Destroy files cautiously

Do you have old tax returns that are simply gathering dust in your home?  It might be time to look at which files you no longer need, but you should be aware of time lines.

The reason most people hang onto old tax documents is to provide support if the tax people come knocking.

So, just how long should you keep your old income tax records?

Canada Revenue Agency (CRA) says you should keep your supporting documents for at least six years.  The CRA also notes that you should have the receipts and documentation to support your claims ready in case you are selected for a review.

The CRA’s Information Circular IC78-10R4 provides further information regarding books and records and their retention and destruction periods.  This document is available electronically and outlines some additional information that taxpayers may read.

Certain sections of the Income Tax Regulations also deal with the retention of books and records.  Under the act, books, records, and their related accounts and source documents have to be kept for a minimum of six years from the end of the last tax year to which they relate.

Failure to comply with this requirement could result in prosecution by the CRA.

The time periods for retention can be longer in other cases.  People unsure that they have filed their tax return correctly may want to hold onto their tax returns for up to a decade.  The taxpayer release provisions allow CRA to go back up to ten years.  The federal minister may grant relief for any tax year that ended within ten years before the calendar year in which the taxpayer’s request or income tax return is filed.  One example may be a person who has missed filing for the disability tax credit.

Taxpayers who have purchased property or investments more than six years ago in non-registered accounts should also retain the original confirmation slips, investment statements, and source documents.   The time period for holding onto these documents could be significantly longer than six years.  An example of this is an investor who purchased common shares many years ago and still owns them.  To verify the adjusted cost base when the investment is sold or upon death, the original source documents should be retained.

In some cases, your accountant might have retained old copies of their tax returns.  Obtaining an understanding of your accountant’s retention policies, if any, may also make your decision a little easier.  Speak with your accountant before proceeding with destroying any documents.  We also recommend obtaining an understanding of the record keeping requirements of your province as procedures vary.

Many people may like the thought of disposing of those files that pre-date the new millennium.  We encourage people to take some precautions prior to disposing of any tax or financial information.

Your tax files have important information about you, including your social insurance number.  With identity theft on the rise, we encourage all individuals to burn or shred all tax and financial documents including statements, credit card offers, receipts, insurance forms.  Identity theft occurs when your personal information (including your name, date of birth, address, credit card, Social Insurance Number and other personal identification numbers) is stolen and used without your knowledge to commit fraud or other crimes.  Be careful what you throw out in your garbage or recycling.

The website of the Office of the Privacy Commissioner of Canada lists five key steps to reduce the risk of identity theft.

  • Protect your computer by using a firewall, anti-virus software and other security measures. An increasingly common practice is the use of malicious code (viruses, worms and Trojan horses) to acquire the personal information needed to commit identity theft.
  • Always be suspicious of e-mails from financial institutions, Internet service providers and other organizations asking you to provide personal information online. Reputable firms generally do not ask for personal information in this manner, but if you are at all uncertain, look up their phone number in the phone directory and call them. Clues to fraudulent e-mails include lack of personal greetings and spelling or grammatical errors. Under no circumstances should you click on any links in the e-mail or cut and paste them into your browser – chances are the link will take you to a fake website.
  • Identity theft does not solely take place online. Protect your mail – place outgoing mail in post office collection boxes or at your local post office. Promptly remove incoming mail from your mail box. Get into the habit of shredding or destroying pre-approved credit card, insurance or loan applications, bills, credit card receipts — anything that contains your personal information — when no longer needed. Also, get into the habit of checking your credit report on an annual basis — the major credit reporting bureaus will provide one free report each year.
  • Do not give out personal information over the phone, unless you know the person to whom you are speaking, or you initiated the call yourself. If someone calls with an offer that sounds too good to be true, it probably is. Do not let them pressure you into disclosing personal information or making any other commitment — if they do pressure you, hang up.
  • If, for any reason, you believe or suspect that your personal information may have been compromised, contact the proper authorities (bank, credit card issuer, credit reporting bureaus, utility provider, and so on) as soon as possible. Depending on the nature, extent and severity of the compromise, you should also consider contacting local law enforcement.

Sharing pension may save tax dollars

Get used to the term pension splitting.  We’ve been hearing a lot lately about this part of the proposed Tax Fairness Plan unveiled lat October by federal Finance Minister Jim Flaherty, which is designed to save taxes by transferring pension income from the hands of one spouse or common-law partner in a higher marginal tax bracket to the hands of the other spouse in a lower tax bracket.

Pension income splitting is primarily referring to couples receiving pension income.  Many single individuals and widows have frowned upon the plan for this reason.

The main reason for splitting pension income is to reduce the household tax bill.  But there are other issues that go beyond tax savings.  Many social benefits are income tested and reducing income may assist the higher income spouse to obtain more benefits by splitting pension income.

A good example of this is the Old Age Security (OAS) claw-back – when income exceeds $64,511 pensioners must repay part of their OAS.   Transferring income over this threshold to the lower income spouse may assist the higher income spouse in receiving more OAS.

Another example relates to the pension income amount ($2,000 annually).  If the lower income spouse does not already have pension income then transferring pension income to the lower income spouse will enable both to qualify for the pension income amount.

Pension Splitting

Individuals may be permitted to allocate up to one-half of their pension income to their spouse or common-law partner.  It is important to define for splitting purposes what “pension income” is eligible.  The following is a list of eligible income that may be split (taken directly from the Department of Finance website:

  • Income in the form of a pension from a registered pension plan (RPP), regardless of the recipient’s age (i.e., a pension from an employer-sponsored defined benefit plan or defined contribution plan).
  • Income from a registered retirement savings plan (RRSP) annuity, a registered retirement income fund (RRIF), a LIF (a locked-in RRIF), or a deferred profit sharing plan (DPSP) annuity, if the recipient is 65 years of age or older.

Income that is ineligible includes

  • Old Age Security (OAS)
  • Guaranteed Income Supplement (GIS)
  • Canada Pension Plan (CPP) / Quebec Pension Plan
  • RRSP annuities, RRIFs, and DPSP annuities (if recipient is under age 65)
  • RRSP withdrawals
  • Income from retirement compensation arrangements (RCAs)

Noted above is that CPP income does not qualify as eligible pension income for splitting under the Tax Fairness Plan.  Existing rules already permit spouses and common-law partners to share CPP provided both are at least 60 years of age, collecting CPP and have submitted the appropriate forms.

Tax Calculator

The Department of Finance website also has a “Senior’s Tax Savings Calculator”.  It provides an estimate of the federal income tax savings but may not provide an estimate of the combined effect on taxes and all benefits.  The online calculator can be a useful tool for planning purposes but should never be substituted for professional advice from a qualified accountant.  There are many factors which should be considered before automatically splitting your income, including age, income levels, medical expenses, disability, current thresholds for Old Age Security, current thresholds for the Age Credit; whether the pension income amount ($2,000 annually) is currently being utilized by both spouses; and registered account balances

Some decisions to split pension income could have a negative outcome.  Using Mr. and Mrs. Irvine as an example, they earn $110,000 and $60,000 of pension income (primarily RRIF payments) respectively.  If the higher income spouse transfers $25,000 of pension income then both incomes will be $85,000.  Although they may save a little in taxes, the OAS clawback will likely exceed the tax savings.  We emphasize that it is important to look at all government benefits, credits, pension amounts and components that are unique to your tax situation.

April 2008

If the proposed income splitting is approved for 2007 then it is likely that you and your spouse will not need to make a decision until April 2008, when it is time to file your personal income tax returns for 2007.  At that time, the spouse with the highest income can allocate up to 50 per cent of their income to be taxed in the hands of the lower-earning spouse.  Your accountant will be able to prepare an analysis to determine the optimal amount of pension income to split with your spouse.  The result may be an increase in taxes payable for the lower income spouse and a decrease in the taxes payable for the higher income spouse.  One would only proceed with this if the combined tax liability is reduced.  If the legislation is passed and the tax liability is reduced, then both you and your spouse must jointly agree to the allocation by making an election in your 2007 tax return prior to April 2008.  This election would be required on an annual basis.


Pension income amount can decrease tax bill

The federal government, in its budget announcements last year, increased the pension income amount, doubling the maximum amount of eligible pension income that can be used to calculate the credit to $2,000.

The following will help you understand the pension income amount and the potential tax planning strategies available.

The pension income amount is used to calculate the pension income credit.  In 2006, you are entitled to a Federal tax credit of 15.25 per cent of the pension income amount (up to a maximum of $2,000).

The Canada Revenue Agency website ( provides some useful tools to assess whether you can take advantage of the pension income amount.  The first thing to check is your prior year tax return, determine if you have reported pension or annuity income.   Important note:  Old Age Security, Canada Pension Plan, death benefits, and retiring allowances do not qualify for the pension income amount.

The second item to note is that pension income is calculated differently depending on your age.  Individuals who are younger than 65, generally are not eligible for the pension income amount.  The two main exceptions for individuals younger than age 65 include:  payments from a Registered Pension Plan (provided they are life annuity and not lump sum payments) and annuity payments arising from the death of your spouse under a Registered Retirement Savings Plan (RRSP), Registered Retirement Income Fund (RRIF), Deferred Profit Sharing Plan (DPSP) and other specified plans.

Are you 65 or older?

If you are at least 65, then the following represents some of the main types of pension income that may be considered: annuity payment out of a RPP, RRSP or a DPSP; payment out of a RRIF; interest component from a prescribed annuity; or accrual income included in respect of non-exempt life insurance policies and non-prescribed annuities.

To get the maximum pension credit, your goal should be to have at least $2,000 of pension income for both you and your spouse (assuming your spouse is also at least 65 years old).  The following are a few strategies to consider:

Strategy 1:  If your spouse does not have a pension then you should consider creating one for them at age 65.  The 2007 Federal Budget announcement proposes to extend the RRSP conversion age from 69 to 71.  If you are older than 71 but your spouse is younger than 71, you may be able to create pension income. This can be achieved by opening a spousal RRSP and making a contribution to the plan.  This assumes that you are able to utilize the RRSP contribution deduction and you have RRSP carry forward room.  When this income is withdrawn as an annuity payment, the pension income created may be eligible for the pension income amount (up to $2,000 annually).

Strategy 2:  Although there are restrictions that may apply, if your spouse has eligible pension income but is not able to utilize the pension credit because their tax payable has been reduced to nil by using other tax credits, you should transfer the unused portion of their pension income credit to you.

Strategy 3:  If you do not have any qualifying pension income, are age 65 or over, and do not want to draw down your registered assets at this time, you could consider purchasing a non-registered Guaranteed Income Annuity (GIA) from a life insurance company.  Note:  this is very similar to a Guaranteed Investment Certificate (GIC).  The deposit should be enough to produce $2,000 of interest income and this income will qualify for the pension income amount. The reporting of the income is done on a “policy year” basis rather than “calendar year,” so it is important to determined the best time to purchase these.

Strategy 4:  Roll a portion of your RRSP to a RRIF at age 65.  If your RRSP is $200,000 then you may want to consider transferring $50,000 of this amount to a RRIF at age 65 (see chart below) and keeping the remaining $150,000 in your RRSP.  The following chart outlines possible transfer amounts from an RRSP to RRIF that may create $2,000 of pension income in the first year:

Minimum       RRIF

            Required        Transfer

            Withdrawal    Amount         

Age     (Per Cent)      ($)

65           4.00              $50,000

66           4.17              $47,962

67           4.35              $45,977

68           4.55              $43,956

Strategy 5:  Individuals without a registered account may want to consider purchasing an annuity.  Annuities purchased outside of an RRSP are taxed on the prescribed basis.  This means that a portion of the annuity income payment is considered a return of capital and the remainder is interest income.  The annuity purchase should be sufficient to produce $2,000 of interest income annually.

Strategy 6:  Individuals that are 65 years old with an RRSP may want to consider transferring a portion of their RRSP into an annuity.  Annuities purchased with funds from a registered account create an income stream that is fully taxable.  As a result a smaller amount from a registered account (compared to a non-registered account) would enable people to fully utilize the pension income amount.

Strategy 7:  As noted above, the Federal Budget proposes to extend the RRSP conversion age from 69 to 71.  Individuals converting their RRSP to a RRIF at age 71 are not required to make a minimum payment in that first year.  It may be prudent for some individuals to make a $2,000 withdrawal during the first year to utilize the pension income amount.

Individuals who have not reached the pension age yet may still find the above advantageous for planning purposes.  Others between ages 65 and 71 should determine if their household is fully utilizing the pension income amount.  Some households may find that they are able to offset up to $28,000 of income with the pension income amount over a seven-year period.

Before implementing any strategies discussed in our columns we recommend that you speak with your professional advisors.


Looking at retirement options

Retiring employees and those who change careers or are displaced for various reasons are often faced with some difficult decisions, because how they deal with pension plans can have consequences for their retirement

Decisions can be easier if people understand their options clearly and the resources available.  Some may not have a choice with respect to their pension.  But for others the confusion begins when you’re given various options.  Many companies offer employees a choice between taking their pension in the form of a monthly payment or a single lump sum payment.   The following summarizes the two main types of pension plans – defined contribution plan and defined benefit plan (also known as money purchase).

Defined Contribution Plan

The contributions into this type of pension plan are established by formula or contract.  Many defined contribution plans require the employer and/or employee to contribute a percentage of an employee’s salary each month into the pension fund.  The employer does not make a promise with respect to the amount of retirement benefits.  The key point to take away is that the employee bears the risk of pension fund performance in a defined contribution plan.  We encourage individuals to take advantage of any pension matching your employer may offer.  With this type of plan employees are generally given a choice amongst different types of investments (i.e. conservative, balanced, aggressive).

Defined Benefit Plan

With a defined benefit plan, the employer is committed to providing a specified retirement benefit.  The benefit is established by a formula, which normally takes into account the employee’s years of service, average salary and some percentage amount (usually between one to two per cent). The key point to take away is that the employer bears the risk of pension fund performance.  Another key point is that the employee is able to calculate their benefit with more certainty then a defined contribution plan.

Monthly amount

Those with a defined benefit plan know with more certainty what their monthly payment amount will be, providing benefits for financial planning.  The end benefit is less known for people with defined contribution plans.  A key question to ask yourself:  “Is the pension your primary asset or main source to fund retirement?”  If the answer is yes, then we would encourage most people to take the monthly pension.  If your pension is not your primarily asset or you have multiple sources of income then leaving the fund and receiving a lump-sum may make sense.

Lump Sum

Choosing this option means that the monthly pension is forfeited.  For defined benefit plans, the intent of the lump sum option is to give the employee what is known as the present value (or commuted value) of the monthly pension amounts that would otherwise be received.  The calculation, which is usually made by an actuary, makes assumptions about life expectancy and inflation and uses a discount factor to determine what the lump sum equivalent should be. The lump sum amount is meant to represent the effect of receiving a lifetime worth of pension payments (from retirement to death) all at once.  It is important to note that individuals that leave the pension and receive a lump sum, may purchase an annuity with some or all of these funds.

Helping You Decide

The following are some factors to consider when deciding whether to stay with the pension, purchase an annuity or take the lump sum.

Retirement Planning:  Determining what you would like from your retirement may assist you in making the decision.

  • Is the pension your primary asset?
  • Would you lose sleep worrying about managing a lump sum?
  • Will the fixed monthly amount cover your monthly cash flow needs?
  • Are you concerned about outliving your savings?
  • Do you like the idea of managing your finances at retirement?
  • What other sources of income do you have to fund your retirement?

Investments:  Some people may want the freedom to choose their own investments while others may choose the hands off approach.

  • How are the funds currently being managed?
  • If you chose the lump sum would you manage the funds yourself or obtain assistance from a financial advisor?
  • How much risk are you willing to take with your investments?

Pension Benefits:  Many employers provide individuals that choose to stay with the pension a few other benefits that should be factored in.

  • Do you have a defined benefit plan or a defined contribution plan?
  • How long have you been a member of the pension plan and how is the pension formula calculated?
  • Is the monthly pension indexed?
  • Does the monthly pension option provide medical, dental or life insurance coverage?

Tax Consequences:  Major decisions relating to your pension should be discussed with your accountant.

  • Are there any immediate tax consequences?
  • Are any retiring allowances transferable to your RPP or RRSP?
  • How will the choice of options affect future income taxes?
  • Is it possible to split any income? (Note:  the Federal Finance Minister’s “Tax Fairness Plan” announced on October 31, 2006 outlines what income is eligible to be split)
  • Are you single, married or living common-law?
  • Does your pension provide a benefit to your surviving spouse (if applicable)?
  • Is leaving an estate important to you?
  • How close are you to retirement?
  • Are you in good or poor health?
  • Are you likely to get full value from a monthly pension?

Estate Planning:  Individuals interested in leaving an estate may feel the lump sum offers more advantages.

Life Expectancy:  This is perhaps the most important component to the decision making process.  Most people normally begin the decision process by doing a few calculations.  With every calculation people would have to make assumptions with respect to life expectancy.  If you were to live to an old age, significant value may be obtained by leaving your funds in a defined benefit plan or by purchasing an annuity with lump sum proceeds.

Spending the time to think about the above issues will allow you to have a more productive discussion with your professional advisors prior to making any decisions.  The choice people make with respect to their pension is one of the most important financial decisions they need to make.


When the dust settles on income trusts

Although a few weeks have passed since the news effecting the taxation of income trusts, time isn’t helping investors forget the Oct. 31 announcement.

The spectrum of comments in the media has ranged from general acceptance to outrage.  Two things are certain-  investors dislike negative surprises and the federal government is not going to reverse this announcement.

Investors who overweighted income trusts for a long period of time have profited handsomely.  One could surmise that it was good while it lasted.  The best way to combat volatility and uncertainty in the market is to diversify your portfolio.

The first step in diversifying your portfolio is to establish an Investment Policy Statement (IPS).  An IPS provides the framework for developing a disciplined investment approach.  A disciplined investment approach nearly always prevails in the long run.  Every individual has to obtain an understanding of the level of risk they are comfortable with.

An IPS also highlights the need to rebalance individual positions and asset classes periodically.  Determining an appropriate asset mix between cash, fixed income and equities is the most important decision investors need to make and a critical component of an IPS.   Any change in your personal situation or the taxation of investments should result in individuals reviewing their current IPS.

Illustration:  Mr. Patterson has the following asset mix – 5 per cent cash equivalents, 30 per cent fixed income and 65 per cent equities.  The cash equivalents component is invested in a money market fund.  Fixed income is comprised of Guaranteed Investment Certificates (GICs), bonds and treasury bills.  Mr. Patterson’s 65 per cent equity component is invested as follows:  common shares (25 per cent), preferred shares (10 per cent), mutual funds (10 per cent), exchange trade funds (10 per cent), and income trusts (10 per cent).  In the first week following the October 31 announcement, the income trust sector index declined on average approximately 14 per cent.  Some of Mr. Patterson’s exposure was to real estate income trusts which were not impacted.  There is no doubt that Mr. Patterson’s portfolio was negatively impacted from the income trust news.  Fortunately, other components of his investments, primarily his common shares, performed positively during this same period and his combined portfolio actually increased in value.

Concentration and Timing

Mr. Patterson’s portfolio mix described above provides one example of a diversified portfolio.  In many cases a diversified portfolio really shines when negative market events occur.  Individuals that chose to concentrate or overweight a portion of their portfolio within income trusts have been impacted the most, as were those people who purchased income trusts recently.  We encourage investors to understand the asset class weightings in their portfolio.  What component of your portfolio is comprised of income trusts?   Once determined, this should be compared to your overall investment plan.

Structured Products

As the income trust market has grown in popularity so too has structured products that pool these types of investments.  Many of these pooled products are structured as “closed end funds.” They trade on an exchange and may not be readily redeemable from the fund company.  As these structures trade on an exchange they may trade at a discount or premium to the actual Net Asset Value (NAV) of the underlying investments.  Some closed end funds have very low trading volumes and in the absence of individuals wanting to purchase, individuals entering market sell orders may receive a discounted value.   These structures often provide investors the ability to redeem at NAV at predetermined times.  We encourage investors to obtain an understanding of these dates and the various redemption privileges.

Active versus Passive

Individuals who have purchased structured products may want to determine whether the fund is actively managed or whether it has a passive structure.  Fees for actively managed funds are generally a little higher than passive structures.  Examples of a passive structure may be a basket of 100 of the largest income trusts, equally weighted.  Certain actively managed structures may provide a flexible mandate to change to other income asset class types, while others may be restricted to income funds only.  Investors should determine whether their funds hold income trusts and whether the mandate is flexible or not.  Investors holding active and passive income trust structures should assess these strategies in light of the recent news.

All Or None

For those investors that are holding individual income trusts the options are a little different.  The recent news highlights the need to hold quality investments.  Investors should clearly understand that the recent announcement does not wipe out the fact that many of these trusts are solid businesses that will continue to pay a stream of consistent income.  The tax efficiency will continue until 2011.  Often at times investors feel they have to make an all or none decision.  If you are undecided as to the best course of action then sometimes the middle road is the best option.  Selling half of a position that you are uncertain about will reduce your overall exposure but still provide you some income and hopefully the benefits if the trust market stabilizes or improves from its current state.

Stop Loss Orders

When uncertainty still exists regarding a specific investment many investors choose to put a stop-loss order to minimize further downside risk.  This type of order is used not only to reduce further losses but also to protect unrealized gains. This type of order is automatically triggered once the security’s price declines to the stated limit within the determined time and becomes a market sell order.  Investors should be cautious when entering stop orders on thinly traded positions.

Tax Consequences

Individuals that hold income trusts within a taxable account should assess their current tax situation.  Most individuals that have held these investments for a significant time may still have significant unrealized capital gains.  Selling prior to year-end may realize these gains and create a taxable capital gain.  Others that have recently purchased income trusts may have unrealized capital losses.  Tax loss selling is a strategy that can be used to offset capital gains from other investments.

What type of investment would you purchase today?  Some individuals may see value in those income trusts that have declined in value.  Others may choose preferred or common shares.  Solid research on blue chip equities has been a long-standing successful approach to equity investing.

Before implementing any strategy noted in our columns we recommend that individuals consult with their professional advisors.

To trust or not to trust, that’s the question

The popularity of income trusts had been on the rise for years.  With monthly payouts and enhanced yields amid declining interest rates, many investors considered the trust attractive.  The Conservative government’s election promise to leave the taxation of income trusts alone further enhanced the popularity.

But everything changed on October 31 when Ottawa announced its “Fairness Plan,” a move to redesign the way income trusts are taxed that may investors felt was unfair.  Here’s a primer on the issue:

So what is an income trust?

An income trust is an equity investment that was designed to distribute cash flow generated from a business to unit-holders.  People requiring income from their investments were attracted to this structure as income is generally paid monthly or quarterly.  As a result of these distributions income trusts are often referred to as “flow-through” investments.  They typically fall under the following four categories:  1) royalty/energy trusts; 2) income/business trusts; 3) limited-partnerships; and 4) real estate income trusts.

Why were income trusts were created?

Investors who require income found trusts attractive as many paid out income on a monthly basis.  Over the past few years in an environment of declining interest rates, they provided an opportunity for risk tolerant investors to enhance their yield.  The majority of investment returns tend to be generated by the monthly/quarterly distribution stream while total returns may be increased or reduced by changes in the underlying unit price.  With an aging population there is no surprise that there was a strong demand for quality income trusts paying investment income.

What is the problem?

Income trusts are designed to be tax efficient.  Their tax effectiveness comes from the trust being able to distribute the pre-tax business income out to unit-holders.  Provided this income is distributed out to unit-holders then the trust has little to no tax to pay.  People receiving distributions from income trusts may or may not have been taxed immediately on these amounts.  Individuals holding these investments within registered plans, such as RRSP and RRIF accounts, were able to defer tax on this income even further.  The trust structure is considerably different than a corporate structure that must first pay tax on company profits prior to paying dividends to shareholders.  This is the primary problem that led to the recent announcement.  Ottawa may not have been too concerned in the past when trust conversions were primarily done by smaller businesses and taxation dollars were minimal.  With the recent announcements by BCE and Telus to convert to an income trust structure the Government was compelled to act in the interest of supporting their eroding tax base.  It is clear this became a greater issue when some of Canada’s largest companies began contemplating trust conversion.  As a result the Federal Government announced a new Tax Fairness Plan designed to balance the taxation of income trusts and corporations.

Tax Fairness Plan

The proposed Tax Fairness Plan has impacted income trust investors with the exception of those invested in real estate income trusts.  For the other three types of income trusts, profits within the trust will be taxed at corporate tax rates before distributions and distributions will subsequently be treated as dividend income.  These proposed changes are to take effect in the 2011 tax year for trusts that are currently publicly traded.  New income trusts that begin trading after October 31 are impacted immediately.

Political risk in Canada

Prior to investing in income trusts investors should have been aware that this recent announcement from Finance Minister James Flaherty was at least a possibility.  Just over a year ago, former Finance Minister Ralph Goodale spooked income trust investors by announcing that the Liberal Government was looking into the taxation of income trusts.

Ongoing risks

Prior to October 31, many investors may have felt the greatest risk to investing in income trusts is political uncertainty.  Another major risk is that distributions are not guaranteed.  When distribution payments are reduced, people’s income stream will be reduced and the market tends to respond negatively.  One common way to analyse income trusts is to look at the stability of distributions and the payout ratio (cash distributions dividend by available distributable income). Payout ratios greater than 100 per cent of available distributable income is generally an indicator that the trust may need to adjust the distribution level.  Volume of trading is also a concern with some income trusts.  Supply and demand has always driven the markets and some trusts are relatively illiquid.  Energy and resource related trusts are generally impacted either negatively or positively by changes in the price of the underlying commodity.  Changes in the level of interest rates have also had a significant effect on unit prices.  As with any equity investment, it is important to continually analyse the merits of the underlying business.

Coming Up

Many investors may be concluding that the existing trust market is likely to shrink considerably by 2011.  Our next column will provide a few options for investors to consider.  We will also provide an illustration of an investor with a diversified portfolio.

Saving taxes without changing your investments

Most of us would like to reduce the amount of tax that we pay.   One of the easiest ways to minimize tax is to ensure your investments are structured appropriately between your cash account and registered account. People that structure their investments appropriately are often able to save more of their hard earned dollars.   For those individuals who do not have their investments structured appropriately the solution may be as simple as a “Swap.”

Swaps are a technique used to change the structure of a person’s investments between accounts.  It involves exchanging certain investments from a registered account (RRSP/RRIF) for investments in a cash account.  Swaps can often be conducted for a nominal fee.

Fixed Income

Investments which generate interest income such as GICs, term deposits and bonds are often referred to as fixed income.  These types of investments are generally best held within a registered account, such as an RRSP or RRIF.  One of the reasons for this is that all withdrawals from an RRSP are taxed as regular income, similar to interest income, regardless of the type of income generated.  Fixed income within an RRSP provides more certainty for planning purposes.


Investments which generate dividend income and/or capital gains are best held in non-registered accounts (commonly referred to as cash or margin accounts), as opposed to a person’s RRSP or RRIF.  The main reason is to utilize the tax characteristics of dividend income and capital gains.  The tax rates on these two types of income are considerably more favourable than interest income.  Another benefit for owning equities in a cash account is that unrealized capital gains are not taxed until an individual realizes the gain (sells the investment).  Losses on equities held in a cash account may be applied against capital gains.  Growth in your cash account may also allow you to make further contributions to your RRSP at a later stage.

Investment Accounts

In order for an investor to consider a swap they must have both types of investment accounts (cash and registered) with the same investment dealer.  For those individuals who deal with multiple institutions, they may not be able to facilitate a swap.  The cost to complete a swap is usually negligible when compared to the potential tax savings.  Some people may be in a position to sell a few positions and repurchase them in the appropriate accounts.  Others may have mutual funds or other investments which have redemption fees if sold.  Other investments, such as Working Opportunity Funds, may generally not be sold until their maturity date.  Swaps may allow investors to minimize their transaction costs while improving their portfolio’s structure.

Illustration #1

Mr. Smith has an RRSP worth $250,000.  His RRSP contains both growth equities and preferred shares generating dividend income that total approximately $10,000 per year.  Outside the RRSP he has $100,000 earning 4% in a GIC.  Every year Mr. Smith has been reporting $4,000 in interest income on his tax return.  Currently in the 43 per cent tax bracket, he is paying $1,720 in taxes each year relating to this income.

Swap Solution

Mr. Smith could swap $100,000 cash into his RRSP in exchange for $100,000 in equities.  GICs within the RRSP would be able to compound on a tax-deferred basis.  In the cash account, the growth equities would not be taxed until Mr. Smith sold the investments.  When the investments are sold, the growth would only be taxed at one-half of the capital gain.  Dividends received from preferred and common shares would be taxed at a more favourable rate.  In the end, Mr. Smith will pay less in taxes by simply changing the structure.

Illustration #2

Mr. Field has several investments within his RRSP which are not growing at the rate in which he had originally hoped.  He has looked at the costs in which to sell these investments; some have a mandatory holding period while others have redemption fees if sold prior to maturity.  He has incurred some losses within his RRSP that he has not been able to take advantage of.  In addition, he is concerned that his RRSP is not growing at the rate that it needs to in order to reach his retirement objective.  Outside his RRSP he has $50,000 in term deposits which are soon to mature.  Every year he is paying tax on the interest income while seeing very little growth within his RRSP account.

Swap Solution

For a nominal fee Mr. Field may swap the proceeds from the term deposit into his RRSP and have future interest income tax sheltered.  The individual equities which are swapped into his cash account will have a book cost equal to the market value as of the date of the swap.  If Mr. Field should choose to redeem the funds after the swap, the redemption fees may result in generating a capital loss which can be utilized in the cash account.  For those investments that Mr. Field is not able to sell, he can simply hold onto them – if growth appears then it will be taxed as a capital gain.  If the positions do not grow then he will have no taxable income.  If the positions decline in market value, Mr. Field would be able to generate a capital loss that could be applied against future capital gains.

We caution investors to carefully consider the implications of mutual fund swaps later in the calendar year as they may have capital gain and other income distributions.  A swap can be an excellent way to structure investments in the most tax efficient manner.

This article is for information purposes only.  It is recommended that individuals consult with their own tax advisor before acting on any information contained in this article.

You’ll need a plan in order to live on investments

We recommend anyone requiring income from their investments to establish a plan.

An important component of that plan is to ensure income is transferred from a client’s investment account to their banking account.

Although investment firms still issue manual cheques, the number of transactions executed electronically is rising rapidly as investors are becoming more comfortable trusting the electronic transfer of funds from one account to another.  With electronic transfers, there is no risk of mail being lost and transactions are done in a timely manner.  When transfers are done on a scheduled basis they are referred to as a systematic withdrawal plan – often referred to as a SWIP.

A financial institution usually requests a void cheque from the investor’s banking account to obtain the institution, transit and account numbers.  SWIPS are set up to electronically transfer a predetermined amount from an investment to a banking account.  Understanding the income currently being generated from the investments, maturity dates, and liquidity of the portfolio are key components to look at when setting up an appropriate SWIP.

Investors have flexibility with respect to the amount of income they would like to receive and when they would like to receive it.  The following illustrations provide an overview of how SWIPs are often used.

Illustration 1:  Mr. Jackson requires a high level of income from his portfolio. He has requested we send him all of the income from his investment account on the first of every month.  Mr. Jackson has $200,000 invested generating approximately $12,000 per year in income.  We provided Mr. Jackson with an expected income report and noted that his monthly income ranges from $600 to $2,000; however, his average income is approximately $1,000 a month.  For the month of September he earned $740 investment income.  This amount will automatically be transferred to his investment account on the first of October.

Illustration 2:  Mrs. Reynolds has several investments that generate income.  She has a mixture of common shares, preferred shares, convertible debentures, and bonds.  Mrs. Reynolds would like to see her portfolio grow a little further before she begins pulling out all of the income generated.  She has decided to set up a SWIP that automatically transfers the investment income from the income funds to her bank account on the first of every month.  The income from the preferred shares and the bonds will stay in the investment account.  At some point in the future she may increase the SWIP to include all income.

Illustration 3:  Mrs. Walker has a cash flow need of approximately $4,000 per month.  Her sources of income are from CPP, OAS, and a small pension, all of which add up to approximately $2,400 per month.  How is Mrs. Walker going to fund the monthly shortfall of $1,600?  The most obvious place to look is her investments which are currently generating approximately $800 per month; short of the $1,600 she requires monthly expenses.  We explained to Mrs. James how a SWIP can be set up to transfer a flat dollar amount, such as $1,600, even if this amount exceeds the monthly income generated in the account.  We established a plan that allowed for certain investments to be partially or fully liquidated over time to ensure the monthly payments could be sustained during her lifetime.  This included factoring in projected income amounts and maturity dates of her investments.  With this type of SWIP more planning is required.

Preferred shares reduce taxes

The main reason to invest in preferred shares is for investment income.  With the recent changes announced by the federal government, dividend income from Canadian public companies will now be taxed more favorably.   The increase in the dividend tax credit eases the tax burden for most individuals generating dividend income within non-registered accounts.  Preferred shares are an excellent alternative for producing tax efficient income when compared to interest-bearing investments, such as bonds and GICs which are fully taxed.

One way to understand preferred shares is to combine the features of both common shares and bonds.  Preferred shares are similar to common shares in that they are both equity investments and represent an ownership interest in a corporation; however, preferred shares behave more like a bond.  The following are the main similarities between preferred shares and bonds:

  • Preferred shares produce a reliable stream of dividend income very much like the interest paid on a bond.
  • Preferred shares are interest rate sensitive similar to bonds – when interest rates rise, the price of preferred shares generally falls, and when rates fall, the price rises.
  • The same independent services that rate bonds, namely, Canadian Bond Rating Service Inc. and Dominion Bond Rating Service Inc., also rate many preferred issues.
  • Like many bonds, most preferred shares can be “called” or “retired” by the issuing company.
  • Both bonds and preferred shares may be purchased in other currencies.

The similarities between preferred shares and bonds help to illustrate how preferred shares may be suitable for conservative investors wishing to include lower risk equities in their portfolio.  For investors heavily weighted in income trusts the addition of preferred shares can help to achieve greater diversification.

Preferred shares offer the following advantages:

  • They typically yield one to three per cent higher than most dividends from common stock issued by the same company.
  • Dividends are paid quarterly but each company may pay on a different month.  With a little planning many investors purchasing three or more preferred shares may be able to structure a consistent tax-efficient monthly income.
  • Most preferred shares are listed on the Toronto Stock Exchange, making them easy to buy and sell.  New preferred shares are issued at par values (generally $25), making them affordable for many individual investors.
  • They rank senior to common shares in the event that the issuing company becomes insolvent or is liquidated.  If a company runs into financial problems, the board of directors may vote to reduce or skip the preferred dividend without placing the company in default.  Fortunately most preferred shares are “cumulative,” so missed dividends accumulate and must be paid to preferred shareholders before any dividends are paid to common shareholders.
  • Dividends on some preferred shares may be increased by the board if the company does especially well. This feature is generally referred to as “participating” preferred shares. Most preferred shares are “non-participating” where the dividends never change, regardless of how well the common shares perform.

Not All Preferred Shares are Created Equal:  As capital markets expand and become more complex so have the characteristics of preferred shares.  Prior to investing in preferred shares it is important to understand the different types, features, and the associated risks of each.

Hard Retractable:  Hard retractable preferred shares have a fixed maturity date usually between five and ten years from the date of being issued.  They have a feature that allows the shareholder (investor) to force the company (issuer) to redeem the shares at par value for cash on a specified date.  This type of preferred share most closely resembles bonds.  As noted above, the value of preferred shares will vary with changes in interest rates.  Hard retractables are generally less sensitive to interest rate fluctuations because of their fixed maturity date.

Soft Retractable:  There are a large variety of issuers of soft retractable preferred shares with different yields, credit qualities and maturities.  Soft retractable preferred shares are term preferred shares that give the company (issuer) the option of repaying the par value in cash or in common shares.  Shareholders (investors) can force redemption by the company, but the consideration offered can vary.   As a result the investors’ retraction feature is considered “soft” (for cash or shares) as opposed to “hard” (for cash). This payment option gives the company greater flexibility because they can pay the preferred retraction in shares instead of cash if it is advantageous for them to do so.


Unlike hard or soft retractables, perpetual preferred shares have no fixed maturity date. They pay a straight dividend for as long as they remain outstanding. The shares may be redeemed at the option of the company but the holder has no retraction rights.  If a perpetual preferred is not redeemed by the issuer, investors have the option of selling them in the secondary market or holding them indefinitely.  The risk in holding this type of preferred share is that they are very sensitive to fluctuations in interest rates because they are comparable to long bonds in the way they trade.  Compared to all other classes of preferred shares of similar credit rating, perpetuals are riskier.  Perpetuals may complement a balanced portfolio strategy and a diversified portfolio of preferred shares.

Floating and Split are two additional types of preferred shares with their own unique features.  Before investing in preferred shares it would be prudent to understand their various attributes along with the opinion of the debt rating agencies while keeping an eye on interest rates.  Some investors may benefit from using a basket approach with different types.

Before implementing any investment ideas or strategies discussed in our columns we recommend that you speak with your financial and tax advisors to discuss your specific situation.

Venture capital funds suit those with risk, time

Working Opportunity Fund is Western Canada’s largest venture capital fund.  In existence since 1992, the privately managed fund qualifies for a combined 30% tax credit evenly split between federal and provincial governments on investments that can be used to reduce the amount of income tax individuals will have to pay.

Tax Credits:  The BC Tax Credit limit is $2,000 in any one year, and the Federal Tax Credit limit is currently $750 per year.  Neither have lifetime limits.  Let’s assume an investor purchased $5,000 of WOF.  The combined tax credit would be $1,500.   The net cost of the investment would be $3,500 ($5,000 less $1,500 tax savings).   An investment of $5,000 would enable investors to fully utilize the Federal Tax Credit and partially utilize the BC Tax Credit.  Investments greater then $5,000 and less then $13,333 have limited appeal since they will only benefit from the BC Tax Credit.  Investments over $13,333 have even less appeal as those amounts do not qualify for either BC or Federal Tax Credits.

RRSP Eligible:  In addition to provincial and federal tax credits, the WOF investments are also eligible to be held within an RRSP.   For an individual in the top marginal tax bracket, a deduction of $2,185 ($5,000 x 43.7 per cent) is also eligible.  Some advisors may highlight the fact that a $5,000 WOF that is put within an RRSP has a net cost of $1,315 ($5,000 – $1,500 – $2,185).   Since most investments are RRSP eligible we urge investors not to view this as a significant benefit with this type of investment.  We recommend that investors obtain a clear understanding of the types of investments that are eligible and suitable for an RRSP.

Determining Suitability:  The primary importance when investing is to ensure that an investment is suitable for you given your risk tolerance and investment objectives.  Tax minimization should be considered a secondary investment objective.  The merits of an investment should always supersede a decision to invest purely to minimize income tax.  WOF is considered venture capital and we classify this type of investment as more suitable for those investors who have a higher risk tolerance and a longer time horizon.  Another item to consider prior to purchasing WOF funds is your investment needs.  These types of investment typically do not pay an income and therefore are not suitable for those requiring income.

Liquidity:  Another secondary investment objective is liquidity.   Liquidity is the ability to sell the investment into cash, ideally without penalties.  The typical holding period for the Working Opportunity Funds is 8 years.  Shares may be redeemed early in a limited number of situations including:  bankruptcy, disability, permanently unable to work, involuntary loss of employment, or death.  In these cases, an early redemption fee of $75 would be payable to WOF and if the redemption is within 5 years of the purchase date then the federal and provincial tax credits would have to be repaid.

Investment Performance:  Performance numbers for past Working Opportunity Funds may be accessed through the website  Many of the funds have posted negative performance numbers since inception.  One important component we recommend investors to look at is the Management Expense Ratio (MER) on these funds.  Research will reveal that the MER is generally higher than regular mutual funds.  Higher fees ultimately impact performance.  Although past performance is not a predictor of future performance, it should be an integral part of doing your due diligence.

The Rule of 72:  If you are earning a nine per cent annual rate of return, how long will it take to double your money? Assuming various rates of return, The Rule of 72 can help you understand how long it may take to double your money. For example, if your target rate of return is nine per cent, then you simply divide 72 by nine to determine that it will take eight years to double your money.  In eight years, $10,000 will become $20,000.  If you are able to generate an average return of ten per cent, you will have $20,000 in approximately seven years.  If you are earning an average return of 5 per cent, it will take over 14 years to double your money.

Doubling Your Money















Some investors may be attracted to WOF investments solely for the tax credits.  We recommend that individuals look at past performance numbers even though “past performance is no indication of future performance”.  A mandatory holding period of eight years is a very long time, therefore, in our opinion the higher MER, historical performance and locked in features make other investment options more attractive.

Strategy to consider:  Investors who have WOF investments within their RRSP may feel they have no flexible options for eight years.  One simple strategy that generally costs only $25 is to swap the WOF investments out of an RRSP and into a non-registered account for an equal amount of cash.  WOF investments generally do not pay income so it is quite possible that the swap could reduce your annual taxable income.  Another benefit to holding a WOF in a non-registered account is that if the value declines below the market price at the time of the swap then the investor will at least be able to claim a capital loss.

Before implementing any strategies discussed in our columns we recommend that you speak with your financial and tax advisors.