A more relevant question might be "How will you choose to retire?" Retirement means different things to different folks and the scale of your financial needs for the future are all governed by factors that are largely beyond your control. These include issues such as inflation, your health and your marital/family status at time of retirement, the city and type of home that you may wish to live in during your "golden years". And of course, the expectation of what your investments will yield to be able to support your plans.
When we talk to our clients and ask them about their retirement plans, usually two issues predominate the conversation. The first is how much time are we given in which to grow the investment to produce an adequate revenue base, and the second is how much "risk" are you prepared to endure in order to meet your objectives.
The development of a properly designed investment portfolio would not be complete if it didn't adequately address issues such as:
These factors can only be assessed on a case-by-case basis and you are encouraged to avoid off-the-shelf investment and pension solutions.
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It's not what you earn, it's what you keep
We find that investors lock their sights so firmly on the Return On Investment that they often forget that CCRA is sitting in the wings waiting to take a big bite out of their earnings.
In many instances, it proves to be a better strategy to accept a lower rate of return if the investment is ultimately taxed at a lower rate. The type of investment you choose will determine how much you actually keep after tax.
For illustration, let's look at three common types of investments:
Guaranteed Investment Certificates (GIC), Preferred Shares and Common Stocks.
Let's assume that you invest $10,000. For this example the GIC and Preferred Shares pay 10%, and you make a 10% profit on the sale of your Common stock. This means that all three types of investment options earn $1,000 before tax. However, after tax the picture is completely different.
Assuming you are in a 50% tax bracket the amounts after tax are:
If you need income then the Preferred Shares give you the best after tax rate of return. The stocks are volatile and there is no guarantee that after a year that their price will have increased. However if you do not need income, the stocks, provided they have increased at a similar annual rate, will accumulate tax free and will only be taxed on sale.
This also holds true for investments in Mutual Funds. If you invest $10,000 in a mutual fund with an aggressive trading strategy your after tax rate of return will be far lower than a Mutual Fund with a buy and hold strategy. After 15 years your GIC will have $23,847, your aggressive trading mutual fund will have $29,942 and your buy and hold mutual fund will have $37,862. (This assumes a 50% tax bracket, all investments earn a 12% rate of return, all distributions of income and/or capital gains are at year end and reinvested net of taxes and the aggressively traded mutual fund has a 10% annual distribution.)
All or a blend of these investment options should be thoroughly explored with your professional advisor to help determine which will provide you with the lowest taxable rate while at the same time satisfying your need for interim liquidity.
Next to the value in your home, your business might very well be your greatest financial asset, and after your passing, the company may play a crucial role in meeting your family's financial needs. Taking steps to ensure your business' ongoing profitability and strong management can be just as important as considering the planning opportunities available to minimize taxes on your death.
One of the first issues to resolve is what will happen to the business when you die. You may wish the business to be kept in the family, sold to a buyer outside the family, or liquidated. The options you choose will largely depend on things such as the nature of the business, the likelihood of its continued success after your death, and the abilities of your family members and/or key employees to properly run the operations.
If the family is neither capable nor wants to run the business, it may be in everyone's best interests to sell or liquidate the company on or before your retirement. If some family members are currently active in the business while others are not, dividing ownership equally among your family may seem fair, but could end up disrupting the operations and causing stress and dissension in the family. Often in these instances you could use other family assets or life insurance as an asset to ensure fairness to all parties.
Should you decide to keep the business in the family, you should seek professional advice to help you decide whether to transfer ownership during your lifetime or upon your death, who will receive the business' shares and in what proportion, whether the shares will be gifted or sold, and the most tax-effective way to structure the transfer.
If you do not own 100% of your company's shares, the transfer of its legal control may be smoothed by a carefully drafted Shareholder's Agreement. Key Person Life Insurance owned by you or your company is an excellent way to fund any tax liability arising on your death and can potentially be used to buy out any outsiders should you wish the company to be returned to 100% family ownership.
You may have some questions about venturing into the market. Here is a compilation of some Frequently Asked Questions that will hopefully address your concerns. Should you you have any comments that are not covered here, please feel free to contact us at your convenience.
The following are questions that people have recently submitted. We invite you to use the auto-email link to ask questions of your own. Ask The Advisor
Generally speaking, a Financial Advisor is an independent, licensed professional whose income is closely hinged to your investment success. Some Financial Advisors charge a flat fee-for-service basis at a rate of $75 to $200 an hour, or on a percentage of the managed portfolio. There are also planners who sell financial products, from which they derive commissions ranging from 1 percent to 6 percent and, there are many who offer a combined fee and commission in return for managing your account.
A "broker", full-service or otherwise is usually an employee of a large investment firm licensed to trade in mutual funds and stocks, and generates his or her income primarily on a commission whenever an investment is either bought or sold. Brokerage firms are usually structured similar to real estate firms with the house taking a percentage of the sales commissions.
No matter where you choose to conduct your business, your security is held "in trust" by a government regulated and insured institution. Since there is no shortage of professionally developed investment research materials and statistics, the difference in your bottom line comes down to the skill of the individual handling your account and the care that is taken helping you to reach your goals.
There are many instances where it is not the right thing from a taxation point of view to invest further in your RRSP. For example, if you are not able to get a tax deduction for the "top up", and your investment generates unrealized capital gains you will be far better off not topping up your RRSP.
RRSP's do offer various options for withdrawal and disposal of assets which include converting it to a Life Income Fund (LIF), purchasing an annuity which generates lower taxation rates on the proceeds, and even over contributing just as you turn 69. (the tax credits outweigh the penalties) They all strongly depend on your individual circumstance and your personal requirement for income as you index towards to the maturity date. These issues can be easily evaluated by your Financial Planner to help you make the best decision and develop a strategy that is right for you.
To help Canadians plan for their children's education, the government has conceded to allow the education investment to be otherwise used should the registered child choose to not attend college or university. You can now save for your children's education and earn a minimum 20% return on your money, and that's GUARANTEED!
A Registered Education Savings Plan (RESP) allows you to accumulate tax sheltered funds designated for education. For every dollar you contribute to a RESP you receive a Canada Education Savings Grant (CESG) for 20% of your contribution. The maximum amount eligible each year for the grant is $2,000. If you contribute $2,000 you receive a grant for an additional $400 so you now have $2,400 in the plan which earns a return for you. You may make a contribution for a previous year provided you did not make a contribution during that year. You choose from a number of different mutual funds. All growth is tax sheltered until withdrawn by the named beneficiary.
You can nominate one or a number of beneficiaries provided they are related to you by blood or adoption. That way if one of the beneficiaries chooses not to attend college or university the funds can be redirected to the other beneficiaries. And, the best part is if none of the beneficiaries attend college or university up to $40,000 can be transferred tax free into your RRSP provided that you have sufficient contribution room.
This is a question that I am often asked, fortunately when the individual is still young enough to do something about it. When you reach the age when you need long term care such as a retirement home the monthly cost is substantial. A public facility typically charges $800 a month for a room with three beds or more, $1,200 a month for a room with two beds and $1,800 a month for a room with one bed. A private facility typically ranges from $2,200 a month for a private room up to $4,800 a month for a suite.
If you move in at age 70, the amount of capital you will need depends on how long you live and the return you earn on the capital. Assuming you take a single room at a cost of $2,200 a month and you earn 6.5% a year on your capital you will need:
Living 10 years $200,000 Living 15 years $250,000 Living 20 years $300,000
At the end of that time your capital will be exhausted so you better not underestimate your life expectancy.
Fortunately, there is an alternative. It is possible to purchase insurance which will provide you with a monthly amount until you die if you are unable to perform 2 or more activities of daily living, or if a physician decides you require long term care.
The cost for this type of insurance is inexpensive. For example the premium for a 55 year old purchasing a $100 a day benefit ($3,100 a month) is only $73.65 a month.
Is this a good investment? Investing this same amount monthly for the next 15 years assuming at 6.5% return you will have accumulated $36,000. Requiring $3,100 a month you will have exhausted the money in a year.
When you sell stocks or mutual funds normally you have to pay capital gains tax on any profits that you have made. If you are in the top tax bracket and your profit is $1,000 you will pay approximately $320 in tax. Previously there was nothing you could do about it, but now there is an opportunity to defer the tax until a more advantageous time or when you need to withdraw the money.
How does this work? Some mutual fund companies have set up a class of shares which allow you to transfer between the funds in that class without paying capital gains tax. So if you feel that the US is going to be outperformed by Europe you switch from the US fund to the European fund. Similarly if you feel now is a good time to switch from technology to bio-technology you can do so, and once again no taxes are paid.
These types of funds have a major advantage due to deferral of taxes. Let's see how substantial the advantage is. We'll assume (a) you bought and sold your stocks once a year, and (b) the stocks and the funds all earned the same rate of return. In this example, by keeping your money within a class of approved funds, you are able to accumulate the same value within the funds in only10 years' time. The same return would take almost 15 years of buying and selling comparable stocks, and remitting tax.
Moving your tax deferred status from industry sector to sector until you wish to draw it out or hold it for a time when you can take advantage of a more advantageous tax situation is a good idea! As usual, taxes distort investment decisions and all that counts is your after-tax rate of return.
The answer is don't have a mortgage - seriously. But, if you need to borrow money to purchase a house, then instead of a conventional mortgage, if you are able to, use a line of credit as an alternative.
A secured line of credit has a much lower rate of interest than a mortgage. For example on a typical line of credit if Prime is at 7.5%, you will probably pay only 7.75%. Whereas, the mortgage rates for various terms when prime was at 7.5% were:
...and these are closed rates. You are locked in until the respective anniversary date.
Over the average mortgage amortization period of 25 years, if the difference between the line of credit rate and the mortgage rates remain the same, the savings of a line of credit over a conventional mortgage for the different length terms are significant:
Other advantages are that you can make payments as frequently as you like and you can pay down as much as you like. So you have in fact, a fully open, flexible mortgage.
There are however, also two disadvantages.
Everybody is aware that you can borrow to invest in an RRSP or even in a non-registered investment. Up to now you had to borrow an amount which may or may not be leveraged and then pay it back over a period of time. If the loan was leveraged you also faced the risk of the lender initiating a margin call. There is now another alternative.
You invest monthly in a fund with an amount of your own money, plus an equal amount loaned to you monthly by the bank. In order to provide the bank with the comfort and cushion they require, you will need to floor plan the investment account with 3x the amount of the monthly borrowed money. For example, if you plan to borrow $500 monthly, you will require $1500 of your own cash in order to start the program off. For the concept to work, the interest must be paid monthly and the investment must of course, earn more than the cost of the bank loan. By supporting debt, you are using someone else's money to make money, there is no margin call, and no structured repayment schedule.
If the investment is good and consistent, how much more will you make?
If you borrow from the bank at 7% and earn 10%, after 10 years you will have almost 21% more money after paying back the bank and subtracting the interest paid over the 10 years. Every 1% more that you earn equals approximately 4% more money. So if you earn 11% you will have 25% more money after 10 years.
This however, is not for everyone. If you borrow $100 a month your monthly interest cost in the first year is approximately $4 but by the 10th year is approximately $66 as your loan increases by $100 a month.
Individuals who return to grad school generally do not have the surplus cash available with which to make an RRSP contribution, as they now need these funds for tuition. Moreover, if there is extra income available, this surplus just generates a further tax obligation since students are not eligible to receive any RRSP deduction. However, it is possible to make an RRSP contribution and have the cash at the same time!
You are permitted to withdraw tax free up to $20,000 from your RRSP to pay for either your own, or if married, your spouses' education. The maximum you are allowed to withdraw in any calendar year is $10,000. The money withdrawn must be repaid over 10 years, starting the year after you finish the course, or at the latest, the fifth year after the first withdrawal. Any money not repaid is considered as taxable income. Both you and your spouse can each have your own plan.
The money can be used for any expense not just tuition or books. The educational program has to be a full-time course, must have at least 10 hours of instruction a week and last for 3 consecutive months. It must be a course offered by a recognized university, college or institution that trains or improves skills for an occupation. A university outside Canada qualifies if the course leads to at least a Bachelor's degree and lasts for a minimum of 13 consecutive weeks.
If you are disabled, the course may be attended part-time. Your RRSP contribution must remain in your plan for at least 90 days before you withdraw it. At age 70, or if you become a non-resident, any amount that has not been repaid must be repaid in full or be included in your income. You can find the guide and forms for this RRSP support on the Canada Customs and Revenue Agency site located at http://www.ccra-adrc.gc.ca/E/pub/tg/rc4112eq/
As a service to both our clients and those who drop in just to visit us on our website, we cordially invite your questions and feedback about investments, financial planning, and taxation issues that are of concern. During our normal course of meeting with our clients and conducting business, we are in regular contact with members of the legal and accounting profession, taxation specialists and CCRA.
We would only be too happy to include your questions and respond to them either in this forum for others to share, or at your option, on a personal one-to-one basis. - Of course at no cost or obligation.
To submit a question or a comment, please enter your query below and if you wish to have Richard Segal respond off-line personally, be sure to include a telephone number and your name.