The benefits of consolidating investment accounts

In the last 10 years, there have been a number of changes to investments and regulations. Many of these changes have an impact on your financial plan and tax situation. All firms have been spending significant amounts of capital to become compliant on the disclosure rules and upgrading technology and systems.

These systems are designed to generate reports which assist wealth advisers in managing clients’ accounts.

Most clients today may have several types of accounts, including Registered Retirement Savings Plans, Locked-In Retirement Account (LIRA), Joint-With Right of Survivorship Account (JTWROS or Individual / Cash Account), in-trust for account, corporate account, Registered Education Savings Plan, Registered Disability Savings Plan (RDSP), and Tax Free Savings Account (TFSA).

Registered accounts all have specified limits that you must stay within; the tracking of the limits is complicated enough even if all of your accounts are held at one institution.

When we meet with prospective clients, we notice that they may have their investments at multiple financial companies.

I am still puzzled as to why people want to complicate their life by having the same types of accounts noted above at multiple institutions. Is it because you were not happy with the first institution you opened accounts with? Was it the closest financial institution to make that last-minute RRSP contribution? Was it an inheritance that just seemed easier to keep at the same place? Maybe it was a short-term advertised special on a TFSA that brought them into another institution. It could be that you bought a proprietary product that could not be transferred after you purchased it.

Whatever the reason, there are many disadvantages for people having multiple accounts at different institutions. We recommend developing one good relationship with a portfolio manager or wealth adviser to better manage risk, reduce the time for regulatory and tax obligations and to simplify your financial life. Below, we have mapped out some good reasons to consolidate your accounts with one institution.

Foreign Income Verification Statement (T-1135)

There are harsh penalties for individuals who do not correctly file the Foreign Income Verification Statement, T-1135 with the Canada Revenue Agency. The form can be rather time-consuming to complete if you have multiple accounts at different institutions.

On an annual basis, we forward our clients their Foreign Income Verification Statement that contains information about their foreign holdings and income to report on T-1135.

If all of their non-registered investments are held within this one account, they can simply provide this statement to their accountant with minimal effort for reporting.

If they have multiple non-registered accounts, then clients or accountants will have to develop a system to integrate all of the totals for the foreign investments at each firm to come up with the required figures.

Over-contribution Penalties

There is no restriction to the number of TFSA and RRSP accounts you open.

If you open a TFSA with a financial firm, I would suspect they would be contacting you annually to make your contribution for the year. If you inadvertently say yes to more than one institution, then it would be fairly easy to over-contribute to your TFSA.

If you over-contribute to a TFSA, or any registered plan, then you may be subject to a tax penalty equal to one per cent per month of the over-contributed amount. If you have more than one TFSA as an example, it is important that you tell the adviser at each institution what you have contributed.

T5008

Years ago, financial firms did not have to report dispositions to CRA. Now, each disposition in a non-registered account is reported on a T5008 form.

These forms are not necessarily sent to clients in the mail, but can be accessed on My Account with CRA online.

We always caution clients who do their own tax return to carefully review the auto-fill function that transfer the T5008 information automatically to your return. The information transferred in from T5008 is just the proceeds amount and do not include the adjusted book value. It is important to also input the adjusted book value manually.

We send our clients a tax package that includes a Realized Gain (Loss) Report, which contains both the adjusted book value and the proceeds. We encourage clients to refer to the information on the Realized Gain (Loss) Report and use the T5008 slips to verify completeness and accuracy of the proceeds.

Average Cost

In Canada, we have to use average cost. Tracking the average cost of the investment assets can be straight forward if all of your investments are at one institution.

If Darlene bought 100 shares in 2015 of ABC Company at $70/share and another 100 shares in 2018 at $100/share, she would own 200 shares with a combined adjusted cost base of $17,000 (or $85 “average cost” per share). If Darlene sold 100 shares then the adjusted cost base per share is $85 and would be reflected correctly on the realized gain (loss) report if both blocks of shares were purchased at Institution A.

Let’s say Bill bought 100 shares in 2015 of ABC Company at $70/share at Institution B. In 2018, Bill buys another 100 shares of ABC Company for $100/share at Institution C. Neither Institution B or C would know about the other purchase and both Realized Gain (Loss) Reports would be incorporate the average cost of the shares sold.

Individuals who have more than one cash account must ensure holdings are not duplicated. If they are duplicated, then care must be taken to adjust the book values on dispositions as you cannot rely on the Realized Gain (Loss) Reports for tax purposes. This is one of the reasons why financial firms put a disclaimer on reports as they cannot provide assurance that you do not own additional shares elsewhere.

Asset Mix

An important component of investment performance is asset mix. Consolidation can help you manage your asset mix and ensure that you have not duplicated your holdings and are therefore, not overexposed in one sector.

Unless your wealth advisers have been given a copy of all of your investment portfolios, it will be difficult for them to get a clear picture of your total holdings.

Even if you were able to periodically provide a summary of each account to each Advisor, as transactions occur you would still need to update every advisor with those changes.

Technology

Most financial firms provide access to view your investments online. If you have accounts at different institutions, you will need to get online access from each. It is not as easy to get a snapshot of your total situation when you have multiple accounts spread across multiple institutions.

Many firms provide paperless statements and confirmation slips. As time goes on, most people will gravitate to the benefits of paperless. You do not have to worry about your mail getting lost or delivered to your neighbor. You will get your statements quicker. You don’t have to worry about storing older statements or shredding them. You can easily forward information to your accountant in PDF form if required. You can be travelling, or in your home, and have the access to your investments. If you had one online platform this process is even easier.

Tax Receipts

If you hold non-registered investment accounts at several institutions, you will receive multiple tax receipts.

By consolidating your accounts, you will receive a limited number of reporting slips for income tax each year. Reducing the number of tax receipts may also reduce the amount of time your accountant will spend completing your tax return.

Tax information can also be set up to paperless at many firms. You can log onto the communication centre of the website and retrieve updates on when your information will be available.

Managing Cash Flow

Projected income reports from different institutions will be presented in various formats and at different points in time.

For you to obtain a complete picture of your financial situation, you will have to manually calculate the total income from your investments. In situations where you have instructed your financial institution to pay income directly from an investment account to your banking account, it becomes more complicated to manage when there are multiple investment accounts.

We like to have a detailed Investment Policy Statement which clearly states the required cash flow and from which investment accounts that cash flow is being derived.

Estate Planning

One of the steps in an estate plan is to deposit all physical share certificates and to reduce the number of investment accounts and bank accounts. Having your investments in one location will certainly simplify estate planning and the administration of your estate. It also assists the people helping you as you age.

Monitoring Performance

Some investors may be comparing the performance of one firm or adviser to another. Investors should be careful when doing this to ensure they are really comparing apples to apples.

One investment account may have GICs while another may have 100 per cent equities. It is easier to understand how all of your investments are performing when you receive one consolidated report from one adviser.

When you have all accounts consolidated with one financial institution it is easier to obtain a consolidated report.

Conversion of Accounts

If you have multiple RRSP accounts and are turning 71, you may want to consider consolidating now and discussing your income needs. If you have three RRSP accounts, you will have to open up three RRIF accounts. It is easier to consolidate all of the RRSP accounts before age 72 and open one RRIF account.

Mapping out whether to select the minimum RRIF amount or elect a greater payment when you have only one account is significantly easier.

Account Types

Fee-based accounts are usually suitable for a household that has total investment assets of $250,000 or more at one institution.If you have $100,000 at Institution A, $130,000 at Institution B, and $50,000 at Institution C then you would not be exposed to the fee-based option. Consolidating allows these types of accounts to be an additional option.

In addition, most financial firms have a declining fee schedule. As your account value grows, the fees as a percentage may decline.

Service

In a perfect world, all clients’ at all financial institutions are treated equal. The reality is that the largest clients get better service.

By having $100,000 at six different institutions you are probably getting minimal service at each institution. If you consolidated these accounts at one institution we would suspect that you would get significantly better service.

Other Benefits

When you have all registered and non-registered investments at one location it is easier for financial planning purposes. Consolidation enables you to fund RRSP contributions through in-kind contributions.

Sometimes it is recommended to change the structure of your investments between accounts to improve the overall cash flow and tax efficiency standpoint — this can only be done if your accounts are at one financial firm.

Kevin Greenard CPA CA FMA CFP CIM is a portfolio manager and director of wealth management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week in the Times Colonist. Call 250-389-2138.

It’s tax time — will you do it yourself, or hire a professional?

In 1988, I got my first job working at an accounting firm. It was a great year to start in the accounting world as most clients were still doing everything manually. Individual tax packages could be picked up at the post office or mailed to clients for those who wanted to prepare the personal tax return (T1) themselves, small businesses often recorded transactions on manual ledgers and nearly every corporation would have to hire a local accountant to prepare the annual financial statements and file the corresponding corporate tax return (T2).

Accounting firms were largely the only ones using computers and newer technology to prepare and file tax returns. At this time there were three accounting bodies, Chartered Accountants (CA), Certified General Accountants (CGA) and Certified Management Accountants (CMA). These three organizations are now unified under one organization, and referred to as a Chartered Professional Accountant (CPA).

Corporate Tax Returns

Over time, point of sale systems, accounting systems, payroll systems and automation have been introduced directly to businesses. This made the larger volumes of transactions more manageable. In some cases, business owners learned how to do this on their own. In most other situations, accounting firms and bookkeepers helped business owners with this transition. Today, the owner of the business and bookkeepers normally compile all the daily information. This compiled information is then provided to CPA firms to do the final journal entries, financial statements, tax returns and regulatory filings. In the future with cloud computing gaining popularity, businesses will not be limited to using accountants within a limited geography.

On a daily basis, we are communicating with our client’s accountant to ensure that they are getting the information from us that they need. For example, if a holding company has a portfolio of investments, it wouldn’t be unusual to have hundreds of transactions in a year (i.e. purchases, sells, interest income, and dividend income). Annually, we will export all of the transactions during the year into an excel spreadsheet that is forwarded to both the client and the client’s CPA. This spreadsheet saves the accounting firm time by not having to enter every transaction. We also forward all the PDF copies of the statements, fee summary, realized gain (loss) statement, and T-1135 Foreign Verification statement. Nearly every one of our corporate/business clients uses a CPA firm. Proving this information to your CPA firm enables them to spend time giving you proactive big picture advice rather than spending time on data entry.

 

Personal Tax Returns

In the initial meeting with a new client, we always obtain the name of their accountant who prepares their personal income tax return. We obtain the accountants name, email, phone number, and fax number. Most accountants will have an annual tax checklist that they provide to their clients with the information they require. We also provide a letter to clients with a summary of the information that they can expect to receive from our team, firm and others. The letter outlines the timing of when they will receive the tax information. Because the information is coming from multiple sources and at different times, we encourage our clients to have a system to organize this information and pass on everything they receive to their accountant.

The timing of when you give your information to your accountant is important. We always encourage clients to wait until the beginning of April before giving their information to their accountant to ensure they have all the information needed to properly file their tax return.

We keep good analytics with respect to whether our clients use the services of a professional accountant. Ten years ago, about 85 per cent of our clients used the services of an accountant. Five years ago, the percentage using professional accountants had dropped to 75 per cent. Today, 67 per cent of our clients are using the services of an accountant.

Of the 33 per cent of our clients who do their own tax returns, nearly all use a software package, such as Turbo Tax. We still have a handful of clients who like preparing their tax return with the paper copies and mailing them in.

 

Professional Advice

Not everything is constant with tax policies and accounting rules. CPAs have to adapt to these changes quickly. In some cases there is a lot of overlap between the advice given from CPAs and financial advisers. One example is managing taxable income, especially in retirement. The decision of where cash flow is generated should give consideration to the tax consequences. This is especially important when clients have corporate investment accounts. The level and timing of wages and dividends can fluctuate and should be integrated into the timing of registered account contributions and withdrawals. With so many different types of registered accounts (RRSP, RRIF, LIRA, TFSA, RRSP, RDSP) it is important to have the correct combination based on your short and long term goals. Some of the decisions are driven by required cash flow and some are based on minimizing tax during your lifetime.

If a person is doing both their own self-directed investing and doing their own tax return, then they would not have any professional to obtain advice. Both accountants and wealth advisers are being asked financial and estate planning questions all the time. What is really valuable is when an accountant and wealth adviser provide proactive advice. The term, “you don’t know what you don’t know” certainly applies. The gap in knowledge can range from things that impact tax decisions in the shorter term like the contribution and withdrawals noted above. The decisions you make today could impact taxation for several years in areas such as income splitting rules, changes in RRIF minimums, and whether to collect CPP early. Accountants and wealth advisers have the tools to help with projections and decision making.

Quality of life and changes in your life are both good reasons to have qualified professionals that you know and trust. Even though you may be fully capable of doing your own taxes today, it will take time and you may miss something that you are not aware of. One simple proactive tip from an accountant or wealth advisor could save you thousands of dollars in taxes.

Deterioration in health has many cascading financial consequences and this becomes especially true if the spouse that does the tax returns becomes sick or passes away. It puts even more stress on the spouse during a difficult time if they have neither an accountant or wealth adviser that they know to speak with. During a meeting we may learn about a client’s health deteriorating. Depending on the severity, it can impact tax and estate planning. One example that has an income-tax impact is when we have recommended clients to talk to their doctor about completing Form T2201 for the Disability Tax Credit Certificate. Often at times people may qualify for the disability tax credit, but they did not know. We have had many clients get thousands of dollars back in taxes once they received appropriate advice. If we see years with high medical expenses then this could be an opportunity to offset with other taxable income, such as a higher RRIF withdrawal.

With accountants and wealth advisers working together, you will have two sets of proactive eyes making sure you are getting the best advice. In addition, you can spend your spare time, saved by not doing your taxes, with things that you really enjoy doing.

Kevin Greenard CPA CA FMA CFP CIM is a portfolio manager and director of wealth management with The Greenard Group at Scotia Wealth Management in Victoria.

Many couples should consider spousal RRSPs

For couples that make approximately the same annual income, a spousal RRSP may not be necessary. The greater the disparity between incomes with couples, the more important it is to consider spousal RRSPs. This is especially true if one person is in an upper tax bracket and your spouse is in a lower tax bracket. If investment dollars are limited, then the recommendation would normally be for the upper tax bracket individual to make an RRSP contribution.

With fewer and fewer income splitting opportunities between spouses, it is important to understand the strategies that remain. Spousal RRSPs are an effective way to split income between spouses during your lifetime. However, it is important that you know the rules.

What is a spousal RRSP?

A spousal RRSP is an account to which you contribute, however your spouse is the annuitant of the account. This means that you receive the tax deduction for the contribution to the account, but your spouse will receive the proceeds from any withdrawals from the spousal RRSP. Once the contribution is made, your spouse becomes the owner of the funds within the account.

The advantages of a spousal RRSP

The biggest advantage of a spousal RRSP is the opportunity to split retirement income between spouses.

Effective retirement planning would result with both spouses having equal income producing assets at retirement. This would allow the family to take advantage of splitting income instead of having it all taxed in one individual’s hands, which is normally at a higher marginal tax rate.

Most people will not have equal assets at retirement, so the spousal RRSP is a method to help ensure that you work towards equal assets at retirement.

Usually, the higher income spouse (and therefore the spouse that is likely to have higher assets at retirement) will contribute to a spousal RRSP for the lower income spouse to allow them to accumulate assets for retirement. When you finally retire, the withdrawals from the spousal account will be taxed in the hands of your spouse, usually at an overall lower tax rate than would be the case if the withdrawal was taxed in your hands.

The advantage to this income splitting strategy is based on the fact that the contributor receives a tax deduction at a higher tax rate than the income will ultimately be taxed at.

Know the rules and be careful of the attribution rules

There are rules in the Income Tax Act called attribution rules that are designed to prevent abuse of spousal RRSPs. The rules state that:

• Withdrawals from a spousal account will be taxed in the hands of the contributor if a contribution has been made to any spousal account in the year of the withdrawal or the previous two years. What this means is that if you made a contribution to any spousal account, you must wait three years before your spouse can withdraw it without it being taxed back to you.

The attribution rules do not apply in the following circumstances:

• If funds are transferred directly for your spouse or common-law partner to a RRIF and only the minimum payments are withdrawn, there is no attribution. However, there is attribution on funds withdrawn in excess of the minimum payment as long as the three years is still in effect. After the three years has passed, there is no further attribution.

• If funds are used to purchase a life annuity or a term certain annuity to age 90, there is no attribution

• If the spouses are living apart due to a breakdown of relationship at the time of payment

• If either spouse becomes a non-resident of Canada at the time of payment

• If the contributing spouse dies in the year of payment

• If the deceased annuitant is considered to have received the amount because of death

One of the most popular questions relating to spousal RRSPs is: “Can my spouse co-mingle their own RRSP with that of their spousal RRSP that I contribute to?”

The answer is yes, however, once you co-mingle the accounts, they are considered a spousal account and therefore subject to the attribution rules discussed above.

We do not recommend co-mingling RRSP accounts. There are reasons to keep the accounts separate, depending upon your circumstances. Having two plans provides you with extra flexibility with respect to withdrawals. For example, if your spouse was not working and wanted to withdraw funds out of their RRSP, they could withdraw them out of their own RRSP and have the income taxed in their hands. If however, the funds had been co-mingled and a spousal contribution had been made within the last three years that income withdrawal would be taxed in the hands of the contributor.

If you are at the age where you have only RRIF accounts and are pulling out the minimum, then co-mingling the accounts at this stage is normally okay.

Other factors and looking at the long term

In some situations, one spouse may be temporarily out of the work force and will have significant income in the future. Individuals that own corporations or other assets should seek professional advice to see how a Spousal RRSP could integrate into a longer-term plan. Stability of marriage, future inheritances, projected retirement dates, and changes in Canadian tax laws are additional factors to consider.

 

Regulatory Change Helps Drive Popularity of Fee-Based Investment Accounts

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The investment services industry is changing at a dramatic pace, with investors demanding more choice, more transparency, and more personalized advice. One of the fastest growing trends within the financial services sector is the use of fee-based accounts. While there are many reasons for the increasing popularity of these accounts among advisers and clients alike, recent regulatory changes have been a major catalyst.

Traditional vs fee-based account structures

In the past, the most common type of account structure has been a transactional one, wherein commissions are charged for each buy or sell transaction. With fee-based accounts, however, advisers do not receive commissions—instead, they agree to a set fee schedule, usually charged on a quarterly basis. This fee is normally based on the portfolio’s market value and composition. Buy and sell recommendations are based solely on the client’s strategic needs and goals. If an investor’s account increases in value, so do the fees paid to the adviser; conversely, if an investor’s account declines in value, so do the fees paid. With a fee-based structure, the adviser has a direct (and overt) incentive to ensure that the investor’s account increases in value.

Client relationship model initiative enters second phase

The recent increase in the use of fee-based accounts correlates to a large extent to the implementation of the second phase of the “Client Relationship Model” (CRM), a regulatory initiative passed by the Canadian Securities Administrators in March 2012 The CRM affects both the Mutual Fund Dealers Association and the Investment Industry Regulatory Organization of Canada.

While the key objective of CRM1 was relationship disclosure and enhanced suitability, the key objective of CRM2 is to increase transparency/disclosure for investors with regard to fees paid, services received, potential conflicts of interest, and account performance. All of these mandatory disclosures are being phased in from 2014 to 2016.

In July 2014, CRM2 mandated pre-trade disclosure of all fees prior to an investor agreeing to buy or sell an investment. With a traditional transactional account, an adviser must disclose all of the fees a client is required to pay, such as any commissions for transactional accounts when buying or selling positions. However, many investors have complained about “hidden” and unexpected fees, especially with respect to mutual funds. With CRM2, all of these fees now have to be fully disclosed prior to the transaction.

This move to greater transparency is a major shift from certain types of transactions that had no disclosure requirements in the past. For example, an adviser used to be able to purchase a bond and embed their commission in the cost of the bond on the trade confirmation slip. Now, fixed income trades also require full disclosure. In other cases, even if there was disclosure in the legal sense of the word, understanding this disclosure required clients to read the fine print in lengthy prospectus documents. Similar CRM2-type regulations for full disclosure were implemented in Australia and the UK in 2013, requiring transparency regarding all fees. Not surprisingly, this resulted in a significant reduction in the number of financial advisers working in the industry in both countries. It’s possible that we could also see a reduction in the number of advisers here, once the new rules are fully implemented in Canada.

Fee-based accounts are already onside of the new rules, as transparency is embedded in their structure: The client has a discussion about fees with their adviser up front, and a fee-account agreement with full disclosure is then signed by both the investor and the adviser. 

Comprehensiveness

Another reason for the growth in popularity of the fee-based platform is the fact that many advisers now offer a comprehensive wealth offering, which includes both investment and planning-related services. This differs from the role of the stock broker of the past.

Clients have a variety of financial planning needs, primarily with regard to retirement and estate planning. Many advisers can offer detailed financial plans and provide access to experts in related areas, such as insurance, and will and estate planning. An adviser will often communicate with the client’s accountant and lawyer to ensure everyone is on the same page.

In a traditional transactional account where commissions are charged for every buy or sell, it has always been challenging for advisers to be compensated for additional services such as financial planning. Consequently, many transactional-based advisers simply would not offer these services to their clients.

Some unique benefits

Certain benefits are unique to fee-based accounts.

Rebalancing without additional cost

For example, this structure enables wealth advisers to rebalance portfolios as needed to reduce risk at no additional cost. Multiple types of rebalancing are important when managing risk. At the macro level, let’s assume a client’s optimal asset mix is 60% in equities and 40% in bonds. After a period of strong equity markets, the client’s equity percentage rises to 68%. Reducing equities by 8% and allocating this to fixed income is rebalancing at the macro level. At the micro level, there is an optimal position size for one holding. In this example, let’s assume the optimal position size is $24,000 for each company held in the portfolio. If one stock rises significantly above or below the optimal position size, then consideration for a rebalancing trade should occur.

Several trades could be required on an annual basis to rebalance a portfolio. With transactional accounts, the commissions for doing multiple small adjustments would likely be prohibitive. However, not doing the trades because of the commission payable in a transactional account means that you’re not managing risk as effectively.

The adviser’s ability to make tactical shifts in an account is another benefit of fee-based accounts. For example, there are times when investors benefit from moving in or out of USD-denominated holdings. Being able to make these changes when the currency is right should be done without concern for the trade’s commission cost. Being able to move between sectors based on current outlook can also be strategic, especially when transaction charges are not a factor (if a transaction charge is 2% to sell and 2% to buy, then the cost of any switch trade has to increase by 4% to break even).

Income splitting and “householding”

Fee-based accounts also offer couples and families one more opportunity for income splitting by setting up account-designated billing for their fees. For example, the higher income spouse can pay the fees for the lower income spouse. Let’s assume the lower income spouse has an RRSP and a TFSA. The higher income spouse can put funds into the lower income spouse’s account as a contribution of fees without attribution. In another example, a client with multiple fee-based investment accounts (i.e. one non-registered and five registered) can arrange to have all of the fees paid out of the non-registered account.

“Householding” is a term used in fee-based accounts to link accounts together for fee-billing purposes. As the total of the householded assets increases, the percentage fee for the adviser’s services decreases. Let’s say we have a middle-aged couple with $400,000 in investments. The couple has parents with $680,000 in investments, over which the couple has power of attorney. The couple also has a corporate account totalling $120,000 in investments. By householding, or combining all accounts under one agreement, the household value becomes $1,200,000, which results in lower overall fees for everyone.

Deducting investment council fees

Another benefit of a fee-based structure for non-registered accounts is the ability to deduct investment council fees as “carrying charges and interest expense.” Many investors are still not aware of these tax benefits. Anyone who has non-registered accounts would be well advised to read the Canada Revenue Agency’s (CRA) interpretation bulletin on this topic (IT-238R2). The investment council fees cannot be deducted for registered accounts, but there is the benefit of paying the fees for registered accounts from a non-registered account, especially for younger clients where registered accounts are deferred for many years.

Adviser-managed accounts

Over the last several years, adviser-managed accounts have been the fastest growing segment of the broad fee-based group. In this type of account, the adviser is licensed as a portfolio manager and able to use his or her discretion to execute trades.

In setting up the adviser-managed account, one of the criteria is that the account must be fee-based. The regulators have made it clear that a portfolio manager is not permitted to use discretion when it comes to commissions or transaction charges. One of the starting points to setting up a managed account is to get a clearly defined investment policy statement that sets out the relevant guidelines that will govern the management of the account. At this same time, a fee-based agreement is signed that clearly outlines the negotiated fee structure.

Shifting to a new model

As the financial services industry continues to change and evolve, so do the solutions being offered. There is now more flexibility and choice in how a wealth adviser and an investor can work together.

High-net-worth clients are looking for advisers who have the credentials and licensing to offer discretionary portfolio management. Within that context, there is also an expectation that financial planning and other related services will be part of the overall fee-based structure. The traditional model of solely doing stock trades for trading commissions is becoming an increasingly difficult business model to sustain.

Kevin Greenard is a portfolio manager and associate director of wealth management with ScotiaMcLeod, a division of Scotia Capital Inc. and ScotiaMcLeod Financial Services Inc.

Exploring the world of fixed income investments

The term fixed income can be confusing, especially when the financial industry has so many names for the same thing. For someone new to investing I typically draw a line down the middle of a page. On the left side of the page I label this “debt”, and on the right hand side I put “equity”. Debt is another term often associated with “fixed income”. In explaining what debt is I begin by using a simple example, a two year annual pay Guaranteed Investment Certificate (GIC). With a two year GIC you are giving your money to a company and in exchange you receive interest for the use of the capital. You receive your original capital back at the end of two years. You have no direct ownership in the company with debt.

The equity side of the page would have common shares, this is what most people would directly link to the stock exchange. Although some fixed income investments trade on a stock exchange, the majority of listed securities are equities. When the news is flashing details of the TSX/S&P Composite Index, the Dow, or the S&P 500 – these would all be equity indices reflected on the equity side.

Most people would agree that on the equity side of the page it would not be a good idea to put all your eggs in one basket. A prudent approach would be to diversify your equities by holdings various different stocks (i.e. between 20 and 30 different companies) in different sectors and geographies.

All too often I come across investment portfolios that have zero diversification on the fixed income side. As an example, it may be a person that has $500,000 or a million dollars all in GICs. In my opinion the best approach to fixed income is to have diversification – different types and different durations.

If we move back to the left hand side of the piece of paper, underneath debt we have already listed GICs. Let’s list a few other types of fixed income investments including: corporate bonds, government bonds, real return bonds, bond exchange traded funds, notes, coupons, preferred shares, debentures, bond mutual funds, etc.. Over the last decade there has been a huge growth in non-domestic bonds for retail investors. Perhaps one area that is often underutilized by many Canadians is the use of international bonds. Bonds are available in different developed countries. Advisors are able to purchase direct foreign bonds in developed countries and emerging markets. The emerging market bond space has opened up many different opportunities. With certain structured bond investments, these can be hedged to the Canadian dollar or not hedged (you are exposed to the currency risk).

Within each of the above main categories there are sub-categories. As an example, with bond ETFs one could purchase numerous different types, including: floating rate, short duration (example: one to five years), long duration, all corporate, all government, high yield, US bonds, etc.

Another example of subcategories can be explained using preferred shares as an example. Preferred Shares are generally classified as “fixed income” even though they pay dividend income (similar to common shares that are on the equity side of the page). For clients who have non-registered funds, a portion of your fixed income in preferred shares can be more tax efficient than interest paying investments. The main types of preferred shares are retractable, fixed-reset, floating rate, perpetual, and split. All have unique features that an advisor can explain to you.

When equity markets perform well it is natural that they become overweight in a portfolio. We encourage clients to periodically rebalance to their preferred asset mix. In good equity markets this involves selling some of the growth in equities and purchasing fixed income investments. When equity markets are declining, the process of rebalancing could result in selling fixed income and purchasing equities at lower levels.

The idea of adding “fixed income” is not that exciting in this low interest rate environment, especially when many “equity” investments have yields that exceed investment grade short duration bonds. Opportunities still exist in fixed income for reasonable yields, especially when you explore different types of fixed income. One always has to assess the risks they are comfortable with. As an example, I ask clients what they feel is the greater risk, stock market risk or interest rate risk. By stock market risk, I define this as the risk that the equity markets will have a correction or pull back (say, 10% or greater). By interest rate risk, I mean that interest rates will jump up materially and do so quickly (in a short period of time).

Every model portfolio I manage has fixed income. This is the capital preservation and income side to a portfolio. The percentage in fixed income really comes down to a clients risk tolerance and investment objectives. Time horizon and the ability to save additional capital is also a key component in determining the allocation to fixed income. It is important to first determine the right amount to allocate to fixed income, and second, to diversify it to enhance liquidity and overall returns.

Kevin Greenard CA FMA CFP CIM is a Portfolio Manager with The Greenard Group at ScotiaMcLeod in Victoria. His column appears every second week in the TC. Call 250-389-2138.

 

Fee-based accounts benefit investors in the long run

A fee-based account is a tranparent way of paying your financial advisor.  The fee is charged based on the market value of the assets being managed, and it is distinctly different than a transactional account, where commissions are charged for every buy-and-sell transaction. 

When clients open up a fee-based account, they sign a fee-based agreement that establishes the agreed upon fee, how the fees are calculated, when the fees will be charged and the accounts involved.   

There are a number of benefits for clients in moving to a fee-based account. 

Working on a “fee for service” basis, rather than a commission or transactional fee basis, means the best interests of the client are more aligned with those of the advisor. If fees are based on the market value of the account, then the only way an advisor will be compensated further is if they can grow your account in value.  If your account declines in value, then so does the compensation paid to your advisor.  

Another benefit of a fee-based account is the additional services clients receive from their financial advisor.  Financial professionals today are rarely called stock brokers because the services offered extend well beyond buying and selling stocks. Financial planning meetings cover many topics such as tax and insurance as well as education, retirement and estate planning. 

Financial professionals today spend a significant amount of time understanding each client’s needs and integrating this into an increasingly complex tax and regulatory environment. 

As a result, the amount billed for fee-based accounts is referred to as an “investment council fee” for income tax purposes.  The main benefit is the fees relating to non-registered accounts can be deducted on your income tax return as a carrying charge.  If your fee is one per cent before tax, and your marginal income tax bracket is 30 per cent, your fees have a net cost to you of only 0.70 per cent.   

Fees are typically charged quarterly. As an example, Jane Wilson opened a new fee-based account and invested $750,000 on Jan. 1 with an annual fee of one per cent.  She will have no fees charged for three months. Around the middle of April, the first quarterly fees would be charged at $1,875 ($750,000 x 0.25 per cent).  Wilson’s fees are one-quarter of one percent after each quarterly period. 

Other methods of compensating that are not fee-based often have commission charges upward as high as five percent on the first day of buying the investments. For an advisor to be successful with a fee-based business, he or she needs to establish good long term relationships. 

The periodic payment of fees better aligns the interests of clients and financial professionals.  When explained to clients, most would prefer to spread out the fees over time as services are provided versus paying a large amount on the first day.  

One question we are asked is how the quarterly fees are actually paid.  To illustrate we will use Don Spalding, who has three investment accounts totaling $750,000 – $500,000 in a non-registered account, $200,000 in his RRSP account, and the remaining $50,000 is in a Tax Free Savings Account. 

There are a few different options for how Spalding can cover the quarterly fees. 

The first option is to have the fees charged to each of the respective accounts.  Wilson had only one account and the fee of $1,875 was simply charged to that one account.  Mr. Spalding has three accounts and each account is charged the respective amount based on one-quarter of one percent of the market value of each account. 

The first quarterly amount for Spalding is $1,250 for the non-registered account, $500 for the RRSP, and $125 for the TFSA.  He has the option of keeping cash in each account to cover the fees, depositing cash quarterly or selling investments. 

With fee-based accounts, Spalding has the option to instruct us to designate the billing of the fees to come out of one account.  Don could instruct us to pay the fees for his RRSP and TFSA accounts from the non-registered account.  This enables him to maximize the amount he maintains in his registered accounts keeping it tax sheltered. 

The payment of fees from a designated account enables an advisor to fully invest the non-designated accounts and to utilize compounding growth strategies such as the dividend reinvestment plan.  Fee-based accounts can assist with income splitting as the higher income spouse can pay the account fees of the lower income spouse.

Liquidity is another benefit of fee-based accounts.  As there is no cost to buy investments, the same applies to changing or selling investments.  If you require money for any reason, there is no commissions payable for selling or rebalancing your investments.  Rebalancing can include reducing a position that has performed well, dollar cost averaging on a position that has underperformed, adjusting sector exposure, modifying asset mix, and changing the geography of your investments. 

Another benefit of fee-based is the ability to link additional family members to the platform.  Clients with children and grandchildren often would like introduce them to the benefits of full service brokerage, but do not individually have the capital to be able to open accounts on their own.  This could include parents wishing to assist adult children in opening and funding Tax Free Savings Accounts and grandparents who wish to open Registered Education Savings Plans for their grandchildren.  Fee-based accounts that are linked can make wealth transfer strategies within the family group of accounts significantly easier.

New disclosure rules on adviser’s fees could reduce ranks

Over the next few years, you are likely to hear more about what is referred to as the “client relationship model,” or CRM.  CRM is a regulatory requirement introduced by the Canadian Securities Administrators to enhance disclosure, which partially came into effect this year.  Further phases over the next three years are intended to enhance the standards financial firms and advisors must meet when dealing with clients.  These amended rules provide greater disclosure requirements for advisors and enhance the standards they must meet when assessing the suitability of investments for their clients.

The key objective is increased transparency for investors surrounding the fees they pay, services they receive, potential conflicts of interest and the performance of their accounts

All of these mandatory disclosures will be phased in from 2014 – 2016.   Similar CRM mandatory disclosure rules were implemented in Australia and England.  The implementation of the changes in those countries resulted in a significant reduction in the number of financial advisors working in the industry once rules required them to be transparent about all the fees charged.  I suspect that once the new rules are fully implemented, there will also be a reduction in advisors working in Canada.    

To help illustrate how these changes may affect you, let’s look at GICs and mutual funds.

Many people may be aware that when a financial institution receives investments from people, they then lend that money to other people at a higher rate, simply acting as an intermediary for profit. What most people likely do not know is that every time you invest in a GIC, the financial institution makes a spread, or simply put, a profit. 

Depending on the rates of the day and the length of the term that profit could be range from 10 to 25 basis points per year invested.  The range of the fees could be as low as 0.10 per cent for a one year GIC to 1.25 per cent for a five year GIC.   So on a $100,000 GIC for 5 years, your local financial institution might make between $500 (low end) and $1,250 (high end).  One percent equals 100 basis points in financial lingo.  Low-end is calculated 10 basis points x five years x $100,000.  High-end is calculated 25 basis points x five years x $100,000.  Starting this coming July, all financial institutions will have to disclose this to everyone. 

Let’s move to mutual funds. Take that same $100,000 and assume that you invest it into a balanced mutual fund. There are three potential ways the advisor could get compensated for their advice.  They could charge a fee initially, between one and five percent – referred to as Front End (FE). 

Front End is sometimes referred to as Initial Service Charge (ISC).  Some advisors have adapted a structure similar to banks and don’t charge a Front End fee.  Other advisors could do a Deferred Sales Charge Fee (DSC), where the client pays nothing initially but the advisor collects around five per cent immediately, so in this case, $5,000 from the mutual fund company because you are now committed to that fund family for six or seven years.

The fees to redeem the DSC mutual fund in the first couple of years may be approximately five per cent, and declining over a six or seven year period at which point the fund can be sold for no DSC costs.

There is also a variation called Low Load (LL) which is simply a form of DSC. If you see DSC on your statements, you know you are locked in.   Then inside, embedded in every mutual fund is an ongoing management fee.  As an example, a typical Canadian equity fund may have a 2.5 per cent embedded annual fee that is divided up amongst the advisor every year along with the mutual fund manager and their company.   These combined fees are often referred to as the Management Expense Ratio (MER).  I have found that the MER is rarely disclosed and, with the new rules, it will have to be.

It is very likely that many investors do not know how their advisor makes money or what fees they really are paying.  Knowledgeable and professional investment advisors, just like a good accountant, deserve to charge a reasonable fee for their service. But unlike accountants who send you a bill, investment advisors can currently sell you a product and not tell you what they just made.

More advisors are moving to a fee-based approach which is transparent and, in many cases, tax deductible. There is so much more to come that it may be a good idea to start asking questions now. The next time your banker or your advisor speaks to you about a new investment, consider asking for a complete breakdown of what fees you are paying going in to the investment, what the advisor is getting paid, if any fees apply to sell the investment, and what your fees will be each year thereafter for the advisor to manage your affairs. 

Advisors that have always provided complete transparency to their clients will not need to make any changes in the way they communicate with their clients. In fact, they may end up benefiting from the CRM changes. 

Greater scrutiny required for transfer of funds

Years ago, investors could bring cash into a brokerage firm and have it deposited into their investment account.  Those days are gone and the movement of funds is all electronic. 

One of the requirements when opening an investment account is to provide banking information.  We ask new clients to provide a void cheque for two primary reasons – to support that you are resident and to set up an electronic link between your investment account and your bank account.  

We have clients who have different bank accounts linked to different investment accounts.  As an example, Mr. and Mrs. Smith each have registered accounts with us and they have linked them to their respective individual bank accounts.  Mr. and Mrs. Smith also have a non-registered joint with right of survivorship account that they have linked to a joint bank account. 

We can link your investment accounts up to any financial institution.  There are a few advantages to having your bank and investment accounts at the same place, including one card and password to see everything.   

The electronic process is both done automatically and manually.  To illustrate we will use Mr. White and Mrs. Brown.  Mr. White is required to withdraw $24,000 from his RRIF account during the year.  He has requested payments of $2,000 are sent to his bank account automatically at the end of each month.  Mrs. Brown is planning a vacation with her grandchildren and would like $5,000 as a one-time transfer.  This transfer is an example of a manual process of a one-time transaction.  In both cases, the amounts are transferred electronically to the account linked to the specific investment account when the account was opened. 

If your bank account changes it is important to notify your financial institution so they can update your information accordingly.  Although the above payments to Mr. White and Mrs. Brown were electronically executed, they were both verbally confirmed by the advisor.  This part is important to stress as financial advisors can not take instructions to amend banking information, or transfer money, by email for security reasons.    

We often have clients who want us to send money to children, family members, or other third parties.  Similar to personal requests, and changes to banking information, third party requests for transfer of funds can not be done by email.   These types of requests require both verbal confirmation and a signed letter of direction providing details of the transfer request.   This is to protect client accounts against unauthorized email instructions, known as spoofing, and fraud.  The letter of direction can instruct us to issue a cheque payable to another individual.  The letter of direction may also provide wire transfer instructions.

Clients are often surprised to learn that we can purchase many different foreign currencies and do so quite frequently. 

We have clients who wish to purchase certain currencies throughout the year when exchange rates are favorable.  These same clients may maintain bank accounts in different countries, the most common being the United States.   In other cases, they have intentions to wire transfer the funds to assist family members living abroad. 

If we have purchased euros, British pounds or pesos for a client then these funds can be wired in the same currency if they provide the recipient’s banking information including, name, address, bank name, account number, routing platform (also known as ABA Number, IBAN or SWIFT), routing number, bank address, bank city, bank region, and bank country.

Clients who have a discretionary investment account set up with a Portfolio Manager results in the ability for the Portfolio Manager to use their discretion to buy and sell investments.  This discretion does not extend to transfers in and out of the investment account, or transfers between accounts.  In some cases, we have clients that wish to fund their annual Tax Free Savings Account (TFSA) by transferring either cash or securities from their non-registered account to their TFSA.   This type of transfer would require the client’s verbal permission prior to execution. 

Advisors can send money to your bank account but we are not able to transfer money out of your account even if we have your verbal permission.  The only exception to that is if you have set up, and signed, a Pre-Authorized Contribution (PAC) form that instructs us to withdrawal a certain amount at set dates.  As an example, Mrs. Grey contributes $500 every month into her RRSP account through a PAC.  At the end of every month, $500 is transferred from Mrs. Grey’s bank account to her RRSP investment account.

With online banking it is often possible for you to transfer money between accounts.  As an example, you can move money from your savings account to your investment account relatively quickly, especially if your bank is related to your investment firm.  We caution people to double check amounts prior to moving funds into an RRSP and TFSA account.  There are strict penalties for over-contributions.   Even if your investment accounts are at a different institution, most provide the ability to set another financial institution up as a payee (similar to a bill payment) to facilitate transfers.

When clients sell a home or a major asset, the proceeds from this sale may result in you receiving a cheque from a law firm or the buyer.  If the cheque is in your name and you wish to deposit this immediately at a financial institution then the cheque would be considered a third party cheque.  Investment institutions may still be able to deposit these cheques; however, there is greater risk as the issuer of the cheque is not you.  Financial institutions should ask the reasons for the third party cheque and where the source of the funds are from.  An alternative to providing this information is for you to request that drafts, certified cheques, and regular cheques be made payable directly to your financial firm and in the memo field you can provide instructions to have “In trust for” and your name and account number entered.  Another alternative is to deposit the third party cheque into your own bank account and write a personal cheque directly to your financial institution.