The “Total Return” Shell Game

No “Interest Rate Sensitive” Security is an Island…

Just what is this “total return” thing that income portfolio managers like to talk about, and that Wall Street uses as the performance hoop that all investment managers have to jump through? Why is it mostly just smoke and mirrors?

Here’s the formula:

  • Total Income + (or -) Change in Market Value – Expenses = Total Return — and this is supposed to be the ultimate test for any investment portfolio, income or equity.

Applied to Fixed Income Investment Portfolios, it is useless nonsense designed to confuse and to annoy investors.

How many of you remember John Q. Retiree? He was that guy with his chest all puffed up one year, bragging about the 12% “Total Return” on his bond portfolio while he secretly wondered why he only had about 3% in actual spending money.

The next year he’s scratching his head wondering how he’s ever going to make ends meet with a total return that’s quickly approaching zero. Do you think he realizes that his actual spending money may be higher? What’s wrong with this thinking? How would the media compare mutual fund managers without it?

Wall Street doesn’t much care because investor’s have been brainwashed into thinking that income investing and equity investing can be measured with the same ruler. They just can’t, and the “total return” ruler itself would be thrown out with a lot of other investment trash if it were more widely understood.

  • If you want to use a ruler that applies equally well to both classes of investment security, you have to change just one piece of the formula and give the new concept a name that focuses in on what certainly is the most important thing about income investing — the actual spending money.

We’ll identify this new way of looking at things as part of “The Working Capital Model” and the new and improved formulae are:

  • For Fixed Income Securities: Total Cash Income + Net Realized Capital Gains – Expenses = Total Spending Money!
  • For Equity Securities: Total Cash Income + Net Realized Capital Gains – Expenses = Total Spending Money!

Yes, they are the same! The difference is what the investor elects to do with the spending money after it has become available. So if John Q’s Investment pro had taken profits on the bonds held in year one, he could have sent out some bigger income payments and/or taken advantage of the rise in interest rates that happened in year two.

Better for John Q, sure, but the lowered “total return” number could have gotten him fired. What we’ve done is taken those troublesome paper profits and losses out of the equation entirely. “Unrealized” is “un-relevant” in an investment portfolio that is diversified properly and comprised only of investment grade, income producing securities.

Most of you know who Bill Gross is. He’s the fixed Income equivalent of Warren Buffett, and he just happens to manage the world’s largest “open ended” bond mutual fund. How was he investing his own money during other interest rate cycles?

Well, according to an article by Jonathan Fuerbringer in the Money and Business Section of January 11, 2004 New York Times, he’s removed it from the Total Return Mutual Fund he manages and moved it into: Closed End Municipal Bond Funds where he could “realize” 7.0% tax free.

(Must have read “The Brainwashing of the American Investor”.)

He doesn’t mention the taxable variety of Closed End Fund (CEF), now yielding a point or two more than the tax free variety, but they certainly demand a presence in the income security bucket of tax-qualified portfolios (IRAs, 401k(s), etc.).

Similarly, the article explains, Mr. Gross advises against the use of the non investment grade securities (junk bonds, for example) that many open-end bond fund managers are sneaking into their portfolios.

But true to form, and forgive the blasphemy if you will, Mr. Gross is as “Total Return” Brainwashed as the rest of the Wall Street institutional community — totally. He is still giving lip service validity to speculations in commodity futures, foreign currencies, derivatives, and TIPS (Treasury Inflation Protected Securities).

TIPs may be “safer”, but the yields are far too dismal. Inflation is a measure of total buying power, and the only sure way to beat it is with higher income levels, not lower ones. If TIPS rise to 5%, REITS will yield 12%, and preferred stocks 9%, etc.

No interest rate sensitive security is an Island!

As long as the financial community remains mesmerized with their “total return” statistical shell game, investors will be the losers.

  • Total Return goes down when yields on individual securities go up, and vice versa. This is a good thing.
  • Total Return analysis is used to engineer switching decisions between fixed income and equity investment allocations, simply on the basis of statements such as: “The total return on equities is likely to be greater than that on income securities during this period of rising interest rates.”

You have to both understand and commit to the premise that the primary purpose of income securities is income production. You have to focus on the “Income Received” number on your monthly statement and ignore the others… especially NAV.

If you don’t agree with the next three sentences; if they don’t make complete sense: you need to learn more about Income Investing:

  • Higher interest rates are the income investor’s best friend. They produce higher levels of spending money.
  • Lower interest rates are the income investor’s best friend. They provide the opportunity to add realized capital gains to both the total spending money and total working capital numbers.
  • Changes in the market value of investment grade income securities, Yogi says, are totally and completely irrelevant, 97% of the time.

Annuities – how they work and why have one!

Retirement is near or perhaps you are already retired. It’s time for choices. How do you want to receive your income? Is an annuity a good choice?

Annuities can be considered as backwards, long-term mortgages with a couple of twists. Rather than a financial institution giving you a lump sum and you repay them monthly, the annuity does the opposite. The payment to you is normally a level fixed amount that is payable for as long as you live with a minimum payout guarantee. You also have the choice of having payments continue for as long as at least one person is alive in the case of joint annuities.

Annuities can be purchased with both registered and non-registered money. If purchased with registered funds, the payments are fully taxable to you. If you purchase the annuity with non-registered money, then only a small portion will be taxed – most of it will be tax-free.

So what is the attraction of an annuity?
 Guaranteed income for your lifetime (or the lifetime of 2 people for joint annuities)
 You cannot outlive your money
 You want to minimise your income tax payable (from non-registered funds called “Prescribed Annuities”) compared to other investments such as mutual funds or GICs
 You do not have to worry about the ups and downs of investment markets – no management needed
 You want to minimise the impact of lifestyle income reducing your OAS payments under the clawback rules in the Income Tax Act
 The principal of the annuity is protected from claims by your creditors
 You can name a beneficiary (or beneficiaries) for the remaining payments if you pass away before the end of the guaranteed period

Nothing is perfect, so what are other considerations?
 Once purchased, it cannot be cashed
 You cannot change the level of income or other terms after it is purchased
 You no longer have control of the money or how it is to be invested or managed

Some of the choices you will need to make include:
o Single life or joint life?
o Do you want a guaranteed payment period and if so, for how long?
o If you chose a guaranteed payment period, who should be the beneficiary if you pass away before the end of that period?
o Do you want level or increasing payments?
o Should you replace the capital used to purchase the annuity with life insurance so your heirs can still get the full value of your estate?

Could an annuity be the best choice for you?

Dying isn’t free (no good deed goes unpunished!)

I know this sounds a bit irreverent or flippant however it is meant to stimulate some hard thinking about the real costs of dying. Sure, there are lots of lists around, but I haven’t found 1 yet that covers everything I have seen in nearly 43-years in this industry. Is this list perfect? Absolutely not – but it will get you thinking about your own and your family’s situation. Remember, not all of these will apply to you – but some will – and the costs range widely.

* Probate Fees * Legal Fees * Copying and certifying fees * Paid searches for titles, etc. * Legal notifications to family * Legal notifications to creditors * Asset Transfer fees * Estate Accounting Fees * Terminal Tax Return Fees * Estate Tax Return Fees * Rights and Things Tax Return Fees * Ongoing Tax Return Fees if estate not settled within 12 months * Testamentary Trust Tax Return Fees *Preparing and filing tax election fees (estate and personal) * Executor and Trustee Fees (annually until Estate and all trusts closed) * Executor and Trustee disbursements – copying, telephone, faxing, certifications, mileage, parking, travel expenses * Valuation fees – real estate, listed personal property, personal property, real estate and other capital and/or depreciable property * Transfer costs for title transfer to Executor and/or Trustee and eventually to residual beneficiaries * Commissions paid for asset sales – real estate, estate sales, sale of listed personal assets, if necessary * Commissions paid to investment advisors for selling stocks and bonds not held in managed-money accounts *Income taxes payable – terminal tax return, estate tax return(s), Rights and Things tax return, Trust tax return(s) * Tax due on transfer of pensions and registered assets to other than spouse * Shrinkage of realisable asset value due to urgency of sale – tax paid on FMV not $ received – must replace lost $ * Account closing fees on nominee accounts and self-directed investment accounts
* Court fees – Probate and other as necessary if Will contested * Court costs if you die intestate * Banking Fees – estate bank accounts, trust bank accounts * Rental Fees – safety deposit box or other secure location *Funeral, memorial and related costs – cultural, faith-based, community or family expectations. Wake or similar * Costs of collecting promissory notes owed to deceased – loans to family members and businesses * Terminal care costs not covered by Government, group or personal plans * Legal costs to defend Will from challenges * Payment of all legally enforceable debts – including ones you guaranteed or co-signed * Perpetual pet care * Costs of care for children and other dependents (maybe your parents!) * Cost to close your social media accounts * Payment for ongoing business management until it is sold * Short-term emergency funds for survivors * Ongoing income for survivors including education costs * Cash Bequests * Murphy is alive and well – expect a visit along with family discord! * Your guess: ______________________________

I can promise a few things about this list: a) your estate will have at least one cost not included here; b) you will be very unpleasantly surprised at the total amount of money (and time) involved; c) your estate will be cash-poor – not enough cash in the bank to pay these costs which means that; d) the net value of your estate, without proper planning and a source of replacement tax-free cash, could even be bankrupt which means your family and heirs would get zero. Do you and your family need assistance?

Lifting the veil on ETFs – Part 3 of 4

Taxation
By their nature, ETFs are tax efficient and can be more attractive than mutual funds. When a mutual fund realizes a capital gain that is not offset by a realized loss, the mutual fund must allocate the capital gains to its shareholders. These gains are taxable to all shareholders, even those who reinvest the gains distributions to purchase more shares of the fund. In contrast, ETFs are not redeemed by holders (instead, holders simply sell their ETF shares on the stock market, as they would a stock), so investors generally only realize capital gains when they sell their own shares for a profit or when the ETF trades to reflect changes in the underlying index.

Trading
An important benefit of an ETF is the stock-like features offered. A mutual fund is bought or sold at the end of a day’s trading, whereas ETFs can be traded whenever the market is open. Since ETFs trade on the market, investors can carry out the same types of trades that they can with a stock. For instance, investors can sell short, use a limit order, use a stop-loss order, buy on margin and invest as much or as little money as they wish.

Risks

Effects on stability
ETFs that buy and hold commodities or futures of commodities have become popular. The commodity ETFs are in effect consumers of their target commodities, thereby affecting the price in a spurious fashion. In the words of the International Monetary Fund (IMF), “Some market participants believe the growing popularity of exchange-traded funds (ETFs) may have contributed to equity price appreciation in some emerging economies, and warn that leverage embedded in ETFs could pose financial stability risks if equity prices were to decline for a protracted period.”

Regulatory risk
Areas of concern include the lack of transparency in products and increasing complexity, conflicts of interest and lack of regulatory oversight. You must take the time to do your own research before investing to fully understand these risks.

Criticism
John C. Bogle, founder of the Vanguard Group, a leading international issuer of index mutual funds (and, since Bogle’s retirement, of ETFs), has argued that ETFs represent short-term speculation, that their trading expenses decrease returns to investors, and that most ETFs provide insufficient diversification. He concedes that a broadly diversified ETF that is held over time can be a good investment.

The Wall Street Journal reported in November 2008, during a period of market turbulence, that some lightly traded ETFs frequently had deviations of 5% or more, exceeding 10% in a handful of cases. According to a study on ETF returns in 2009 by Morgan Stanley, ETFs missed their 2009 targets by an average of 1.25 percentage points, a gap more than twice as wide as the 0.52-percentage-point average they posted in 2008. Part of this so-called tracking error is attributed to the proliferation of ETFs targeting exotic investments or areas where trading is less frequent such as emerging-market stocks, future-contracts based commodity indices and junk bonds.

Lifting the veil on ETFs – Part 2 of 4

Stock ETFs
The first and most popular ETFs track stocks. Many funds track national indexes.

Bond ETFs
Exchange-traded funds that invest in bonds are known as Bond ETFs. They thrive during economic recessions because investors pull their money out of the stock market and move into bonds (for example, government treasury bonds or those issued by companies regarded as financially stable). Because of this cause and effect relationship, the performance of bond ETFs may be indicative of broader economic conditions. There are several advantages to bond ETFs such as the reasonable trading commissions, but this benefit can be negatively offset by other fees and costs.

Actively managed ETFs
Most ETFs are index funds and as such, there is no “management” involved. Some ETFs, however, do have active management as a means to hopefully out-perform the nominal bench-mark index. Actively managed ETFs are at risk from arbitrage activities by market participants who might choose to front run its trades as daily reports of the ETF’s holdings reveals its manager’s trading strategy. The actively managed ETF market has largely been seen as more favorable to bond funds, because concerns about disclosing bond holdings are less pronounced, there are fewer product choices and there is increased appetite for bond products.

Leveraged exchange-traded funds (LETFs), or simply leveraged ETFs, are a special type of ETF that attempt to achieve returns that are more sensitive to market movements than non-leveraged ETFs. Leveraged index ETFs are often marketed as bull or bear funds and because of the leveraging involved, returns and losses are magnified!

ETFs compared to mutual funds

Costs
The first rule to remember – NOTHING is free! Since ETFs trade on an exchange, each transaction is generally subject to a brokerage commission. Commissions depend on the brokerage and which plan is chosen by the customer. Full-service brokers typically charge a percentage commission on both the purchase and sale and may be negotiable depending on the dollar value involved. A typical flat fee schedule from an online brokerage firm $10 to $20, but it can be as low as $0 with certain discount brokers with minimum account values. Due to this commission cost, the amount invested has great impact on costs. Someone who wishes to invest $100 per month may have a significant percentage of their investment destroyed immediately, while for someone making a $200,000 investment, the commission cost may be negligible.

ETFs generally have lower expense ratios than comparable mutual funds. Not only does an ETF have lower shareholder-related expenses, but because it does not have to invest cash contributions or fund cash redemptions these costs are eliminated. Mutual funds may charge 1% to 3%, or more. Index fund (which by the way are NOT the same as ETFs – see future edition of Money Magazine) expense ratios are generally lower, while ETFs are normally in the 0.1% to 1% range.

The cost difference is more evident when compared with mutual funds that charge a front-end or contingent back-end load as ETFs do not have any additional loads at all. Potential redemption and short-term trading fees are examples of other costs that may be associated with mutual funds that do not exist with ETFs. Traders should be very cautious if they plan to trade inverse and leveraged ETFs for short periods of time. Close attention should be paid to transaction costs and daily performance rates as the potential combined compound loss can sometimes go unrecognized and offset potential gains over a longer period of time.

Lifting the veil on ETFs – Part 1 of 4

Recently, one of the big 5 banks did a customer survey on ETFs and one of the questions was: “What do the letters ETF mean?” The responses shared were interesting to say the least! Most thought they stood for Emergency Task Force! Another group though it was an abbreviation for Energy Transfer Fund (like a carbon offset trading scheme I presume), some said it was an Environmental Trust and still others suggested Electronic Transfer of Funds. Apparently, less than 5% correctly identified the letters as meaning Exchange Traded Funds! Interesting to say the least since ETFs are attracting lots of attention these days, for various reasons – some accurate and others not.

They’re still quite new and would-be investors are bound to have lots of questions. In this article, I am only going to touch on the generalities of ETFs and some of the more common versions. Future issues of Money Magazine and this blog will delve more deeply into each area discussed here.

An (ETF) is an investment fund traded on a stock exchange much like a stock. It holds assets such as stocks, commodities or bonds and trades close to its net asset value over the course of the trading day. Most ETFs track an index, such as a stock index or bond index. ETFs may be attractive as investments because of their apparent lower costs, potential tax efficiency and stock-like features.

What is an index?
You probably know terms such as the S&P/TSX Total Return Index (the most quoted Canadian index) or the S&P 500 Index in the US on the news. Those are indexes. An index is a selection of stocks or bonds that represents a given market. Each index has rules about how many securities are included and how they are weighted. Indexes are mainly used to measure changes in the market they represent. Remember, an Industrial Average (such as the Dow Jones Industrial Average {DJIA} is NOT an index, but that is a subject for another review!).

An ETF combines the valuation features of a mutual fund which is bought or sold at the end of each trading day for its net asset value, with the tradability features of a stock or bond which trades throughout the trading day at varying.

Structure
ETFs offer investors an undivided interest in a pool of securities and other assets and thus are similar in many ways to traditional mutual funds except that shares in an ETF are bought and sold throughout the day through a broker-dealer. Unlike traditional mutual funds, ETFs do not sell or redeem their individual shares at net asset value, or NAV. Instead, brokers purchase and redeem ETF shares directly from the ETF.

Index ETFs
Most ETFs are index funds that attempt to replicate the performance of a specific index. They may be based on stocks, bonds, commodities or currencies. An index fund seeks to track the performance of an index by holding in its portfolio either the contents or a representative sample of the securities in the index. Some index ETFs, known as leveraged ETFs or inverse ETFs, use investments in derivatives to seek a return that corresponds to a multiple of, or the inverse (opposite) of, the performance of the index.

Some index ETFs invest 100% of their assets proportionately in the securities underlying an index, a manner of investing called “replication”. Other index ETFs use “representative sampling”, investing perhaps 80% to 90% of their assets in the securities of an underlying index and investing the remaining 10% to 20% of their assets in other holdings such as futures, option and swap contracts and securities not in the underlying index. There are various ways the ETF can be weighted, such as equal weighting or revenue weighting.

The 7 parts of Financial Planning

There are a lot of misconceptions about financial planning – and more and more often the word “holistic” is being tacked on to this process – a meaningless and confusing addition in my mind. Done properly, financial planning has always been about “the whole person” and “the whole family” and about all of those things that are important to the client. It really isn’t financial planning when done properly since finances are not a goal but rather a means – finances are an asset to be used to achive important goals in people’s lives. So here is my take on the 7 parts of “financial planning”.

Life Planning
 What gets you up in the morning?
 For what are you striving in life?
 What excites you about your future plans?
 How do you see your personal or business legacy?
 What is important in your life today?

Cash Flow Management
 Sources, reliability and expected duration of current and future income
 Taxation of current and future income
 Expenses review and analysis
 Includes any Education funding requirements
 Income tax planning – personal, investment and business sources of income

Debt Management and Net Worth Enhancement
 Good Debt versus Bad Debt
 Analysis of Debt amounts, repayments, interest rates and purpose
 Restructuring opportunities for enhancing Net Worth growth
 Net Worth targets
 Non-retirement financial goals and objectives (education, asset acquisition, travel, etc.)
 Funding of goals from surplus or designated cash flow
 Includes all assets other than personal effects and non-realisable collectables, antiques and jewelry

Investment Management
 Individual Risk Tolerance Profiles
 Full investment analysis and review including purpose, goals and priority
 Targeted holdings and transition plans as appropriate
 Tax efficiency and effectiveness
 Includes business review from investment perspective including eventual disposition plans

Risk Management
 Lifestyle protection
 Asset protection
 Cash-flow protection
 Retirement protection

Estate Planning
 Legacy planning
 Survivor income and bequest planning
 Tax planning for your estate and legacy
 Charitable bequests (if applicable)
 Special needs bequests (if applicable)

Retirement Planning
 Current sources of income, duration, taxation and indexing
 Expected sources of income, duration, taxation and indexing
 Lifestyle objectives – 3 stages of retirement – lifetime income requirement
 Tax efficiency and effectiveness of income
 Protection of lifetime income from erosion by inflation

Each client has different priorities and it isn’t my job as a planner to tell them what to do or in what sequence things should be done, with one exception. Without Life Planning be done first, the rest is just a bunch of meaningless numbers with no importance or urgency attached – and also a waste of everyone’s time!

The Real Reasons not to do any Estate Planning

Honestly, I know you have good reasons for not making an estate plan. Some reasons raise legitimate questions of strategy and importance. Let me give you the answers you need to take action.

I’ve heard plenty of excuses over 30 years as an estate lawyer. Procrastinating tops the list. I’ve prepared a list of excuses that may ring a bell with you. But I have gone a step further. I’ve countered each excuse with tips to help you.

Look at this list and check off how many of these excuses you have used.

Excuse 1. I don’t know how to get started to make an estate plan.

“What is an estate plan after all? How much is it going to cost me? Where am I to go to begin? Is it really necessary to see a lawyer?”

Answer: It does not matter how you start. Everyone needs a basic plan. You need a will and powers of attorney. These will protect your family and money. Start with creating these documents as your first goal. Then you can adapt and build from that foundation.

Making a will is simple. The government has a will for you if you fail to make your own. The government rules are inflexible. You can find your brother, who you haven’t spoken to in years, gets everything. Is that your choice? Is that where your life savings should go?

Do you want to decide who gets your money and when? Make a will.

You can put the right person in control of your money. You get to name your executor when you make your will.

Excuse 2. I don’t know the best way to give all my stuff away.

“I expect to spend all my money before I go. Why should I bother making a plan? My family gets along. Everyone should just be able to work things out without me.”

Answer: Once you are out of the picture all bets are off. Family members can stop talking to one another when they fight over the contents of your home. Who is to get the piano, mom’s rings or dad’s medals?

You do estate planning for the people you leave behind. They need your instructions to be set out in your will.

Excuse 3. I don’t have a clue how to reduce taxes.

“The whole tax idea is too hard for me to figure out. There are probate taxes, income taxes and more. I don’t want to see an accountant to figure this all out.”

Answer: It is true. Your largest tax bill is due when you die. It only makes sense to try to lower that bill if you can. A good estate lawyer can explain the best ways to save taxes. This is part of any estate plan.

You can make sure you pay less in taxes. You then leave more of your money for people and charities. I’ll continue this in the next post.

Related Post:

The 7 Biggest Estate Planning Blunders to Avoid

Edward Olkovich (BA, LLB, TEP, and C.S.) is an Ontario lawyer, nationally recognized author and estate expert. He is a Toronto based Certified Specialist in Estates and Trusts. Edward has practiced law since 1978 and is the author of seven estate books. © 2013

The 7 Biggest Estate Planning Blunders to Avoid

1. Never Finding Any Time

This is the first and biggest mistake people make — they never do any estate planning. Why does this happen? Are we really too busy or is it that we just don’t know how to get started? For most people, it’s trying to find all the answers by themselves. That’s impossible. You need to find out who can help you find the answers you need.

2. Not Having Any Plan

Many people leave things to chance because they think they’re not rich. It’s a mistake thinking the people you leave behind will automatically manage and figure things out. In every family there are differences of opinion concerning money.

Problems can occur whenever someone else must try to interpret what you want done.

If you don’t bother making an estate plan, the government will provide one by default. Their idea of what happens to your money leaves no room for your personal wishes, flexibility, or tax savings.

Your personal estate plan lets you decide what happens to your money and everything else that is valuable to you. You need to learn how to give away all your stuff to keep the government rules from doing it for you.

3. Paying Way Too Much Tax

The government has ways to make you pay taxes even after you’re gone. If you have a vacation property, a business, substantial investments, or even a registered pension plan, don’t think you can give these away tax-free.

An estate plan can give away your property and reduce, or altogether eliminate, taxes. Think how grateful your beneficiaries will be.

4. Not Making Your Will

If you fail to make a will, the government writes one for you. You have no say about who is in charge of your estate, who gets a share of your money, or how and when it is distributed. You also lose the chance to use any tax-reduction strategies.

Yet people die all the time without having a will. Why? Often they have no idea what is involved in making a will or why it’s the cornerstone to every estate plan.

Wills are legal documents that must pass certain legal tests. Judges are often called upon to interpret or declare homemade wills invalid. Don’t try to make a will by yourself. Invest in a professionally prepared will to get peace of mind. Start your research by finding the right advisor.

5. Becoming a Target of Financial Abuse

Who can protect you and your money if you no longer can? Don’t think that your family, spouse, or children will automatically have access to your bank accounts to pay your bills.

Your estate plan should include power of attorney documents. You sign these written legal documents to designate someone as your agent to make financial and/or health decisions for you. You can choose who will control your money and make health-care decisions when you no longer can.

6. Not Dealing with Insurance, Business, and Charities

Missing an opportunity to deal with these items in an estate plan can be devastating.

There are certain tax-free advantages with insurance or a qualified incorporated business. Your estate plan should always consider these items to capitalize on the benefits.

Donating to charity, religious, or public causes as part of your estate plan can reduce your income tax liabilities. Giving to charity can be rewarding in more ways than one.

7. Not Updating Your Plan

No estate plan will work if it is out of date. Learn why updates are necessary when changes occur, including:

• a change in your personal relationships (marriage or divorce)

• new children, grandchildren, or stepchildren

• changes in your legal and moral obligations

• moving to another province, state or country

Edward Olkovich (BA, LLB, TEP, and C.S.) is an Ontario lawyer, nationally recognized author and estate expert. He is a Toronto based Certified Specialist in Estates and Trusts. Edward has practiced law since 1978 and is the author of seven estate books. © 2013

Education and Tuition Claims at Tax Time

I am right in the middle of the annual early season tax rush and many of the early filers expect refunds. I always get a few new clients each year as referrals from existing clients and it is always interesting to see previous returns they have either done themselves or have paid someone else to complete.

One area of particular interest is the claim for various tuition and education expenses. In most instances, I see that previous filers have almost universally transferred the claim from a dependent child to one of the parents. Of course this is permitted but my question is why would someone do this without at least explaining the consequences of making that choice. After questioning these clients, no-one has ever explained their options – or their child’s options!

While I find this strange, I guess it is the easy way out for many preparers – they don’t have to take time and run things both ways and the explain to their clients. I don’t see it that way at all.

When I explain the potential short-term advantage to the parent in question versus the potential long-term benefit to their child, they have always opted to change the filing and leave the unclaimed tuition and education items in the hands of their children.

So – what do I show them? All of these expenses involve post-secondary education and the intention is that the child will pursue some level of advanced career placement with the potential to earn above-average income, which is great to see. Wouldn’t it be nice for them to have the luxury of choosing when to claim those accumulated expenses after they begin working? Wouldn’t it be nice for them to maybe have an entire year of employment income – and pay ZERO taxes on it? Would that help reduce or maybe even eliminate debts that had accumulated during their education – including Student Loans?

Something worth considering before you rush to file your return – the potential tax savings in the hands of the student are major considerations versus the potential for some short-term savings in the hands of an employed parent. Don’t choose the easy way out – do the numbers first.