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
- 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
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Capital Gains “Splitting”
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||
| Capital Gain | |||
| You |
$ 10,000
|
||
| Spouse |
$ 10,000
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||
| 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
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| Overall savings on |
$10,000
|
$ 799
|
|
| Increase in your after-tax annualized rate on tax savings alone |
2.6%
|
- 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
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Leveraging
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||
| 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
|
- 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 |
- 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
- Interest deductibility re-enforced by recent decision of Supreme Court of Canada (Singleton Case)
- *Re-arrange affairs to make mortgage interest deductible