Financial Planning 101
The Financialist • Issue 100 • January 2009
BY CORY HILL CFP CIM
Regardless of stock market conditions and interest rates, there are always proven ways to improve one’s financial position.
It is in these uncertain times that the tenets of financial planning should be reviewed to see what, if any, changes we can make to help improve our financial health.
Emergency Fund
This is often overlooked but nevertheless is an important part of any sound financial plan, regardless of one’s stage of life. The traditional rule of thumb is that three months gross income should be set aside for emergencies or to cover unforeseen expenses. Many will use a line of credit as an emergency fund. In the absence of short term cash savings, this will work; however, the ideal would be to have cash on hand to deal with an unexpected financial event.
Debt
Another tenet of sound financial planning is to reduce or eliminate debt as quickly as possible to reduce interest carrying costs and improve one’s personal balance sheet. The first debt we should pay off is our non-deductible, personal debt. This would be debt where there is no tax deduction for the interest costs. Then we should pay off the debt that carries the highest interest rates; and finally, pay off debts that have the lowest interest costs. In most households, the first debt to be paid should be consumer debt such as credit cards, lines of credit and chattel loans such as car loans. Once those are gone, one should concentrate on paying down the principal of their mortgage.
Increasing the frequency of payments will help to reduce the time it takes to pay off debt and will also help to reduce the interest costs.
Taxes
We are all supposed to pay the appropriate amount of tax vis-à-vis our income. However, CRA is typically not overly helpful when it comes to proactively pointing out deductions that we may miss. Therefore, it is incumbent on all of us as taxpayers to ensure that we pay the appropriate amount of tax.
This entails keeping track of our income and expenses that may have an effect on our taxable income, as well as receipts that may be used for deductions from our income. To file a tax return, we can enlist the help of a qualified tax professional for somewhat more complicated returns or there are some excellent tax programs available that do a good job at not only preparing and submitting returns electronically, but also have many intuitive features built in to help the average taxpayer spot deductions that may be available.
Savings
One sure-fire way to reduce our tax bill is to contribute the maximum allowable to an RRSP each year. In recent years there has been some debate on the merits of RRSP investing versus other types of savings plans. This is an important discussion to have with your advisor. Bearing this in mind, the RRSP still offers Canadians one of the best tax deductions available.
Insurance
We all need some form of insurance to protect what is valuable. Typically, the most valuable asset one has is their ability to generate income. It is an important part of any financial plan to ensure we carry the appropriate type and amount of insurance to protect ourselves and our families from an unplanned interruption in our income, to protect our estate from the effects of taxation and to ensure a level of security for our loved ones, should we pass away.
Estate Planning
We should all seek to simplify and document our estate to the best of our ability. This includes having an up to date and professionally written will, power of attorney and in many cases, a representation agreement for healthcare decisions.
You should review your will and other estate documents periodically to ensure they are still relevant and accurate. As well, it is important to review beneficiary designations on various investments to ensure they do not conflict with the will or add confusion to your estate plan.