Regulatory Change Helps Drive Popularity of Fee-Based Investment Accounts


The investment services industry is changing at a dramatic pace, with investors demanding more choice, more transparency, and more personalized advice. One of the fastest growing trends within the financial services sector is the use of fee-based accounts. While there are many reasons for the increasing popularity of these accounts among advisers and clients alike, recent regulatory changes have been a major catalyst.

Traditional vs fee-based account structures

In the past, the most common type of account structure has been a transactional one, wherein commissions are charged for each buy or sell transaction. With fee-based accounts, however, advisers do not receive commissions—instead, they agree to a set fee schedule, usually charged on a quarterly basis. This fee is normally based on the portfolio’s market value and composition. Buy and sell recommendations are based solely on the client’s strategic needs and goals. If an investor’s account increases in value, so do the fees paid to the adviser; conversely, if an investor’s account declines in value, so do the fees paid. With a fee-based structure, the adviser has a direct (and overt) incentive to ensure that the investor’s account increases in value.

Client relationship model initiative enters second phase

The recent increase in the use of fee-based accounts correlates to a large extent to the implementation of the second phase of the “Client Relationship Model” (CRM), a regulatory initiative passed by the Canadian Securities Administrators in March 2012 The CRM affects both the Mutual Fund Dealers Association and the Investment Industry Regulatory Organization of Canada.

While the key objective of CRM1 was relationship disclosure and enhanced suitability, the key objective of CRM2 is to increase transparency/disclosure for investors with regard to fees paid, services received, potential conflicts of interest, and account performance. All of these mandatory disclosures are being phased in from 2014 to 2016.

In July 2014, CRM2 mandated pre-trade disclosure of all fees prior to an investor agreeing to buy or sell an investment. With a traditional transactional account, an adviser must disclose all of the fees a client is required to pay, such as any commissions for transactional accounts when buying or selling positions. However, many investors have complained about “hidden” and unexpected fees, especially with respect to mutual funds. With CRM2, all of these fees now have to be fully disclosed prior to the transaction.

This move to greater transparency is a major shift from certain types of transactions that had no disclosure requirements in the past. For example, an adviser used to be able to purchase a bond and embed their commission in the cost of the bond on the trade confirmation slip. Now, fixed income trades also require full disclosure. In other cases, even if there was disclosure in the legal sense of the word, understanding this disclosure required clients to read the fine print in lengthy prospectus documents. Similar CRM2-type regulations for full disclosure were implemented in Australia and the UK in 2013, requiring transparency regarding all fees. Not surprisingly, this resulted in a significant reduction in the number of financial advisers working in the industry in both countries. It’s possible that we could also see a reduction in the number of advisers here, once the new rules are fully implemented in Canada.

Fee-based accounts are already onside of the new rules, as transparency is embedded in their structure: The client has a discussion about fees with their adviser up front, and a fee-account agreement with full disclosure is then signed by both the investor and the adviser. 


Another reason for the growth in popularity of the fee-based platform is the fact that many advisers now offer a comprehensive wealth offering, which includes both investment and planning-related services. This differs from the role of the stock broker of the past.

Clients have a variety of financial planning needs, primarily with regard to retirement and estate planning. Many advisers can offer detailed financial plans and provide access to experts in related areas, such as insurance, and will and estate planning. An adviser will often communicate with the client’s accountant and lawyer to ensure everyone is on the same page.

In a traditional transactional account where commissions are charged for every buy or sell, it has always been challenging for advisers to be compensated for additional services such as financial planning. Consequently, many transactional-based advisers simply would not offer these services to their clients.

Some unique benefits

Certain benefits are unique to fee-based accounts.

Rebalancing without additional cost

For example, this structure enables wealth advisers to rebalance portfolios as needed to reduce risk at no additional cost. Multiple types of rebalancing are important when managing risk. At the macro level, let’s assume a client’s optimal asset mix is 60% in equities and 40% in bonds. After a period of strong equity markets, the client’s equity percentage rises to 68%. Reducing equities by 8% and allocating this to fixed income is rebalancing at the macro level. At the micro level, there is an optimal position size for one holding. In this example, let’s assume the optimal position size is $24,000 for each company held in the portfolio. If one stock rises significantly above or below the optimal position size, then consideration for a rebalancing trade should occur.

Several trades could be required on an annual basis to rebalance a portfolio. With transactional accounts, the commissions for doing multiple small adjustments would likely be prohibitive. However, not doing the trades because of the commission payable in a transactional account means that you’re not managing risk as effectively.

The adviser’s ability to make tactical shifts in an account is another benefit of fee-based accounts. For example, there are times when investors benefit from moving in or out of USD-denominated holdings. Being able to make these changes when the currency is right should be done without concern for the trade’s commission cost. Being able to move between sectors based on current outlook can also be strategic, especially when transaction charges are not a factor (if a transaction charge is 2% to sell and 2% to buy, then the cost of any switch trade has to increase by 4% to break even).

Income splitting and “householding”

Fee-based accounts also offer couples and families one more opportunity for income splitting by setting up account-designated billing for their fees. For example, the higher income spouse can pay the fees for the lower income spouse. Let’s assume the lower income spouse has an RRSP and a TFSA. The higher income spouse can put funds into the lower income spouse’s account as a contribution of fees without attribution. In another example, a client with multiple fee-based investment accounts (i.e. one non-registered and five registered) can arrange to have all of the fees paid out of the non-registered account.

“Householding” is a term used in fee-based accounts to link accounts together for fee-billing purposes. As the total of the householded assets increases, the percentage fee for the adviser’s services decreases. Let’s say we have a middle-aged couple with $400,000 in investments. The couple has parents with $680,000 in investments, over which the couple has power of attorney. The couple also has a corporate account totalling $120,000 in investments. By householding, or combining all accounts under one agreement, the household value becomes $1,200,000, which results in lower overall fees for everyone.

Deducting investment council fees

Another benefit of a fee-based structure for non-registered accounts is the ability to deduct investment council fees as “carrying charges and interest expense.” Many investors are still not aware of these tax benefits. Anyone who has non-registered accounts would be well advised to read the Canada Revenue Agency’s (CRA) interpretation bulletin on this topic (IT-238R2). The investment council fees cannot be deducted for registered accounts, but there is the benefit of paying the fees for registered accounts from a non-registered account, especially for younger clients where registered accounts are deferred for many years.

Adviser-managed accounts

Over the last several years, adviser-managed accounts have been the fastest growing segment of the broad fee-based group. In this type of account, the adviser is licensed as a portfolio manager and able to use his or her discretion to execute trades.

In setting up the adviser-managed account, one of the criteria is that the account must be fee-based. The regulators have made it clear that a portfolio manager is not permitted to use discretion when it comes to commissions or transaction charges. One of the starting points to setting up a managed account is to get a clearly defined investment policy statement that sets out the relevant guidelines that will govern the management of the account. At this same time, a fee-based agreement is signed that clearly outlines the negotiated fee structure.

Shifting to a new model

As the financial services industry continues to change and evolve, so do the solutions being offered. There is now more flexibility and choice in how a wealth adviser and an investor can work together.

High-net-worth clients are looking for advisers who have the credentials and licensing to offer discretionary portfolio management. Within that context, there is also an expectation that financial planning and other related services will be part of the overall fee-based structure. The traditional model of solely doing stock trades for trading commissions is becoming an increasingly difficult business model to sustain.

Kevin Greenard is a portfolio manager and associate director of wealth management with ScotiaMcLeod, a division of Scotia Capital Inc. and ScotiaMcLeod Financial Services Inc.

Exploring the world of fixed income investments

The term fixed income can be confusing, especially when the financial industry has so many names for the same thing. For someone new to investing I typically draw a line down the middle of a page. On the left side of the page I label this “debt”, and on the right hand side I put “equity”. Debt is another term often associated with “fixed income”. In explaining what debt is I begin by using a simple example, a two year annual pay Guaranteed Investment Certificate (GIC). With a two year GIC you are giving your money to a company and in exchange you receive interest for the use of the capital. You receive your original capital back at the end of two years. You have no direct ownership in the company with debt.

The equity side of the page would have common shares, this is what most people would directly link to the stock exchange. Although some fixed income investments trade on a stock exchange, the majority of listed securities are equities. When the news is flashing details of the TSX/S&P Composite Index, the Dow, or the S&P 500 – these would all be equity indices reflected on the equity side.

Most people would agree that on the equity side of the page it would not be a good idea to put all your eggs in one basket. A prudent approach would be to diversify your equities by holdings various different stocks (i.e. between 20 and 30 different companies) in different sectors and geographies.

All too often I come across investment portfolios that have zero diversification on the fixed income side. As an example, it may be a person that has $500,000 or a million dollars all in GICs. In my opinion the best approach to fixed income is to have diversification – different types and different durations.

If we move back to the left hand side of the piece of paper, underneath debt we have already listed GICs. Let’s list a few other types of fixed income investments including: corporate bonds, government bonds, real return bonds, bond exchange traded funds, notes, coupons, preferred shares, debentures, bond mutual funds, etc.. Over the last decade there has been a huge growth in non-domestic bonds for retail investors. Perhaps one area that is often underutilized by many Canadians is the use of international bonds. Bonds are available in different developed countries. Advisors are able to purchase direct foreign bonds in developed countries and emerging markets. The emerging market bond space has opened up many different opportunities. With certain structured bond investments, these can be hedged to the Canadian dollar or not hedged (you are exposed to the currency risk).

Within each of the above main categories there are sub-categories. As an example, with bond ETFs one could purchase numerous different types, including: floating rate, short duration (example: one to five years), long duration, all corporate, all government, high yield, US bonds, etc.

Another example of subcategories can be explained using preferred shares as an example. Preferred Shares are generally classified as “fixed income” even though they pay dividend income (similar to common shares that are on the equity side of the page). For clients who have non-registered funds, a portion of your fixed income in preferred shares can be more tax efficient than interest paying investments. The main types of preferred shares are retractable, fixed-reset, floating rate, perpetual, and split. All have unique features that an advisor can explain to you.

When equity markets perform well it is natural that they become overweight in a portfolio. We encourage clients to periodically rebalance to their preferred asset mix. In good equity markets this involves selling some of the growth in equities and purchasing fixed income investments. When equity markets are declining, the process of rebalancing could result in selling fixed income and purchasing equities at lower levels.

The idea of adding “fixed income” is not that exciting in this low interest rate environment, especially when many “equity” investments have yields that exceed investment grade short duration bonds. Opportunities still exist in fixed income for reasonable yields, especially when you explore different types of fixed income. One always has to assess the risks they are comfortable with. As an example, I ask clients what they feel is the greater risk, stock market risk or interest rate risk. By stock market risk, I define this as the risk that the equity markets will have a correction or pull back (say, 10% or greater). By interest rate risk, I mean that interest rates will jump up materially and do so quickly (in a short period of time).

Every model portfolio I manage has fixed income. This is the capital preservation and income side to a portfolio. The percentage in fixed income really comes down to a clients risk tolerance and investment objectives. Time horizon and the ability to save additional capital is also a key component in determining the allocation to fixed income. It is important to first determine the right amount to allocate to fixed income, and second, to diversify it to enhance liquidity and overall returns.

Kevin Greenard CA FMA CFP CIM is a Portfolio Manager with The Greenard Group at ScotiaMcLeod in Victoria. His column appears every second week in the TC. Call 250-389-2138.


Fee-based accounts benefit investors in the long run

A fee-based account is a tranparent way of paying your financial advisor.  The fee is charged based on the market value of the assets being managed, and it is distinctly different than a transactional account, where commissions are charged for every buy-and-sell transaction. 

When clients open up a fee-based account, they sign a fee-based agreement that establishes the agreed upon fee, how the fees are calculated, when the fees will be charged and the accounts involved.   

There are a number of benefits for clients in moving to a fee-based account. 

Working on a “fee for service” basis, rather than a commission or transactional fee basis, means the best interests of the client are more aligned with those of the advisor. If fees are based on the market value of the account, then the only way an advisor will be compensated further is if they can grow your account in value.  If your account declines in value, then so does the compensation paid to your advisor.  

Another benefit of a fee-based account is the additional services clients receive from their financial advisor.  Financial professionals today are rarely called stock brokers because the services offered extend well beyond buying and selling stocks. Financial planning meetings cover many topics such as tax and insurance as well as education, retirement and estate planning. 

Financial professionals today spend a significant amount of time understanding each client’s needs and integrating this into an increasingly complex tax and regulatory environment. 

As a result, the amount billed for fee-based accounts is referred to as an “investment council fee” for income tax purposes.  The main benefit is the fees relating to non-registered accounts can be deducted on your income tax return as a carrying charge.  If your fee is one per cent before tax, and your marginal income tax bracket is 30 per cent, your fees have a net cost to you of only 0.70 per cent.   

Fees are typically charged quarterly. As an example, Jane Wilson opened a new fee-based account and invested $750,000 on Jan. 1 with an annual fee of one per cent.  She will have no fees charged for three months. Around the middle of April, the first quarterly fees would be charged at $1,875 ($750,000 x 0.25 per cent).  Wilson’s fees are one-quarter of one percent after each quarterly period. 

Other methods of compensating that are not fee-based often have commission charges upward as high as five percent on the first day of buying the investments. For an advisor to be successful with a fee-based business, he or she needs to establish good long term relationships. 

The periodic payment of fees better aligns the interests of clients and financial professionals.  When explained to clients, most would prefer to spread out the fees over time as services are provided versus paying a large amount on the first day.  

One question we are asked is how the quarterly fees are actually paid.  To illustrate we will use Don Spalding, who has three investment accounts totaling $750,000 – $500,000 in a non-registered account, $200,000 in his RRSP account, and the remaining $50,000 is in a Tax Free Savings Account. 

There are a few different options for how Spalding can cover the quarterly fees. 

The first option is to have the fees charged to each of the respective accounts.  Wilson had only one account and the fee of $1,875 was simply charged to that one account.  Mr. Spalding has three accounts and each account is charged the respective amount based on one-quarter of one percent of the market value of each account. 

The first quarterly amount for Spalding is $1,250 for the non-registered account, $500 for the RRSP, and $125 for the TFSA.  He has the option of keeping cash in each account to cover the fees, depositing cash quarterly or selling investments. 

With fee-based accounts, Spalding has the option to instruct us to designate the billing of the fees to come out of one account.  Don could instruct us to pay the fees for his RRSP and TFSA accounts from the non-registered account.  This enables him to maximize the amount he maintains in his registered accounts keeping it tax sheltered. 

The payment of fees from a designated account enables an advisor to fully invest the non-designated accounts and to utilize compounding growth strategies such as the dividend reinvestment plan.  Fee-based accounts can assist with income splitting as the higher income spouse can pay the account fees of the lower income spouse.

Liquidity is another benefit of fee-based accounts.  As there is no cost to buy investments, the same applies to changing or selling investments.  If you require money for any reason, there is no commissions payable for selling or rebalancing your investments.  Rebalancing can include reducing a position that has performed well, dollar cost averaging on a position that has underperformed, adjusting sector exposure, modifying asset mix, and changing the geography of your investments. 

Another benefit of fee-based is the ability to link additional family members to the platform.  Clients with children and grandchildren often would like introduce them to the benefits of full service brokerage, but do not individually have the capital to be able to open accounts on their own.  This could include parents wishing to assist adult children in opening and funding Tax Free Savings Accounts and grandparents who wish to open Registered Education Savings Plans for their grandchildren.  Fee-based accounts that are linked can make wealth transfer strategies within the family group of accounts significantly easier.

New disclosure rules on adviser’s fees could reduce ranks

Over the next few years, you are likely to hear more about what is referred to as the “client relationship model,” or CRM.  CRM is a regulatory requirement introduced by the Canadian Securities Administrators to enhance disclosure, which partially came into effect this year.  Further phases over the next three years are intended to enhance the standards financial firms and advisors must meet when dealing with clients.  These amended rules provide greater disclosure requirements for advisors and enhance the standards they must meet when assessing the suitability of investments for their clients.

The key objective is increased transparency for investors surrounding the fees they pay, services they receive, potential conflicts of interest and the performance of their accounts

All of these mandatory disclosures will be phased in from 2014 – 2016.   Similar CRM mandatory disclosure rules were implemented in Australia and England.  The implementation of the changes in those countries resulted in a significant reduction in the number of financial advisors working in the industry once rules required them to be transparent about all the fees charged.  I suspect that once the new rules are fully implemented, there will also be a reduction in advisors working in Canada.    

To help illustrate how these changes may affect you, let’s look at GICs and mutual funds.

Many people may be aware that when a financial institution receives investments from people, they then lend that money to other people at a higher rate, simply acting as an intermediary for profit. What most people likely do not know is that every time you invest in a GIC, the financial institution makes a spread, or simply put, a profit. 

Depending on the rates of the day and the length of the term that profit could be range from 10 to 25 basis points per year invested.  The range of the fees could be as low as 0.10 per cent for a one year GIC to 1.25 per cent for a five year GIC.   So on a $100,000 GIC for 5 years, your local financial institution might make between $500 (low end) and $1,250 (high end).  One percent equals 100 basis points in financial lingo.  Low-end is calculated 10 basis points x five years x $100,000.  High-end is calculated 25 basis points x five years x $100,000.  Starting this coming July, all financial institutions will have to disclose this to everyone. 

Let’s move to mutual funds. Take that same $100,000 and assume that you invest it into a balanced mutual fund. There are three potential ways the advisor could get compensated for their advice.  They could charge a fee initially, between one and five percent – referred to as Front End (FE). 

Front End is sometimes referred to as Initial Service Charge (ISC).  Some advisors have adapted a structure similar to banks and don’t charge a Front End fee.  Other advisors could do a Deferred Sales Charge Fee (DSC), where the client pays nothing initially but the advisor collects around five per cent immediately, so in this case, $5,000 from the mutual fund company because you are now committed to that fund family for six or seven years.

The fees to redeem the DSC mutual fund in the first couple of years may be approximately five per cent, and declining over a six or seven year period at which point the fund can be sold for no DSC costs.

There is also a variation called Low Load (LL) which is simply a form of DSC. If you see DSC on your statements, you know you are locked in.   Then inside, embedded in every mutual fund is an ongoing management fee.  As an example, a typical Canadian equity fund may have a 2.5 per cent embedded annual fee that is divided up amongst the advisor every year along with the mutual fund manager and their company.   These combined fees are often referred to as the Management Expense Ratio (MER).  I have found that the MER is rarely disclosed and, with the new rules, it will have to be.

It is very likely that many investors do not know how their advisor makes money or what fees they really are paying.  Knowledgeable and professional investment advisors, just like a good accountant, deserve to charge a reasonable fee for their service. But unlike accountants who send you a bill, investment advisors can currently sell you a product and not tell you what they just made.

More advisors are moving to a fee-based approach which is transparent and, in many cases, tax deductible. There is so much more to come that it may be a good idea to start asking questions now. The next time your banker or your advisor speaks to you about a new investment, consider asking for a complete breakdown of what fees you are paying going in to the investment, what the advisor is getting paid, if any fees apply to sell the investment, and what your fees will be each year thereafter for the advisor to manage your affairs. 

Advisors that have always provided complete transparency to their clients will not need to make any changes in the way they communicate with their clients. In fact, they may end up benefiting from the CRM changes. 

Greater scrutiny required for transfer of funds

Years ago, investors could bring cash into a brokerage firm and have it deposited into their investment account.  Those days are gone and the movement of funds is all electronic. 

One of the requirements when opening an investment account is to provide banking information.  We ask new clients to provide a void cheque for two primary reasons – to support that you are resident and to set up an electronic link between your investment account and your bank account.  

We have clients who have different bank accounts linked to different investment accounts.  As an example, Mr. and Mrs. Smith each have registered accounts with us and they have linked them to their respective individual bank accounts.  Mr. and Mrs. Smith also have a non-registered joint with right of survivorship account that they have linked to a joint bank account. 

We can link your investment accounts up to any financial institution.  There are a few advantages to having your bank and investment accounts at the same place, including one card and password to see everything.   

The electronic process is both done automatically and manually.  To illustrate we will use Mr. White and Mrs. Brown.  Mr. White is required to withdraw $24,000 from his RRIF account during the year.  He has requested payments of $2,000 are sent to his bank account automatically at the end of each month.  Mrs. Brown is planning a vacation with her grandchildren and would like $5,000 as a one-time transfer.  This transfer is an example of a manual process of a one-time transaction.  In both cases, the amounts are transferred electronically to the account linked to the specific investment account when the account was opened. 

If your bank account changes it is important to notify your financial institution so they can update your information accordingly.  Although the above payments to Mr. White and Mrs. Brown were electronically executed, they were both verbally confirmed by the advisor.  This part is important to stress as financial advisors can not take instructions to amend banking information, or transfer money, by email for security reasons.    

We often have clients who want us to send money to children, family members, or other third parties.  Similar to personal requests, and changes to banking information, third party requests for transfer of funds can not be done by email.   These types of requests require both verbal confirmation and a signed letter of direction providing details of the transfer request.   This is to protect client accounts against unauthorized email instructions, known as spoofing, and fraud.  The letter of direction can instruct us to issue a cheque payable to another individual.  The letter of direction may also provide wire transfer instructions.

Clients are often surprised to learn that we can purchase many different foreign currencies and do so quite frequently. 

We have clients who wish to purchase certain currencies throughout the year when exchange rates are favorable.  These same clients may maintain bank accounts in different countries, the most common being the United States.   In other cases, they have intentions to wire transfer the funds to assist family members living abroad. 

If we have purchased euros, British pounds or pesos for a client then these funds can be wired in the same currency if they provide the recipient’s banking information including, name, address, bank name, account number, routing platform (also known as ABA Number, IBAN or SWIFT), routing number, bank address, bank city, bank region, and bank country.

Clients who have a discretionary investment account set up with a Portfolio Manager results in the ability for the Portfolio Manager to use their discretion to buy and sell investments.  This discretion does not extend to transfers in and out of the investment account, or transfers between accounts.  In some cases, we have clients that wish to fund their annual Tax Free Savings Account (TFSA) by transferring either cash or securities from their non-registered account to their TFSA.   This type of transfer would require the client’s verbal permission prior to execution. 

Advisors can send money to your bank account but we are not able to transfer money out of your account even if we have your verbal permission.  The only exception to that is if you have set up, and signed, a Pre-Authorized Contribution (PAC) form that instructs us to withdrawal a certain amount at set dates.  As an example, Mrs. Grey contributes $500 every month into her RRSP account through a PAC.  At the end of every month, $500 is transferred from Mrs. Grey’s bank account to her RRSP investment account.

With online banking it is often possible for you to transfer money between accounts.  As an example, you can move money from your savings account to your investment account relatively quickly, especially if your bank is related to your investment firm.  We caution people to double check amounts prior to moving funds into an RRSP and TFSA account.  There are strict penalties for over-contributions.   Even if your investment accounts are at a different institution, most provide the ability to set another financial institution up as a payee (similar to a bill payment) to facilitate transfers.

When clients sell a home or a major asset, the proceeds from this sale may result in you receiving a cheque from a law firm or the buyer.  If the cheque is in your name and you wish to deposit this immediately at a financial institution then the cheque would be considered a third party cheque.  Investment institutions may still be able to deposit these cheques; however, there is greater risk as the issuer of the cheque is not you.  Financial institutions should ask the reasons for the third party cheque and where the source of the funds are from.  An alternative to providing this information is for you to request that drafts, certified cheques, and regular cheques be made payable directly to your financial firm and in the memo field you can provide instructions to have “In trust for” and your name and account number entered.  Another alternative is to deposit the third party cheque into your own bank account and write a personal cheque directly to your financial institution.   

Skipping a generation in your estate planning

I’ve heard several people over the years say they never thought they would have so much money. A growing number of aging people have accumulated significant savings and investments from years of savings, investing wisely, inheritances, property dispositions or selling a business – and are looking for different options when it comes to minimizing taxes and structuring their estate plan.

Taking care of immediate children is still very much a priority, but it’s not the only one. Some of their children are often already well off financially and many are retired themselves.

We are seeing more and more cases where grandparents are leaving money to grandchildren, but there should be extra caution and professional advice when structuring plans to transfer wealth. Income splitting can extend to grandchildren and can lower taxes as a family.

The following are a few examples of how we have assisted clients in helping out their grandchildren.

Outright Gift

The strategy of gifting money to adult grandchildren can be very tax smart. A person who is aged 65 or older may have government benefits such as Old Age Security clawed back if income exceeds certain thresholds set annually. In many cases income taxes can be reduced and government benefits increased by gifting funds to an adult grandchild in a lower income tax bracket. We do not recommend significant gifts to minor children directly as this could violate what is commonly known as the attribution rules.

Registered Education Savings Plan

For grandchildren under 19, grandparents should consider the Registered Education Savings Plan. This is a fantastic vehicle to tax-shelter money, income split with family members, and receive government grants. I’ve had clients set up an RESP for every grandchild they have. They require a consent form from the parents, as there is a limit to the Canada Education Savings Grant.

Tax Free Savings Account

For grandchildren who have reached the age of majority, giving funds to contribute to a Tax Free Savings Account can be an excellent way to income split. Your grandchildren can use this account to build up funds to use one day as a down payment on a home. By moving the funds from a grandparent’s taxable account to a non-tax account this will also reduce the family tax bill.

Paying Down Mortgages

Let’s assume you have the option of investing $100,000 into a two year guaranteed investment certificate or gifting these funds to your granddaughter who is paying 4.6 per cent on her mortgage. The $100,000 would result in $2,000 of interest income which would be fully taxable. If the grandparent was in the 30 per cent tax bracket then the government would receive $600 of this money. If you’re in a higher tax bracket, the amount would be higher and you would also be in the position of potentially losing even more government benefits. Your granddaughter is currently paying $4,600 annually in interest on her mortgage and is not able to deduct the interest costs. By gifting $100,000 the government would receive $600 less, you may receive more government benefits next year, and your daughter would save $4,600 a year in interest costs and also have a reduced mortgage.

Buying a Home

Buying a home is perhaps the toughest financial hurdle for most young people to clear, as salaries are insufficient for many to qualify to buy even a basic home. In one case, a grandmother considered moving into an assisted living arrangement. She had a grandson and two granddaughters, who wanted to purchase her home, which has a $600,000 value. The grandmother has significant pensions and capital outside of her principal residence and does not need the full proceeds from selling the home. During a meeting we mapped out a plan where she gifted each grandchild $100,000. The grandson could purchase the home from his grandmother for $500,000 ($600,000 fair market value less the $100,000 gift). The grandson would then be able to qualify for a mortgage for $500,000, the proceeds of which could be distributed as follows: $300,000 to grandmother and $100,000 to each granddaughter for them to each use towards the purchase of a home.

Insurance Products

In a small number of situations where people are wishing to keep certain gifts out of public record, an insurance product is a solution. By naming a specific beneficiary the insurance proceeds would bypass one’s estate and avoid probate fees. We have also seen situations where grandparents have taken out a second generation insurance policy to leave a significant gift to grandchildren.

Control investment costs, increase your net return

Many people don’t pay too much attention to the costs associated with investing. If we look at both your returns and cost of investing, we can create what is called your net return.  Your net return can potentially increase by either improving your return, or lowering your cost of investing.

To illustrate we will use Mr. Lee, a 55 year old investor who has $500,000 in an RRSP account.  Mr. Lee has explored the following four options with various costs of investing (increasing at one per cent increments with each option) and service levels:

Option 1:  Self managing investments through Exchange Traded Funds (ETFs) – often referred to as couch potato investing.  With this approach, you receive no planning or investment advice.  This approach is passive as it holds the investments that are in the respective index and are not actively managed.  The annual cost of investing for this option can be around 0.5 per cent, or $2,500 in the first year.

Option 2:  Working with an advisor owning direct holdings in a fee based account.  The fees for this option can fluctuate depending on the advisor and the amount invested.  The fee often decreases as the account value increases.   The benefit of this option is that an advisor is able to assist you with both planning and your investments.  Option 2 is the most transparent with respect to fee disclosure of all options.  If Mr. Lee put the $500,000 into a balanced portfolio, it would typically be priced at 1.25 to 1.5 per cent.  For our example we will use 1.5 per cent, or $7,500 in the first year.  It is important to note that a good advisor is well worth the additional fee over the ETF approach.

Option 3:  Purchasing mutual funds is another commonly used investment approach.  Mutual funds are actively managed by a portfolio manager that has a specific skill set in the fund(s) that you’re buying.  Mutual funds have embedded annual fees called a Management Expense Ratio (MER).  In addition to the MER, funds may be sold on a front end basis with addition fees of up to 5 per cent initially, or sold on a back end basis where you are typically not charged a fee initially but would be charged a fee if you sell the fund within the applicable Deferred Sales Charge (DSC) period, often seven years.  The fee may be as high as 6 per cent initially if sold in the first year, and declining every year until the DSC schedules is complete. An advisor selling funds may look at Mr. Lee and think his time horizon is ten years and that he may be invested in the funds through the DSC schedule.  If Mr. Lee is sold funds on a back end basis where DSC may apply, he is somewhat squeezed into a corner if he is not happy with his performance, or would like to make a change within the DSC period.  For purposes of this illustration we will assume that the only fees Mr. Lee pays is the 2.5 per cent annual MER, or $12,500.

Option 4:  Mr. Lee has heard about some guaranteed insurance products called segregated funds.   The primary difference between mutual funds and segregated funds is that the later is an insurance product.  Being an insurance product, the investments can be set up with different maturity and death benefit guarantees.  Another feature is segregated funds have the ability to name beneficiaries to bypass probate and public record.  In the case of Mr. Lee the funds he has are registered.  With registered accounts it is not necessary to purchase an insurance product to get this benefit as he already has the ability to name a beneficiary, his spouse, which also will assist them in avoiding probate on the first passing.  There is a cost to have the insurance benefit noted above. For illustration purposes we will assume the annual MER for a basket of segregated funds is 3.5 per cent, or $17,500 annually.

The long term effect on accumulated savings can be quite shocking when different net returns are explored over a ten year period.  To help with the illustration, we will make the assumption that investment returns over the next ten years will be six per cent for all four options.

Option 1:  ETF approach – net return is 5.5 per cent (6.0 per cent less the 0.5 per cent fee). A net return of 5.5 per cent compounded over ten years would have grown Mr. Lee’s $500,000 RRSP to $854,072 at the beginning of retirement.  He would have been responsible for all of his choices of ETFs and have no planning advice.  Although costs are low with option 1, there is a high degree of involvement to determine timing of when to buy the ETF and which ones to buy.

Option 2:  Direct Holdings in Fee-Based Account – net return is 4.5 per cent (6.0 per cent less the 1.5 per cent fee). A net return of 4.5 per cent compounded over ten years would have grown Mr. Lee’s $500,000 RRSP to $776,485 at the beginning of retirement.  The additional cost of investing over option 1 would more than likely be offset by higher returns with a good advisor.  A knowledgeable advisor is also able to provide you financial planning tips, and service that enables you to do other things in retirement.

Option 3:  Holding a Basket of Mutual Funds – net return is 3.5 per cent (6.0 per cent less the 2.5 per cent fee). A net return of 3.5 per cent compounded over ten years would have grown Mr. Lee’s $500,000 RRSP to $705,299 at the beginning of retirement.

Option 4:  Holding a Basket of Segregated Funds – net return is 2.5 per cent (6.0 per cent less 3.5 per cent fee). A net return of 2.5 per cent compounded over ten years would have grown Mr. Lee’s $500,000 RRSP to $640,042 at the beginning of retirement.

The above illustrates a one per cent change in the cost of investing for each option – it clearly shows how these small changes can have a material impact on your long term financial success.  The same exercise can be done assuming different percentage returns (i.e. four, five, six, and seven).

The importance of teamwork in managing affairs

Couples who both have an equal interest in managing their investments are not as common as you might think.  The best case scenario is, of course, that both are working with a financial advisor to ensure continuity and an easier transition when one spouse passes away.  But that doesn’t always happen.  Even the simplest of investment approaches can be quite overwhelming and confusing to the surviving spouse who has never manager their financial affairs.

Although the spouse who has handled the finances may feel they are taking car of their spouse, it may actually do more harm than good.  The obvious pitfalls are failure to manage risk, getting too emotionally attached, missing out on opportunities and spending a good part of their spare time in order to avoid paying an advisor commissions for trades.  They can easily miss a big picture item that can cost dearly later on.  A good financial planning tip can often cover years of fees for an advisor. Ensuring your spouse has a good adviser after you’re gone is more valuable than trying to save a few dollars today.

There are a few basic suggestions to simplify your finances and hope both you and your spouse.

■ Consolidating accounts is almost always a good move, regardless of your age.  By closing unnecessary bank and investment accounts you reduce the amount of work considerably.  You will have fewer tax slips, and have a much clearer picture of your situation.  The more financial institutions you deal with the more phone calls and paper work that will be left for your spouse and executor after you are gone.

■ Having all monthly registered pension plan payments (employer pensions, Old Age Security, and Canada Pension Plan) automatically deposited into one bank account will make it easier to budget.   This one bank account should be linked electronically to your non-registered investment account.  RRIF payments can be set up for monthly payments to be transferred from your investment account to your bank account.  Having all transactions flow in and out of one account makes it easier to track income and expenses.

■ Organizing your financial papers will be helpful for you and your spouse.   Check with your advisor and Canada Revenue Agency regarding what documents can be destroyed and shredded.  We recommend cancelling charge cards you no longer use.  If you do owe anyone money that is not registered (i.e. mortgage), we recommend you inform your spouse of these amounts.  Insurance policies that have been cancelled should be clearly labelled.  Any valid insurance policies should be organized with your spouse knowing where they are stored.

■ Old share certificate that have value should be deposited into an investment account.  Old share certificates with no value should either be shredded or clearly marked as having no value.  An advisor can search old share certificates to provide assurance whether an investment is defunct.

■ We recommend having one easy to access list of professionals you work with (banking contact, accountant, lawyer, investment advisor, insurance company), including all their contact information.  This list should provide key information, such as where your will is stored and the name of your executor.  It is quite common for couples to name their spouse as their primary executor.  Your advisor can provide a list of some of the main responsibilities of being an executor.  Obtaining an understanding of your duties should be done while you’re updating wills, power of attorney, representation agreements, and other legal documents.  Your spouse should know where your will is located and who is the executor (if your spouse is not the executor).

■ Ensure that you have the correct beneficiary designated on each registered account.  In the majority of cases it is advantageous to name your spouse.  If you are naming anyone other than your spouse then we recommend that you obtain advice to ensure it is appropriate and you understand the consequences.

■ Obtain financial and accounting advice for any non-registered investment and bank accounts that are solely in your name.   There are many benefits for opening joint with right of survivorship accounts with your spouse.  Changing ownerships on accounts should only be done after an informed discussion with your advisor.

Nearly every couple has additional steps they should follow that are unique to their individual needs.  We encourage couples to come in to investment and planning meetings together.  These meetings help your financial advisor formulate a plan that helps both of you.  The best way you can take care of your spouse is to ensure that all is in order today and that a trusted advisor will be available to help after you’re gone.