Inheritance enhances retirement and estate plan

Over the years we have helped new clients and existing clients deal with inheritances. In the majority of cases the inheritances are coming from parents. These can be done upon the parent’s passing away but are also done while they are alive in more and more cases. In other cases we have clients receiving inheritances from uncles/aunts, siblings, friends, and other individuals.

The greater the inheritance the more critical it is to get some professional advice. One positive part of receiving an inheritance in Canada is the money is not taxed. Following are some topics we would discuss when a client receives an inheritance.

Paying off debt

We like the idea of paying off debt, especially personal mortgages, credit cards, and lines of credit that are not tax deductible.

To begin with, we obtain a summary of all loans, current rates, and repayment penalties, if any.

If only some debt is repaid, then the highest non-deductible interest rate debt should be paid off first. If fees or penalties apply, it is important to obtain an understanding of these and your wealth adviser should be able to map out the best options.

If you still would like to invest some, or all, of your cash then you’re best to take a new loan out for the specific purpose of investing.

The interest expense incurred from the money borrowed is generally tax deductible if the purpose of the use of the borrowed funds is to earn income in non-registered accounts.

Increased income

One of the results of receiving an inheritance is that your annual taxable income is likely to increase. If you purchase GICs and bonds, you will have to factor in the interest income received. If you purchase equities, you will have tax efficient dividend income to report and some deferral options.

We provide an estimate of what the income will be once the investments are selected and calculate an estimated income tax liability if the funds are invested in a non-registered account.

Type of non-registered account

If you feel a non-registered account is your best option you should determine the type of account.

If you are single the choice is easy; an individual account. If you are married or in a common-law relationship, you may consider to open an individual account and keep the funds only in your name. Alternatively, you may open a joint-with-right-of-survivorship (JTWROS) account with your spouse or common-law partner.

The person who received the inheritance would be primary on the account. If a non-registered account is already opened then we have a discussion regarding the risk of commingling funds in the event of a marriage breakdown.

This discussion has many other components to talk about including tax, income splitting, and estate wishes. Consulting a family law attorney may be required in cases of marital breakdowns.

Topping up RRSPs

One way to defer some of the above income is to deposit funds into a tax sheltered Registered Retirement Savings Plan, if contribution room exists.

The greater your income, the better this option is. If your income is at or below the lowest tax bracket then there may be other options you would want to consider.

The determining factor is your future income expectations. As an example: John received $250,000 as an inheritance. He is using $150,000 to pay off all debt and would like to invest the remaining $100,000. John has accumulated a $140,000 RRSP deduction limit, as he has never contributed the maximum each year. John plans to work for the next five years and earns approximately $80,000 in T4 income.

One option we may suggest to John is to contribute the $100,000 into his RRSP and claim $20,000 a year as a deduction over the next five years assuming that there is no extra cash flow for additional contributions. One of the main benefits of putting funds in the RRSP (and not claiming the full deduction right away) is that all income is tax sheltered.

Tax Free Savings Account

Any income earned within the TFSA is tax free, if you have never set up a TFSA, the cumulated TFSA contribution limit for 2019 is $63,500. It may be worthwhile to understand the advantage of this type of account and top up to the maximum limit. Starting in 2019, the annual limit is $6,000, indexed to inflation thereafter.

If you have both non-registered account and TFSA, then we would recommend you to transfer your assets (up to the maximum limit) from the non-registered account into the TFSA, to take advantage of the tax-free feature.

Skipping a generation

Sometimes the people receiving the inheritance do not need the funds themselves. In these situations we often map out a strategy that will skip to the next generation. Sometimes this will help younger generations pay off mortgages, purchase a home, or build up retirement savings

Structure of accounts

Many Canadians only have RRSP or TFSA accounts. Often when significant funds are received (inheritance, sell of a business, life insurance proceeds), people open their first non-registered account.

One thing that we see is people buying GICs and bonds where the interest income is fully taxable in a non-registered account while leaving the equity investments which have tax-efficient dividend income within their RRSP. When this happens, the structure of investments is backwards.

There are many benefits of consolidating investments at one institution, including lower fees and more account options. It is beneficial to deposit the inheritance cash into a non-registered account at the same institution as the RRSP. If this is done then the structure can be corrected.

We are able to do a series of trades that will correct the overall structure will ensure that interest income on fixed income is tax sheltered within the RRSP. By holding Canadian equities in the non-registered account, you will receive the benefit of the dividend tax credit, and taxation of capital gains and losses.

Updated documents

Obtain the appropriate forms to update your investment accounts, Powers of Attorney, beneficiaries and ownership. We always encourage people to update their Will and other legal documents (if necessary).

Kevin Greenard CPA CA FMA CFP CIM is a Portfolio Manager and Director, 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.

 

Act today to minimize a massive final tax bill

Taxpayers, naturally, are fixated on trying to minimize tax in the current year. This is a classic scenario of someone not being able to see the forest for the trees. The forest is your ultimate final tax liability. The trees are the current year taxes. The final tax bill in Canada consists of any income up to the time of death, accrued gains are deemed to be realized at the same time and estate administration tax (probate fees).

Annually, in early June we will look at our client’s tax returns and see the level of taxable income and tax payable they incurred in the current year. When the current tax payable is too low we may schedule an estate planning meeting.

The estate planning meeting typically starts off by a rough tax calculation of what your final tax liability would be today, based on your current assets, if you were to pass away. If you have not gone through this exercise, then it is worth doing. In some cases, the government stands to inherit a significant portion of your net worth if not structured appropriately. The conversation is setting the framework for a more detailed analysis done as part of the financial planning process.

Throughout our working lives we commonly reduce our annual tax bill by making Registered Retirement Savings Plan (RRSP) contributions. An important item for people to understand is the tax consequences when withdrawals are made and also the tax consequences upon death.

Withdrawals from registered accounts are generally considered taxable income in the year the payments are made. Over time your RRSP account may have generated different types of income including dividend income, interest income and capital gains. All of this income would have been deferred. All RRSP and Registered Retirement Income Fund (RRIF) withdrawals are considered ordinary income taxed at your full marginal tax rate regardless of the original type of income.

When a registered account owner dies, the total value of their registered account is included in the owner’s final tax return. The final tax return is often referred to as a terminal tax return. The proceeds will be taxed at the owner’s marginal tax rate. The highest marginal tax rate (British Columbia and federal) is currently 49.8 per cent. An individual that has $800,000 in an RRSP/RRIF account may have to pay $398,400 of that amount to Canada Revenue Agency in income taxes. If the RRSP names the estate as beneficiary, then an estate administration tax or probate fee of approximately $11,200 would apply. Accounting, legal, and executor costs can result in less than half being directed to your beneficiaries and more than half going to taxes and other fees.

These taxes must be paid out of the estate. CRA considers you to have cashed in all of your registered accounts in the year of death. Paying over 50 per cent of your retirement savings to CRA is not something investors strive for. There are a few situations where this tax liability can be deferred or possibly reduced.

Spouse

Registered assets can be transferred from the deceased to their spouse or common law spouse on a tax-free rollover basis provided they are named as beneficiary. The rollover would be transferred into the spouse’s registered account provided they have one. If the spouse does not have a registered account, they are able to establish one. The registered assets are brought into income on the spouse’s return and offset by a tax receipt for the same amount. This rollover allows the funds to continue growing on a tax-deferred basis. The rollover does not affect the spouse’s RRSP contribution room.

If your spouse is specifically named the beneficiary of your RRIF account, then you should consider designating your spouse as a “successor annuitant.” As a successor annuitant, the surviving spouse will receive the remaining RRIF payment(s) if applicable and obtain immediate ownership of the registered account on death. These assets will bypass the deceased’s estate and reduce probate fees. You should discuss all estate settlement issues with your Wealth Advisor and financial institution to obtain a complete understanding.

Minor child or grandchild

Registered assets may be passed onto a financially dependent child or grandchild provided you have named them the beneficiary of your registered account. In order to be financially dependent, the child or grandchild’s income must not exceed the basic personal exemption amount. A child that is under 18 must ensure that the full amount is paid out by the time that child turns 18.

Financially dependent child

A child of any age that is financially dependent on you can receive the proceeds of your registered account as a refund of premiums. This essentially means that the tax will be paid at the child’s marginal tax rate, likely to be considerably lower than your marginal tax rate on the terminal tax return.

Rollover to Registered Disability Savings Plan

In 2010, positive changes occurred to help parents and grandparents who have a financially dependent disabled child or grandchild. Essentially this enables the RRSP accounts of parents and grandparents (referred to as the annuitant) to be rolled over to the RDSP beneficiary. The estate benefit is that up to $200,000 of the annuitant’s RRSP can be transferred to the beneficiary’s RDSP. Care should be taken to make sure the transfer qualifies under current tax rules and thresholds. The end goal is to minimize tax and hopefully your beneficiaries receive a larger inheritance. We recommend you speak with a Wealth Advisor if you are considering naming a disabled child or grandchild the beneficiary of your registered account.

Rollover to Registered Retirement Savings Plan

The RDSP is my favourite option for rollover, but what happens if the RRSP/RRIF is greater than $200,000 (the maximum rollover for the RDSP)? Another good option to explore if the child is dependent on you by reason of physical or mental infirmity is the tax free rollover of the registered account (i.e. RRIF) into the disabled child’s own registered account (i.e. RRSP). With disabled children there are no immediate tax consequences and there is no requirement to purchase an annuity. You may want to discuss the practical issues relating to having your registered account rolled into registered account in the name of a disabled child.

Other planning options for children with disabilities

A combination of the RDSP and RRSP rollover is normally sufficient if the annuitant has a small to medium sized RRSP/RRIF account. Other planning options are available if you have a sizable RRSP and are worried about disabilities payments from the government.

Beneficiaries

Care should be taken when you select the beneficiary or beneficiaries of your registered accounts. If you name a beneficiary that does not qualify for one of the preferential tax treatments listed above, then it could cause some problems for the other beneficiaries of your estate. An example may be naming your brother as the beneficiary of your RRSP and your children as beneficiaries of the balance of your estate. In this example, the brother would receive the full RRSP assets and the tax bill would have to be paid by the estate, reducing the amount your children would receive.

Important points

Every individual situation is different and we encourage individuals to obtain professional advice. Below we have listed a few general ideas and techniques that you may want to consider in your attempt to reduce a large tax bill:

  • Pension credit — you should determine if you are able to utilize the pension tax credit of $2,000. If you are 65 or older, then certain withdrawals from registered accounts may qualify for this credit. Rolling a portion of your RRSP into RRIF would allow you to create qualifying income. For couples this credit may be claimed twice – effectively allowing some couples to withdraw up to $4,000 per year from their RRIF account(s) tax-free (provided they do not have other qualifying pension income).
  • Single or widowed — single and widowed individuals will incur more risk with respect to the likelihood of paying a large tax bill. Single and widowed individuals should understand the tax consequences of them dying as no tax deferrals are available.
  • Charitable giving — one of the most effective ways to reduce taxes in your year of death is through charitable giving. Those with charitable intentions should meet with their professional advisors to assess the overall tax bill after planned charitable donations are taken into account.
  • Life insurance — one commonly used strategy is for individuals to purchase life insurance to cover this future tax liability. The tax liability created upon death coincides conveniently with the life insurance proceeds. This would enable individuals to name specific beneficiaries on their registered account without the other beneficiaries of the estate having to cover the tax liability.
  • Estate as beneficiary — if you name your estate the beneficiary of your registered account then probate fees will apply. An up-to-date will provides guidance on the distribution of your estate.
  • Life expectancy — Individuals who live a long healthy life will likely be able to diminish their registered accounts over time as planned. Ensuring your lifestyle is suitable to a longer life expectancy is the easiest way to defer and minimize tax.

A wealth adviser should be able to generate a financial plan to review with you and your accountant. The financial plan should outline the tax your estate would have to pay if you were to die today. This will begin a conversation that may allow you to create a strategy that reduces the impact of final taxes on your estate and throughout your lifetime.

Kevin Greenard CPA CA FMA CFP CIM is a Portfolio Manager and Director, 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.

 

Looking at total rate of return rather than yield alone

Yield is essentially the income an investment will pay, such as interest or dividend payments, and is normally expressed as a percentage.

Yield will fluctuate on equity investments based on the current share price. Typically, as the share price goes up, the yield goes down. On the flip side, as the share price goes down, the yield goes up.

The board of directors of a company makes the decision with respect to the dividend(s) the company will declare. This is normally stated as a dollar amount. Using ABC Bank as an example, the share price of the bank is currently at $80 per share. The board of directors would like the annual yield to be approximately four per cent. The board declares a dividend of $0.80 per share for the current quarter. If this dividend was kept the same for the next three quarters, the annual distribution would be $3.20 per share owned. Assuming the share price stays the same, the annual yield would be four per cent ($3.20 / $80).

The board of directors can choose to increase the dividend, and this is often done when the stock price appreciates. If the share price for ABC Bank increased to $100 per share, the yield would drop to 3.2 per cent ($3.20 / $100). The board of directors would have to begin declaring a quarterly dividend of $1 per share to maintain a four per cent annual yield based on shares valued at $100.

It is always nice when your investments will return dividends to you. The dividends are normally only part of the equation when looking at the holdings for your account. The change in the share price is also another important part to every investment. An investment that just pays income, with little hope of capital appreciation, would typically be classified as an “income” investment. An investment that does not pay a dividend, would typically be classified as a “growth” investment. The rate of return on a growth investment, that does not pay a dividend, would be 100 per cent determined by the change in the share price.

Many companies would be considered “balanced,” meaning that they would pay some form of dividend and also have an expectation of share price appreciation. As an example, three companies all make the same level of income in a given year, say six per cent. The first company chooses to pay a six per cent dividend to shareholders. The second company chooses to pay a three per cent dividend to shareholders and retain three per cent. The third company chooses to not pay a dividend and retain the full six per cent. When a company does not pay out some, or all, of its earnings, the share price would normally appreciate in value. Of course, many other factors influence the share price.

In the above example, we would anticipate that the share price for the third company would increase greater than the first company. Total return on an equity investment is the sum of the dividend plus the change in the market value of the shares.

Capital deployment

One of the many important components for us when we are analyzing new companies to add to the model portfolios is deployment of capital. As a portfolio manager, we are always assessing management and how they deploy capital that they are not distributing. If a company distributes all of its earnings, it is not necessarily building up extra capital. Investors will receive the dividends and it is up to the individual investors to ensure those returns are reinvested for continual growth.

Income needs

Retirees often require regular income from their portfolio. If we are sending monthly amounts to clients, this is often referred to as a Systematic Withdrawal Plan. The natural tendency when income is needed is to look at only stocks that pay a high level of dividends. Within our clients’ Investment Policy Statement, we outline the cash-flow needs that they have for the next two to three years. In the majority of cases, we create a one to two year wedge, the portion of the portfolio that is not in any equity (dividend or no dividend) — it is set aside in a cash-equivalent type investment that will not be impacted by changes in the stock market. We refer to this as a wedge. When a wedge is created, it takes the pressure off of a portfolio to create dividends to replenish cash. The focus can then shift to ensure you pick the best risk adjusted total rate of return group of investments. Some of those investments will pay large dividends, some smaller dividends and some no dividends.

Fixating on yield

I have had many conversations with clients about the danger of being fixated on yield. Occasionally, I will have someone ask me about some “high yielding” names that are paying very high dividends. In some cases, we will see that the companies are distributing more than they are actually earning which is not sustainable. In other cases, we see people being caught in the “income trap” and not factoring in the capital cost of the investment. As an example, you purchase 1,000 shares at $10 per share of High Yield Company totalling $10,000. You purchased this company because you read in the paper it is paying a six per cent dividend. If after a year the share price drops to $9.40 then the market value of this company would only be $9,400. The dividend of $600 would be taxable despite you really not making any real return if you were to liquidate at the end of the year. Essentially, a high yield is only part of the equation. An equally important component, if not more important, is the base amount invested in each company.

Universe of investments

If an investor focuses only on higher dividend paying stocks, much of the investment universe would be excluded as an option. Many dividend paying stocks are interest rate sensitive. Many sectors such as technology and certain communication stocks are known to have either no yield or low yields. Adding a mixture of income and growth investments reduces risk in a portfolio and should help smooth out volatility in the long run.

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 tough to get it right on both sides of the equation

During the last quarter of 2018, the TSX/S&P Composite declined 10.11 per cent on a total return basis while the first quarter of 2019 the TSX/S&P Composite posted gains of 13.27 per cent on a total return basis.

 

 

When the stock market takes a sharp downward correction, the natural response from investors is to try to anticipate the decline and sell off before this happens.

It sounds easy when you are looking in the rear view mirror. Timing when you are in or out of the markets is in essence basing your investment strategy on a speculative approach rather than a disciplined investing approach that incorporates a long-term vision and goals. Short-term emotional thinking can cloud long-term investment decisions.

 

 

The best way to illustrate the challenges of trying to time the stock market is by looking at an investor who is currently fully invested.

Mr. James has $1 million invested in a non-registered account and is currently earning $35,000, or 3.5 per cent, in annual income (primarily dividend income and minimal interest income). In addition to this income, Mr. James’s investments have averaged 4.5 per cent annually in capital gains over time.

 

 

The total annual average rate of return is the sum of both of these parts — the income and capital gains. The total average annual rate of return over the last five years has been approximately 8.0 per cent annually.

Mr. James decided that he wanted to be a market timer. By market timer, I mean that he felt he could predict the direction of the stock market and would sell his investments if he anticipated a decline in the markets.

If Mr. James sells off his investments and converts his portfolio to 100 per cent cash, then his income will drop to $16,000 per year, assuming that savings accounts are earning 1.60 per cent.

The downside to savings accounts is that interest income is fully taxable each year in a non-registered account. Mr. James currently has the majority of his investments earning tax-efficient dividend income with some tax deferred growth. As a result of the difference in taxation between interest income and dividend income, the impact on income would be even greater than 1.90 per cent (3.50 to 1.60).

For purposes of this article, we have assumed that both interest income and dividend income are equal. In additional to the differential in the income lost, Mr. James would not have potential for capital gains while out of the market.

Mr. James should also factor in that if all of his investments are sold then he would have to report all the realized gains on his investments and lose the deferral benefits that exist with non-registered equity investments. If you have stock that has increased in value, you do not have to pay tax on the capital gain until it is sold.

If Mr. James has a stock that has declined in value and he realizes a loss then he has to use caution when timing transactions. He must wait at least 30 days before repurchasing a stock sold at a loss or risk violating the superficial loss rules and having the original loss declined.

From an income standpoint, Mr. James will immediately see his dividend/investment income drop $19,000 a year ($35,000 to $16,000). He will also possibly be losing capital growth on his portfolio. The potential tax liability, superficial loss rules and loss of income are the easy components to quantify for Mr. James. It is the change in the capital side or growth that is the tough part to compute in order to determine if Mr. James made the right decision to liquidate.

If the markets increase, Mr. James clearly made a mistake. He will have lost the differential in the income and the capital growth. If the markets remain flat, Mr. James still made a mistake with the differential as his income will drop $16,000 a year.

If the stock market goes down, it’s not necessarily a given that Mr. James will benefit from having liquidated his account.

If Mr. James makes a correct prediction that the stock market declines then for him to benefit he has to also make another correct timing decision to buy back into the market at lower levels to potentially be better off.

If the markets decline and Mr. James does not have the insight to buy back in (before it rises back to the level that Mr. James originally sold at) then he would still be worse off. In essence Mr. James has to make two correct timing decisions: (1) selling before the markets decline, and (2) buying back before they rise.

Mr. James should also factor in the timing in which he feels his predictions for the market will unfold. To illustrate this component we will assume no transaction costs, only the income component (we will exclude capital changes) and no tax impact to the trades for simplification purposes.

The difference between the current income Mr. James is earning of 3.5 per cent and the new income of 1.60 per cent if he converts everything to cash is 1.90 per cent. Depending on how long Mr. James is out of the market impacts how much the stock market would have to decline to make the strategy of going to cash successful.

Let’s assume that Mr. James waits six months, one year, two years and three years before buying back into the stock market. If every year Mr. James is losing 1.90 per cent in income then the longer he waits the greater the stock market has to decline. At the six month point, the markets would have to decline 0.95 per cent (1.90 x .5) or greater, at the one year point the markets would have to decline 1.90 per cent (1.90 x 1) or greater, at the two year point the markets would have to decline 3.80 per cent (1.90 x 2) or greater, and at the three year point the markets would have to decline 5.70 per cent (1.90 x 3) or greater.

Making two correct short-term timing decisions against a stock market that has a long term upward bias is not as easy as it may seem. The markets can rebound incredibly fast — the 13.27 per cent increase in the first quarter of 2019 is only one example. From a psychological standpoint, most people would have the tendency to fear that the markets will decline further after the 10.11 per cent decline in the last quarter of 2018. Most investors would not have had the natural tendency to purchase investments at the beginning of this year. Sticking to a long term disciplined strategy helps deal with the short term quarterly swings of the market.

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.

 

 

Asset mix should be tied to cash-flow needs and market conditions

The term asset mix refers to the portion of your investments that are held in cash, fixed income, and equities. Asset mix has historically been touted as the most important decision with respect to managing risk adjusted returns. We don’t disagree.

The key question that many people should be asking themselves is the portion of their portfolios that should be in these three categories. Every decade we feel investors have had to shift how they look at asset mix to maintain the best risk adjusted returns. This has largely been the result of declining interest rates.

Rather than rely on older textbook solutions to asset mix we feel clients should focus on cash flow needs and current market conditions. When we meet with clients, one of the first questions we ask them is if they need any cash from their portfolio. Essentially we are asking them the time horizon of a portfolio and whether they are planning to make a significant withdrawal of funds. In more than 90 per cent of times when we ask clients this question, the majority of the investment portfolio is to be invested for the long term (greater than seven years).

We also ask clients whether they have any income requirements from the portfolio, or smaller withdrawal requirements. Many of our retired clients will request that we send them monthly cash flow from their investments. If a client desires $5,000 per month from their portfolio then we would typically put aside 12 to 24 months of cash as a “wedge” earmarked for these smaller withdrawals. This is done to ensure that investments do not have to be sold at the wrong time in the market cycle.

We also ask clients if they will require any significant withdrawals from their portfolio in the next three years. Examples of significant withdrawals will be funds to repair home (i.e. roof), renovations, new vehicle, recreational (i.e. boat, motorhome) and real estate purchases. These amounts are also documented within an Investment Policy Statement and earmarked as part of the “wedge” to ensure the funds can be liquidated and sent when needed regardless of market conditions.

We feel cash flow needs and current market conditions should be the primary determinate for asset mix. To give you an example of older guidance often used with respect to asset mix we have outlined a few observations by decade below.

The 1980s

In the 1980s, interest rates were high and many advocated for retirees to transition portfolios to 100 per cent fixed income. This was during a period when bonds, GICs, CSBs, CPBs, and term deposits actually returned a decent level of interest income to live off. Purchasing annuities was a popular option as yields were significantly higher and translated to higher payouts. Financial plans which make long term assumptions based on 1980s high interest rates were materially over stated when interest rates subsequently declined in future decades.

The 1990s

In the 1990s, the strategy most promoted was to encourage investors to have the fixed income percentage equal to their age. The idea was that as you are aging your portfolio would shift into more conservative investments that paid income to you in retirement. Fixed income still generally had higher income than equities.

The 2000s

In the 2000s, many promoted the strategy of laddering your bonds and fixed income. A bond ladder means you have different bonds with varying maturity dates. This was a way of spreading out interest rate risk. As bonds matured in the ladder, you could use some of the capital if necessary and reinvest the remainder.

The 2010s

Bond laddering started to decline as interest rates started to bottom out. Most economists, and fixed-income bond managers, were recommending to keep the bond duration (term to maturity) shorter. The reason for this is the inverse relationship that bond yields have to the bonds actual price. For example, if interest rates go up, most existing bond prices would decline. The greater the duration of the bond, the greater the decline typically.

To deal with this uncertainty of interest rates, many hybrid type investments were created that had features (resets, call dates). Most of these types of investments lack significant volume and can have material price swings which was not typical of fixed income type investments.

The present and the 2020s

Fast forward to today and what we anticipate in the decade ahead. The following are the top ten bullet points we discuss with our clients:

1) Many chief investment officers and economists feel that central banks simply can’t afford to raise interest rates significantly above current levels. The level of government debt would only spiral out of control further. Interest rates are most likely to stay at low levels for a long time.

2) In Canada, we have raised interest rates five times since the historic lows reached in 2017. If the economy softens, the Bank of Canada is in a position to cut interest rates.

3) The term “fixed income” seems rather archaic when many fixed income rates can shift with many of the new fixed income products. The term step up and floating are just a couple of the terms using in fixed income today.

4) It is ironic that most equities have a higher level of dividend income then the interest yields on fixed income. If investors want high income they can typically achieve this with good quality dividend paying equities.

5) Most bonds pay “interest income,” which is fully taxable in non-registered accounts. Canadian equity investments pay tax efficient dividend income (eligible for the dividend tax credit). All equity investments in a non-registered account can provide deferral of unrealized gains and tax preferred treatment on disposition (only 50 per cent is taxed).

6) Bonds trade outside of an exchange and the price transparency is not as good as equities which trade on an exchange. With most bond purchases, the financial firm you are dealing with is acting as principal, rather than as agent. With a principal transaction, the firm will buy the bond off of the client and put it in their own inventory of bonds to either hold or resale.

7) Fixed income often lacks a high volume of transactions (i.e. preferred shares) and is also susceptible to material price fluctuations. Some fixed income lack liquidity (i.e. longer term GICs and term deposits).

8) Increased scrutiny by regulators of suitability of asset mix on investment portfolios. This creates a natural tendency to possibly be overly conservative unless a full discussion is done with your portfolio manager or wealth adviser. Importance of communicating cash flow needs (both short term income requirements and required significant withdrawals).

9) Conservative investors choosing to have asset mixes heavily weighted in fixed income should have lower return expectations for the next decade ahead. Interest rates will likely stay at low levels for a long time. With even a moderate level of inflation and full taxation on income, after tax returns will not be the same as the past several decades.

10)In order to achieve the best risk adjusted returns, investors will have to invest more heavily in equities than past decades. This means that investors will have to deal with more market volatility and stick to a disciplined plan. Our recommendation for retirees who are opting to increase equity components in their portfolio is to avoid high risk and speculative positions.

It is crucial when working with a portfolio manager or wealth adviser to map out cash flow needs and any significant withdrawals. It is only after that is completed that an appropriate asset mix can be set up and the best decisions can be made on where to draw on those cash flow needs.

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.

 

 

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.

A spring break refresher on RESPs

Parents and grandparents, who typically set up Registered Education Savings Plans (RESPs), are referred to as the “subscriber.” The children or grandchildren are referred to as the “beneficiary” of the registered plan.

Parents are juggling many different things. Financial planning may not be the highest priority, especially if paying bills is a challenge. With all the different types of accounts, it can be a little confusing on where best to put the little bit of savings that may be available. Do you pay down the mortgage, make an RRSP contribution, open up a TFSA, or save for your child’s education?

The strategy I map out for young parents is to contribute $2,500 each year for the first fourteen years of your child’s life, and $1,000 when your child is 15. Doing the contributions early each year allows a greater amount of time for the value of the RESP to grow. If coming up with $2,500 as a lump sum is difficult, we suggest setting up a pre-authorized contribution (PAC) of $208.33 every month (assuming only one child). Automating this with your bank helps ensure you keep with the plan.

Tuition and textbooks are only part of the cost of education. Being able to have funds set aside for housing, living costs for school and transportation is important to add to the calculation. The RESP can help cover the costs of all of these expenditures.

One misconception is that the proceeds from an RESP can only be used to pay for tuition and textbooks. Withdrawals can be used to pay for all post-secondary education costs. The only reason we ask for a copy of the tuition receipt is to verify that the student is attending a qualifying education program or is enrolled in a specified education program. Most of the criteria focus on the programs having the appropriate number of hours.

Apart from the rising cost of education, the government provides the Canada Education Savings Grant (CESG) for contributions made up until the end of the calendar year in which the child turns 17. The basic CESG provides a grant of 20 per cent, up to a maximum of $500 per child. The lifetime maximum grant is $7,200. The plan noted above has annual contributions of $2,500 for 14 years ($500 CESG each year x 14 = $7,000) and a $1,000 contribution in the 15th year ($200 CESG). This contribution schedule enables the subscriber to claim and obtain the maximum $7,200 per beneficiary.

In addition to these federal grants, the British Columbia Training & Education Savings Grant (BCTESG) is also available. If you have children who were born in 2006 or later, the province will contribute $1,200 as a BCTESG. Below is a table taken from this website.

Grant application period for eligible children

Birth year 1st day of eligibility 1st day to apply Last day to apply
2006 Child’s 6th birthday in 2012 Aug. 15, 2016 Aug. 14, 2019
2007 Child’s 6th birthday in 2013 Aug. 15, 2015 Aug. 14, 2018
2008 Child’s 6th birthday in 2014 Aug.15, 2015 Aug. 14, 2018
2009 Child’s 6th birthday in 2015 Aug.15, 2015 Aug. 14, 2018, or the day before the child turns 9 (whichever is later)
2010 Child’s 6th birthday in 2016 The day the day child turns 6 The day before the child turns 9

The nice part about the BCTESG is that you just have to open an account and apply for this to receive $1,200 — no contribution is necessary. Most banks and credit unions will be able to assist you with the BCTESG; however, most full-service divisions of investment firms do not offer the BCTESG.

Now that we have mapped out the strategy of contributions the next decision is to decide how to invest the money. If you are eligible for the BCTESG, we recommend that you apply and keep these funds in a separate account. Because some firms do not offer the BCTESG, if you have included both BCESG and CESG in a single account, the entire account becomes tainted and you will not be able to be transfer the RESP to most full-service investment firms in the future.

With the BCTESG, we recommend investing this in a mutual fund at a bank or credit union. My opinion about the type of mutual funds when the beneficiaries are young, and the time horizon is greater, is to invest primarily in equity mutual funds.

With the account that is accumulating, the CESG, the funds can be invested in a number of different ways depending on the financial institution you are dealing with. If you open the account up at a bank or credit union then you are likely investing primarily in mutual funds. If you open the account up at a full-service investment firm then you could explore different options outside of mutual funds, especially once the account gets built up.

The priority, initially should be setting the savings discipline and obtaining all available grant money. As the beneficiaries get closer to needing the money, then shifting some or all of the investments into something more conservative to reduce risk generally makes sense.

Time to get educated

The time has come and the beneficiaries are going for higher education. Other than a copy of the qualifying “paid” tuition enrolment receipt (not the T2202A noted below) and a form signed by the subscriber, getting the funds out of an RESP is straight forward. The initial contributions from the subscriber are not taxed and can be paid out either to the subscriber or to the beneficiary — it is the subscriber who dictates how those funds are dispersed.

The CESG and the income earned (dividends, interest, and capital gains) are both taxed in the hands of the beneficiary as education assistance payments (EAP) when taken out. The firm you have the RESP through is referred to as the promoter and must issue a T4A to the beneficiary in the year of withdrawal. In most cases, we try to spread the EAP portion over four years (i.e. or the length of the program). The beneficiary will likely have limited other income while going to school. In the majority of cases, the end result is zero tax being paid on the CESG and the growth within the RESP.

Line 323: Your tuition, education and textbook amounts

The federal government eliminated the education and textbook tax credits in 2017. Students are still able to deduct eligible tuition fees paid for the tax year. A course typically qualifies for a tuition tax credit if it was taken at a post-secondary education institution or for individuals 16 or older who are taking a course to creating skills in an occupation and the institution meets the requirements of the Employment and Social Development Canada (ESDC).

The institution should issue a T2202A (Tuition and Enrolment Certificate) at the end of the year which lists the total paid in the calendar year that is eligible for the student to claim on his or her income tax return. The student must claim the amount paid even if mom and dad paid the tuition.

The student must first try to use the credits on their own tax return. Schedule 11 of the student’s tax return will list the total eligible tuition fees and the total tuition amount claimed by the student.

Line 324: Tuition amount

What if the student has limited or no income to utilize the tuition amount? The student has the ability to either carry the tuition amount forward to future years or transfer up to $5,000 of the tuition amount to your spouse, common law partner, parent, or grandparent. It is a little bit of a funky calculation and at first might seem a little strange.

I will illustrate with a student who has tuition costs of $9,300. During the year, the student earns $13,500 in taxable income. On Schedule 11 that we referred to up above, the student can claim some reductions of this. To keep things simple, we will assume only the basic exemption of $11,809 (2018) is available. The net amount is $1,691 ($13,500 – $11,809) and the student must first use this. The $9,300 total tuition amount is reduced by $1,691 (the amount claimed by the student. The amount remaining of the tuition amount is $7,609 ($9,300 – $1,691).

I know above I mentioned up to $5,000 can be transferred to your spouse, common law partner, parent, or grandparent. The maximum amount that can be transferred is $5,000 less the amount the student is claiming, which in this case is $1,691, equals $3,309. The student will then be able to carry forward, to future years the difference of $4,300 ($9,300 less $1,691 claimed by student and $3,309 transferred in the current year).

When I look at our client’s notices of assessments, I sometimes see unused tuition carry forward credits from previous years. Tuition amounts are non-refundable tax credits. This essentially means that in the past the client did not have any taxes to pay and was not unable to transfer the tuition amounts. Once the tuition amounts are carried forward to another year they are not able to be transferred. Although past carry forward tuition amounts did not provide an immediate tax benefit, they may have a current or future value. If you’re not sure how current tuition costs should be claimed or transferred, we recommend you speak with your accountant.

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.

Do you need to make income tax instalment payments?

Twice a year, Canada Revenue Agency sends out instalment reminder letters to those taxpayers who are required to make payments. The February letter outlines the required payments on, or before, March 15 and June 15. The August letter outlines the required payments on, or before, Sept. 15 and Dec. 15.

 

The February 2019 notice will be based primarily on your 2017 tax return. If you owed more than $3,000 in taxes in 2017, then you will likely be asked by CRA to make instalments on March 15 and June 15t through the February 2019 notice. CRA would not know what your income was for 2018 by the time the February notice are sent. Nor will it know what your income will be for the current year.

The August 2019 notice will enable CRA to adjust the numbers based on your actual 2018 net tax owing. If your net tax owing was less than $3,000 in 2018, you will likely not be asked to make instalment payments on Sept. 15 and Dec. 15.

It is important to note that you have to pay your income tax by instalments for 2019 if both of the following apply:

• Your net tax owing for 2019 will be above $3,000 in British Columbia

• Your net tax owing in either 2018 or 2017 was above $3,000 in British Columbia

The instalment payments are to cover tax that you would otherwise have to pay in a lump sum on April 30 of the following year. Instalments are designed so that taxes are paid throughout the calendar year while you are earning the taxable income.

Infrequent income spike

We often see individuals who have sold a rental property, businesses or investments, which generates a significant capital gain. This is a one-time spike in income, which is not going to necessarily repeat. One of the flaws in the instalment notice is that it is simply an automated process based on the $3,000 thresholds notice above. The year after you have a spike in income, many people are asked to make instalment payments.

You do not have to pay your income tax by instalments for 2019 if you know your net tax owing for 2019 will be $3,000 or less in British Columbia, even if you received an instalment reminder in 2019. It is always best to check with your accountant before skipping instalment payments.

Common areas triggering instalment notices

If you are an employee, and have no other sources of income, you likely do not have to worry about making instalment payments. Your employers has an obligation to withhold appropriate income tax from your earned income. Individuals who work more than one job may also have an insufficient amount of tax withheld, as each employer has based the withholding tax on payroll tables and income from the one job. If you do have two jobs and when both incomes are combined, you are in a higher tax bracket than the payroll table. This will normally result in taxes being owed at the end of the year. You can always request that your employer withholds a higher level of tax on a voluntary basis.

There are situations where taxpayers have income from activities other than employment. In many of these cases, tax is not withheld at source, meaning that you may have to pay tax at the end of the year. This often impacts individuals who have multiple forms of income.

Examples of situations that can result in instalment payments include self-employment income, RRIF payments, Old Age Security payments, Canada Pension Plan benefits, rental income, certain pension income, capital gains and other investment income.

Speaking with a wealth adviser and accountant about instalment payments can often result in some helpful tips on ways to reduce your net tax owing, or even eliminate the need to make the CRA scheduled instalment payments. The easiest way to reduce your net tax owing is by voluntarily withholding tax on certain forms of income on an automated basis. You can withhold tax on your RRIF income by talking to your wealth adviser. Another common strategy is to complete the “Request for Voluntary Federal Income Tax Deduction” form to have tax withheld on Canada Pension Plan and Old Age Security.

Interest and penalties

For some people, making the instalment payments is not a big deal. They simply make the four remittances a year on time. In order to make these instalment payments on time, you have to be organized, have the funds previously set aside and remit them to CRA on or before the required dates.

If taxpayers do not make the required instalments, they may have to pay interest and penalty charges. CRA charges instalment interest on all late or insufficient instalment payments. Instalment interest is charged at the posted prescribed rate (changes every three months) and compounds daily. CRA may also charge penalties if the taxpayer makes payments that are late or less than the requested amounts. Penalties normally apply when your interest charges are more than $1,000.

The worst part about these types of interest and penalty charges are that taxpayers cannot deduct these on their tax return. This is an absolute cost that is permanently lost.

Notice of assessments

One of the services we provide to clients is a review of their tax returns. Fifteen years ago, we used to ask clients to bring in tax returns and notices of assessment, but now we have been able to proactively get this information online, directly from CRA. One of the first documents that we read every year is a client’s notice of assessment. With respect to instalments, we look for three things:

1. Do they have a requirement to make instalment payments?

2. Were any interest or penalties assessed in previous years for not paying required instalments?

3. How can we help the client automate the process?

In some cases, withholding tax on RRIF, CPP and OAS is not enough. Some clients do not wish to voluntarily send CRA any money ahead of time. One of the services we provide for clients with a non-registered account is the ability for us to pay their required instalment amounts directly from their investment account. We have access to the numbers on the CRA website and if a client has provided consent, we can take care of those payments on their behalf. This is particularly valuable for our clients who are busy, travelling or aging.

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 Colonsit. Call 250-389-2138. greenardgroup.com

 

When to stop contributing to an RRSP

Most articles are written about “contributing” to an RRSP. This one highlights that many people should either avoid RRSPs or stop contributing to them.

Going a step further, calculations should be made to determine if you should withdraw funds from an RRSP.

In many cases, we will recommend that people convert their RRSP to a RRIF before age 71. Age 64 or 65 are common ages for conversions to a RRIF, which we will explain below.

For some people, the decision to convert an RRSP to a RRIF early is purely for cash flow reasons and out of necessity. For individuals in the top tax brackets, taking the regulatory approach and keeping the funds in an RRSP until age 71, for maximum deferral, is normally the best option.

The transition to retirement often coincides with your final RRSP contribution. It could be your last high-income earning year, or it could be offsetting the retiring allowance by using up your RRSP Deduction Limit. In some cases, if you arrange to retire early in the year, an RRSP contribution may not be necessary. In years where your income is uncertain, then we do not recommend contributing early in the year. Closer to the end of the year, you can determine whether contributing to an RRSP makes sense.

If taxable income is on the lower end, then you should consider converting your RRSP early, especially if you are 65 or older. If you are not maximizing your Tax Free Savings Account (TFSA), then pulling funds out of an RRSP and funding a TFSA can reduce your tax bill in the long run. If you are not receiving eligible pension income, then we advise individuals 65 and older to covert a portion of their RRSP to a RRIF. Those 65 years and older can claim up to $2,000 as a pension income amount, effectively allowing each individual to pull $2,000 out of their RRIF tax free.

Another very important factor is that couples can income split RRIF income beginning at age 65. Individuals who are collecting Old Age Security, and earn more than $77,580 in 2019, will have to repay (often referred to as clawback) 15 per cent of the excess up to the total amount of OAS received. If possible, care should be taken to withdraw funds out of an RRSP so that the combined taxable income is below the annual clawback threshold.

If the goal is to minimize tax in the current year, contributing the maximum to RRSPs and delaying RRIF withdrawals until age 72 may provide this outcome.

Let’s change the focus from minimizing tax in the current year to minimizing tax during your lifetime. The key variable on whether or not you minimize tax during your lifetime is life expectancy. To illustrate, we will use a hypothetical client, Jill Jones.

Jill is single and has recently retired at age 65 with $500,000 accumulated in her RRSP. We have projected that CPP, OAS and investment income will result in Jill receiving annual income of $22,000. Jill also has access to non-registered cash, so cash flow is not an issue.

Jill does not have to convert the RRSP to a RRIF early for cash flow. We ran some preliminary projections for Jill with two broad scenarios: 1) convert RRSP to a RRIF immediately and begin pulling out $28,000 annually, and 2) waiting until age 71 to convert to a RRIF and withdrawing the minimum required payments beginning at age 72. To illustrate the estimated tax on both of these scenarios, we used different life expectancy, being age 65, 71, 77, 83, 89, and 95. Below are the 11 outcomes we outlined with Jill. For purposes of this illustration we used a conservative four per cent rate of return.

Option 1 — Convert RRSP early

Planned conversion age Annual end of year withdrawal Deceased age Estimated estate tax
Outcome 1 65 $28,000 71 $184,261
Outcome 2 65 $28,000 77 $149,486
Outcome 3 65 $28,000 83 $105,485
Outcome 4 65 $28,000 89 $51,370
Outcome 5 65 $28,000 95 $2,525

Outcomes 1 through 5 have Jill beginning to pull funds out slowly starting at age 65. By beginning to pull funds out immediately at low levels, Jill will have more funds at her disposal to enjoy her retirement. She will be able to claim the pension income amount and top up her TFSA. She can invest any residual income to generate tax efficient dividend income and capital gains. Jill is reducing the risk of a significant tax bill as a result of a shortened life, especially in outcomes 3 to 5 when compared to option 2 below.

Option 2

Planned conversion age Annual end of year withdrawal Deceased age Estimated estate tax
Outcome 6 71 0 65 $225,687
Outcome 7 71 0 71 $294,394
Outcome 8 71 Minimum 77 $261,243
Outcome 9 71 Minimum 83 $212,211
Outcome 10 71 Minimum 89 $142,742
Outcome 11 71 Minimum 95 $51,089

Outcomes 6 through 11 have Jill keeping her funds within an RRSP until age 71. In the reviewing the above numbers with Jill, we outlined the biggest risk in deferring the conversion to a RRIF is if she passed away in her late 70s or early 80s. The tax rate on the majority of what is left in the RRSP is taxed at 49.8 percent (assuming tax rates remain at current levels). If Jill lives to age 95, then keeping to minimum withdrawals over the years has turned out to be a good decision. Delaying conversion and withdrawing the minimum payments help those investors who are concerned about living too long and running out of funds.

Many other options exist for Jill. Often the right answer is in-between, including a partial conversion or a full conversion between the ages of 65 and 71. When clients ask for my advice, I normally begin the conversion with planning for the most likely outcome. Genetics, current health condition and lifestyle are also factors. Asking clients this question, “What concerns you most, the thought of living too long and running out of money or potentially having to give half of your hard earned money to Canada Revenue Agency?”