How to be your own banker

The Advocate, Wednesday March 15, 1995

There are only two ways to put money to work. The most commonly used one is to loan or "rent" your savings out to a financial institution. The problem is, all rented money earning interest is subject to income tax. This means a person with a $28,000 taxable income would lose 41 per cent of the interest to taxes. So a 10 per cent rate of return would be reduced to under 6 per cent after tax. With inflation at 6 per cent, for example, his real return in terms or purchasing power is 0 per cent.

The otherr way of investing is to "own" somthing. The only way to own something is to use your savings to "buy" something that is considered an investment, something that appreciates in value.

For example, let me ask you this question: How much interest do you get if you own an apartment building? It's amazing the answers I get. They range from 2 per cent to 20 per cent. But the naswer is no interest. By "owning" the apartment you get "profit", which is the amount of money left after taxes, upkeep, utilities, etc. If you own part of a business (stock), these profits can take on the form of dividends.

Now the real benefits start to settle in. There is a dividend tax credit. The person who earns 8 per cent in dividends will have more after-tax spendable dollars than someone earning 10 per cent in interest. Furthermore, you get capital gains when you "own" something. Currently they still come to you 25 per cent free of tax.

To digress briefly, I personally feel it is very unfair to most Canadians to eliminate the $100,000 tax free capital gains exemption. Why have we been penalized while other individuals have not? Some people have received their entire $100,000 tax free while the majority of tax-paying Canadians have not. I hope those in Ottawa recognize this and restore it.

Let me continue. The "owner" has two potentials for gain, dividends (profit) and capital gains (increase in value) and both carry less tax than interest. What do the banks do with the money you lend to them? They invest it by buying something that makes "profits" (dividends) and capital gains which has to earn more than the interest they pay you.

Why not eliminate the middle man and be your own banker. For example, own the thing that owns the thing. Buy the bank's stocks directly, whereby you enjoy substantial returns and all the tax-free benefits. Most good mutual funds have bank stocks in their portfolios.

Let me go you one better. Reverse the process. Instead of loaning your money to the bank, why don't you borrow it from them and pay them interest. As I mentioned in last month's article, "Tax-Free Withdrawals From Your RRSP," if you invest the proceeds in a Canadian corporation (mutual fund), the interest you pay on the loan is tax-deductible. It is condsidered the same as a business loan.

Now instead of paying tax on interest earned you are saving tax on interest paid.

Please refer to my June 16, 1993 article "Financial Leverage" or contact me for a copy.

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Created: Thu May 16 10:30:50 1996
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