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Free Online Presentation November 6, 12:15 pm

Once more the World Money Show and Canadian Money Saver Magazine have generously invited meme to be part of their 3 day Extravaganza of investing and financial planning running from November 4 to 6.

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To register and find out more, please click on the following link:Registration Link: https://online.moneyshow.com/2020/november/canada-virtual-expo/speakers/ffvcms0311172/colin-ritchie/?scode=051449

Even More Wills, Chills and Thrills – A Few More Things to Consider When Drafting a Will

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During these times of turmoil and Covidic confusion, many of my clients have had Wills on the brain. Although many Wills do a good job covering off the basics, I still often finish reviewing my new clients’ old Wills with a vaguely uneasy feeling that there are a few too many “what ifs” left floating in the wind for my liking. And when I also reviewing their beneficiary designations, I really start to get fidgety. Thus, in effort to stop my squirming, I am inflicting this article upon you today.

In law school, I was trained imagine the worst and to make you think about things that you don’t like talking about at cocktail parties. Fortunately, my job is also to provide you with safety valves and solutions to protect you and yours if the worst actually does come to pass. Admittedly, in many cases, this extra worrying will be unnecessary and any extra issues, tension and confusion left unresolved will eventually work itself out with few permanent scars. On the other hand, if life does come up snake eyes, a little extra planning can easily pay for itself many, many times over in terms of problems avoided, relationships preserved, and dollars saved. In my view, when you’re talking about the transfer of a lifetime’s worth of hard work, sacrifice and saving to the people and causes you love most in amounts that can profoundly their futures, this is one of those times when it’s worth sweating the small stuff. 

Noting all of this, here are a few of the extra things I suggest considering before you sign your Will’s back page:

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  • Not being able or getting around to update your Will and beneficiary designations on insurance or registered plans in the future. I am particularly thinking of clients who lose their capacity to make legal decisions due to disease or injury but may linger for many years after diagnosis or mishap.  Most people assume that they can just make changes to their plans if someone dies in the wrong order or life throws a curveball, but this isn’t always possible. To counter this contingency, I like to include:
  • Backup guardians and trustees and perhaps secondary backups.
  • Indexing cash gifts to inflation or making them a percentage of the estate instead so that they keep up with inflation or grow/ shrink with the size of your estate if it is larger or much smaller than anticipated.
  • Distributing assets like accounts, real estate and company shares as part of an heir’s share of the estate rather than a stand-alone gift. In other words, if the goal is to equally divide an estate amongst your 3 children but for your youngest son is to get the cabin, divide your estate evenly but specify that your son’s share includes the fair market of the cabin at death net of taxes. In that way, regardless of what the cabin is worth in the future, your boy still gets his mancave but the estate is divided equally. Worried about the cabin being worth more than his fair share? Either he can get a mortgage to buy out his sibs at death or you can provide other options in your Will like him paying out his siblings over time at an interest rate that is based on the market rate at that time.
  • Contingency planning for life insurance and registered plans if leaving these assets jointly to your children with descendants of their own or who might have them in the future. Without this planning, if a child with descendants predeceases you, it is very likely that your other children would just get a larger piece of the pie and the children of the deceased would both go hungry and might even be stuck indirectly paying for some of the taxes on some registered plans they never received. Although many clients accurately assume that children who receive this extra share would do right by their nieces and nephews:
  • Some of your kids may honestly believe that they are just following your wishes when keeping the extra share or may never understand that there has been an injustice in the first place;
  • If the recipient children have creditor issues or incapacitated, they might not be able to set things right even if they want to; and
  • If the grandchildren are still minors or even young adults, it could be messy and complicated to determine how to get the money back to the children, avoid unnecessary taxation and determine who is to manage the money in the meantime.
  • Including provisions to hold an inheritance in trust if your now-healthy heirs are incapacitated at the time they inherit or perhaps beset by other problems, like creditor issues or addictions. Why take the chance that an inheritance might end up managed by the government, squandered, used to feed an addiction or handed over to creditors rather than your kith and kin?
  • Flexibility to move any trusts created in your Wills to other jurisdictions if your children or other heirs end up living abroad. It’s also really important to get good advice if you have heirs with U.S. citizenship or living in the U.S to avoid your heirs pay far more taxes than necessary.
  • Contemplating potential money issues and uncertainties might arise amongst your beneficiaries and trying to head off as many at the pass in advance. Along those lines, I suggest dealing with the following:
  • Stipulating executor fees and ongoing fees for trustees managing trusts for your heirs directly in the Will. Although courts generally award fees based on a percentage of your estate and you can do the same in your Wills, this can cause problems. Either the person doing the work doesn’t want to rock the boat and claim a fair (or any) executor fee or perhaps they does claim a fee and the rest of your heirs feel (perhaps with justification) that it is more than you would have wanted, particularly if the executor is also an heir and doing some of the work for their own benefit. The size of the estate doesn’t often match its complexity so naming a percentage in your Will might over or undercompensate your executor. Ultimately, although this is not a perfect solution, I have landed on picking a flat fee and indexing it to inflation or, if using a percentage, including a minimum or maximum value that is also inflation indexed. I also suggest doing the same thing for trustee fees as well in order to ensure that they also get paid yearly if required to manage trust funds for some of your heirs in an amount that is fair, transparent and not open to creative interpretation.
  • Including a memo that distributes your personal effects and then stipulating a way to divide the remainder, with provisions for compensation payments if there is a significant disparity in the value of the assets distributed. Some people fight more about the picture albums and artwork than the bank accounts. Trying to head this off at the pass in advance or even sitting down with your children to get clarity who gets what and agreeing upon a process for divvying up your “stuff” can go a long way to eliminating sour faces at future family picnics. Some people even put masking tape labels on the back of contentious possessions with the name of the future heir on the back! Others have an auction between heirs to buy your velvet Elvis print and bobblehead collection, although others think starting a bidding war over the family heirlooms and assets is just a recipe for disaster.
  • Providing guidance or perhaps including even a guardian fee for the people caring for your children. It is often exceedingly difficult to quantify the extra costs your guardians might incur raising your children and it can be an awkward conversation if the person managing their money and the person managing your children are not the same. Providing a statement of general principals to your trustee, such as to take a liberal and expansive view of expenses and to clarify things like including your guardian’s vacation costs when travelling, or to with your children might make your guardian and trustee’s relationship far more comfortable and productive. It is also a great idea to provide guidance on the sort of lifestyle you wish to provide your children. See my earlier articles on “Voices from Beyond the Grave” that discusses this and other related issues in more detail on either my or the Canadian Moneysaver websites for more details.
  • Considering whether the same person should be trustee and guardian. This is often done without incident, but there is a significant conflict of interest if the person deciding how much of the guardian’s mortgage, cable bills and property tax should be paid from the a child’s trust fund is the same person incurring these expenses. Every now and then, we lawyers hear cautionary tales about guardians who may have dipped into their charges’ trust funds a little too liberally, perhaps so that the children can’t afford to attend university or don’t have that down payment for their first home that mom and dad anticipated would be there.  This may be due to fraud or overly generous accounting, but it also might due to picking people to raise your children who are not also good at managing an investment portfolio or budgeting for the future. Moreover, both jobs require significant time commitments. Perhaps picking different people to watch your money than those you’ve picked to watch your kids is actually doing your guardians a rather large favour.
  • Not automatically picking children or spouses as executors or trustees. Being an executor is a generally thankless task and it takes longer to wind up many estates that most people expect. Although it can be expensive and not without problems, picking a professional trustee or at least someone who isn’t one of your heirs to do the job might sometimes be the best solution. Do consider the following before naming family as your executors:
  • Do your children get along and work well together if you pick them to act as a team? Do you want to include tie-breaker provisions in case they can’t agree? Does it make sense to name children who now live in distant lands or to require that they also sign off on every decision?
  • Will any children feel excluded if their siblings are picked as executors and they are not? As well, siblings not chosen may have unrealistic expectations regarding how long an estate should take to settle and have been noted to unfairly hound executors for their piece of the pie far sooner than is reasonable. The excluded siblings may also often feel without justification that the chosen child has not done a good job at maximizing the value of an estate or overpaid everyone involved, from the estate lawyer down to the woman hired to clean out your refrigerator after you’re gone.
  • Does your new spouse really want to be executor if it means your old kids are breathing down her neck? Conversely, how would your children from prior relationships feel if the new spouse is your sole executor or perhaps managing trust funds for them or their children? How do they feel about your spouse even managing his own trust fund if whatever is left at his goes to them,  particularly if that spouse has unlimited spending powers?  Likewise, if the children are managing your spouse’s trust fund and deciding both how much to pay out each month and how to invest the cash, how would your spouse feel about that?  If the kids are to get what’s left down the road, there is also a real temptation for them to both be cheap when budgeting money to your spouse while also picking riskier investments that focus more on growing their own future inheritance than the more conservative income-focused portfolio that better ensures your spouse will never run out of cash. The expression “conflict of interest” was perhaps invented with these situations in mind. The expression “family squabble” certainly was.
  • Is there even the slightest chance of a Will challenge, particularly if you have a blended family or you don’t treat your children equally in some provinces? An inheritance is a once in a lifetime windfall and no matter how people get along until that point, big money can still lead to big problems, particularly if you are not around to make sure that everyone plays nice. Moreover, if your children are forced to wait until your new spouse dies before getting their inheritance, they may actually get legal advice telling them to challenge your Will since they will have little chance of challenging their stepparent’s Will at a later date, assuming that there is anything left to challenge by that point anyway.
  • Is there a reasonable chance that anyone acting as trustees of any ongoing trusts will have to act as “bad cops” to their siblings, nieces or nephews and thus wreck Christmas dinners for decades to come or who will ultimately cave to pressure in order save future Christmases? This is another great reason to consider a professional trustee, particularly if dealing with heirs with potential addiction issues, creditor problems or a money management handicap.
  • Determining whether it makes sense to pass on or sell family assets like businesses and cabins. Will passing along these assets in kind to your family mean starting a new family feud rather than continuing a family legacy. Issues include:
  • Treating children with sweat equity in the business or farm fairly while also providing for your other children.
  • Balancing your business children’s desire to potentially run and grow the business vs. non-business children’s desire for cash flow and safety.
  • Do your children have the experience to run your business and to work together? Is this a recipe for success or the ingredients for creating a family disaster?
  • Who gets to make business decisions? Equal voices can mean gridlock or non-business children having too much say in matters they don’t understand but providing control to one can cause resentment or to make unfair or unpopular decisions. Who sets salaries for the business children? Are profits to be reinvested or a set percentage paid out each year? What if the child you pick isn’t up to the task and ultimately squanders not only his inheritance but his siblings’ as well by running the business into the ground?
  • What if any of the children wants to sell their share of the business or cabin and the others can’t or won’t buy them out?
  • Are your children able and willing to pay ongoing property expenses and do their share of the maintenance for family cabins and cottages?  If one child really doesn’t use the place as much, should they be paying the same portion of costs? Does that child really want the place?
  • Balancing financial autonomy with financial prudence.  Except for smaller gifts, I generally recommend holding a youngster’s share of an estate in trust until they are at least 25 years of age and often suggest handing over the inheritance to those children in stages so that they can learn and make mistakes with only a small portion of the inheritance before being entrusted with the big bucks later. Some of my Wills even require the children to co-manage their trusts with the original trustee for a while so that they get on-the-job experience managing investments, budgeting and taxes before getting to call their own shots. Although there are horror stories about younger heirs burning through their legacies and many years of their lives when trusted with too much too soon, I worry almost as much about responsible, well-intentioned kids hiring the wrong financial advisors or trying to do too much on their own with insufficient experience. On the other hand, in Wills that hold a child’s share of the estate until they are in their mid-30’s or so on, I usually draft the trusts in such a way that the money can be handed over ahead of schedule if the child has proven themselves along the way if the trust is no longer worth the expense. For trusts with a larger dollar value or time line, also consider appointing a “protector”. This gives your heirs someone to notify if the trustee is not up to scratch and the protector can swoop in, fire the incumbent and appoint a new trustee if appropriate. Otherwise, getting rid of a bad trustee is as hard and frustrating as getting ink stains out of your favourite shirt and far, far, far more expensive.
  • Decoupling family finances. While money is probably not the root of all evils, I do see it as a major cause of many family spitting matches. Accordingly, I ask my clients to carefully consider whether or not to leave assets like private companies and real estate jointly to multiple family members for the reasons expressed previously. In situations where it is the right decision or the only practical choice, I encourage clients to take additional steps, like signing agreements or at having family discussions in advance to set up ground rules, particularly to cover what would happen if one of the children later wanted out, such as a buyout procedure, valuation formula and the appropriate timeframe for payouts. Do investigate life insurance in these situations as well in the hopes of paying some of the children out in cash rather than making them get shares in the family business instead. You might even make the children to get the business or cabin pay for this insurance in the first place!
  • Providing surety in blended family situations. Decoupling finances can be even more important for blended families. For first marriages, it is common for the surviving spouse to inherit all or most of the family assets and that usually makes sense. In second marriages, however a lot can go wrong if the children from your first kick at the can are forced to wait to inherit until your second dearly beloved is no more. This can poison relationships, result in those Will challenges I mentioned earlier in places like B.C. and might even result in your children missing out on any part of your estate if your new spouse outlives them, remarries, goes on a decade long spending spree or ultimately leaves  their inheritance to their favourite charity, the pool boy or their own children instead of yours.  If it isn’t possible to provide for your children while also protecting the surviving spouse (again, more life insurance might be a solution in some cases), many families leave the survivor’s share in a trust that ensures that the remainder flows to the children or their descendants eventually. While this situation isn’t ideal, picking the right trustee and providing sufficient guidelines in the trust can at least go a long way to minimizing family tension, particularly if the children at least receive something at the first passing, perhaps when they need a financial leg up the most.
  • Equalizing inheritances for children with large age gaps. If you’ve already put some of your older children through school, covered their spring break adventures, paid for 10 years of interpretative dance or tuba lessons, funded a closet full of must-have jeans,  two decades worth of pizza and so on, is it fair to leave your estate equally to all your children when the younger ones never received such benefits? In situations like this, I often use a general education and maintenance trust to cover all expenses for anyone in school or under a set age, with the remainder divided equally amongst all of your children, regardless of age, when the last of them no longer qualifies for payments. This might comprise 40% of the estate if no surviving spouse and is designed to provide the younger children with the support and extras that their older siblings received during your lifetime. The remaining 60% would be equally divided amongst all the children, with older children receiving their portion of the 60% immediately. When the dust settles, all the children have been provided with the same leg up and luxuries prior to get their university diplomas or reach adulthood but your older children are not forced to wait until their youngest sibling gets a diploma before having the cash to buy their first home.
  • Including provisions to gift over an inheritance on a child’s death.  Although most Wills contemplate what happens if a child predeceases you, most don’t deal with what happens if a child inherits but passes on while leaving behind a spouse. In most cases, your son or daughter-in-law would likely inherit and your grandchildren would only what’s left after (s)he is also deceased. If that spouse remarries, has additional children in the future or squanders the cash, then your grandchildren may end up with nothing, less than you would like or perhaps inherit it far later in life than you would have wanted. Leaving the money in a trust that names your child and their own descendants as beneficiaries can ensure that your grandchildren get what’s left on your child’s passing or can even gift over to your other children instead at that time if none of these grandchildren exist and you really don’t like your son /daughter-in-law. As an added bonus, this type of trust structure can actually save your child a lot of money along the way in taxes avoided by allowing gains and income to be taxed in your grandchildren’s hands at their rates, making any inheritance go a lot further. You might even name your child to be their own trustee in some cases in order to maximize flexibility and decrease both complexity and costs of running the trust.

Conclusion

My job as a lawyer is to find the dark cloud hidden inside the silver lining, no matter how small and unlikely.  Although many of the extra provisions I’ve just enumerated in copious detail may be ultimately be unnecessary in many cases, the downside is generally just a few extra dollars and hours “wasted.”  On the other hand, taking a bit more time now to think and plan for the unpleasant and unthinkable might be a game changer.

Covid Contemplations: What to Do If You Have Been Socially Distanced by your Finances

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In this eerie time of social distancing, medical mayhem and financial carnage, I feel like a background character in a cheesy made-for-tv movie starring B-grade actors from the 70’s. Unfortunately,  the chaos and risk are all too real, although the consequences and aftermath remain a riddle wrapped inside an enigma.

For those of you, however, who are trying make sense of their financial picture, I do have a few suggestions to lessen the financial pain and some things to keep in mind when you are deciding what to do next.

Consider Future Tax Issues When Making Your Financial Decisions Today

When reading some of the tax-planning options I discuss below, particularly those about harvesting capital losses, it’s also really important to consider how things might look a few years down the road when Covid19 is hopefully a distant and not particularly fond memory, like door-to-door salesmen and (fingers crossed) manbuns. I simply can’t imagine a future that doesn’t include significant tax hikes, particularly for those in the higher tax brackets or for most people in their year of death. I also worry if this might also include increasing the inclusion rate for capital gains from 50% or, for those of you not up on tax-speak, what percentage of any realized capital gains is actually included as taxable income and what part is tax-free. Keep in mind that this was something tax types were stressing about even before this all came down.

In the past, as much as 75% of capital gains were taxed on sale. If the inclusion rate goes to 75% again, this would mean paying 50% more tax on gains than we are right now! For example, if you had a $10,000 capital gain and were in the 40% tax bracket, you’d have to pay $2,000 in tax at the 50% inclusion rate ($10,000 x.50 x.40). If it goes to 75%, then you’re out of pocket $3,000 ($10,000 x .75 x.40). Hopefully, if the inclusion rate is increased, it’s not quite so drastic – I just used 75% as an example since it was a number our government had charged previously. Essentially, just like when setting any other tax rates, they can pick any number they want, limited only by the fact that they want to get re-elected and probably don’t particularly enjoy having their likeness burned in effigy.

A) Capital Gains

For those of you with unrealized capital gains from those bank stocks you bought in the days of disco, there are some planning opportunities available for you, particularly if you expect to be in a lower tax bracket than usual this year anyway.  Here are some of the reasons why you might want to trigger some of those gains now:

  • Your other sources of income are also affected this year and you’ll be in a lower tax bracket than usual. Although paying taxes ahead of schedule is not something I love doing, you might be better biting the bullet now vs. selling in a few years during the new tax reality. It also may also mean not having as much money in the market to capture any future market recovery and receive dividend payments if you have to divert some of your capital to pay the tax bill next year unless you have offsetting capital losses so consider this carefully. On the other hand, it’s not like you need to pay the tax bill today – this is a bill you won’t need to cover until April 2021.
  • You have other stocks that are underwater and would generate capital losses upon sale. You could apply those losses against those gains so you won’t have to pay the tax man this year and can keep all of your capital invested to hopefully participate in any recovery and generate income while you wait.
  • You have losses from previous years already on the books to use up so you won’t actually be triggering a tax bill. Triggering gains at the current inclusion rate, even if you aren’t actually paying any tax on them because of your offsetting losses, will still save you tax in the future if inclusion rates change going forward as I explain later in this article.
  • You are worried and were going to take some money off the table anyway.
  • Your portfolio wasn’t properly diversified, previously, it would have meant paying too much tax to rebalance previously. Now that values might have declined, that tax bill isn’t so high and the tax pain isn’t too great. Although you are selling when markets are down, you will also be purchasing your new investments at a discount. This works even better if you have some of those offsetting losses we also discussed.
  • Your risk tolerance has changed, or you no longer like your current mix of investments anyway.
  • Your capital gains are inside your company and you are really worried about the inclusion rate for gains increasing going forward. If this happens, corporate investors will suffer another hit. Our tax system allows companies to pay out the non-taxable portion of capital gains tax-free to its shareholders (i.e. currently the 50% that isn’t taxed). If the inclusion rate went to, say, 75%, then shareholders would only be able to take out 25% of the gain tax-free, which is half of what they can do now. When coupled with the higher tax rates we’ll likely be paying in general going forward, this might be enough incentive to lock in those tax-free payments now, particularly if the business owner isn’t making as much money from other sources that year anyway. If this might be you, then you might hold off on selling company-owned investments that have losses, as realized losses offset how much of the gains you can withdraw tax-free.
  • You are looking at other uses for your money, such as permanent life insurance, income-splitting it with a spouse or through a family trust, paying down debt or perhaps helping the children out a bit more now than you’d previously anticipated.

As a final point, it is also important to remember that if you do sell a stock that is in a capital gain position but you still love it, there is nothing that stops you from buying it back whenever your heart desires. Although you must wait 30 days after selling a loser before repurchasing it, there is no such rules when reconnecting with a former flame that you previously sold at a profit.

Capital Losses

When deciding whether or not to trigger capital losses, here are some of the things to keep in mind when making decisions:

  • If tax rates and the inclusion rate both increase in the future, triggering capital losses in later years to offset future gains might save you more money over time than triggering them now, particularly if you’re ultimately going to be in a higher tax bracket in the future anyway.

 We talked earlier about how the inclusion rate works for capital gains and how an increase of the inclusion rate from 50% to 75% would mean including $7,500 of every $10,000 capital gain as taxable income rather than just $5,000. The same is true for capital losses – if the inclusion rate was increased from 50% to 75%, this means that you get to deduct $7,500 per $10,000 of bad decisions rather than only $5,000.

It all comes down to when you trigger the losses. Typically, when inclusion rates are increased, those increases don’t apply to losses already on the books. For example, if you trigger a $10,000 gain in a dystopian future reality where inclusion rates are 75% but had an unused $10,000 capital loss on the books from this year, the two would no longer cancel each other out. Because you triggered the loss at a time when the inclusion rate was only 50%, you would only get to deduct $5,000 of that total loss of $10,000 but had to include $7,500 of the $10,000 gain as income, meaning you would still need to pay tax on $2,500. It’s always possible that the government could increase the inclusion rate for past losses if they decide to increase the inclusion rate for new gains. Personally, I think it’s more likely to find discount hand sanitizer  and toilet paper on sale next week than for that to happen.

  • If you want to trigger capital gains this year for some of the reasons discussed above, i.e. you’re going to be temporarily in a lower tax bracket and are okay paying some tax now at current rates, you won’t want to trigger any capital losses this year, as they have to applied against this year’s gains.
  • Triggering losses now will give you more flexible for rebalancing your non-registered portfolios going forward since you can apply these losses against future gains so that you can rebalance without tax consequences until those losses are used up.
  • You have some big capital gains from the last 3 years and want to carry back this year’s losses to get back some of last year’s taxes. You’ll have to wait until you file your 2020 tax return to do this, but it might be worth the wait if you were in a high tax bracket then and don’t expect to be in the same place going forward.
  • You adopt the bird-in-the hand approach and want to deal with today’s taxes and inclusion rates rather than guessing about how things might look in the future. Likewise, you might expect some of your losers to rebound and might want to just lock in the losses now for flexibility’s sake even if this means having more taxable capital gains in the future if your reinvested dollars make money.

As a final thought, it is important to remember that you,  your spouse, your company, etc. must wait 30 days to repurchase any investments you sell in order to be able to realize your capital loss. If you are still really bullish on the investment’s long-term future, then you could look at similar alternatives, at least until the 30 days have expired, unless you’re happy to sit on the sidelines for the short term.

Find Some Balance

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Somewhat ironically, some of my client’s biggest financial planning headaches a few weeks ago was not being able to rebalance their portfolios without triggering big tax bills. In many cases, this meant having a disproportionately large share of their investments in perhaps a few stocks that had been in their lives longer than their children.  Adding to the risk,  many clients owned several similar stocks in the same sector with the same problem, such as perhaps 3 or 4 Canadian bank stocks they’d first started acquiring when the first Trudeau was doing his thing.

All that has now changed. Although you may still love your BMO or Royal Bank shares, it may now be possible to trim those positions in favour of a new infatuation. It doesn’t mean abandoning all of those legacy stocks, but merely hedging your bets. Although playing the field is not a great recipe for romantic success, investing is an entirely different kettle of fish. Rather than just looking at the tax side of things, you might be better off focusing on building a properly diversified portfolio that fits like a glove even if it means cutting an extra cheque to Ottawa in order to make this happen.

If you are looking to rebalance, perhaps this is the time to add a few new types of investments to your portfolio, particularly:

  • some that don’t trade on the stock market and hopefully haven’t taken as strong a gut punch to their prices as public market stocks have suffered;
  • expanding your portfolio geographically beyond just Canadian dividend payers and some companies from down in Trumpland;
  • investments that offer some downside protect through options or the ability to short-sell or which are designed to allegedly make money in any market conditions, although this doesn’t always happen.

The current buzzword is that people should “invest like a pension” and strive for less risk and smoother returns by expanding their mix of investments. Although even pension funds or companies that invest like them have taken a kick to the teeth this last month, their extra levels of diversification have generally helped them some of those extra body blows that the average Joe has endured.

Look to Refinance Loans

For those of us with mortgages, one of the consolation prizes (albeit one on par with a getting a participation ribbon for finishing  58th place in a 5 km race) are much lower borrowing rates. If you have loans of any type, get professional advice regarding whether it makes sense to redo those loans at current rates despite any penalties that might apply.  For those of us with variable loans, the monthly savings can be really significant and will hopefully help ease the pain for years to come.

For those of us with family trusts and loans at 2%, start planning to refinance those loans at 1% this July, as it appears very likely that the minimum loan rate will drop back to 1% at that time.  This will also apply to spouse loans as well, so it’s worth looking at updating those too. Despite the hassle, it’s recommended that you actually physically repay past loans and then re-advance the funds.

This will allow more future investment income to be taxed in low-income family members’ hands and less in yours at your higher rates.

Consider Setting Up a Family Trust or a Spousal Loan

If the rates do drop to 1% in July (this will be clear by the end of April and is based on a government formula that suggests that this will happen with room to spare), then those of us with large unregistered investment portfolios have the opportunity to income-split a lot more successfully with spouses, children and other lower income family members. Noting the current yields on many investments and the hope of stocks eventually recapture some of their past glories, the tax savings from loans to family investment trusts or spouses are even more mouthwatering. Until now, the unrealized gains on the higher income spouse’s portfolios may have been a deal breaker, as it meant paying too much tax to free up the capital to loan to your spouse or trust. For better or for worse, this may no longer be the case, both because of reduced gains and perhaps if the higher income spouse is in a lower tax bracket this year.

Be Prudent If Investing New Money into the Market Today

Although current yields on many investments are (apologies to my vegetarian, vegan or pescatarian readers) as mouthwatering as prime rib on a cold winter’s day, there is still a lot of uncertainty in the market. Although it is a personal decision as to whether you wish to deploy any dry powder you may have to take advantage of these eye-popping yields, do keep in mind that we might not have seen the bottom and it’s hard to determine how the fallout will affect different stocks and industries. Consequently, you may wish to keep in mind some of the following if you’re contemplating dipping a toe back into today’s rather frothy investment waters:

  • Consider dollar cost averaging rather than trying to do market timing. We don’t know if we’ve hit the bottom so you may benefit from easing money bank into the market over a number of weeks or months rather than going “all in” on what your fortune teller says is your lucky day.
  • Yield is a wonderful thing. If you do want to put new cash into the market, take advantage of those high yields rather than counting on future gains. The income will reduce the risk and can be redeployed back into the market if you so desire or can be a way of providing more money for your family during a time when many family budgets will be stretched extremely thin. Because of the current calamity, even blue-chip stocks have yields formerly reserved for junk bonds. As a result, there is no need to travel too far down the risk spectrum just to get a few more percentage points when safer stocks are already paying you handsomely
  • Be sure that you have a sufficient contingency fund set aside to cover you and your family’s expenses so you’re not stuck having to sell some of those investments you just purchased at the worst possible time. If in doubt, bump  up the size of the contingency fund.
  • Be even more conservative if you are borrowing to invest. Although rates are astonishingly low right now, leveraged investing only works if you can pay back your loans when the time comes. Accordingly, think long and hard before proceeding and reread my last three bullets at least twice. I strongly suggest staying away from margin accounts at this point as a margin call might ultimately be the financial kiss of death. If you do borrow to invest, carefully investigate the spread between secured lines of credits and borrowing using a traditional mortgage. Despite the decrease in rates, there can still be a big difference in cost between borrowing using a HLOC or using a mortgage. Although the mortgage option is less flexible and requires you to also pay down some of the principal with each payment, it might still be the way to go.
  • Diversify, diversify, diversify. Because the fallout is still so uncertain, spread your money over many different sectors and investments. It’s better to take some of the risk off the table by hedging your bets. Rather than waiting for fair weather and your ship to come in, consider funding a fleet of smaller boats that will see you safely into the future even if some of them don’t ever reach the shore.

Look into Estate Freezes

An estate freeze is a strategy that involves owners of private companies swapping their common shares for fixed value preferred shares. New common shares are then issued to other family members or to a family trust and all future increases in company value will be taxed in their hands. Private business owners do this sort of thing this for a couple reasons:

  • To increase how much capital gains can be sheltered from tax if the business is sold. If the existing shareholders won’t be able to shelter all the gains from tax upon sale under their own lifetime capital gains exemptions, having new growth taxed in other’s hands allows these other family members to dip into their own exemptions to increase tax sheltering at that time.
  • To minimize the tax bill on their deaths by capping the value of their shares and transferring future growth to younger generations.

Despite not owning a private company, are you the proud owner of a non-registered investment or real estate portfolio that you want to pass along to your kids, grandkids or favourite financial planner? An estate freeze might still be the thing for you. Transferring those assets into your company on a tax-free rollover basis in exchange for fixed value preferred shares lets any future growth accrue inside a family trust or in your heirs’ hands rather than yours.  As a result, when your time comes, you can pass into the great beyond knowing that your final tax bill is a lot smaller and your heirs’ inheritance that much larger than might have been the case.

In most of this instances, estate freezes only work if the new common shares subsequently grow in value.  Accordingly, doing a freeze this year when share prices for most private and public companies are at Black Friday prices can mean tremendous tax savings in years to come if values do bounce back, particularly if tax rates and the inclusion rate are both higher in the future.

Learn About Your Options

Keep informed about government programs and tax changes that might help you and your family, such as EI, reduced RRIF withdrawal requirements, extensions to tax filing and installment payments, changes to your bank rates, mortgage or loan deferral options and so much more.

Conclusion

I am hoping that one day, hopefully soon, we can look back on today’s events in the same way many of us look back on 2008 and 2009 and perhaps how my parents viewed my teenage years – incredibly trying and stressful, but something we all survived and put behind us.  I’ve tried to give you a lot to think about but there are so many moving parts and uncertainty that this is probably a good time to get professional advice before taking any big steps. In the meantime, let’s just focus on being good to each other and realizing that we’re all in it together.

A Stand Against Capital Punishment – Ways to Minimize Your Capital Gains Tax Bill Part 3 – More Advanced Strategies

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If you’re not full to bursting with ideas on how to save on capital gains tax after my first two servings in this feast of ideas, today’s offering will hopefully round things off nicely. Here are some more strategies that you can consider for minimizing your family’s capital gains bill.

  • Trigger and Use Capital Losses Strategically. Although some people call November and early December “autumn”, we financial types think of it as “tax loss selling season.” That’s when investors look to sell some of their losing investments to create a loss they can use to offset again capital gains they’ve earned that year and then either against any of the three prior years or against any future gains if any of the loss still remains. Here are some specific things to keep in mind when doing this: 
    • The “superficial loss rules” prevent you from claiming your loss if you or your spouse buys back the same stock or fund within 30 days before or after buying or selling your loser. It also catches you if either of you buys back those stocks in a different account, such as an RRSP or TFSA,  or even in a trust or corporation you or your spouse control. Moreover, if repurchasing in a registered account, the outcome is even worse. It means losing your right to claim that loss forever, as you cannot claim your loss now and you don’t generate gains or losses inside of registered accounts, which means you won’t get to claim it later, either. Accordingly, if you still like the investment’s long-term prospects but want to trigger a loss now, consider waiting and re-buying after the deadline expires or buy a similar but not identical stock or fund asap if you’re not willing to wait.
    • Sometimes it is possible to have the superficial loss rules work for rather than against you, such as when a spouse with no capital gains or in a lower tax bracket is the one that owns the loser investments.  If the high-income spouse buys that same dog stock within 30 days before or after the low-income spouse sells it and then waits a full 30 days after that point before selling herself, then the high-income spouse will be able to claim the capital loss.

Here is a quick example of this: Jack owns a stock in his non-registered account worth $10,000 which he bought for $25,000 and is in a far lower tax bracket than Jill, who has some big capital gains to report that year. If Jack sells his stock on April 1 and Jill buys that same stock in her non-registered account on April 2 and then sells it herself on May 5, then she will be able to report a capital loss of about $15,000 on her tax return, although Jack won’t be able to do the same.

    • Consider tax loss selling for its own sake when you have big losses on the books and have similar stocks or investments you could purchase with the sales proceeds yearly. Even you don’t have any immediate capital gains to realize down the road, it’s nice to lock in some of your capital losses when you get a chance and if doing so makes investment sense. Having losses on the books gives you more flexibility in the future, such as allowing you to re-balance your accounts without triggering gains, can also mean avoiding big tax bills in years you’re in higher tax brackets. If you still love the stock, then there is nothing to stop you from buying it back so long as you stay clear of the superficial loss rules.
    • You have no choice if you have capital gains already earned that year when realizing losses – you have to first apply the losses against that year’s gains. Accordingly, be careful about your timing when selling winners or losers if your ultimate goal is to apply the loss against gains you’ve earned in past years or expect to earn in the future. For example, if expecting to sell a rental property at a big gain next year and this might push you into the highest tax bracket, either avoid selling your losers until next year or be sure not to trigger capital gains this year that would use up those losses.

Here is a quick example of some potential savings. Assume an investor with $80,000 in taxable income, including a $40,000 capital gain (i.e. $20,000 in taxable gains), has the choice to offset that gain this year by applying unused losses from the past or selling an investment with a $40,000 capital loss or triggering / applying that loss next year when he is planning to sell his rental property when his total taxable income, including $200,000 in taxable capital gains (i.e. $400,000 in total gains) is expected to be $250,000.

Scenario

Total Income   Total Income  

Net of Loss

Tax Saving from

Applying Loss

Loss claimed in 2019 $80,000 $60,000 $5,640
Loss claimed in 2020 $250,000 $230,000 $9,960

Thus, by waiting until 2020 to apply the capital loss, this canny investor has about 77% more money to spend on nice dinners out.

    • Check to see if you have unused capital dividend credits on your small business before triggering capital losses. Capital dividends are dollars your company can pay out to you tax-free and represent the 50% of previously realized capital gains that weren’t taxed corporately. Unfortunately, if you haven’t already used up that room, 50% of future losses can reduce the amount of money you would have otherwise been able to pay out tax-free. Thus, do declare and pay out your capital dividends every year, even if you keep the money invested corporately so you don’t end up with egg on your face in the future when reporting future capital losses. 

 

  • Donate and Repurchase Your Stock Market Darlings Instead of Gifting Cash. As I explained in my recent articles on charitable gifting, if you donate appreciated stocks, the government forgives your capital gain but still gives you credit for donating an amount equal to the stock’s value at the time of the gift. If you love the stock, there is nothing that stops you from repurchasing the stock using the cash you would have otherwise donated instead. Thus, the charity gets the same gift you originally intended, you still own the same amount of your favourite stock, but the prior capital gain on that stock has now been erased. See my previous articles on personal and corporate donation to learn more about this strategy and how to use it most effectively, particularly when deciding whether to gift personally or corporately.

 

  • Pick the Right Person to Own the Right Investments.  As illustrated in some of the examples I’ve laid out in this series, there is a lot of money to be saved when gains are realized when you’re in lower tax brackets. One simple way of saving is having the lower income spouse own the investments with the bigger upside if (s)he is likely to be in that bracket for some time to come. If that spouse doesn’t have as much money to invest, consider having the higher income spouse pay more of the family bills so that the lower income spouse has the money to invest in that stock or real estate purchase that you’re sure will double in 5 years. In some cases, the right person may not be a person at all, but a trust that names both spouses and all your dependents that you control. As I’ve done with some of my clients, the wealthier spouse loans money to the trust at the prescribed government rate (currently 2%). Each year, you can decide how to distribute income and gains from the trust amongst everyone you’ve named as a beneficiary. If that includes minor children, university students not earning a significant income, or even older children that are in tax brackets a lot lower than yours, there is a lot of money to be saved. Although the lender has to declare that loan interest each year for tax purposes, which does have to be taken into account when crunching the numbers to make sure this is right for you, the trust does at least get to write off the interest. I’ve written about these trusts previously if you want to check out my website or comb the Canadian Moneysaver archives.

Finally, those of you with minor children can also consider setting up in-trust accounts for your young ones. Regardless of their age, all capital gains will be taxed in their names not yours, although dividends and interest would be taxed in the name of the person funding the in-trust account in most cases, with a few exceptions. Be careful when considering this option, however, as once the money is in an in-trust account, it belongs to the child. Once (s)he reaches the age of majority in their province of residence, (s)he can ask for the money with no strings attached!

  • Own the Right Investments in the Right Account.  Not only is there money to be saved when lower income family members are the ones triggering those big capital gains, there is more tax to be avoided if those gains are held in the right account! Unfortunately, many Canadians use their Tax-Free Savings Accounts as “high” interest savings accounts that perhaps pay 3% interest if the stars align just so. Instead, consider holding your investments with the biggest upside inside your TFSA and your “high” interest savings accounts on the outside looking in. Although you will have to pay tax each year on your token interest, this can be more than worth the sacrifice if it saves you mountains of capital gains tax if your TFSA investments pan out.  Just be aware that if they don’t, you won’t be able to write off the losses against capital gains.

Secondly, realize that any gains inside your RRSP will be 100% taxed upon withdrawal.  Thus, it might make sense to have more of your tax efficient investments, like those that pay eligible dividends and produce capital gains owned in your non-registered accounts and more of the interest-payers inside your RRSP. Although you should consider keeping the same overall investment allocation, you could essentially swap capital gains payers in your RRSPs or RRIFs for interest payers in your open accounts, although this is not a universal rule.

Thirdly, as I’ve written about before, it might make sense for some of us to pull money from RRSPs or RRIFs before we need it if we’re in low tax brackets and invest it in a TFSA or, if you have no room, your open account. Although you won’t have as much money to invest and compound than if you’d left your money in your RRSP, only 50% of your future gains will now be taxed and any eligible dividends you receive will now qualify for the dividend tax credit. There are a lot of things to consider when deciding whether to pull money out of your RRSP or RRIF ahead of schedule, so I recommend getting detailed planning advise before taking this step.

  • Sometimes, the best answer is to delay, delay, delay.  In some situations, procrastination is a good thing, as is sometimes the case in the world of capital gains planning. Although most of us shudder at the thought of the size of our potential tax bills at death, it might be a better choice in some instances than paying the piper ahead of schedule even at lower rates. There are a lot of moving parts in this calculation, such as how big a gain you’re facing, how long you expect to live (and ultimately pay tax at death) and the difference between your current tax rate and what you’d likely be paying at the time you’re scheduled to meet with the grim reaper. By paying tax early, you will have less money to compound going forward. Accordingly, you’ll also want to look at the expected rate of growth on your investment, too, as the higher the rate of return, the higher the opportunity cost of selling early.

The following example assumes a retiree who thinks he has 10 years to live is considering triggering a $100,000 capital gain ($50,000 of which is taxed) on a stock he originally purchased for $20,000 which averages 7% growth per year. I’ll assume it doesn’t earn any dividends. His taxable income is $115,000 that year excluding the capital gain. Alternatively, he could wait until death to sell that investment, at which time he expects to have a taxable income from all sources of over $1,000,000, which places him well within the highest tax bracket.

Scenario

Total Income  Inc. Gain

After-tax Portfolio at death Net of Tax

Sell Now $165,000 $170,725
Sell at Death $1,000,000 + $182,260

 

Of course, when making this decision, the investor should also look beyond just tax to include important investment considerations, such as an over-concentration in one stock, his overall portfolio mix and expectations for the stock going forward. It could still be the wise move to sell off at least some of this position ahead of schedule despite tax considerations.

Conclusion

A sometimes-forgotten component of good investing is tax planning – figuring out how to minimize the portion of the capital gains the government takes off the table when you decide to cash in your chips and pocket some of your stock market winnings. Although it is important to ensure that you don’t let good tax planning lead to bad investment decisions – sometimes, any way you slice it, the right time to buy or sell means paying a bloated tax bill – it is also a mistake not to consider tax when making any investment decision. It’s a lot like failing to read the whole menu before ordering at a new restaurant – although you might end up making a good choice, you might have missed out on making a great one.