My name is Mark Goodfield. Welcome to The Blunt Bean Counter ™, a blog that shares my thoughts on income taxes, finance and the psychology of money. I am a Chartered Professional Accountant. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. My posts are blunt, opinionated and even have a twist of humour/sarcasm. You've been warned. Please note the blog posts are time sensitive and subject to changes in legislation or law.

Monday, June 13, 2022

Planning for the Creeping Tax Liability in your Corporation

In January, I wrote a post titled RRSPs and Corporations – Your Silent Creeping Tax Liability. The blog noted that whether you are currently working, near retirement or in retirement, you and/or your corporation have silent creeping tax liabilities accumulating in your Registered Retirement Savings Plan ("RRSP") and/or corporation.

I followed up in April, with a post on some potential planning to address the creeping RRSP liability. Today, I discuss some planning and considerations to reduce the creeping corporate tax liability you may be accruing.

Corporate Tax Attributes


Many corporations have built up corporate tax attributes that can be accessed prior to retirement or in retirement that can reduce the tax liability related to you and/or your corporation. I discuss these below.

Shareholder Loans

Repayment of shareholder loans owing to you and other shareholders is the most tax efficient way to remove funds from your corporation on a tax-free basis.

Capital Dividend Account

If your corporation has a capital dividend account ("CDA") balance, paying out capital dividends is a great way to remove funds on a tax-free basis and reduce your ultimate corporate tax liability (Non-resident shareholders are subject to withholding tax on capital dividends). See this blog post I wrote for all the details of a capital dividend account. 

For some unknown reason, many corporations do not pay out tax-free capital dividends from their CDA on timely basis. Since this account is a "moment in time" account, this can prove very costly if you incur capital losses. For example, if your corporation had previous capital gains and the CDA balance is say $100,000 today, but the corporation incurs capital losses of say $60,000 tomorrow, the CDA account will be reduced by $30,000 to $70,000. Thus, your corporation will have forgone $30,000 in tax-free dividends if the capital dividend had been paid before the capital losses were incurred. 

Due to the poor stock markets this year, you may be triggering capital losses as part of the corporation's investment and/or tax planning. Discuss paying out a capital dividend with your investment advisor and accountant before triggering any capital losses this year. 

Refundable Dividend Taxes On Hand

Your corporation may have balances in the following two notional accounts: Eligible Refundable Dividend Tax on Hand (ERDTOH) and Non-Eligible Refundable Dividend Tax on Hand (NERDTOH). These accounts are the successor accounts of what was formerly known as Refundable Dividend Tax On Hand (RDTOH). These accounts are essentially prior years corporate taxes paid that are refundable when the corporations pays dividends to the shareholders. The accounts act as a mechanism to ensure that you and your corporation are not double taxed. 

While your corporation needs to pay a taxable dividend to trigger refunds from these accounts (the rules are confusing, speak to your accountant), the government essentially pays your corporation a refund somewhat equivalent to the personal tax you owe on the dividend, so you net out much better than if you paid a taxable dividend with no refundable tax.

Return of Capital

If your corporation has “hard” paid-up-capital (“PUC”) for money you previously paid to purchase corporate shares from treasury, you should be able to return most of the PUC tax-free.

Income Splitting


Payment of Wages

If you have family members who work in the business and are not paid a salary or are paid a very low salary, consider paying them a “reasonable salary”. I say reasonable, as the CRA requires a salary to family members to be reasonable to be deductible.

Tax on Split Income Rules

The Tax on Split Income Rules (“TOSI”) rules are very complicated and far beyond today’s brief discussion. However, in general, TOSI will not apply on amounts paid to a business owner’s spouse or common-law partner, who are inactive in the business, so long as the business owner has reached age 65 during the year. This will be the case where the amount would have been excluded from TOSI had it been received by the business owner directly, by virtue of the fact that they would have otherwise met another exclusion. So, an inactive spouse whose shares were subject to TOSI before the business owner turned 65, will in most cases, now be able to receive dividends on their shares without the TOSI rules applying. It may also be possible to reorganize the company when the business owner turns 65 to provide shares to the inactive spouse.

Tax Reorganizations/Tax Planning


If you have a successful corporation (especially an active corporation), your accountant or tax lawyer may have one or two reorganization/tax plan ideas to consider that could possibly lower your creeping tax liability. The Federal budget in April this year contains proposals to limit a couple of these planning ideas, so you should speak to your accountant to review whether there are any planning opportunities still available that may work for you and your corporation(s).

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation. Please note the blog post is time sensitive and subject to changes in legislation or law.

Monday, May 30, 2022

The One-Two Punch of Inflation and a Weak Stock Market

We are currently facing the highest inflation rates in forty years. In April, the inflation rate was 6.8% in Canada and 8.3% in the United States. It is scary to think that these rates pale in comparison to the levels hit in the 1980’s which were as high as almost 14% in Canada and 15% in the United States.

In addition to the current inflationary pressures, the stock markets performance is also the weakest since 2008. How this double whammy affects you is based on your age, working status and income bracket. Today, I will look at two scenarios: those of you still working and those of you retired or close to retirement.

Working Individual


The Effect of Inflation on Your Cost of Living 
 
The current environment of low interest rates (although they are moving higher quickly), the war on Ukraine and supply chain issues are a rare economic mix. I certainly have no clarity of where inflation is going and I am definitely not qualified to comment. I will just say personally, I am concerned we are stuck with higher than usual inflation for a while until the supply chain is restored to “normal” or the demand side drops.

While not representative of the population in general, a sizable portion of my blog’s readership are high-net-worth (“HNW”) individuals and owners of successful private corporations. If you are part of this economic group, you are undoubtedly feeling the impact of the rise in inflation. However, in general, HNW individuals are typically not as significantly impacted by inflation, as their higher monthly income provides a buffer to absorb higher monthly costs. In addition, many HNW jobs and business goods and services are in demand currently, resulting in higher wages and/or profits. While the above is not the case in all situations, for many high-net-worth people, inflation has a minor impact on their day to day lives.

If you are not a high net worth individual, the rise in inflation can be painful. The high cost of gasoline, groceries, restaurants, clothing, travel, appliances, cars etc. has raised your monthly costs 7% or so, or maybe higher depending upon how you consume or if you are required to drive long distances for work.

So how does one offset inflation costs if their wages are not covering the increase in costs? Essentially, you have to watch your day-to-day spending and consider delaying or cutting-out some discretionary spending. This is also a suitable time to update or create a monthly budget.

You may want to consider the following tips to help you offset your rising costs and expenses:

1. Review your Mortgage Term -As we are seeing, governments are increasing interest rates to offset inflationary pressures. How high and for how long these rate hikes continue are unknown. But interest rates in most cases cause the largest potential impact to family costs in the form of higher mortgage costs. If you have a mortgage advisor or financial planner, you should discuss with them whether you should lock in rates for a longer-term mortgage to provide cost stability. If you do not have a planner, educate yourself as best as possible and speak to people you trust about what tact you may want to take in respect of your mortgage.

2. Reduce and Consolidate Consumer Debt - Consumer debt can become very costly when interest rates rise. You need to consider if you can pay down any of this debt or consolidate into a lower interest rate.

3. Contain Food Costs -This is not a micro-cost savings blog, so I am not going to get into cost saving details, but as we all know, grocery and restaurant costs have increased substantially. You may need to pay more attention to your grocery planning and cut back on your restaurant visits.

4. Drive Smartly -With the explosion in gasoline prices, it may be prudent to cut down some non-essential driving and when driving with your spouse or companion, you may want to use the most gas efficient vehicle rather than the “nicer car”.

5. Cancel Unnecessary Subscriptions and Fees -You may want to review your various subscriptions and fees; as if you are like most people, one or two are not providing much value. This would include gym costs that are often new years resolutions that fade by March.

6. Review Larger Discretionary Costs -You unfortunately may have to consider cutting back or delaying on planned discretionary expenditures such as travel, home improvements, RRSP contributions etc.

Many of your other expenses can be reduced or cut. Again, I suggest you prepare a detailed budget to help identify those expenses.

The Second Punch – The Stock Market Decline

The stock market has taken a large hit in 2022 (the TSX has done better than most), however, the reality is that unless you are near retirement, you should have several more years to make-up any current year losses whether you are a high-net worth individual or not.

While your investment statements will not be pretty, the strong market returns of the last few years have created a buffer. Historically, a long-time horizon until retirement will allow you to recover any current losses and hopefully have some significant future returns.

This may be the appropriate time to review your advisor’s three, five and ten year investment returns to their established benchmarks and review their annual fees, to ensure you returns are reasonable and you are receiving value for your fees. I will not discuss potential re-allocations of your portfolio, as those should be discussed with your investment advisor. Keep in mind short-term fixes often come back to haunt you when things turn around. So, keeping to your plan with a couple tweaks, often is the best course of action, but speak with your advisor who is aware of your personal situation.

Given many people have reported significant capital gains the last few years, you may want to discuss with your advisor (or consider yourself if you are a DIY investor) realizing capital losses on speculative holdings or other stocks that have suffered losses and do not fit your current investment strategy. Any losses realized in 2022 can be carried back against capital gains in 2019, 2020 and 2021.

The Effect of Inflation and Poor Markets on Retirees or Those People Close to Retirement


I have written a couple times on how much money you need to retire. In 2014, I wrote an extensive six-part series titled How Much Money do I Need to Retire? Heck if I Know or Anyone Else Does! (the links to this series are under Retirement on the far-right hand side of the blog).

I updated this series between January and March 2021, including a discussion on the factors that can impact both the funding of your retirement nest egg and your withdrawal rate in retirement. The randomness and unpredictability of these factors can derail even the most detailed retirement plans.

Two of the most impactful factors on retirement planning are inflation and sequence of returns. As both these factors have reared their ugly heads at the same time, this one-two combo can really throw a wrench into the accumulation of your future nest egg if you are close to retirement. Furthermore, they can impact the retirement savings and withdrawal rates of those already retired.

Inflation Can Dramatically Impact Your Retirement


Many financial plans I have seen over the last few years have been using a 2% inflation rate. However, a 2% inflation rate is at least in the short-term 4-5% too low. If inflation holds, many retirees will need to reduce costs and may have to make larger than anticipated withdrawals from their retirement funds.

The following excerpt taken from Investopedia, quantifies an example of the damage inflation can do to an American receiving social security. “In terms of the actual amount of money that inflation can cost retirees, the numbers are startling. LIMRA Secure Retirement Institute constructed a model demonstrating the effect inflation could have on the average Social Security benefit over a period of 20 years. According to its research, a 1% inflation rate could swallow up $34,406 of retirees’ benefits. If the inflation rate were to increase to 3%, the shortfall would total more than $117,000”.

Hopefully, the spike in the inflation rate is a short-term blip and government policies cause the rate of inflation to settle down to more recent levels. If not, there is no magical panacea. Retirees will be forced to review spending and possibly cut-back on items that are not necessary or substitute cheaper alternatives.

Stock Market Declines and Sequence of Returns


As discussed above, for non-retirees, a drop in the market historically provides short-term pain only, as the investors portfolio has a long-time frame to recover and grow. However, for retirees (and possibly near-retirees) that is not the case and they are subject to what is known as Sequence-of-Returns Risk. For purposes of retirement planning, this refers to the random order in which investment returns occur and the impact of those random returns on people who are in retirement. In plain English, it relates to whether you are the unlucky person that retires into a bear(ish) market in 2022 or the lucky person who retired into the bull market five years ago. This is important because if your returns are poor early on, your retirement nest egg will not last as long as someone who had good returns early in retirement.

For full transparency, most of the discussion below comes from prior blogs I have written on the subject of sequence of returns.

The sequence of returns phenomenon is illustrated very clearly on page 7 of this report by Moshe Milevsky and by W. Van Harlow of Fidelity Research Institute. In this example, two portfolios have the same return over 21 years but in inverse order. The portfolio with the positive returns initially ends up worth $447,225 in year 13, while the portfolio with the negative returns was depleted in year 13.

If you read the article, you will note the authors also discuss the affect of inflation.

Can you solve for the sequence of returns?


Michael Kitces and Wade Pfau two of the most renowned retirement specialists both seem to agree that people can reduce the impact of sequence of returns near to, or early in retirement, by using something called a rising equity glidepath in retirement.

This strategy has you starting retirement with a lower equity component in your portfolio—30%, for example—and increasing it throughout retirement to, say 65% or 70%. The advice is counterintuitive, since consensus advice has always been to reduce equity as we age. But as Mr. Kitces and Mr. Pfau point out here and here (at the 6:12 mark), the glidepath actually reduces losses in your nest egg when you most need it (at the beginning of your retirement) and allows for recovery in later years as your equity increases.

I am not qualified to condone or dismiss the equity glidepath. I am just pointing out some alternative thinking by two retirement specialists.

Retirement planning is difficult at the best of times, it can get downright ugly when inflation and poor markets occur simultaneously. Let’s hope, these are just short-term blips, but they are a wake-up call to the random risks we always have in saving for retirement and more acutely, for those already in retirement.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation. Please note the blog post is time sensitive and subject to changes in legislation or law.

Monday, May 9, 2022

Talking with Your Parents about Planning, Documenting and Meeting on Their Estate

Let’s be honest, talking with your parents about estate matters can be a very uncomfortable discussion. In my experience, this process sadly starts in many cases, when a parent becomes sick or has a terminal illness. This is very unfortunate and not the best time to start estate planning.

This parental discussion has a fair bit to unpack, as there are three component pieces. The planning component, which some parents do not undertake. The documenting element, which is often not done or incomplete. Finally, there is the family meeting which occurs infrequently. I will discuss each of these factors separately below.

How to Start the Planning Conversation


Many parents (I will use the plural parents throughout this blog post, but the discussion will apply equally to the "singular" parent) plan their estate without prompting. Others think it will magically plan itself or they just procrastinate as they do not want to contemplate their ultimate demise. In many cases, parents do not think it is their children's business to even discuss their estate planning. 
 
So how does a child/children raise the estate planning issue without causing their parents to think they are greedy, nosy or rubbing their hands in anticipation of an inheritance? Here are some suggestions I have gleamed from various articles and from my personal experience.

1. This may seem crude, but use another person’s poor planning as a way to start the discussion. Your parents may provide the opening when discussing “the mess their friend Mrs. Smith left her estate in”. Alternatively, you may bring up a bad situation one of your friend’s parents had or use an article in a newspaper or publication that discusses a messy situation caused by poor estate planning.

2. Set-up a scheduled time to meet with your parents and siblings to discuss their wishes for the estate, so that you and your siblings can support their desires. This meeting will hopefully make your parents feel that they are not being ambushed and feel there is a family consensus. Let your parents know specific dollar amounts do not have to be disclosed, which can sometimes be an impediment.

3. Directly ask if your parents are working with a planner. This may lead to an opening and request for a referral, or they may get their back-up. If the latter, don’t pressure them. It is very important to be patient and empathetic. Try again at a later time, maybe when one of the opportunities in #1 present themselves.

4. Flip the situation around and say you are working on your own planning and your advisor has asked is there anything your parents can share with you so that it can be built into your planning. Alternatively, where your parents may not be financially secure, the siblings can say they want to ensure they can help, but need to be able to plan for the assistance (or if the assistance will not be available, they want to help you minimize these financial concerns by planning in advance for such things as a reverse mortgage).

There is no magic bullet to get the discussion started. Maybe one of the above strategies will work for your family dynamics. In any case, ensuring your parents have started their estate planning is beneficial for them and you and your siblings, especially if the children are executors of their estate.

I suggest proper planning includes most of the following:
 
  • preparation of wills (should not be finalized until the family meeting discussed below)
  • personal care and financial powers of attorney
  • personal and possibly corporate tax planning
  • estate and probate planning
  • introductions to your parent’s key financial, insurance, tax etc. advisors

Documenting Assets and Wishes


Having your parents complete their estate planning is a huge first step. However, if they do not document their assets, wishes, digital passwords etc. they will leave you and or your siblings and the executors a huge mess and a morose game of hide and seek at a time of mourning and distress. I therefore suggest strongly you get your parents to complete an estate organizer or listing of their assets and location. 

The listing will include at minimum the following:
 
  • location of important documents like will(s) and power of attorneys
  • where the safety deposit key and jewelry can be found
  • details of all bank, investment and real estate information
  • location of insurance policies and details of the policies
  • a summary listing of financial advisors' names and contact information
  • details of digital information from cryptocurrency to Facebook passwords
  • details of any prepaid funeral arrangements and/or wishes in regard to their burial 
There are several estate organizers on the internet or if you have a financial advisor, they will likely have one.

In 2012, I wrote a blog post A Tale of a Fathers Selfless Act of Love. This should act as your guide to the ultimate in planning and documentation. The link to the actual article noted in the blog is here.

Setup a Family Meeting


If your parents have planned and documented, then the final and penultimate task would be a family meeting (if not done as part of the planning). 
 
Some people suggest a family meeting have a formal agenda, others a less formal tone. In any event, the meeting’s objective is to ensure your parents' choices and decisions are heard in their voice by the family, so there is never a dispute to what you really wanted. 
 
Your parents can accomplish the following by having a family meeting:

1. Share their spiritual and personal values and hopes for the future of their family (see this blog post I wrote on ethical wills).

2. Discuss their healthcare wishes for all to hear. This would be the time to clarify who the power of attorney is for healthcare and their views on the right to resuscitation and even assisted death. For anyone who watches the TV show This is Us, in a recent episode Rebecca (the mother who has early onset Alzheimer’s) calls a family meeting to discuss who will make her health care decisions and how she expects her family to live and carry on once her Alzheimer’s progresses. I thought this was a great example set by the show.

3. Share their draft wills to determine if their thoughts on asset distribution are aligned with what their children want. Some parents will be open about the will, some will disclose certain information without actual financial details, and some will not want to discuss the will. If your parents have an open discussion about their planned distribution of assets, they may be surprised their perception is not reality. For example, they may have thought the children would want to share the cottage, but only one child even has interest in the cottage and they don’t have the financial means for the upkeep. This discussion can result in changes to the draft will.

4. Discuss any possible perceived or actual inequalities in their will(s) and their rationale. The rationale does not have to be accepted by all, but everyone can now at least understand these were not arbitrary or punitive decisions and could save significant family dis-harmony after their passing.

5. Identify who will be named executors. Most children have no idea of the responsibilities and the burden of being named an executor of the will. Your parents can explain the duties of the executor and determine if the children or child they wish to be an executor(s) are/is willing to undertake the position.

6. Indicate their burial plans and desires.

These are some of the key issues a meeting can address, but the agenda is only limited by what your parents wish to discuss. In the end, the meeting provides a forum for your parents to discuss their wishes for healthcare and asset distributions in their own words and voices; which leaves no room for speculation upon their passing.
 
Talking to your parents about planning, documenting and meeting on their estate is a tall order. However, whatever you can accomplish from the above list will be beneficial for the estate, your parents and siblings and the executors. 

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation. Please note the blog post is time sensitive and subject to changes in legislation or law.

Monday, April 25, 2022

Planning for the Creeping Tax Liability in your RRSP

I am back. I needed a hiatus to deal with various administrative issues relating to the blog, including having the blog suddenly disappear into the ether for a couple days. I believe everything is now sorted out and I am ready to resume blogging.

In January, I wrote a post titled RRSPs and Corporations – Your Silent Creeping Tax Liability. The blog noted that whether you are currently working, near retirement or in retirement, you  have silent creeping tax liabilities accumulating in your Registered Retirement Savings Plan ("RRSP") and/or corporation.

I received very positive feedback on this post and several readers asked me to follow up with some potential planning to mitigate these “creeping” taxes. Today, I will do just that in relation to planning for the tax liability of RRSPs (also some planning not directly related to your RRSP tax liability). Later next month I will follow-up with some planning in respect of corporations “creeping” tax liability. While most of the potential planning considerations relate to those close to or in retirement, there are some considerations for you “young-ins”.

RRSPs


Spousal RRSPs

As a quick refresher, spousal RRSPs are contributions typically made by the higher income spouse (contributor) based on their RRSP contribution room (not their spouses), on behalf of their lower income spouse (known as the annuitant). A spousal RRSP made by the higher income spouse will generate the maximum tax refund to the family unit.

Conceptually, by utilizing a spousal RRSP, retirement funds effectively move from a spouse that will be highly taxed in retirement to a spouse that will be taxed at a lower rate in retirement.

It should be noted,that if the annuitant spouse withdraws funds from their spousal RRSP within at least 3 years of a contribution, there is an attribution rule that will require the withdrawal to be added to the contributing spouse’s income in the year of the withdrawal (i.e. – if you made a spousal RRSP contribution in January 2020, your spouse must wait until 2023 before they make a RRSP withdrawal, or else the withdrawal is taxed in your hands). This rule seems to confuse many people; the CRA provides a good example of how this rule works here.

With the introduction of pension income-splitting in 2007, which allows you to transfer up to 50% of your pension income (including RPP, RRSP, RRIF and annuity income amongst other income types) to your spouse or common-law partner, by completing form T1032, many people assume spousal RRSPs have gone the way of the Dodo bird. However, this is not entirely true.

For example, in pre-retirement years, it may be prudent for a low-income spouse to withdraw funds from their spousal RRSP (as long as they do not breach the 3-year rule noted above) if they expect their marginal tax rate in retirement to be higher. This provides maximum planning flexibility. In determining whether the marginal income tax rate savings are worthwhile, you will need to consider the time value of money and inflation versus the actual tax savings.

A further benefit of a spousal RRSP is that a lower income spouse will receive 100% of the funds from their spousal RRSP/RRIF and be eligible to split their spouses RRSP/RRIF. If you do not utilize a spousal RRSP, only 50% of the higher income spouse’s RRSP/RRIF could be split. The spousal RRSP thus provides the maximum income splitting flexibility in retirement.

Your RRSP

Similar to a spousal RRSP, it may be beneficial to withdraw funds from your own RRSP in a low income year (say a poor commission year). Or more likely, in the years between retirement and when you have to convert your RRSP to a RRIF (by December 31st of the year you turn 71) if your income is lower and you expect a higher marginal tax rate in retirement.

Prescribed Rate Loan


Where one spouse has significant non-registered assets and pays tax at a high or the highest marginal tax rate and the other spouse has a low marginal tax rate with minimal assets or taxable income, consideration should be given to a prescribed rate loan. See this blog post on the topic. The current prescribed rate is 1% until June 30th, but the rate will very likely increase in the third quarter.

While this tax planning technically has nothing to do with a RRSP, it may reduce the taxable income of the higher spouse such that some of their RRSP/RRIF income is taxed at a lower rate.

Pension Credit


If you are between the ages of 65 and 71 with no pension income, you may wish to consider converting a portion of your RRSP into a RRIF and drawing $2,000 per year from the RRIF. This will allow you to claim the $2,000 pension income tax credit. If you do this, you may want to just transfer $14,000 at the outset and take $2,000 per year from age 65-71.

Old Age Security


To the extent you may draw your RRSP down in your early 60’s or take the minimum RRIF amount in your early 70’s, always ensure your planning considers the OAS clawback. The clawback for 2021 starts at $79,845 of net income ($81,761 for 2022). Once the $79,845 limit is exceeded, you will have to repay 15% of the excess over this amount, to a maximum of the total amount of OAS received which is reached at $129,581 of net income.

Tax Efficient Investing


I wrote on this topic in 2017, here are the links to my two blog posts, Part One and Part Two. These posts discuss which type of account (non-registered, registered, TFSA) is the most tax advantageous to hold investments and maximize returns. Investing efficiently may in some cases reduce your ultimate RRSP and thus your “creeping” tax liability, because you increase other more tax efficient sources of income than your RRSP.

Withdrawal Ordering Methodology


While the methodology of your retirement withdrawals will not directly affect your creeping RRSP tax liability, it is part and parcel of minimizing your overall tax burden in retirement.

Fixed Amounts  

You, your financial planner, or accountant can generally project what income sources will be included in your income each year in retirement. Those will include CPP, OAS and the minimum RRIF withdrawal amounts and non-registered account interest and dividends and possibly rental income etc. There may be other amounts, but these are the standard income sources. From these amounts you can determine an initial projected pension splitting amount. Once you do this, you will know how much income you will have to cover your yearly cash withdrawal requirements and what your marginal tax rate will be approximately. You then need to plan the most tax effective way to cover any retirement cash shortfalls with other accounts such as non-registered accounts, excess RRIF withdrawals and TFSAs in the most tax effective manner.

Ordering

So, what is the best ordering methodology? Depends on whom you ask.

Some people suggest that the best way to make withdrawals in pre-retirement and retirement is to take money from the least flexible and least tax efficient source first. This methodology would typically result in you first drawing from your RRSP/RRIF, then your non-registered account and then your TFSA. A somewhat similar suggestion is that you take money from accounts with the highest tax liability at the lowest possible marginal tax rate. Others suggest you keep your RRSP intact and defer the tax as long as possible. Then there are other financial experts who suggest you keep your TFSA intact to provide the utmost in tax-free withdrawal flexibility. Finally, in a recent Globe and Mail article by Frederick Vettese (it is behind a firewall for Globe subscribers only), he suggested it may be best to drawdown from multiple sources rather than trying to keep your RRSP intact (to defer tax) as long as possible.

What these various opinions prove, is that there is not a one size fits all methodology and each person needs to review their circumstances and run various scenarios (with your financial planner or accountant if you have one) to find what is the correct methodology for you.

Looking out at the Grim Reaper – Taxes on Death


The above planning may need to be tweaked when you consider the taxes due on your death. Typically, when the last spouse dies and the balance of their RRIF and the deemed gains on their investments are taxed, it leaves their estate in the highest marginal rate or at a much higher rate than prior to their passing. 

Tim Cestnick in another Globe and Mail article (again behind a firewall) suggests it may be more advantageous to bring in more RRIF income (and contribute the excess RRIF income less taxes to your TFSA) over many years at a lower rate, than to defer the tax on your RRIF to your death at the highest or higher marginal rate. Again, you need to review your own particular circumstances (the time value of money will require the tax savings to be large enough to make this worthwhile), but this is something that should be considered.

Much of the planning I discuss above unfortunately requires significant number crunching to achieve the optimal results. This planning can be complicated and requires a huge time commitment. I suggest engaging a financial planner or your accountant to prepare a plan for your retirement, it will be typically money well spent.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation. Please note the blog post is time sensitive and subject to changes in legislation or law.

Monday, February 28, 2022

Taking a Hiatus

Due to several technical and administrative issues, I am placing the blog on hiatus.

I truly appreciate the loyalty of my readers and hope to resolve and clarify these issues over the next month or two, so that my hiatus is short-term and not permanent. I appreciate your patience.

Monday, January 31, 2022

Estate Planning Missteps -Observations from a Grizzled Accountant

On Friday, Canadian Family Offices.com published the first of a two part-series I wrote titled, "Three big estate-planning missteps, from a long-time accountant". Canadian Family Offices is a new resource for high-net-worth people and the family offices and advisors who manage their finances.

While the target audience of this series includes families that have their own family or multi-family office and high-net-worth individuals, the discussion is applicable, at least in part, to anyone whether your estate is $100,000 or $100,000,000.

The article can be found here

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation. Please note the blog post is time sensitive and subject to changes in legislation or law.

Monday, January 24, 2022

2021 Financial Clean-up and 2022 Tune-up

In prior years, my last post of the year was typically about undertaking a "financial clean-up" as a vital component to maintain your financial health. This year, I am combining a 2021 clean-up with a 2022 financial tune-up.

For each financial topic or issue below, I will discuss what you should do to clean-up for 2021 and get ready for 2022 so your finances and taxes will be in order. 
 
Yearly Spending Summary  
 
2021 Clean-up

I use Quicken to reconcile my bank and track my spending. A couple weeks ago I printed out a summary of my 2021 spending by category for the year. This exercise usually provides some eye opening and sometimes depressing data. However, the information is invaluable. It provides the basis for yearly budgeting, income tax information (see below), and among other uses, it provides a starting point for determining your cash requirements in retirement. As someone who retired at the end of 2021, I reviewed this data to determine what expenses could be reduced or cut-out in retirement and what my ongoing costs would approximate. Unfortunately, it appears many of my costs will likely remain constant in my early retirement years other than some disability insurance I decided not to renew.
 
2022 Tune-up
 
During my career, I often discussed financial, retirement and estate planning with my clients. One of the questions I typically asked for these planning exercises (especially for those whose spending was excessive), was what was the breakdown of their monthly costs? I would say in at least 60% of the cases, people had little idea of their actual spending and when they undertook the exercise they were surprised at the quantum of their actual spending. If you are one of those people, I strongly suggest you buy a software program that lets you download your bank data (so it limits your time tracking your spending) or create a detailed excel spreadsheet with expense categories down the vertical axis and the month across the horizontal axis. Then fill in the spreadsheet at each month end. 
 
By undertaking this expense tracking for 2022, you will be able to budget, plan short-term and project your retirement spending if you are nearing retirement.   

Portfolio Review


2021 Clean-up
 
January is a great time to review your investment portfolio and annual rate of return (also your 3, 5 and 10 year returns if applicable). The million-dollar question is how your portfolio and/or advisor/investment manager did in comparison to your investment policy and appropriate benchmarks such as the S&P 500, TSX Composite, an international index and a bond index. This exercise is not necessarily easy (although many advisors and almost all investment managers provide benchmarks, they measure their returns against). The Internet has many model portfolio's you can use to create your own benchmark if you are a do-it-yourself investor.

While 2021 was another strong year in the markets, I would not skip reviewing your investment portfolio because your returns were strong. I say this for the following two reasons:

1. Your returns should still be measured against the appropriate benchmark based on your risk tolerance and intended asset allocation for 2021 and on a multi-year basis. Even if you had strong investment returns in 2021, it is still quite possible you may have under-performed your benchmark last year or over a three, five or ten year comparative basis. This information is important when reviewing your advisor's performance.

2. We are usually concerned with ensuring our returns are not worse than a benchmark. However, what if your 2021 returns were way higher than the benchmark? This could mean that your manager is over-reaching their mandate. I would ask them to explain why they so outperformed. Make sure that the out performance was within their mandate and that they did not take on more risk then within your investment policy. If they did, that is an issue in itself and could also lead to outsized losses in 2022.
 
2022 Tune-up
 
In combination with your 2021 clean-up, you should consider if any circumstances have changed in your life such that you need to review your asset allocation and/or risk tolerance with your advisor.
 
In 2021 the market seemed to be constantly rotating amongst different sectors and thus, your asset allocation may be out of sync in say resources or technology. This should be reviewed with your advisor or reviewed by yourself if you are a DYI investor. 
 
While your risk tolerance should in theory typically remain relatively stable year to year, if you lost your job due to COVID or are retiring in the near future then maybe your risk tolerance may need to be adjusted downwards which could affect your asset allocation. Alternatively, if you work in one of the areas of the economy that boomed during COVID and have received a large pay raise and/or large bonus you may now have a bit more risk tolerance. In any event, this and your asset allocation should be revisited with your advisor or considered if you are a DIY investor.

You may also want to review the additional services your advisor has available and ensure you are taking advantage of these services. Many are now providing financial and wealth planning services.
 

Income Tax Items


2021 Clean-up
 
As noted above, I use my yearly Quicken report for tax purposes. I print out the details of donations and medical receipts (acts as checklist of the receipts I should have or will receive) and summaries of expenses that may be deductible for tax purposes, such as auto expenses. If you use your home office for business or employment purposes (remember, you need a T2200 from your employer), you should print out a summary of your home-related expenses.

Where you claim auto expenses (even if significantly less due to COVID restricted driving) you should get in the habit of checking your odometer reading on the first day of January each year. This allows you to quantify how many kilometers you drive in any given year, which is often helpful in determining the percentage of employment or business use of your car (since, if you are like most people, you probably do not keep the detailed daily mileage log the CRA requires). Keep in mind if audited, you will need to go back and complete a log; using an estimated percentage of business use based on your odometer reading will likely not cut-it with a CRA auditor.
 
As I have a health insurance plan, in January I start to assemble the receipts for my final insurance claim for the 2021 calendar year. I find if I don’t deal with this early in the year, I tend to get busy and forget about it.

To facilitate the claim, I ask certain health providers to issue yearly payment summaries. This ensures I have not missed any receipts and assists in claiming my medical expenses on my income tax return. You can do this for among others: physiotherapists, massage therapists, chiropractors, and orthodontists—even some drug stores provide yearly prescription summaries. This also condenses a file of 50 receipts into four or five summary receipts. 
 
2022 Tune-up
 
January or February is the perfect time to sit back and consider your income tax situation. 
 
On a personal basis, if you are married or common-law, review your 2021 income to see if there is a significant discrepancy in taxable income and marginal tax rates between you and your spouse/partner. If yes and the higher earning spouse has significant savings, consider a prescribed loan (the rate is still 1% for the first quarter of 2022, but many feel it will be raised in the second quarter of 2022).
 
If one spouse has lost their job and is helping the other while looking for another job, review whether a salary can be paid. A reasonable salary based on actual work undertaken will typically be deductible where the working spouse is self-employed or has a corporation. However, if the working spouse is an employee, this can be problematic unless an assistant is required by their employer and their T2200 reflects such. Claiming a spouse's salary when you are an employee is far more complex than that of a self-employed person. If you are considering it, you should review this with your accountant.
 
Another thing to consider where a spouse has lost their job or has reduced earnings due to COVID is whether they should draw down on their RRSP at a low marginal tax rate in 2022. This may make sense where they expect to be back at a much higher marginal rate in the near future (2023 or later).
 
Where your spouse has a spousal RRSP, you have to navigate certain rules (if a spousal contribution was made in the last two years, the withdrawal will be taxed in the higher income spouse's income so it is likely a non-starter). Also keep in mind the statutory tax withheld on the RRSP withdrawal may be lower than the actual tax your spouse may owe on their tax return.   

If you own a corporation, you should touch base with your accountant to discuss if your corporation has a tax-free capital dividend account available, if the company has refundable tax on hand, is your company going to be potentially subject to the small business claw-back etc. or if there are any tax reorganizations or planning that can be undertaken to minimize current or future corporate and personal taxes.

Year-end financial clean-ups are not much fun and are somewhat time consuming. But they ensure you get all the money owing back to you from your insurer and that you pay the least amount of taxes to the CRA. In addition, a critical review of your portfolio or investment advisor could be the most important thing you do financially in 2022.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation. Please note the blog post is time sensitive and subject to changes in legislation or law.

Monday, January 10, 2022

RRSPs and Corporations - Your Silent Creeping Tax Liability

Happy New Year and I hope 2022 brings you and your family good health and a quick return to something resembling normality. This is my first blog post since December 31st when I officially retired from my public accounting firm. The term “retired” is used loosely. I look at it as a bit of a sabbatical after almost 40 years in public accounting. I will be looking for a new opportunity outside the public accounting realm in accordance with the terms of my retirement agreement, possibly in the family office, multi-family office or investment manager space; I am too young (at least in my own mind) to full stop retire.

Back to the topic at hand. In late December I was updating a retirement spreadsheet I have for changes in my current circumstances and future income tax minimization. 
 
In reviewing the income tax section of the spreadsheet, the quantum of my future or "deferred" tax liability struck me once again. Whether you are currently working, near retirement or in retirement, you have silent creeping tax liabilities accumulating in your Registered Retirement Savings Plan ("RRSP") and/or corporation [for me, in my professional corporation ("PC")]. In my experience, we tend to "forget" or minimize this tax liability, so I though I would discuss it today.

RRSPs are Great while you are Working, not as Great when you Retire


I think most readers will know this, but to quickly recap, contributions to a RRSP result in a tax deduction in the year made (or subsequent year if you don’t fully claim the contribution) and your RRSP grows tax-free until you convert the RRSP by the end of the year you turn 71. For most people, a RRSP works well as their contributions are made at a time their marginal tax rate is higher than they expect in retirement, so they have an ultimate tax savings. Despite the tax effectiveness of your RRSP, the value is somewhat of an illusion, as you are also accumulating a large, deferred tax liability, as the entire value of your RRSP will be taxable in your retirement.

There are a couple options for a RRSP when your turn 71, including a lump sum withdrawal, the purchase of an annuity or the option most people select, converting their RRSP into a Registered Retirement Income Fund (“RRIF”).

Once you convert your RRSP into a RRIF any future withdrawals are subject to income tax (you are now paying tax on your accumulated lifetime contributions and earnings that were tax-free in your RRSP) a sometimes nasty surprise in quantum for some people. You must start drawing your annual minimum RRIF payment by December 31 of the year following the year you establish your RRIF. Since you will typically still be 71 the year following the establishment of your RRIF, the minimum withdrawal will be 5.28% (you may be able to use your spouses age to lower the withdrawal rate) and will rise each year to around 10.2% by 88 and the withdrawal rates will continue to rise dramatically after age 88.

Each year this minimum withdrawal will be taxable on top of any old age security, CPP, pension income and any other investment or other type of income you earn. The marginal tax rate on these RRIF withdrawals can be substantial depending upon your financial circumstances. Luckily for many, you can elect to split your RRIF pension income with your spouse (Form T1032 -Joint Election to Split Pension Income) and thus, you can often lower your effective family tax rate through this election. However, even with the election, the deferred tax hit on your RRIF withdrawals can still be substantial.

Corporations – You have only Paid Part of the Tax


As noted above, I was struck by the quantum of my tax liability for not only my RRSP, but the investments retained in my PC. For purposes of this discussion, consider a PC to be the same as any corporation you may have. Most active companies will have paid corporate tax historically anywhere from say 12% to 26%, depending upon the corporate province of residence. You have thus deferred anywhere from say 20%-40% in tax by keeping the earnings in your corporation (again depending upon the province). Assuming you need to take money from your corporation in retirement, you will then have to deal with this deferred tax liability when you take the money (typically as a dividend).

Similar to a RRIF, you will owe income tax on this deferred tax (the deferred tax is less than your RRIF, since the corporation paid some tax, whereas you paid no tax on your RRSP). If you have been earning investment income in your corporation, you may have some tax attributes like refundable tax to reduce your tax liability, but the original money earned and deferred by the original active company is still subject to a tax hit even though it is now co-mingled with investment income earned on these deferred earnings. Without getting technical, you still have a large, deferred tax liability as you withdraw funds from your corporation.

Income Taxes and Your Retirement Withdrawal Rate


I have written a couple times on how much money you need to retire. In 2014, I wrote an extensive six-part series titled How Much Money do I Need to Retire? Heck if I Know or Anyone Else Does! (The links to this series are under Retirement on the far-right hand side of the blog). 
 
I updated this series between January and March 2021. Most of my various retirement articles and series revolve around the 4% Withdrawal Rule, which is one of the most commonly accepted retirement rules of thumb. Simply put, the rule says that if you have an equally balanced portfolio of stocks and bonds, you should be able to withdraw 4% of your retirement savings each year, adjusted for inflation, and those savings will last for 30-35 years.

In Part 1 of the original 2014 series, I had a section on some of the criticisms of the 4% rule. The first and the most impactful limitation being the model does not account for income taxes on non-registered accounts and registered accounts Note: many of the studies I discuss in both 2014 and again in 2021, still support that the 4% withdrawal works despite any income tax limitations, but I thought it important to reflect this limitation of the rule.
 
I plan to write a future blog post on possible tax planning that you can consider to minimize the tax hit from your RRSP/RRIF and corporation in retirement.
 
As discussed above, where you have a RRSP and/or corporation, income taxes are a creeping liability. Thus, it is important to ensure that when you are younger, you are cognizant of these taxes and as you get closer to retirement, you ensure you have a financial plan that accounts for these deferred/creeping taxes.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation. Please note the blog post is time sensitive and subject to changes in legislation or law.