The Now Newspaper “Best of Your Neighborhood Award 2013″: http://issuu.com/surrey-now/docs/srysthu20140130
“Your retirement should be enjoyed because you’ve earned it”
When I was a kid, I remember being asked many times to clean my room. I never did a very good job of it. On one occasion, I recall my father sitting down with me and saying: “Tim, I want to educate you on how to do this properly.” It was a polite way of saying: “If you do it like that again, you’re in big trouble next time.”
I can’t help but think of the Canada Revenue Agency and a relatively new program the department has introduced. They call it an “education program” where the taxman sends a letter to certain taxpayers whom the department thinks may be a little aggressive in their tax filings. An excerpt from the letter reads: “The Canada Revenue Agency (CRA) has sent you this letter to give you information about certain claims you made on one or more of your recent income tax and benefit returns. This letter also gives you the opportunity to ask for an adjustment if you find that you incorrectly claimed some items on past tax returns.”
Much like the message my father gave me, the real message being sent by CRA could be read as: “We think you might be doing something wrong, so think about coming clean now – before we decide to audit you.” So, what does this mean for you this year when filing your tax return?
Those at risk
The people most at risk in this program are those who have been reporting recurring losses from their self-employment, rental or professional activities. If you report losses from these pursuits, you’ll save tax because those losses can be applied against other types of income you might have.
The truth is, carrying on legitimate business, professional or rental activities can result in losses – particularly in the early years while you’re still building up your revenue, and perhaps incurring higher costs than you will eventually. But, it’s important to understand what the courts and the CRA have said about these losses so that you can be prepared to have an intelligent discussion with the taxman if you’re one of the approximately 33,000 taxpayers who will receive an “education letter” this year, perhaps followed by an audit or at least some questions.
If you do receive an “education letter,” don’t panic. The courts have spelled out the principles that should be followed by the CRA, and taxpayers, when determining whether losses should be allowed. Understanding these principles and aligning your activities to them can put you in a good position to deal with the taxman if he comes knocking.
A few years ago, the Supreme Court of Canada set out these principles in the case of Stewart v. Canada (2002 SCC 46). The court recognized that our tax law will allow deductions – and losses – where a source of business or property income exists. The court established that if an activity is clearly commercial in nature, with no personal element to it, then a source of income exists. It’s not a requirement that the activity produce a profit every year.
In fact, if you happen to be an incompetent business person and continually lose money every year in a legitimate commercial activity, it’s not the role of the CRA to second-guess your business judgment and then disallow your deductions or losses. That is, when your activities are commercial in nature, CRA cannot disallow losses on the basis that there is no reasonable expectation of profit.
But what about a situation where the activity or endeavour can be classified as personal in nature, or having a personal element to it? In this case, the court established that it must be determined whether the activity is being carried on in a sufficiently commercial manner to constitute a source of income. If so, then deductions and losses may be allowed.
You may face a challenge, however, if the activity has a personal element to it and is not carried on in a sufficiently commercial manner. In this case, a source of income is not considered to exist, and losses won’t generally be tolerated by the taxman or the courts.
In light of the “education program” CRA is undertaking, you’d be wise to build the case today that your business, professional or rental activities are truly commercial in nature. The taxman will look at things such as: the profit and loss experience in past years, your training in the activity being carried on, your intentions when carrying on the activity, and the capability of the endeavour to show a profit.
Article: Globe and Mail
Perhaps you’ve heard of Jon Jacobs, the resort entrepreneur. He hasn’t made money with resorts in the real world, but in the online make-believe world of Planet Calypso. The gamer sold his make-believe real estate for $635,000 in real U.S. dollars, achieving a 35-per-cent annual return. Apparently, a study by the firm In-Stat suggests that online videogame players will invest billions in make-believe property and goods each year.
Those are crazy returns from a crazy investment. If you happen to be an investor, you’re no doubt looking for ways to increase your returns. Look no further than your own tax return. If you can achieve tax savings related to your investments, this will increase your after-tax returns. So, consider the following ideas when filing your tax return this year.
Claim interest costs. If you’ve borrowed money for the purpose of earning “income from property” (call this the “purpose test”) then you’ll generally be able to deduct your interest costs. Income from property includes rents, royalties, interest or dividends.
What about capital gains? The federal government generally takes the view that an investment without a stated interest or dividend rate – such as most common shares or mutual funds – will typically give rise to interest deductibility on the basis that there is an expectation of dividends or interest in the future. If you invest in something that has absolutely no opportunity to provide income – just capital growth – you may run into a problem deducting interest costs if you’ve borrowed to make the investment. When it comes to deducting interest, don’t forget to check your brokerage statements for any eligible interest you might have paid.
Allocate fees to non-registered accounts. If you’re paying fees to your investment adviser, consider the allocation of those fees between your registered plan accounts (RRSP, RRIF, TFSA) and your non-registered accounts. Fees related to your registered accounts are not deductible, but fees on your non-registered accounts generally are. If your adviser spends much more time and effort to manage your non-registered accounts, he may be able to allocate a greater portion of his fee to those accounts.
Report your spouse’s dividends on your return. If your spouse has received dividends from Canadian securities, but has little income, he may not benefit much, if at all, from the dividend tax credit that he’s entitled to claim. In this case, you can report the dividends on your tax return. You’ll be entitled to a higher spousal tax credit because your lower-income spouse will now have less income to report (in fact, you can take advantage of this idea only where it’s going to result in a higher spousal credit for you). In the end, you’ll pay less tax as a couple.
Claim a business investment loss. If you own shares in, or have lent money to, a small business corporation, and the business has gone sour, you may be able to claim an “allowable business investment loss.” This is calculated as 50 per cent of the money lost by you, and can generally be deducted against any type of income – not just capital gains – although some restrictions may apply where you’ve claimed the capital gains exemption in the past.
Consider capital versus income treatment. In some cases you may have the option between reporting your investment profits as business income, or capital gains. First, if you can argue either way, you’ll generally prefer capital gains treatment if you have profits because just 50 per cent of capital gains are taxable. If you have losses, on the other hand, business losses can be applied against any type of income while capital losses must be applied against capital gains.
The problem? You can’t simply report your profits as capital gains and your losses as business losses. The taxman expects consistency. Generally, if you can answer “yes” to many of the following questions, the taxman may consider income rather than capital treatment to be appropriate.
1. Did you complete many transactions?
2. Did you intend to buy and flip the securities for a profit?
3. Did you hold the securities for a short time?
4. Were the securities of the quality you would not hold for long?
5. Did you devote significant time to stock market transactions?
6. Did you borrow much to make the investments?
7. Do you have special knowledge or expertise in the securities market?
Article: Globe and Mail
It can be tough being self-employed. Just ask my good friend, Claudio.
“Tim, I’ve learned that there are some drawbacks to self-employment,” he explained. “First, when you work for yourself you can’t get away with anything. I tried stealing office supplies once, then realized that they were already mine. Then I caught myself sleeping on the job, but couldn’t fire myself,” he said.
“How’s business been?” I asked him. “Well, it can be tough to make ends meet when you’re an entrepreneur,” he said. “But when you’re a broke entrepreneur,” he continued, “your mother always knows you’re broke because you’re likely borrowing $20 now and again from her, and your friends know because you conveniently forget your wallet every time you go out.”
“But Claudio,” I said, “don’t forget about all the tax benefits of being self-employed. When you file your tax return this year, remember the following things – these could save you tax.”
Make sure taxman sees you as self-employed
There are times when the Canada Revenue Agency might consider you an employee rather than self-employed. The problem? Fewer deductions. If you’re doing work for another business on a contract basis, the CRA might try to determine the intention of the two parties: Was the intention to enter an employee-employer relationship, or a business relationship? A written contract may speak to this intention. The CRA will also look at the following factors: Control (if you’re self-employed you’ll generally control many aspects of the services you provide, often including when, where and how you work), integration (a self-employed person can often be replaced and is not so integral to the business that his or her absence would jeopardize the success of the business), ownership of tools (a self-employed person generally provides his or her own tools), and financial risk (a self-employed person bears the risk of loss but also reaps the rewards of profit).
Split income with family
If your spouse, kids or other family members performed some tasks for your business you can justify paying them salary or wages. The amounts you pay must be reasonable for the work completed in order to be deductible against your business income. Take an example where your child worked part-time in your business to help pay for school. Assume you paid your child $5,000 over the course of the summer. If your child’s total income is less than $11,038 for 2013 ($11,138 for 2014) – the amount of the basic personal credit – then he will pay no tax on the $5,000. As a family you’ll save about $2,250 in taxes if your marginal tax rate is 45 per cent, and you will have effectively deducted part of the cost of your child’s education.
Claim home office costs
If your home office is your principal place of business, or is used on a regular and continuous basis for meeting clients, then you’ll be entitled to deduct a portion of many types of costs. These are things you’re paying for anyway, such as mortgage interest, property taxes, home insurance, utilities, repairs and maintenance and landscaping, to name a few. You won’t be able to create or increase a loss from your business activities when deducting home office expenses, but could bring your taxable income down to zero with these expenses. If your home office costs exceed your income then the excess can be carried forward to future years to offset income from the business in the future.
Deduct other expenses
When you’re self-employed, you’re generally entitled to deduct any reasonable costs that you incurred to earn income from your business. There are some restrictions on certain expenses, but the list of deductible expenses is long. Don’t forget to deduct things such as advertising and promotion, meals and entertainment (generally 50 per cent of these costs are deductible), memberships, subscriptions, licences, office supplies, salaries and wages (including those paid to family members, as I mentioned), telephone, vehicle expenses (a portion of gas and oil, insurance, registration, repairs, loan interest, lease costs, automobile club dues, car washes), among other costs.
If your business has grown in size and profitability, you might want to consider carrying on business through a corporation. A small business corporation is entitled to a low rate of tax on its first $500,000 of active business income (about 15 per cent – but this varies by province). This can make sense particularly where you’re able to leave some of your earnings in the corporation without paying it all out to yourself as salary or dividends.
Article: Globe and Mail
Modern medicine is quite amazing. I think we’re getting closer to the day when a human being can be cloned. Setting aside the ethical and legal conundrum this might pose, I can think of many good uses for a second “me.”
Could it be that the “other me” might actually enjoy taking out the garbage, picking up after the dog in the backyard, or massaging my wife’s feet? Could I program the “other me” to long for those tasks?
The “real me” would be hard at work improving my golf game, diligently testing various beverages and food items, and actively pursuing the sleep required to function optimally. A win-win for everyone.
While scientists still work on the cloning process, the Department of Finance long ago made it possible to clone yourself from a tax perspective.
I’m talking about alter ego trusts. It’s time to revisit this invention.
Alter ego trusts are trusts, created after 1999, where the settlor (the person who creates the trust) is the sole person who has a right to all the income of the trust each year. Further, no one but the settlor can have a right to the capital (assets) of the trust while he or she is alive. It’s possible to set up a “joint partner trust,” which is the same as an alter ego trust except that both partners (married or common law partners) have a right to the income of the trust annually, and no one but those two individuals has a right to the capital of the trust while either of them is still alive.
Alter ego trusts are special in that it’s possible to transfer assets to the trust without triggering tax on accrued gains on the assets. This is not the case with transfers to most trusts.
Now, the trust is taxed like other inter-vivos trusts (trusts created during the settlor’s lifetime) at the highest marginal tax rate. Each year, the income of the trust will be taxed in the settlor’s hands, and upon the settlor’s death (or the death of the second spouse or partner in the case of a joint partner trust), there will be a deemed disposition of the assets of the trust, creating a tax liability at that time inside the trust. The bottom line? Alter ego trusts don’t offer tax benefits. But there may still be good reasons to use them.
- 1. Avoid probate fees. Assets that you place into an alter ego trust during your lifetime will fall outside of your estate at the time of your death, allowing you to avoid probate fees (both domestic and potentially foreign probate if you own assets, such as real estate, outside of Canada). Probate fees are charged by the courts in each province (except Quebec) to grant “letters probate,” which certify that your will is valid and your executor has the authority to administer your estate.
- 2. Reduce delays and professional fees. Since the assets in the alter ego trust won’t form part of your estate on death, there won’t be delays resulting from preparing a court application to probate the will, or waiting for the court order. Legal fees for this task can also be avoided. So, your assets can be managed and distributed without these delays and costs.
- 3. Ensure continuity and liquidity. If you set up an alter ego trust, your trustee simply continues to manage your assets upon your death. Nothing changes in this regard. This also means that your trustee can convert certain assets to cash at any time, if desired or necessary, to pay taxes or make distributions to heirs.
- 4. Preserve privacy. Once you’re gone, and your will goes through probate, it becomes a public document. The value of your estate may also become public. A trust agreement, however, is not public and will guard the privacy of this information.
- 5. Protect against litigation. It’s possible for the terms of your will to be challenged by a disgruntled family member or other person. A trust agreement is much more difficult to challenge and can provide greater protection here.
- 6. Replaces a power of attorney. One advantage a trust has over a power of attorney over property is that a trust agreement continues after your death, while a power of attorney does not. Further, the trust is more comprehensive in detailing specific duties and powers to be exercised by your trustee. Finally, a trust agreement offers the settlor greater protection against being unduly influenced by family or friends. The settlor is no longer the owner of the assets because they are now controlled by the trustee.
Article: Globe and Mail
If there’s one thing I understand all too well, it’s the cost of having kids. Last weekend, our daughter approached my wife with a request: “ Mom, can I have $50?”
“Fifty dollars?” Carolyn replied. “What do you think I am? Made of money or something?” Evidently, “Mom” is simply an acronym for “made of money.”
Still, my kids know that I’m more of a pushover than Carolyn when it comes to asking for money. In our home, “Dad” stands for “definitely ask daily.”
We all know it’s going to be expensive raising kids, so you might as well get as much “kid-related” tax relief as you can. When filing your tax return this year, don’t forget these credits and deductions:
Child tax credit: You’re entitled to claim a federal tax credit of $2,234 (for 2013) for each child who was under age 18 in 2013. This will save you about $335 in federal tax. Many provinces have additional amounts available that can add to the tax savings.
Fitness tax credit: You can claim up to $500 annually in fees for sports or fitness activities for your children under age 16. The program must be weekly and last at least eight weeks. If it’s a day camp, it must run for five consecutive days. You may be entitled to an additional $500 for children up to 18 with a disability.
Arts tax credit: Claim up to $500 annually in fees for eligible arts, cultural, recreational or development activities. These can include academic tutoring, language lessons, or literary, visual, or performing arts, music lessons, etc. The program must be for eight weeks or longer, or five days if a day camp.
Child care deduction: Generally, the lower-income spouse is entitled to claim a deduction for child-care costs incurred, up to $7,000 for children under seven and $4,000 for kids seven and over but under 16 in 2013. Special rules apply for children with disabilities. It’s generally possible to pay your child 18 or over to look after those under 16. It’s a great way to split income.
Adoption expenses: If you adopt a child under age 18 you can claim a tax credit for up to $11,669 of those costs (for 2013). This will save you up to $1,750 in federal taxes. For 2014, the limit for expenses will be increased to $15,000 and indexed annually thereafter.
Universal child care benefit: Every family is entitled to receive $100 each month for each child under age six. This is true regardless of your income. The payments are taxable. Apply online at http://www.cra-arc.gc.ca/bnfts/uccb-puge/menu-eng.html.
Canada child tax benefit: You may be entitled to the CCTB, which is a monthly tax-free payment for each child under age 18. The amount of the benefit depends on your family income, province of residence and number of kids. The rate is adjusted on July 1 each year. If you file your tax return late your benefits might be delayed since the benefit is based on your reported income. Low-income families may be entitled to a national child benefit supplement, and if your child has a disability you may be eligible for the Canada disability benefit as well. To figure out your total benefits, check out the online calculator at http://www.cra-arc.gc.ca/bnfts/clcltr/menu-eng.html.
Tuition, education and textbook credits: If your child is enrolled full- or part-time in a qualifying postsecondary program, he or she can claim a credit for their tuition fees. In addition, full-time students can claim $400 per month of enrolment, plus $65 per month for textbooks. Part-time students can claim, in addition to tuition, $120 each month of enrolment and $20 per month for textbooks. Any credits that your child is unable to claim (due to insufficient income) can be transferred to a parent, grandparent, spouse or common-law partner up to a maximum of $5,000. Or, your child can carry those amounts forward to use in a future year.
Student loan interest: If your child has a qualifying student loan he/she may be able to claim a credit for the interest paid on that loan in 2013. Unused credits can be carried forward by your child and claimed in the next five years.
Transit pass costs: The cost of transit passes for your children age 19 or under in 2013 can be claimed by either parent (including common-law partners). The usual conditions for claiming transit passes apply here.
Moving expenses: If your child moved to attend postsecondary school, he or she may be able to claim moving expenses. The usual conditions for moving expenses will apply.
Article: Globe and Mail
I have a number of neighbours who are getting on in years. There’s a particular couple whom we like to visit regularly. George’s short-term memory isn’t what it used to be. He was telling me the other day about a wonderful new golf course that he and his wife visited last fall.
“The course was beautiful, and the green fees were excellent” he told me. “What was the name of the course?” I asked. “Hmm, I can’t recall,” he said. “What do you call that flower that people like to give on Valentine’s Day?”
“You’re talking about a rose,” I said.
“That’s it!” he shouted. “Rose, what’s the name of that golf course that we visited last fall?”
It turns out that George forgot to file his tax return last year. So I reminded him that it’s almost time to get that done for 2013. Then I shared with him the key deductions and credits that seniors should be thinking about when they file their returns this year. Here’s what we talked about.
You can claim this credit if you were 65 or older on Dec. 31, 2013, and your net income is less than $80,256. The maximum claim is $6,854 federally. The actual tax savings from this credit would be 15 per cent of $6,854, or $1,028, plus any provincial savings on top.
Pension income amount
This $2,000 credit may be available if you received eligible pension, superannuation or annuity payments. Sorry, but Canada Pension Plan (CPP) income doesn’t count as eligible income here.
Pension income splitting
If you qualify to claim the pension income amount I just spoke about, you’re generally able to report up to one-half of that pension income on your spouse’s tax return, which will save you tax as a couple if your spouse is in a lower tax bracket. A spouse includes a common-law partner under our tax law.
Split CPP income
If you and your spouse are at least 60 years of age, and one or both of you receive CPP benefits, each spouse may be able to apply to split their benefits with the other (i.e., report half on each other’s tax returns), which can save tax if one of you is in a lower tax bracket.
If you’re 60 to 70 years of age and employed or self-employed, you have to make CPP or Quebec Pension Plan (QPP) contributions, even if you’re receiving CPP or QPP benefits. You can claim a tax credit for these contributions. However, if you’re at least 65 but under 70 years of age, you can elect to stop making contributions (use Form CPT30, the applicable part of Schedule 8 to your tax return, or Form RC381, whichever applies).
You may be eligible to claim a variety of medical expenses, perhaps even previously unclaimed amounts, as long as the expenses were incurred in any 12-month period that ended in 2013. The list of eligible expenses has continued to expand slowly over the past few years. Claim medical expenses on the lower-income spouse’s return to maximize your tax relief.
If you have a severe and prolonged physical or mental impairment, you may be eligible to claim $7,697 if a qualified practitioner certifies, on Form T2201 – Disability Tax Credit Certificate, that you meet certain conditions.
Public transit amount
You can claim the cost of monthly (or longer duration) public transit passes for travel on public transit within Canada for 2013. The cost of electronic payment cards can also be claimed when conditions are met.
Work force credits
If you’re still working, even part time, you may be eligible to claim the Canada employment amount (maximum $1,117) and the Working income tax benefit (see Schedule 6 of your return).
You’re entitled to make contributions to a registered retirement savings plan (RRSP) until the end of the year in which you turn 71. Don’t forget to claim a deduction if you’ve made a contribution for 2013.
And if you’re eligible for the disability tax credit it’s possible to make contributions to a registered disability savings plan (RDSP) to shelter income on those contributions from tax.
Some seniors must pay back all or a portion of their Old Age Security (OAS) benefits if their income exceeds $70,954 (for 2013). If you’re in this boat, examine the types of income you’re earning to see if you can change the type of income earned to reduce the impact of these clawbacks going forward.
Article: Globe and Mail
Your questions have been piling up in the Investor Clinic inbox, and today I’ll answer two of them.
Actually, because they’re somewhat technical, I reached out to a couple of tax experts at BMO Nesbitt Burns: John Waters, head of tax and estate planning, and his colleague Linda Leung, director of U.S. tax planning.
When I make a withdrawal from my registered retirement income fund (RRIF), can I split the income with my spouse? What other sources of income am I allowed to split?
The ability to split RRIF income for tax purposes between a spouse or common-law partner depends on the age of the transferor spouse.
If the transferor is 65 or over (regardless of the age of the transferee spouse), it is possible to achieve pension income-splitting for RRIF income provided both spouses are Canadian residents for tax purposes.
The pension income-splitting rules provide a simple strategy for couples to reduce their overall family tax bill by taking advantage of the transferee spouse’s lower marginal tax rate.
Under the rules, you can allocate up to 50 per cent of eligible pension income to a spouse. Each spouse must make an election on his/her income tax return each year.
For income tax purposes, the amount allocated will be deducted from the income of the spouse who actually received the eligible pension income and added to the income of the other spouse.
Sources of pension income other than RRIFs are also eligible.
If you are 65 or over and receive payments from a registered pension plan, life income fund (LIF), locked-in retirement income fund (LRIF) or lifetime annuity in a registered plan, the income will qualify for splitting. The income portion of certain annuities in a non-registered account may also qualify.
However, if you are under 65, generally, only payments from a registered pension plan will qualify for pension income splitting. RRIF, LIF, LRIF or annuity income will only qualify if received as a result of the death of a spouse.
The Canada Pension Plan has its own set of rules for income “sharing.” Click here for more information.
I have heard that U.S. citizens living in Canada do not have a tax treaty that recognizes the tax-free savings account (TFSA). I also understand that even capital gains on principal residences may be fully taxed by the U.S. Internal Revenue Service on sales of homes in Canada that are owned by U.S. citizens. Do I have this right?
You have a lot of it right. U.S. citizens living in Canada must report worldwide income on their U.S. income tax returns as well as their Canadian tax returns.
Canada does have a tax treaty with the United States that allows U.S. citizens to elect to defer the income earned in an RRSP such that the income would not be taxable for federal U.S. income tax purposes until amounts are withdrawn.
Unfortunately, the same election is not available for TFSAs. As such, any income earned in the TFSA would be included as taxable on an annual basis for U.S. income tax purposes.
The U.S. tax rules with respect to the capital gains on the sale of a principal residence are different from the ones applicable for Canadian income tax purposes.
While the capital gain from the sale of a principal residence is typically exempt from taxation for Canadian income tax purposes, you would only be able to exclude up to $250,000 (U.S.) of that gain ($500,000 if you file U.S. income tax returns jointly with your spouse) for U.S. income tax purposes if certain criteria are met.
The factors that are relevant for the purposes of determining whether or not you are eligible to claim the $250,000 capital gain exclusion generally relate to the length of time you own the principal residence and the length of time you have used that residence as your “main home.” The location of the home (i.e., in Canada or elsewhere) is not part of the criteria.
Article: Globe and Mail
Alex Ghani has always taken a long-term view toward saving and retirement. At the tender age of 33, he established a spousal registered retirement savings plan so, as the higher income earner in the family, he could also contribute on behalf of his wife, Sana.
“It’s a great income-splitting tool for our future retirement income, when it will help keep us in a lower tax bracket,” said Mr. Ghani, now a 38-year-old partner with the chartered accounting firm Prasad Ghumman LLP in Thornhill, Ont.
The spousal RRSP is an underutilized, potentially significant retirement savings strategy, experts say.
“People typically scramble at the end of February to make their RRSP contribution, to the extent they’re making a contribution, and don’t really stop to think, ‘What’s going to be our tax situation when we retire?’ They’re just focusing on today,” said Lorn Kutner, a partner with Deloitte LLP in Toronto.
The spousal RRSP not only provides an immediate tax deduction, and a way for investments to grow on a tax-deferred basis, it can also provide flexibility for income splitting in retirement.
For example, pension income can be split only to a maximum of 50 per cent. So if you’re receiving $1,000 a year in pension income, you can move only a maximum of $500 annually to your spouse. But if you’d managed to make spousal RRSP contributions for several decades, and that money had grown inside the RRSP, that provides the potential for a lot more income splitting, with the additional money coming out of your spouse’s RRSP as their income, Mr. Kutner said.
The spousal RRSP also encourages couples, including those in common-law relationships, to anticipate what their income levels and corresponding tax brackets are going to be in retirement. Typically the higher income spouse will make the contribution on behalf of the partner, allowing for an opportunity to pay a lower tax rate when those funds are ultimately withdrawn, as Mr. Ghani has done.
The spousal RRSP works particularly well for those who are not a member of a pension plan because they are not allowed to split their own RRSP until they are 65 or older, said Cherith Cayford, a facilitator for CMG Financial Education in Victoria. “So if they retire earlier than 65, there’s an opportunity to split some income.”
Conversely, many people are living and working longer, earning income past age 71. RRSP rules state that plans must be terminated by the end of the calendar year in which the plan holder turns 71. Proceeds can then be rolled over into a registered retirement income fund, which requires minimum annual withdrawals starting at age 72. Or they can be invested in a fixed-income annuity.
The spousal RRSP, however, provides the potential for continuing contributions. “I think most people think, ‘Seventy-one, I’m done. I can no longer do contributions.’ [But] as long as your spouse is younger, you can make spousal contributions,” Mr. Kutner said.
And the earlier such contributions are made to a spousal RRSP, the better. “If you start doing this rather late in your RRSP contribution life, then you’re not going to be able to accumulate significant enough assets in your spouse’s RRSP to be able to take advantage of his or her marginal tax rates when they start to withdraw money out of the plan,” Mr. Kutner said.
“So if you’re pretty certain your spouse’s income level in retirement is going to be relatively low, the earlier you start making spousal contributions, the better,” he elaborated.
However, there is a special three-year attribution rule attached to the spousal RRSP that contributors need to understand, or it can catch them off guard. If you make a contribution to your spouse’s RRSP and your spouse withdraws that amount, or a portion thereof, from their RRSP within three calendar years, that withdrawal is treated as income on the contributor’s personal tax return, Mr. Kutner said.
“If I made a spousal contribution to my spouse’s RRSP and I’m in a high tax bracket and she’s in a low tax bracket, CRA doesn’t want her to take it out the next year and be taxed at her rates. This is meant to ensure that you’re doing this within the spirit of the rules, which basically says, ‘This is going to allow income splitting in retirement, not so much in current years,’” he explained.
If, for instance, a $5,000 contribution is made to a spousal RRSP on Dec. 31, 2013, the first $5,000 taken out of the spouse’s RRSP in 2014 or 2015 would be taxed in the contributor’s hands, rather than the spouse’s, because the three calendar years attached to attribution would be 2013, 2014 and 2015. The spouse would then need to wait until at least January of 2016 for the better tax benefit.
But if the spousal contribution was made in January of 2014 – contributions for the previous taxation year can still be made up to 60 days hence – then the three-year attribution rule would apply to 2014, 2015 and 2016, and January, 2017, would be the earliest to avoid attribution back to the contributor.
“If you’re thinking of making a spousal contribution and you have the funds available, it’s probably a good idea to do it by December 31 rather than 60 days past the start of the year,” Ms. Cayford advises.
The only exception to this rule, aside from situations that involve death, is when the taxpayer turns an RRSP into a registered retirement income fund (RRIF) or annuity, with the former requiring statutory annual withdrawals.
A major misperception about the spousal RRSP concerns contribution limits. The eligible amount that can be contributed is based on the contributor’s limits, not the spouse’s, said Robert Snowdon, a chartered accountant in Kanata, Ont.
If, for example, the higher-income earner was eligible to contribute $15,000 to an RRSP, they can apportion that $15,000 any way they wish, to either or both of their own or spousal RRSPs as long as they don’t exceed that limit.
“Be careful not to taint the plans. Keep the spousal contribution plan separate from the plan that the partner contributes to on their own,” said Ms. Cayford. Otherwise, she warned, the high-income earner may end up footing the entire tax bill.
Depending on a couple’s potential retirement incomes, the spousal RRSP could also be an effective strategy to reduce income and therefore also reduce or avoid the Old Age Security clawback, which begins at $70,954 of income and is totally clawed back at $115,716, Ms. Cayford said.
Mr. Ghani said he also views the spousal RRSP’s potential to reduce the OAS clawback he and his wife will eventually face as an important part of their retirement savings strategy.
Article: Globe and Mail
For most, hitting your 50s is a period marked by expanding waistlines, mounting aches and pains and the first genuine bouts of nostalgia. It is also the time to get serious about establishing a retirement nest egg.
Most Canadians earn more money in their 50s than in any other decade, a statistic that, when combined with a honed investment strategy and a retirement game plan, can make for a very lucrative window of opportunity.
Unfortunately, not everyone makes the necessary adjustments to their investing strategy at this milestone, which can prove to be a costly oversight. RRSPs serve as a good step in bridging the gap between expenses and government payments in retirement (see chart). But getting prepared for retirement is not as simple as opening an RRSP account and making an annual contribution.
“The industry has taught us to think about how much money we have accumulated in our RRSP. But it’s really all about the plan,” says Doug Dahmer, founder and chief executive officer of Emeritus Financial Strategies, in Burlington, Ontario.
Most Canadians don’t consider tax planning for retirement, even though taxes will remain their largest expense. RRSPS are just a savings vehicle. One of the biggest challenges for people in their 50s is to figure out how they will turn their savings into an efficient income stream, he says.
Many people put far too much money in their RRSPs, “and what they don’t realize is that they are building a huge tax trap for themselves in the future,” Mr. Dahmer warns, because every dollar coming out of the account upon retirement will get taxed. Spreading some savings out into different investing vehicles can reduce taxes on retirement income flow.
For example, if a retired couple needs to buy a new car for $30,000 and is relying on their RRSP investments, they may have to withdraw $45,000, depending on their tax bracket. That additional income can trigger a government clawback on OAS, pushing the cost of the car to more than $50,000.
Mr. Dahmer advises many of his clients in their mid 50s to stop contributing to RRSPs and instead maximize payments to their tax free savings accounts (TFSAs) and pay down their mortgages. Ten years before retiring, Canadians need to be asking themselves what they want to do and where, because only then can they know how much money they will need, he says.
Lifestyle considerations are essential, agrees Adrian Mastracci, president and portfolio manager at KCM Wealth Management Inc. in Vancouver. Among the questions he asks clients: How will you replace the fulfillment from your work? And what accomplishments do you envision during retirement?
Adrian Mastracci, president and portfolio manager at KCM Wealth Management Inc. in Vancouver, says that turning 50 is the time to ensure that each spouse will have similar assets at retirement. Balancing income streams in advance of retirement will ensure a couple pays the lowest possible tax, regardless of what happens to the government’s “income-splitting” rules. That means that before retirement, the lower-income spouse is better off doing more of the family’s saving and investing and the higher-income spouse should pay more of the household expenses, Mr. Mastracci says.
The goal is to accumulate investment assets of between six and 10 times your annual family income, he adds.
A couple retiring at 65 and planning to spend $75,000 a year, with a life expectancy of 95, will need $1.24-million in savings upon retirement, Mr. Mastracci calculates. This assumes they do not sell their house, receive two-thirds the maximum CPP/OAS payments ($25,000 a year) and achieve an annual return of 5 per cent, in an environment of 2-per-cent inflation.
The 50s “are the critical years for the big push to accumulate your nest egg. If you miss out on the finances during this decade, you may fall short of your family’s retirement goal,” he says.
Investors tend to be more risk-averse as they get closer to retirement. Yet, advisers say it’s important that investors don’t take their foot off the gas when they reach their 50s, especially in today’s low-interest environment. Many direct their clients to balanced funds that hold stocks and – to a lesser extent – bonds, as well as offer international exposure.
To maintain their purchasing power in retirement, fiftysomethings should make sure growth stocks are part of their portfolio today, says Marc Cevey, CEO of HSBC Global Asset Management (Canada) Ltd. He also likes dividend stocks, even though they may look expensive today, because yields are historically high. As a class, dividend stocks will continue to attract aging investors seeking income – in both the developed and developing world, he says, providing support to prices.
Meanwhile, some exposure to bonds will act as a cushion during any rough periods. HSBC continues to favour corporate bonds over government bonds, even though the premium that corporates traditionally offer above governments has narrowed. Default rates are low in North America right now because many companies have strengthened their balance sheets since the financial crisis. Among government bonds, a mix of international holdings with a range of maturities should offer slightly higher returns than Canadian bonds on their own, Mr. Cevey says.
CPP yearly max (couple): $24,920
+ OAS yearly max (couple): $13,237
= Total gov’t payments: $38,157
– Avg retired couple yrly expend.*: $54,100
= Shortfall: $15,943
(*2009; all other figures are for 2014; Source: Service Canada, Statistics Canada)
Article: Globe and Mail
Is now the time to get your household debt under control, or does building up a retirement fund take priority?
“It’s an age-old debate. It happens every year,” says Jeffrey Schwartz, executive director of Consolidated Credit Counseling Services of Canada in Toronto.
But perhaps this is the year that discussion is set to take a new turn. In the third quarter of 2013 the ratio of Canadian household debt to disposable income rose to 163.7 per cent, a new record. Simply put, it means that for every dollar of disposable income we have, we spend $1.63.
This number worries Mr. Schwartz and other debt-watchers here and abroad. Indeed, it has spooked foreign investors who no longer see Canada as a sure bet. The recent plunge in the value of the loonie is one indication of this wariness.
“What am I afraid of? I’m less worried in the short term about interest rates. I’m more worried about a reduction in people’s income,” says Mr. Schwartz.
At the heart of the problem is risk. As debt levels rise, risk rises, too. Lose your job while paying off $1,000 worth of credit card debt, and that’s a pain. Lose your job while trying to pay down $26,000 worth of debt, and that can lead to financial disaster.
“If a lot of Canadians lose that paycheque or it shrinks, then they’re not going to be able to service that debt. They won’t be able to make that minimum payment each month,” he says. “That’s where the real trouble starts.”
Even so, no one is saying retirement planning is unimportant. With some studies claiming that two-thirds of Canadians aren’t saving enough for their golden years, socking away money in a registered retirement savings plan (RRSP) or tax-free savings account (TFSA) seems just as important as debt reduction.
So where should your money go? Here’s a list of what financial advisers tend to look at before steering money one way or another.
You might want to make RRSP contributions if:
- You’re in a higher income tax bracket. The RRSP was made for you. Reduce the amount of tax you pay today and owe less tax when you’re in a lower tax bracket upon retirement. (By the way, there’s no debt-payment write-off at tax time.)
- Your employer matches your contributions or offers a group plan. Yes, this is called free money. If a company offers its employees this benefit, investing in the future is much more tempting. If your portfolio does well, the return on investment grows even larger.
- You are planning to buy a house or go back to school. You can take up to $25,000 out of your RRSP to use as a down payment without having to pay taxes on the funds with the Home Buyers’ Plan. Or withdraw $20,000 to go back to school with the Lifelong Learning Plan. Granted, if you’re swimming in debt already, buying a home is likely not the best move.
- You don’t trust yourself. “Are you addicted to debt?” asks Rhonda Sherwood, a wealth adviser with ScotiaMcLeod in Vancouver. “If you pay down your debt, will you turn your focus to savings – or just rack up more debt?”
It may seem counterintuitive, but paying yourself first, even if it’s just $100 a month, might be the better option than throwing all your money and energy into debt repayment. Set up an automatic payment plan with the bank; you can’t spend what you can’t see.
You might want to pay off debt instead if:
- Your debt is expensive. A high-interest credit card is a balance sheet’s worst enemy – and it can seriously undermine retirement savings, particularly if your RRSPs have hit the doldrums. “If you’re getting low returns on your RRSP and you’re paying high interest rates on your debt, you’re effectively financing your retirement at a very high rate. I can’t put it any simpler than that,” Mr. Schwartz says.
- You can’t stomach the risk. Those living paycheque to paycheque have much more to lose if their investments show lower returns or losses, particularly if they’re entering into their preretirement years and they’ll need the money soon. But that 25-per-cent credit card? Pay it off and you’re getting a rate of return few investments can touch, particularly after taking fees into account.
- You’re in a low income tax bracket this year. Reducing your taxes may sound like a good idea, but if you’re making less money right now, this is not the year to contribute to your RRSP. Your tax savings will be low or even zero. Pay down your debt in 2014 and save that RRSP contribution room for a year when it will do you more good.
So, debt repayment or retirement planning for 2014? Maybe neither, says Stephanie Holmes-Winton, author of Defusing the Debt Bomb, from Dartmouth, N.S. She believes there’s one more option that many Canadians overlook at this time of year: an emergency fund. Without one, more people will either go further into debt when life throws a curve ball, or will take money from their RRSP, thus paying expensive withholding taxes and missing out on years of compounding returns.
Even if you’re heavily in debt, she recommends setting up an automatic savings plan to build the fund before thinking about retirement planning.
“Everyone needs a cushion before they can start long-term savings,” she says.