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Retirement . . . Ready or Not!
If you’re retired, or soon to be, you’re likely a Canadian baby-boomer. You are seeking more information about your retirement beyond merely finances, and advisors are uniquely positioned to provide you with additional retirement insight and planning.
Currently, Canadians aged 65 years old, can expect to live an additional 22 to 24 years, on average. Not only are people living longer, they are leading more active retirements. Achieving success in retirement no longer requires the bills to be paid, and to sit at home awaiting the arrival of the grim-reaper!
To gain access to the investable assets today, and manage them into retirement, advisors should examine their clients in a broader, more complete perspective.
What you need to know
Retirement Element | Ready to Retire | Not Ready |
---|---|---|
Vision | *Unified view of retirement by both partners *Active/equal trade-offs *No Surprises *Guided decision-making for all Retirement Elements | *Costly and scattered decision-making for other elements (below) *Delayed decision-making for investments and accounts *Anxiety over end-of-work |
Health | *Health considerations not informing Interests, Social or Lifestyle elements *Critical Illness, healthcare benefits and/or savings in-place | *Successful and active retirement unattainable if health matters are not addressed, fitness promoted *Unpredictable and high healthcare costs could financially cripple retirement |
Interests and Social | *Activities and friends independent from work, or maintained by choice *Increasing curiosity for hobbies and relationships | *Little or no plans to fill approximately 2,000 hours per year previously spent at-work *Boredom leading to increased health risks |
Lifestyle | *Activities of daily living planned for all life-stages *Living integrated with family and friends, along with mutual activities and family events | *Days passing from one to the next without purpose, interaction or accomplishment |
Home | *Accommodation needs understood for various phases of retirement, mobility and wellness *Costs anticipated, free capital identified *Vacation home transfer planned, with life insurance if necessary | *Home does not match Interests, Social or Lifestyle needs *Costly modifications avoided that could improve quality of life *Inexpensive modifications not planned, destroying peace of mind and quality of life |
Legacy | *Final wishes to be followed *Tax liability at time of transfer accounted for with insurance, for example, and/or planned *Wills, Powers of Attorney considered and constructed to fulfill final wishes precisely | *Unequal or missed distribution of assets and heirlooms *Tax surprises require disposition of assets (like family cottages) to pay terminal return *Tax bill nominally higher without planned giving while alive |
The Bottom Line
Without planning that includes more elements than just finances, retirement and the years leading up to it can be anxiety laden. The period that should be relatively carefree will be the opposite.
Financial planning is a critical element of all retirement plans, but an analysis that focuses solely on money will not prepare you for a successful retirement. Additional items like those mentioned above must also be addressed.
Investment Income and Income Tax
Investments can deliver a major source of income and tax implications for individuals. Each major type of investment income is subject to special tax treatment.
Understanding how your investments are taxed is an important consideration for investment planning since after-tax yield is more important than gross returns. The most common types of income most investors will receive are interest, dividends, and capital gains.
Inside a registered account, like an RRSP or TFSA, these earnings are not taxed. The total withdrawal from an RRSP is subject to income tax, while TFSA withdrawals are not. For investment income that is subject to tax when it is earned, the effective income tax rate can vary widely for an individual.
What You Need to Know
Interest Income
Interest income refers to the compensation an individual receives from making funds available to another party. Interest income is earned most commonly on fixed income securities, such as bonds and Guaranteed Income Certificates (GIC). It is taxed at your marginal tax rate without any preferential tax treatment and is taxed annually whether or not it has been withdrawn from the investment.
Example:
An investor buys a 10-year GIC that has agreed to pay him 4% annually. If the investor bought the GIC for $100, the contract stipulates that they will earn $4 of interest each year for the next 10 years. The investor must report the $4 of interest income on their income tax return each of those 10 years.
Since interest income is reported as regular income, like employment income, it is the least favourable way to earn investment income if it is subject to income tax. Typically, GICs offer relatively less risk than other investments to compensate for lower gross and after-tax returns.
Dividend Income
Dividend income is considered property income. A dividend is generally a distribution of corporate profit that has been divided among the corporation’s shareholders. The Canadian government gives preferential tax treatment to Canadian Controlled Public Corporations (CCPC) in the form of a dividend income gross up and Dividend Tax Credit (DTC).
Taxpayers who receive eligible dividends are subject to a 38% dividend income gross up, which is then offset by a federal DTC worth 15.02% of the total grossed up amount.
Example:
A shareholder of a Canadian Controlled Public Corporation is paid a dividend of $100. This income is an eligible dividend and is subject to the gross up and the DTC. The dividend would be grossed up 38%, so the income is now considered to be $138. The DTC would be 15.02% of $138, the grossed-up amount, equaling $20.73. Therefore, the shareholder would report a dividend income of $138, but would have their federal taxes reduced by $20.73.
The rationale for the gross up and DTC is related to the fact that dividends are paid in after-tax corporate earnings. If there were no adjustments to the dividend, it would result in the dollars being double taxed. This tax treatment makes dividends a more tax efficient way to receive income than interest income. Tax is payable when the dividends are paid out.
Different rules apply for dividends derived from non-Canadian and private corporations and can offer different tax treatment and advantages when professional tax expertise is employed.
Capital Gains
Capital gains are realized on equity investments (such as stocks) that appreciate. For example, if an investor bought a stock at $6 per share and sold at $10 per share, they would have earned a capital gain of $4. In Canada, only 50% of a capital gain is subject to income tax. In this example only $2 of the gain would be taxed. Another desirable trait of capital gains income is that tax is not due until the investment is sold or deemed to have been sold. This provides the investor with a measure of control over the timing of taxes. Whether or not they are the most tax efficient income depends on your province of residence and subsequent tax rates.
The Bottom Line
It is important to ensure that investors understand their tax situation and the implications that different types of investment income can have on future taxes.
Financial, retirement and income planning should include the anticipated tax obligations at both the federal and provincial level. Ensuring an investor’s expert advisors understand overall objectives, risk tolerance and retirement timing can allow them to maximize after tax returns.
Corporate Investments – Getting active around passive income.
By: Michael Lutes CFP, CLU
Certified Financial Planner
Introduction
In Canada, the taxation of passive income earned by corporations has been a topic of interest and debate for many years.
The rules and regulations surrounding this income have evolved, impacting how businesses manage their investments and financial strategies.
In this blog post, we will delve into the essentials of Canadian corporate passive income, including what it is, how it is taxed, and strategies for optimizing your corporate investments.
What is passive income?
Passive income refers to the income earned by a corporation from investments in assets such as stocks, bonds, rental properties, and other passive sources. This income is distinct from active business income, which is generated from a corporation’s core business operations.
Common types of passive income include:
- Dividend Income: Earnings received from investments in shares of other corporations.
- Interest Income: Earnings from investments in bonds, GICs, or loans.
- Rental Income: Income generated from leasing out real estate properties.
- Capital Gains: Profits realized from the sale of investments, such as stocks or real estate.
How is passive income taxed?
Taxation of passive income is governed by the Canadian Income Tax Act. The key principle is that passive income is subject to a higher tax rate compared to active business income to discourage corporations from accumulating excessive passive investments.
Moreover, having too much passive income in any given year will reduce or eliminate a corporation’s access to the following year’s Small Business Deduction, the effect of which can be an additional approximately 15% income tax.
Strategies for managing passive income
To minimize passive income and avoid the potential loss of the Small Business Deduction, business owners should consider the following strategies:
- Withdraw additional funds for investment in RRSP or TFSA accounts.
- Use accumulated Capital Dividend Account (CRA) credit to withdraw funds tax-free and reduce potential for passive income.
- Remove funds tax-free by having the corporation repay any outstanding shareholder loans.
- Focus on capital gains-oriented investment. Unlike interest and dividend income which is earned regularly and taxed in the year it’s received; capital gains can be realized strategically and only 50% of capital gains are included in income.
- Let your winners ride! In other words, if you have unrealized capital gains, you might consider hanging on to them until a future year when you may avoid a further reduction of your SBD. Or hang on and sell them in a year when you already have greater than $150,000 of passive income and have already eliminated the SBD anyway.
- Spread out your gains. Instead of deferring capital gains to future years, sell your winners over two or more years to potentially avoid reducing your SBD.
- Implement an Individual Pension Plan (IPP). An IPP is essentially a business owner’s very own defined benefit pension plan. The money contributed is eliminated from the calculation of passive income.
- Buy permanent life insurance inside the corporation. The investment income is sheltered inside the policy as “cash value” and doesn’t count to the calculation of passive income. Furthermore, on death the entire death benefit can often be paid out to shareholders tax-free.
- Donations from a corporation will reduce the funds that would otherwise be producing passive income. Further, if donating securities or funds with unrealized gains, there are additional benefits such as no tax payable and a credit to withdraw funds from corporation tax-free.
Conclusion
Understanding Canadian corporate passive investment income and its taxation is crucial for businessowners looking to optimize their financial planning strategies. By staying informed about the rules and employing effective tax planning strategies, businessowners can strike a balance between accumulating passive investments and managing their tax liabilities. Consulting with a qualified tax professional or financial advisor is often recommended to navigate the complexities of corporate taxation in Canada effectively.
“How One Advisor Doubled His Book in Six Years”
“How One Advisor Doubled His Book in Six Years”
An article featuring our very own, Corey Butler, CIO – Chief Investment Officer, Wealth Advisor, Ecivda Financial Planning Boutique.
by: BMO Mutual Funds HQ
Corey Butler began his career as a bricklayer, where he learned the value of building a solid foundation. Now a successful Wealth Advisor and Chief Investment Officer at Ecivda Financial Planning Boutique, Butler shares the secrets that have allowed his advisory practice to more than double its assets under management in only six years, and why he sees the BMO Strategic Equity Yield Fund as an important building block for client portfolios.
Click HERE to read the full article!
#ECIVDA #ThinkForward #planningrighttoleft #BMO #BMOglobalassetmanagement
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