Thursday, June 11, 2009

The value proposition of a premium chequing account

Million Dollar Journey has a post today comparing the big five banks' high-end chequing accounts. These accounts charge a substantial monthly fee, and in return provide a number of "value-add" services, including the following:
  • Unlimited transactions

  • Free drafts/certified cheques

  • Discount on safety deposit box rental

  • Discount/waiver of credit card or discount brokerage annual fees
Some of these accounts offer a waiver of the monthly fee if a minimum balance is maintained in the account. For example, BMO's Premium account has no monthly fee if the account's balance never drops below $4,500 (otherwise the fee is $25 per month). The thinking behind these minimum balance fee waivers is that, while the customer avoids paying a fee, they also miss out on interest they would have earned on that balance in a savings account.

I was curious recently as to just how favourable the fee/interest trade-off turns out to be, so I decided to run some numbers. Using the BMO account as an example, I worked out what APR would correspond to $25 per month on a $4,500 balance. Assuming a 40% marginal tax rate (since interest income is taxed at the full marginal rate), I came up with the following:
  • $25 = $4,500 X ((1 + APR / 365)^30 - 1) X (1 - 0.4)

  • APR = 365 X ((($25 / 0.6) / $4,500 + 1)^(1 / 30) - 1)

  • APR = 11.22%
This means that, in order to earn $25 per month after taxes on a balance of $4,500, you would need to find a guaranteed 11.22% APR. Since the market is currently swimming in 11.22% savings accounts, it's a no-brainer, right?

One of the best rates currently available for a Canadian savings account is Canadian Tire's 2.00%. At this rate, a $4,500 balance would earn a mere $4.44 per month after taxes. This means that, with today's interest rates, keeping the minimum balance in this account essentially means that you're "paying" a $4.44 monthly fee for the use of the account. If you take advantage of the features of the account, this can turn out to be extremely worthwhile (a safety deposit box rental can easily run $4 per month).

This doesn't mean that a high-end chequing account is automatically worth it, but it does mean that, at least for the foreseeable future, the cost of such an account is significantly reduced by maintaining the minimum balance.


MDJ said...

Thanks for the link! Keep in mind that if the account minimum threshold is ever breached (even for 1 second), the monthly fee applies. So for those who use these accounts to pay all their bills, they would need substantially more than the account minimum to avoid the fees.

Loonies And Sense said...

Good point. Still, even if you leave an extra $1,000 in the account, you're giving up far less interest than the monthly fee would indicate.

The key thing is, this is a question of "how do I best allocate this $4,500 I have kicking around", and not a case of opening the account and hoping or assuming that the minimum balance will be maintained.

With rates the way they are today, savings can often be used more effectively to avoid costs than to generate income.