Tax Planning Strategies for the Investor

Loans to your spouse l Borrowing to invest l Borrowing for your RRSP l Borrowing to enhance Net Worth at retirement l Employee Loans l Refinancing your Mortgage


Low Interest Rates! Tax-saving Strategies

Loans to your spouse

  • Assume you sell $10,000 security to spouse for $10,000 promissory note
    • Your tax bracket (Top) – 46.4 %
    • Your spouse’s tax bracket (under $30,544 taxable) – 26.9 %
  • 3 years later investment is worth $20,000
Do Nothing
Capital Gains “Splitting”
Capital Gain
You
$ 10,000
Spouse
$ 10,000
Tax Paid
Capital Gains
$ 2,320
$ 1,345
On interest income reported
You 900 x 46.4%
$ 418
Spouse (900) x 26.9%

(242)


$ 2,320
$ 1,521
Overall savings on
$10,000
$ 799
Increase in your after-tax annualized rate on tax savings alone
2.6%

Borrowing to invest

  • Using leverage
  • Not always appropriate for everyone
  • When ok
    • Investor has stable cash flow
    • Mid to long term horizon for investments
    • Investments are not overly risky

Example

  • Assume $10,000 invested for 8 years
  • Assume 9% return
  • Moderately conservative Growth Equity Fund
  • Interest payable at prime say 4%
Without Leveraging
Leveraging
Investor capital
$ 10,000
$ 10,000
Investment loan


10,000


10,000
20,000

10,000


20,000


Growth @ 9% – 8 years
20,000
40,000
Interest expense paid 10,000 @ 4% x 8 years
(3,200)
Tax savings on interest expense @ 50%


1,600


$ 20,000
$ 38,400
Less: Original Loan


10,000


$ 20,000
$ 28,400

Borrowing for your RRSP

  • Interest is not tax deductible
  • However, low rates encourage investor to top-up fund capital into retirement savings
    Example:
  • $20,000 top-up for RRSP
  • Assume 4% interest rate
  • Tax savings used to repay loan
  • Assume 8% growth
  • Loan amortized over 2 years
  • Borrow today; fund 2001 RRSP
Money contributed to RRSP
$ 20,000
Growth – 2 years @ 8% per year

3,328


Projected value of RRSP 2 years later

$ 23,328


Loan payment
Initial loan
$ 20,000
Tax refund applied

(9,280)


$ 10,720
Monthly payments for 24 months at 4% rate
$ 465.36
Total payments made
11,168.64
Interest paid

$ 448.64


Projected value of RRSP January 2004

$ 23,328.00



Borrowing to enhance Net Worth at retirement

Example

  • Age 45
  • Time line 15 years (Retire at 60)
  • Accumulated savings $100,000

Retirement income needed $50,000/annum in equivalent 2002 dollars

  • Inflation 3% average
  • Rate of Return 7%
  • Annual contribution $13,500

Pre Tax Annuity, Today’s Dollars $ 33,000/year
Shortfall  $ 17,000/year

Need to target RRSP of $950,000 at age 60 or a tax-efficient portfolio to generate 50,000 equivalent per year

Potential Solution

  • Use leverage to create a larger investment base today
  • Borrow $140,000 @ 5% – repay over 15 years 13,500 per annum
  • Invest in non-registered portfolio for 15 year period with a view to generating deferred capital gains
  • Target growth rate of 8% / annum 15 year period

Annuity Possible

25 years Age 60 to Age 85

RRSP – pre-tax, in equivalent $ today
$ 15,000
Non-registered – pre-tax, in equivalent $ today

35,000


$ 50,000



Employee Loans

  • Interest-free loan from employer
  • Taxable benefit only at today’s CCRA prescribed rate of 3%
  • Taxable benefit also deductible if borrowed funds used for investment purposes
  • Rules for shareholder loans are more complex

Refinancing your Mortgage

  • Interest deductibility re-enforced by recent decision of Supreme Court of Canada (Singleton Case)
  • *Re-arrange affairs to make mortgage interest deductible