November 2011 – Adviceon Library

What are the main benefits of investing in mutual funds?

What are the main benefits of investing in mutual funds?

The average investor, who buys stocks and bonds, does not have the necessary time to assess securities, nor the expertise to make qualified investment decisions. Mutual funds allow the investor to effectively hire a fund manager to make these decisions. Managers possess training in market analysis and have an understanding of economics. They work to assess the value of a company’s stock and develop an investment strategy that establishes buy and sell criteria, based on an educated, tactical discipline.

Some of the main benefits include:

Instant Diversification. Many have heard the phrase, “don’t put all of your eggs in one basket.” In a mutual fund, investor monies are spread across a variety of different securities investments. By investing in mutual funds, as opposed to individual securities, the account growth or loss is based upon a group of different investments, rather than the performance of a single security.

Professional management. By investing in mutual funds, the investor is not involved in the evaluation and maintenance of the underlying portfolio investments. Instead, the day-to-day decisions of each fund are handled by experienced, professional money managers.

Lower fees and expenses. Mutual funds provide economies of scale. Because mutual funds pool the resources of many investors, the fees per share passed on to each individual investor from purchasing the underlying securities in a mutual fund are often less than if they would purchase the same individual securities on their own.

Convenience. Dividends and capital gains can be used to purchase additional shares, facilitating growth to an investor’s portfolio.

Automatic Investment Planning. Commonly, investors are able to set up a dollar cost averaging plan with their bank or brokerage account to invest a set amount each month into the mutual fund of their choice.

Thousands of mutual funds to choose from. Every type of investment fund—including equity funds, bond funds, diversified funds, balanced funds, and international funds—give you access to investments in the world’s strongest companies.

You can also invest among foreign securities. Although Canada has a strong economy and is a G5 nation, it represents approximately 3% of the capitalization trading in non-domestic markets. The U.S. offers access to the highest capitalization in the world, while tremendous investment opportunity lies outside of North America—accessible via mutual funds.

Financial Consultation. Your financial advisor can help you design your mutual fund portfolio and review it with you on a regular basis. Most advisors offer the majority of the better-performing funds—with both foreign and Canadian securities included, including a wide range of international and global funds.

What is the purpose of life insurance?

Individual life insurance is primarily designed to protect against the financial loss that can occur with the death of a loved one. While individuals are typically very good at insuring their car or their home, they frequently do not insure their most valuable asset; their ability to earn an income. Life insurance provides a death benefit that can provide much-needed income to support your family, your business, or to send your children to college. Additionally, life insurance may offer many tax advantages.

There are two types of individual life insurance: Term life insurance and permanent life insurance. Both term and permanent policies offer an income tax-free death benefit to the policy beneficiaries. There are, however, several key differences to keep in mind when purchasing the right life insurance. It is one of the most important decisions that you can make.

How does life insurance protect my income in the future?

In the event of the death of the insured, life insurance is designed to create capital precisely in the unpredictable event of death. It provides a precautionary financial strategy to stabilize the financial security of loved ones reliant on your income or your capital provision.

Current one-time capital uses are provided by life insurance, such as:

Pay off liabilities such as credit cards, bills outstanding, loans, and/or estate taxes upon death.
Pay for the final expenses associated with a funeral and burial.
Create money to pass on to heirs such as children or a spouse.

An ongoing future use of capital is provided by life insurance, such as:

Investments can be purchased from which to create an income to cover the living expenses of a family; often providing for the retirement of a spouse.
Funds can establish a trust, from which family can acquire income.

What if an insured lives and cannot work due to a disability?

The individual should include some form of disability coverage to replace his or her income. Talk to your advisor about the following other types of insurance:

Income Replacement Insurance: This covers a percentage of your income in the event that you cannot work for a certain period of time due to a disability; some allowing coverage for a lifetime.
Critical Illness Insurance: In the event of a critical illness such as a stroke or heart attack, a significant lump sum benefit can be paid, depending on the plan’s coverage.

Check your group insurance benefits at work which should be considered when buying the above insurance.

Can insurance protect my financial security if I have a critical illness?

Our provincial health plans do not allocate funds to help patients who face a critical illness, to recover financially. They are established, not to build or replace wealth, but to provide basic health care. If you have little or no income, these plans would pay you only a small disability benefit if you meet specific situations. ¹

1. Lump-sum benefits are paid: Critical illness insurance offers a lump-sum payout of cash if you are diagnosed with a critical illness covered by the policy (such as stroke, heart attack, or cancer). Its purpose is to provide a considerable amount of money (referred to as a living benefit).

2. Allows time to convalesce: The critical illness insurance capital can help you convalesce over longer periods and in the company of loved ones, without a concern that the expenses related to a previously enjoyed lifestyle must be immediately eliminated. After all, there may be an extended time necessary to recover before you can return to work.

3. Money for exceptional health care: Critical illness insurance can fund expensive drugs or out-of-country health care. You may need to employ a private nurse to live in your home, hire a nanny, receive physical therapy and/or renovate your home to meet accessibility needs related to the illness. Critical illness insurance can help pay these bills.

4. Critical illness insurance enables a career change: Due to medical advances, many people totally recover from critical illnesses and re-enter the workforce. Unfortunately, many others live the rest of their lives partially disabled, unable to do the same work. There may be a need to finance training for a career and search for new employment. Before you establish a new source of income, where will your money come from? Critical illness insurance keeps you financially stable through a critical illness.

¹ Canada Disability Benefits – Canada.ca

What is a Mutual Fund?

A mutual fund is a pool of investments managed by an investment firm using a variety of instruments such as stocks, bonds, or government securities. When one purchases shares of a mutual fund, the investment firm (not the individual investor) is responsible for the day-to-day investment activity of the securities within that fund.

There are many funds to choose from.

There are a variety of different types of mutual funds available today, ranging from balanced funds, bond funds, blue chips, small caps, foreign funds, and more. Each mutual fund is very different in its make-up and philosophy, for instance some funds own hundreds of different securities, while others may own only a few dozen.

Mutual fund companies do not guarantee returns and investors need to be aware that there is the potential for negative portfolio or market performance that can lead to the loss of money in mutual fund investments. An investor should look for funds with objectives and risk levels that match those of his/her financial strategy.

Using Mutual Funds in your Registered Education Savings Plan (RESP)

Mutual Funds allow the investor the same access to securities as the institutional investor—access to stocks and bonds from many different companies. Moreover, mutual fund investments can gain the tax-advantaged benefits if they are registered in one or more of several savings plans offered by the Canadian government.

Mutual funds area great way to diversify your Registered Education Savings Plan (RESP). You can start investing in mutual funds for your child’s education long before he or she reaches college or university age. Small monthly investments can add up over time to cover all or part of the following costs: tuition, books, accommodation, a cafeteria food plan or weekly groceries, a car payment plus insurance and gas or public transportation, furniture, a telephone, and of course spending money.

The Canda Education Savings Grant (CESG)

The bonus of the RESP is that the government actually grants you a percentage of your contribution. Thus both your contribution and the government’s grant are invested in the RESP. The added benefit of reinvesting the 20% government grant ¹ automatically in the mutual fund creates, even more, potential compounding. The RESP will grow tax-deferred until your student needs it. You can diversify among many types of funds which invest in companies of several international countries. For CESG information click here.

Mutual funds can enjoy tax deferral in the Tax-Free Savings Account (TFSA). The TFSA is a great investment if you are a member of a pension plan and have minimal if any, room to invest in your RRSP due to a high pension adjustment (PA) factor.

Educational Savings Use You can also supplement RESP savings through the TFSA. After-tax investments grow tax-deferred and there is no taxation on withdrawal. This makes the TFSA versatile for deferring investment taxation, plus avoid taxation upon withdrawing monies for numerous uses. However, the TFSA will not offer the benefit of the CESG.

¹ Check here for the limit on the CESG.

Source: CRA

What final expenses occur after my death?

Many watch their parents grow older, and some are passing away. Children of aging parents could face the unpleasant task of last minute planning and subsequently receiving invoices for large funeral and burial expenses.

It is wise to plan your burial ahead—even if you are in great health—by establishing dialogue with everyone concerned. In addition, make sure that you have a will in place that reflects your wishes. Funeral and burial expenses can be expensive. Think over some planning questions now to evaluate your options such as:

• Should the service be in a religious sanctuary? Some people are very committed to their religious affiliation. Often in these cases, the service is held in a sanctuary where the congregation is present.

• What funeral home should be selected? Usually people select one that has been used for other family members over time.

• How do I make arrangements with the funeral director? They are professionals who take care of the many details of the services. Your loved ones will appreciate this preparation.

• Has my burial option been selected? The common burial methods are: earth (and should the plot be near other family members?), cremation, or mausoleum.

• Who shall speak on your behalf at the service? Often your religious leader or someone close to you will say a few words at your service, working with the funeral director.

• Should you request a donation to a charity in lieu of flowers? The immediate family can buy flowers, working with the florist and funeral director. Others might want to donate to a charity of your choice.

• How can you get the best value for services rendered? Each funeral director will have various packages and prices to offer.

• At what location will the after-service (with food, coffee, tea, etc.) be held? Typically, they are held at the home of the deceased or a relative, a religious sanctuary’s social hall, or at the funeral home.

Methods of payment for these expenses. You can prepay your funeral package all at once or by making installments, or you can use life insurance to pay for it later with a tax-free benefit, specifically when needed at death, thus freeing up more cash for retirement. By making these decisions now, the pre-arrangements can save your family a lot of last minute stress and money.

Using life insurance for funeral and burial expenses. The timing of a life insurance benefit payouts is specifically designed to cover cash needs at death, one of which includes final expenses. Consider purchasing a life insurance policy to cover any amounts in excess of your pre-arranged funeral expenses. If it amounts to $50,000, buy a permanent policy for that amount (such as whole life, or term-to-age100).

Life Insurance for parents’ funeral expense. Often children will work to share the premium with siblings for a life insurance policy on the lives of one or both parents to cover their last expenses. This is preferred to the children needing to come up with the cash all at once. Additionally, it allows all the children paying the premium together, to help mom and/or dad. Life insurance works to solve these problems, while creating new cash right when it is needed.

How do you insure your estate taxes?

Your heirs will inherit certain assets tax-free, but not all. Life insurance can cover estate liabilities which would otherwise leave your beneficiaries with debts rather than an inheritance.

“Are you kidding? I thought I would inherit.” Hopefully your children won’t need to utter these words upon your death. Cash bequests, the house, life insurance proceeds, and heirlooms generally pass to the heirs tax-free. However, capital assets are assumed to have been sold at fair market value immediately before death. Each of these deemed dispositions of capital assets such as a cottage occur even if the asset is willed directly to an heir. But the tax liability remains in the deceased’s final tax return and reduces the value of the estate.

Here is the downside. If there is insufficient cash to pay the taxes due, assets your heirs may expect to inherit must be sold. After the death of a second spouse this can include assets such as: an old homestead property, a family cottage, a residence, your farm, an art collection, furniture, or business shares.

Consider taking out life insurance to cover any estate liabilities that could reduce the value of bequests that you want to make to your loved ones. A death benefit is paid out tax-free. Life insurance proceeds can circumvent probate if they are payable directly to a named beneficiary. If the estate is the beneficiary, the life insurance coverage should be raised to cover any probate fees.

How can I make my Will Planning more effective?

Have you decided what will happen to your property after you die? Without a last will and testament (commonly called a ‘will’) the law decides exactly how your estate (the things you own) will be divided among your surviving spouse, children, siblings and parents. When you have your lawyer draft a will, you can make certain your priorities are set forth as directives to be achieved.

• Choose a competent executor. An executor is appointed with the task of administering your will, or carrying out your wishes. You may also want to choose a contingent executor, just in case the first decides not to follow through or is unable to for any reason.

• Incorporate your will with your spouse’s will. This is referred to as a “reciprocal will”. It looks at various potential occurrences such as: “What if my spouse and I die at the same time?”

• Give instructions regarding the type of funeral you desire. Talk with others while living. It is important to visit with your Funeral Director and express to him or her clearly if you would like to be cremated or not, and/or interned at a cemetery, and where (is a plot chosen in advance, say beside a loved one).

• Divide assets specifically amongst chosen heirs. Should you wish to leave specific items to a certain person, make sure this is written in your will. This will avoid confusion amongst your beneficiaries.

• Establish contingent beneficiaries. This can ensure heirlooms pass on to other friends or relatives in the event that current beneficiaries have died.

• Where children are concerned, define legal guardians, and contingent guardians. A will can allow you to choose who will care for your children if both you and your spouse die.

• Outline financial arrangements for your dependents. Review life insurance policies to ensure that they provide adequate capital protection for your loved ones.

• Pre-establish special trust funds, and trustees for dependents, where necessary. Consider how monies are to be invested, and at what age each child should receive his or her share of any monies left to them.

• If divorce is imminent, have your lawyer explain your responsibilities in the Family Law Act and how the law may relate to you and your will. This will define who has a right to financial support after you die. You may want to leave certain assets to the children in trust if a divorce occurs. If you own a life insurance policy, you may be able to change the beneficiary to pass the death benefit to any party tax free, or perhaps pass the funds to your estate and let the will define the beneficiaries of the life insurance.

• Where a spouse is concerned, be careful not to direct a disposition of RRSP assets. Under Canadian Tax Law, RRSP assets are allowed to rollover to a spouse on a tax-free basis. By naming your spouse as your beneficiary, you can ensure that your RRSP assets roll over to your spouse without any complications.

• Consider bequests to charity. Assets such as property or life insurance proceeds can be left to a charity via your will.

Can life insurance solve tax liabilities in my estate?

There are many ways to reduce your estate liabilities. You work hard to earn a living, save for retirement, and own property. It is important to know what your estate liabilities are in relation to: capital gains, mortgage debt, car loans, unpaid taxes, and business-related liabilities. Consider reducing these liabilities:

Reduce the impact of income taxes. Here are some methods to reduce taxes due upon your death:

Use the spousal (and disabled child) rollover provisions of RRSPs or RRIFs.
Leave assets that have accrued capital gains to your spouse to defer tax.
Leave assets without capital gains to other (non-spouse) family members.
While you are alive, gradually sell assets having capital gains, to avoid dealing with the gains all at once in your estate.
Purchase life insurance to cover capital gains taxation in the estate.
Taxes may be payable on gains in relation to:
º income-producing real estate, a second residence, or cottage.
º any other assets left to surviving family members, such as shares of a business.
Consider charitable donations to lessen taxes in the estate.

Reduce probate fees. Probate fees will be based on the value of assets administered through your will. Here are some ways to reduce probate fees:

Establish a spousal trust during your lifetime to hold assets or property for the sole use of your spouse.
Own assets jointly with your spouse.
Distribute assets or cash while alive.
Name a beneficiary (not the estate) on life insurance policies.
Include an alternate beneficiary on your life insurance policies in case your initial beneficiary predeceases you, or dies simultaneously (that way, probate fees will be avoided on the proceeds).