Tax Adverse

The income from these investments are taxed at the top rates.  They include bonds, certificates of deposits, savings accounts, rents etc.  Depending on the province, these investments may be taxed at rates of approximately 50% or more. (For example, Alberta 48.0%, BC 49.8%, Manitoba 50.4%, Ontario 53.53%, Nova Scotia 54.0%).

Tax Advantaged

These investments are taxed at rates lower than those that are tax adverse.  These investments include those that generate a capital gain (stocks, equity funds, investment real estate, etc.), or pay dividends.  The effective tax rate on capital gains varies depending on province from approximately 24% to 27%.  For dividends, the range is between approximately 30% to 41.6%.

Tax Deferred

Tax deferred investments include those investments which are held in Registered Retirement Savings Plans or Registered Pension Plans (such as an Individual Pension Plan).  One advantage of these investments is that the contribution is tax deductible in the year it was made.  The disadvantage is that the income taken from these plans is tax adverse as it is taxed as ordinary income and could attract top rates of income tax.

The growth in cash value life insurance policies such as Participating Whole Life and Universal Life is also tax deferred in that until the funds are withdrawn in excess of their adjusted cost base while the insured is still alive, there is no reportable taxable income.

Tax Free

Very few investments are tax free in Canada.  Those that are tax free include the gain in value of your principal residence, Tax Free Savings Accounts (TFSA’s) and the death benefit of a life insurance policy (including all growth in the cash value account).

While Canada is not the highest taxed county in the world (that distinction belongs to Belgium) it is certainly not the lowest.  (According to the Organization for Economic Co-operation and Development, Canada sits as the 23^rd highest taxed country in the world).   It is also true that in addition to the taxes Canadians pay while they are living, the final insult comes at death.

Generally speaking, you have three beneficiaries when you die.  You have your family, your favourite charities, and the Canada Revenue Agency.  They all take a slice of your estate pie.  Most people would rather leave more to their family and charities than pay the CRA more than they need to.

As our estates grow, they include funds that we intend to leave to our children and possibly to charity.  They also include funds we are likely never going to spend while we are alive.

The secret to optimizing the value of your wealth for the benefit of your estate is to re-allocate those assets that you are never going to spend during your lifetime from investments that are tax exposed to those that are tax free.

One of the best ways to do this is through life insurance.  As mentioned earlier, assets which are tax free include the death benefit of a life insurance policy.  Systematically transferring funds from the tax exposed investments to, for example, a Participating Whole Life Policy, not only eliminates the reportable tax on the funds transferred, it greatly increases the overall size of the estate to be left tax-free to your beneficiaries – your family and your charities.

Case Study

Let’s consider Ron and Sharon, aged 58 and 56 respectively.  They have been told that they have a liquidity need of approximately $1,000,000 which would become payable at the second death.  They are also unhappy about the taxes they are paying annually on their investments.  They elect to re-allocate some of their assets to a Participating Whole Life policy for $1,000,000 with premiums of $31,890 for 20 years.

Over this period, they will transfer a total of approximately $640,000 of investments exposed to income tax to a tax free environment.  If we assume that their life expectancy is 35 years, the Whole Life policy will have grown to a death benefit of approximately $3,300,000*.  This represents a pre-tax equivalent yield over this period of approximately 11%.  Not only is there more than enough to pay the tax bill but there are funds left over for the family and any charitable donation they wish the estate to make.

In addition, with the transfer from a taxable to tax free investment, income taxes that would have been paid during their lifetime has also been reduced.  Along the way, the Participating Whole Life policy has a growing cash value account which could be borrowed against should the need arise.  At the 20^th year for example, the cash value of the policy (at current dividend scale), would be slightly under $1,000,000.

This case illustrates only one example of how it is possible to optimize the value of an estate through asset re-allocation.  By using funds you are never going to spend during your lifetime, you can create a much larger legacy to benefit others while reducing the total cost of your tax bill.

If you would like to investigate this concept to determine the value it can provide you and your family, please be sure to contact me.  As always, please feel free to share this information with anyone you think would find it of interest.

* Values shown are using Equitable Life’s Equimax Estate Builder assuming current dividend scale for 2018.

Worth a read.

https://www.forbes.com/sites/ashleaebeling/2018/02/28/the-healthcare-conversation-you-need-to-have-now/#2a5d8a5d3a35

This article will primarily focus on exactly what effect the Federal Budget will have on private corporations.  There were of course other notable measures, and these included:

• An increased effort to achieve gender equality;
• Continued concern and focus on aggressive tax planning strategies both at home and abroad;
• The implementation of a national Pharmacare strategy;
• Continued and improved support of the indigenous people of Canada.

Of great significance in the Budget were the items that were not mentioned.  These included:

• A change to the tax treatment of Capital Gains. There was some speculation that the inclusion rate of Capital Gains for tax purposes would increase from its current 50%.  This did not happen;
• There was no change to the tax treatment of exempt life insurance policies. There was some speculation that the benefits of a life insurance policy owned by a corporation would be negatively affected.  This turned out to be not the case;
• The rules governing the Capital Dividend Account. The CDA will continue to operate without change allowing for tax-free distributions of the non-taxable portion of capital gains and the death benefit of corporately owned life insurance;
• There has been no additional change in the income tax rate paid by corporations or individuals. The reduction of the corporate federal income tax rate previously announced will continue.

In July of 2017 the government expressed their concern that private corporations taxed at the low corporate tax rate on active business income created an unfair advantage for business owners in growing passive investments within the corporation.  The Federal Budget addressed these concerns with the following introduced measures:

Corporate passive income could reduce the small business tax rate 

The intention of the government was to limit corporations with large amounts of passive investment income from enjoying the small business income tax rate.

The current small business rate limit allows for up to $500,000 of active business income to be taxed at the lower tax rate.  The federal small business tax rate for 2018 is 10% whereas the tax rate for active business income in excess of $500,000 is 15%.   The applicable provincial corporate tax increases these rates to (in BC for example), 12% small business rate and 27% general rate.

Under the measures introduced in the Federal Budget there will be a limit of the amount of passive investment income that can be earned in any one corporate year.  This amount has been set at $50,000.  This was established by assuming a 5% rate of return on $1,000,000 of invested capital.  For every $1 of investment income earned over this threshold amount the small business income limit will be reduced by $5. This means that once a corporation reaches a passive investment income of $150,000 they will no longer be entitled to the small business tax rate.

This measure will apply to taxation years beginning after 2018.

Limiting the Refunding of Corporate Taxes Paid on Investment Income

This measure is introduced to limit the tax advantages that large Canadian Controlled Private Corporations (CCPC) might enjoy with respect to obtaining refundable taxes on the payment of certain dividends.  Usually, passive investment income earned by a CCPC must be paid out as a non-eligible dividend which carries a higher personal income tax rate than eligible dividends which are paid from a pool created by active business income.  In practice, however, any dividend paid by a CCPC can generate a refund of the refundable tax.  This can provide a tax advantage by being able to claim a refund of taxes paid on their passive investment income even though the dividends paid were lower-taxed eligible dividends from their pool of active business income.

This Budget proposes that a refund of the refundable tax is only available where the CCPC pays non-eligible dividends.  This ensures that the refundable tax is available only if the dividends paid originated from the passive investment income of the CCPC.

As with the provisions regarding the reduction of the small business income limit, this measure will be effective starting in 2019.

The 2018 Budget certainly came as a relief to those who were of the opinion that more drastic measures were at hand.  Some business owners, especially those with professional corporations can certainly take pause to consider the bullet they just dodged.  This underscores the need for effective on-going planning as there will always be Federal Budgets and many of them will bring changes that often will not be welcomed.

Strategies are available to help you plan ahead

There is now an investigation into effective tax strategies to bypass the $50,000 annual passive investment income limit.  Some of these may be riskier than others.  One strategy that was certainly beneficial before has now become even more so.

Business owners of private corporations should consider the use of corporately-owned cash value life insurance.  The opportunity to have corporate surplus grow in a permanent life insurance policy without generating passive investment income should not be overlooked. Combined with the Capital Dividend Account not being limited, nor any changes in the taxation of exempt life insurance products, permanent cash value life insurance should be viewed as a preferred investment vehicle for Canadian Private Corporations. 

As always, please feel free to share this article with anyone you think would benefit from this information.

If you have a will in place, great. A will, however, is only a fundamental first step, not a comprehensive plan, point out authors of the 2017 Wealth Transfer Report from RBC Wealth Management.

“One generation’s success at building wealth does not ensure the next generation’s ability to manage wealth responsibly, or provide effective stewardship for the future,” they write. “Knowing the value (alone) does little to prepare inheritors for managing the considerable responsibilities of wealth.” Overall, the report’s authors say the number of inheritors who’ve been prepared hovers at just one in three.

Worse, they say despite best intentions, individuals are repeating history in a negative way.

“Overall, our respondents reveal a marked level of discomfort when confronting the theme of wealth transfer directly: Only 40% say they are comfortable sharing details with their beneficiaries. As such, they risk subjecting their own heirs to the same lack of clarity and understanding they experienced during their own inheritance.”

Two thirds say their own wealth transfer plans aren’t fully developed – a critical barrier to having this discussion in the first place.

While the report focuses on wealthier beneficiaries in society, the lessons remain true for most: There is planning, communication, and a fair bit of education your heirs need in order to make the best decisions about your wealth when the time comes.

1. Recognize that action today can help you create a better future forever.

First, it’s important to acknowledge that creating an estate plan means contemplating your own mortality – an inescapable element of the process. It can also involve some awkward conversations, particularly if you’re not in the habit of talking about money with family and loved ones.

Without planning, however, the outcome you leave may not be the one you would choose.

2. Get help to build your plan, then share it with those who matter.

Estate planning typically isn’t a “do-it-yourself” project. Instead, you’ll probably need to rely on a network of professional advisors who can bring their expertise to different parts of your plan. Your network might include a lawyer and a financial advisor or other representative from your financial institution.

Once you have your plan in place, it’s time to ensure that the people who are impacted by it are aware of your wishes. In the survey, only 35 per cent of those who had inherited money in the past said their benefactors had prepared them in advance.

Members of your professional network can also help you explain your plan to beneficiaries and help those who inherit your assets to understand your preferences and the decisions you’ve made.

3. Encourage education early.

Most of the people surveyed are not confident that the wealth they pass on will be preserved by the people who inherit it. Nearly 60 per cent of Canadian parents said they aren’t sure that their children will preserve or grow their inheritance, though almost 70 per cent said their children were first in line to inherit.

Here’s where a little financial education can go a long way: If you’re concerned about the money management skills of those to whom you’ll leave assets, now is the time to start putting structures in place to build financial literacy. Having a plan is itself an important first step. The survey showed that 58 per cent of those with a plan are confident the next generation will sustain their wealth, compared to just 33 per cent of those who haven’t taken time to prepare.

Finally, although creating an estate plan sounds as though it will only have an impact after you’re gone, the confidence (your own confidence, and the confidence you instill in others with a little bit of preparation) is one of the benefits you can enjoy in life. In sum, these three steps – developing a plan, communicating it to those who matter, and taking action to ensure your wishes will be sustained over generations – can lead to confidence now about the future you’re creating.

Let’s get together to discuss how you can create your wealth transfer plans, and get help in communicating those plans to the people who matter the most.

As always, please feel free to share this article with anyone you think would find it of value.

Income earned by a corporation and then distributed to a shareholder is subject to tax integration which results in the total tax paid between the two being approximately the same as if the shareholder earned the income directly. Integration also means that if a corporation is in receipt of funds which it received tax-free, then those funds should be tax free when distributed to the shareholder.

The Capital Dividend Account is a notional account which tracks these particular tax-free amounts accumulated by the corporation. It is not shown in accounting records or financial statements of the corporation.  If there is a balance in the CDA it may be shown in the notes section of the financial statements for information purposes only.

Generally, the tax-free amounts referred to, are the non-taxable portions of capital gains received by the corporation and the death benefit proceeds of life insurance policies where the corporation is the beneficiary.

Life insurance proceeds received by a private corporation

The death benefit of a life insurance policy that is owned by a private Canadian corporation less the adjusted cost basis (ACB) of that policy, can be credited to the Capital Dividend Account.  The government’s reasoning in deducting the ACB from the CDA credit is that if the corporation had paid the premiums to the individual shareholder to pay for the insurance, those payments would have been taxable.

In calculating the ACB, the following factors are taken into account:

• Premiums or deposits made to the policy increase the ACB;
• Policy loans, paying of dividends in a participating policy and partial dispositions reduce the ACB;
• Repaying policy loans, purchasing paid-up insurance and adding any term insurance riders increase the ACB;
• The annual net cost of pure insurance (NCPI) reduces the ACB.

The NCPI is the pure mortality cost of the life insurance and is contained in a table in the Income Tax Act.  The NCPI, which increases each year with age, is applied to the net amount at risk in determining the reduction of the ACB for that policy year.  The net amount at risk is defined as the total death benefit minus the cash value of the policy.

Normally, the ACB of the policy increases each year ultimately resulting in a total erosion.  Once the ACB reaches zero, the full amount of the death benefit is eligible for Capital Dividend Account credit.

Frequently asked questions about the Capital Dividend Account

Does the corporation have to be Canadian controlled? No.  It is only required that the company is a Canadian private corporation.

Can the corporation be publicly owned? No. Only private corporations qualify.

What is the tax treatment of a Capital Dividend paid to a non-resident shareholder? Capital dividends paid to a non-resident shareholder are subject to a withholding tax.  In the absence of a resident of a country without a Canadian tax treaty the withholding tax is 25%.  With a tax treaty, the rate will be reduced.  For an individual living in the U.S. for example the withholding rate would be 15%.  The capital dividend would most likely be taxable to the non-resident in their own country.

Does the company still get a CDA credit when a policy is assigned to a bank and the death benefit is paid directly to the lender? Yes.  Although the proceeds of the life insurance policy may never actually be received directly by the corporation, it still creates a CDA balance equal to the total death benefit minus the ACB of the policy.

For many business owners the ability to have life insurance paid with lower taxed corporate dollars and still be able to have the proceeds eventually flow to their families on a tax free basis is an opportunity that should not be not overlooked.

As always, please feel free to share this article with anyone you think would find it of interest.

It depends who you ask but there are many – often not so obvious – factors that could make a difference to your net returns when putting your trust in a financial advisor.

Proper financial planning goes beyond how and where you invest. Good financial planning can increase your standard of living throughout your life.

Even for a complete novice it is possible to start investing in products without the help of professionals. The problem with this option is the lack of knowledge. Knowledge is crucial when it comes to investing.

Financial advisors analyse and study the markets on a daily basis and know which factors are likely to influence which part of the economy in a positive or negative way. This knowledge and expertise will have a huge impact on your net returns in the long run.

Just like in any other industry, some advisors will be more competent than others. Additionally, future economic markets are all but certain and financial advisors can only advise on the most appropriate strategy for your finances, they cannot guarantee any sort of return or success. Ultimately you are responsible for your own money and can decide whether or not to take the advice. However, saying that, it is still more prudent to rely on even the most average of advisors than following your own DIY investing approach.

You can study up on as much financial data as is humanly possible but actually putting a sound financial plan into action is not always that easy.

Most DIY investing strategies will focus on index funds which aim to mirror a specific market index. This might be a safer, less complicated strategy but it will also be reflected in the returns you are likely to see. When you invest in a market index for example, it’s obvious that you can’t beat that market. When you engage with a financial advisor however, they are able to propose various alternatives that are not just focussed on one strategy. This has the potential of resulting in excess returns, higher than related benchmark indices.

An advisor will also look at your situation and can recommend investment in specific stocks and securities, depending on the market and company performance indicators. More risky, yes, but that’s why you hire a financial professional. And again, the increased risk will be reflected in your returns which are likely to be higher.

Above we mentioned that an advisor will look at your personal circumstances and design a course of action based upon that. This is important because we are not all the same and we are all in different stages of our lives. The problem with DIY investing solutions is that in most cases it provides a blanket strategy with very little option for personalization. That’s where the personal advice from an advisor becomes invaluable. They can adjust your financial strategy according to changes in your situation and the economic markets to maximize returns.

Your situation is also less likely to get any simpler as time goes on. In fact, it’s bound to grow more complex. You might have children, receive an inheritance and start thinking about retirement. All of a sudden, there’s a lot to think about. If you have access to an advisor, you can discuss this with them and they can advise you on the best possible options. Instead of keeping track of it yourself and potentially losing out on profitable returns.

Managing your own money can be an emotional experience for most people. Believe it or not, emotions can have a detrimental effect on the ROI you are likely to see. Especially if you’ve had negative financial experiences in the past or currently find yourself in a difficult financial position. This is true even for experienced financial individuals. A neutral third party is therefore essential in situations like these. Financial advisors will have your best interest at heart while still being able to make wise financial decisions, without emotions clouding their judgement.

There’s a misconception that advisors are only for the rich and wealthy. Yes, there is a charge for their products and services. But the potential for higher net returns more than makes up for the money spent in the long run. There is great value in a comprehensive financial strategy and informed financial decision making. There’s also more to it than just merely choosing between different investment options.

http://www.theglobeandmail.com/globe-investor/investment-ideas/the-wealthy-expect-more-volatility/article31229824/

Is it time for us to lower our expectations?

If we have to accept lower rates of return, do we still want to be exposed to the same previous level of risk?  There can be tremendous volatility in the equity markets and, as a result, many wonder if they are on the right track with their investment strategy.

4 Questions to ask yourself about your investment strategy

What are my goals?

If we don’t know what the target is, chances are it is going to be difficult to hit it. It is important to have an understanding of what we are investing for. Are we accumulating for shorter term goals, such as the purchase of a house, the education of our children? Or is the major objective to save for retirement? Perhaps it is a combination of these goals. If we know why we are investing and what the time frame for accumulation is we can determine how much risk is acceptable.

What is my risk tolerance?

This probably will depend on where you are in the life cycle. Investors who are in their 20’s to mid-30’s usually tolerate greater risk as they have sufficient time to make up any losses. In the middle years, especially when trying to save while raising and educating our children, steady growth with less risk is often the approach. At retirement, investors usually become extremely risk adverse as this is the time that capital is turned into income to replace earnings.

What are my retirement needs?

Converting capital into a consistent income might be the objective for the retirement years. For example, if we know what our fixed expenses will be, providing a guaranteed investment income that covers these expenses will help us to enjoy a comfortable retirement. While GIC’s might guarantee the capital, it only guarantees the interest rate up to the maturity date. Current interest rates are so low, nervous investors who would be comforted with guarantees may wish to consider a Guaranteed Minimum Withdrawal Benefit plan from an insurance company.

Are my investments tax efficient?

With a registered plan (RSPs, IPP’s etc.) all investments are treated the same – tax deductible going in (highly tax efficient), totally taxable as income coming out (highly inefficient). Even though deposits are not tax deductible, Tax Free Savings Accounts (TFSA’s) are highly recommended due to the fact that all growth is tax free and can be withdrawn at any time with no tax payable.

Looking at non-registered investments, usually the higher the risk the more tax efficient the investment. Pure capital gains are taxed at the lowest rate, guaranteed income (such as a GIC) at the highest rate. Dividends are taxed somewhere in the middle. There are many types of financial vehicles and most of them are appropriate in the right circumstances. Employing effective portfolio allocation can ensure that you are not unduly affected by equity volatility, fluctuating interest rates, or high rates of income tax.

Knowing the answer to these four questions should go a long way in determining whether or not you are on the right track. Having a full understanding of the options available to you is important.

There is nothing as certain as uncertainty. We live in very turbulent times with respect to the investment climate and developing an investment strategy during this time can be a very daunting and confusing task. Given that there are now investment vehicles that deal specifically with many of the issues facing investors today, discussion and consultation has never been more important.

As always, please feel free to share this information with your family and friends.