My name is Mark Goodfield. Welcome to The Blunt Bean Counter ™, a blog that shares my thoughts on income taxes, finance and the psychology of money. I am a Chartered Professional Accountant and a partner with a National Accounting Firm in Toronto. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. The views and opinions expressed in this blog are written solely in my personal capacity and cannot be attributed to the accounting firm with which I am affiliated. My posts are blunt, opinionated and even have a twist of humor/sarcasm. You've been warned. Please note the blog posts are time sensitive and subject to changes in legislation or law.

Tuesday, October 9, 2012

Debt - An Ugly Four Letter Word

Personal debt in Canada has reached its highest level in history. As reported by Statscan, the ratio of debt to personal disposable income (all your debt divided by your annual after tax income) hit a high of 154.34 per cent for the first quarter of 2012, up from 149.22 per cent for the first quarter of 2011. This extreme level of debt is a result of an extended period of historically low interest rates, a sluggish economy and, to some extent, an “I see it, I want it, even if I can’t afford it” attitude amongst many people.

No matter the reason, if you have debt, you need to step-back and determine if you can organize and consolidate your debt and/or make your debt income tax effective. The comments I offer below are mostly organizational in nature and are not intended to help those with serious debt issues. If you are overwhelmed by debt, I strongly suggest you consider engaging a professional debt counsellor who will not only try and help reduce your debt, but will try and address the personal habits that often create or accentuate debt problems.

Organize and Consolidate

A good first step to managing your debt obligations is to summarize your debt. Create an excel spreadsheet and list all the debt you have down the left hand side of the spreadsheet. This will include your mortgage, any lines of credit, all credit cards and any other debt you may have accumulated along the way.

Then, across the top of your excel schedule, have the following columns:

Name of creditor - company or individual to whom you owe your debt
Amount of debt outstanding
Credit limit related to the debt
Interest rate or where floating, terms of debt (i.e. Prime +)
Terms of repayment and date due
Pre-payments - Where term is fixed, what is the maximum pre-payments allowed
Penalties- Are there any penalties for paying off debt early
Deductibility - Is the debt deductible for income tax purposes (see discussion below)
Notes - This will be a catch all for any information not noted in the other columns and for notes on whether debt is connected to other debt or assets (e.g. is your interest rate lower because you have a mortgage, line of credit and investment account with an institution or is the debt or debt rate contingent on any other factor).

Finally, lower on the page, below the debt summary, create a new heading called assets. List all your assets including your house, non-registered accounts, registered accounts, rental properties, TFSA, etc. Create three columns across the top; value of asset, debt related to asset and tax deductibility (in general if the asset is an income producing non-registered asset, any associated debt will be deductible).

As basic as the above sounds, sometimes having everything written down and organized allows you to gain some perspective and take a 10,000 foot view.

Once you have completed the above task, review the interest rate column to determine which debt has the highest interest rates. In most cases, this will be your credit card debt. You should then review whether you have the capacity to use a line of credit or other debt instrument with a lower interest rate to pay off your credit cards and effectively lower your rate of borrowing.

If you have debt at various institutions, ask your main institution for a lower rate on the total debt if you consolidate the debt at that institution.

Tax Deductibility

Finally, you should review whether you have any assets denoted as tax deductible, for which you have no related debt. For most people, those assets would include shares of your own business, non-registered investment accounts that hold stocks, bonds, ETF’s etc. and rental properties. There may be other assets; however, these are the most typical. If you have any of these type assets and they are not encumbered by debt, you may be able to make some of your debt deductible for income tax purposes. Typically, this involves circulating monies; you liquidate interest deductible assets for which there is no related debt (taking care to ensure you are not creating any capital gains) pay off the non-deductible debt and then borrow to replace the original investment assets, making the interest expense deductible. Before undertaking such a transaction, professional advice should be sought.

There is no panacea for eliminating debt. However, at a minimum, you will want to undertake the various steps and review processes noted above, to start consolidating and reducing your debt as well as ensuring your debt is income tax effective to the greatest extent.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.