After a divorce and relocating across the country, I rebuilt my financial infrastructure. Divorce leaves a lot of people with their financial life in ruins and I was no exception. I set out to not only rebuild, but to flourish. I put my education in financial planning to use, I put my planning and organizational skills as an engineer to use. The concepts in these documents are not new, but they are organized in a logical sequence. My hope is to create a step-by-step guide that will help people to rebuild themselves financially.
Reassessing ourselves financially is a healthy practice from time to time, as our needs and goals change. While my restructuring was caused by a divorce that tore my financial foundation in half, you may choose to reassess your situation for any number of reasons. Any reason, or no reason, is a good reason to re-consider for financial situation. This series may also be valuable for young people that are just starting out in life. All of the same recommendations and strategies apply for building as they do for rebuilding.
With today’s online banking environment, it has never been easier to have all of your accounts and financial tools at your fingertips 24/7. This fact makes financial restructuring easier and more powerful than it has ever been before. To easily and instantly move money from one account to another, it is recommended that all of your accounts be with the same financial institution. It’s also important that the institution have a strong on-line banking interface that will allow 24/7 access to your finances. During my marriage, we used Bank of Montreal. So for my post-divorce rebuild, I chose a different institution.
I did that just to maintain segregation from the accounts that were joint. If you are divorced, it’s important to make sure that your accounts are yours alone. I have been using RBC for about 10 years now. By maintaining my mortgage, credit card and an investment account (either an RRSP or a TFSA), my monthly fees are waived so that I enjoy ‘no charge banking.’ RBC’s online interface allow me to access all of my accounts 24/7. To me, that’s banking as it should be…. Free, 24/7 and from home! Let’s take a closer look at each account and how we will fit them into our framework.
Operating (or Chequing) Account
The operating account is the all-purpose account that will function as both an accumulation point for your income and also as a distribution hub for your bills and budgeted monthly expenses. It is also the account that your bank will charge for. All income enters the system via the operating account. This allows us to take an organized approach to accumulating our wealth. All bills and budgeted living expenses are paid from the operating account. Standard payment methods include; on-line bill payment, Interact transfer and cheques.
Take the time to understand the service charges on this account. Operating accounts often assign fees for cheques, Interact payments and on-line bill payments. Depending on how many of these transactions are used monthly, it may be worthwhile to upgrade your account to a plan that does not charge for the transactions you use most often.
Fees: I have a credit card, a mortgage and an investment account at the same bank. I did that because with ‘bundling’ my operating account is free. Once my account was free, I upgraded my account to a level that does not charge fees for the digital payment methods described above. Searching for an operating account that will cater to your needs in the cheapest way possible is very import to your long-term plans. In my case, I could not get my account to be free of charge right away as I needed a mortgage to get there. But, I had planned to do that from the start. Rome wasn’t built in a day and I wanted to enjoy free banking for the long-term. So I planned for that. Below is a look at the RBC choices for a chequing account.
Any funds that have entered the operating account that are not being used for monthly expenses are moved to the savings account using the on-line transfer function.
Short-Term Savings Account
My short-term savings account is called an ‘RBC e-Savings’ account. It’s free as long as I don’t use tellers or bank machines to manipulate the funds within the account. Since I had researched the account characteristics before I created my infrastructure, I was able to build processes that leveraged the free aspects of my accounts. I always move funds into or out of my savings account using on-line transfers. That helps me to not pay bank fees. My savings account provides two important functions for me, those are explained in greater detail below.
The savings account functions as an emergency fund, also called a ”rainy-day“ fund. Once the monthly bills are paid, all excess funds are allocated to the rainy-day fund. Experts differ on how much is recommended in this emergency fund. The important point is to have an amount of cash that is readily accessible for unforeseen expanses. The amount in your emergency fund will depend on a couple of factors; how much do your monthly expenses add up to (many experts recommend holding enough funds in your emergency account to be able to pay two months expenses) and how accessible your longer term savings are (more on that below).
The savings account also acts as a place to accumulate any funds above and beyond the emergency amount to be transferred to longer term savings. As longer term investment vehicles require a minimum deposit amount, extra funds can accumulate here until there is enough left over to be deposited into the long term account.
Firstly, I want to explain that, in this case, long-term does not have a defined time period. The amount of time that funds remain in your long-term savings can vary based on your goals. If you are saving for retirement, then the funds should stay in there until retirement. But many people will save for other objectives. I used a long-term vehicle to save for a down payment for a mortgage for a condominium. Some may save for a car. There are no bad goals here, only tips to help you to achieve them. When selecting a long-term vehicle, we consider growth potential, potential risk and tax consequences. Tax laws vary based on the country that you live in, so please check your laws and act accordingly.
I have selected two separate long-term accounts. I use each to my advantage, by leveraging their individual characteristics. It’s important to understand the individual details of your accounts. Many long-term accounts have minimum contribution amounts, some as low as $25.00. Some accounts have limitations. As an example, it can take three days to access or withdrawal your money. An investment account that is easily available may provide less favorable returns. A person’s specific saving goals will help to shape which strategy is best suited to these goals. Below is an outline of the accounts that I have selected for my longer-term savings.
Tax Free Savings Account (TFSA)
Once your (after-tax) savings are deposited into the TFSA, the savings can grow without tax consequences to the growth (profit). Most TFSAs, including RBC’s, can be ‘self-directed’. This allows you to select the type of investment that you want to use within the TFSA. Funds within the TFSA can be invested into a financial vehicle that reflects both your risk profile and withdrawal plans. It is important to mention that financial advisers frequently consider the risk with an eye towards the length of the investment. As the funds discussed here are for property acquisition, the time-frame is much tighter, and therefore the risk profile is much lower. The withdrawal plan is estimated to be one to two years. For this strategy, the acceptable risk profile is assumed to be NO RISK. With no tolerance for risk, the tax free interest earned will be lower. The 2017 contribution limit for a TFSA is $52,000.00, this is far more capacity than was needed to purchase a property.
Registered Retirement Savings Plan (RRSP)
When you invest in an RRSP, the federal government provides a tax deduction in the amount of the investment purchase. Therefore, RRSPs are considered to be purchased with money that has not been taxed. The RRSP money is then taxed as income at time that it is withdrawn. If the investment is left alone until retirement, the RRSP is then converted into a Registered Retirement Income Fund (RRIF). A RRIF has it’s own set of rules on how the money is withdrawn. Canada does offer a First Time Home Buyers’ program (FTHB) that allows Canadians to ‘borrow’ from their RRSPs, up to $25,000, to purchase a home.
This would be an excellent strategy for existing money as it would allow an immediate purchase, but it is not the smartest saving technique for this plan. The FTHB program dictates that the funds withdrawn from the RRSP must re-paid to the RRSP within 15 years. For that reason, the FTHB program is not the most efficient vehicle for someone that is starting to save for a property purchase. As you open an RRSP, your financial institution will be happy to provide an expert to assist you in selecting an investment that will suit your goals. The experts are paid by the institution or fund company, so there is no need to pay them directly.
TFSA and RRSP Investment Options
Both TFSAs and RRSPs will offer investment options within the account. The options will be determined by the financial institution. At RBC, the options include any mutual funds that RBC manages, guaranteed income certificates (GICs) or cash savings at a pre-determined interest rate. The options are shown below. As the options will be limited to those offered by the bank, it’s important to select your bank carefully. Bearing in mind the characteristics of the two savings accounts, I use them for very different purposes. I used this account when I was saving a down payment for a condominium. I currently use the TFSA for my property taxes, which I accumulate all year long. I use the RRSP for retirement savings.
Pre-Authorized Contributions (PAC)
The smartest way to accumulate wealth is to begin with a Pre-Authorized Contribution (PAC). Once you have a steady income that exceeds your living expenses, setting up a PAC through your bank account is easy and the savings happen automatically. By configuring automatic deposits from your primary account, scheduled for every payday, you do not see or miss the funds that are being contributed. PAC deposits can be made to either the Savings or the Investment account depending on your financial institution.
In creating these accounts, we are creating a logical flow for our wealth. Here is how this system works for me. All income goes into the operating account, usually by automatic deposit. All bills and budgeted living expenses are paid from the operating account. Standard payment methods include; on-line bill payment, Interact transfer and cheques. Paying bills in cash is a bad idea. The payment methods that I have suggested here provide a digital receipt that is very difficult to lose. Paper receipts often get misplaced or destroyed. Any leftover funds are moved to the Savings account. This account maintains a predetermined balance as an Emergency fund. If the new balance of the Savings account is high enough to cover both the Emergency fund and the minimum deposit amount for an investment account, then a deposit of the minimum Investment deposit amount is made to the investment account.
Below is our infrastructure, incorporating all of the ideas above.
Note: A monthly budget is strongly recommended as an important part of this process. We will discuss budgeting in the next article in this series. This process allows you to easily save any funds that are over and above your monthly expenses. This is a great way to save your extra pennies, and to turn them into dollars.