interest is not tax deductible in Canada
- No limit on tax-free gain on sale of primary residence in Canada
- Mortgage insurance in US is normally paid monthly and can be dropped when equity is more than 20%. Mortgage insurance in Canada (CMHC) is normally paid in full up front, either in cash or added to mortgage principal.
- We don't have the different types of mortgages - FNMA, HUD, VA
- Mortgage amortization periods and other options are far different in Canada, but there are too many options to list here. The biggest difference is that the common 30-year, fixed-rate, no prepayment penalty mortgage is not available in Canada.
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