He's coming. And unless you're ready, he could destroy a significant portion of your net worth.
I'm talking about the taxman.
It's common sense, really. Multibillion-dollar stimulus packages and diminishing tax revenues are going to put federal and provincial governments in the red for years to come. And while elected officials are reluctant to talk about it, the only conceivable way to get back into the black is to raise income and other taxes.
Furthermore, it looks increasingly likely that the wealthy are going to bear the brunt of this increased tax burden. There's already been considerable discussion from the Obama administration on the subject of raising taxes on the highest income earners in the United States. Even though Canada's conservative government is likely reluctant to follow suit, it may well be the most financially expedient solution.
As a wealth adviser to wealthy families, this is obviously not what I am wishing for. Don't shoot the messenger. I'm not a tax lawyer; nor am I an accountant. But I work closely with several well-respected members of both professions on an almost-daily basis.
And almost unanimously, they have been quietly confirming that they have been advising their wealthiest clients to restructure their financial affairs to account for higher anticipated tax rates down the road.
One of these professionals is Chris Ireland, vice-president of planning services at PPI Financial Group, a top-rated estate and insurance planning group that provides wealth solutions to high-net-worth families and entrepreneurs across Canada. Mr. Ireland is a CA who's been working with wealthy entrepreneurs and other high-net-worth individuals for over 25 years. While he acknowledges it's tough to know exactly how governments will clean up the fiscal mess, the likely solution is higher taxes at some point.
"It's a logical answer," Mr. Ireland said. "There's large deficits that are not getting smaller - it's going in the other direction. The numbers are pretty scary for a government that's trying to be fiscally prudent."
Of course, it's difficult to know what form those tax changes will take. As Mr. Ireland points out, the government has a number of options: change the capital gains inclusion rate; roll back proposed decreases to corporate tax rates; create a new tax rate for ultra-high-income earners; bump up the GST - any and all of which could hit high-net-worth individuals hard.
For clues, Mr. Ireland has turned his eyes south of the border. As he explains, the risk of a brain drain or exodus of wealthy people to low-tax jurisdictions in the United States was at least one factor behind lower tax rates in Canada. If the Obama administration follows through on its plans to raise tax rates on the wealthy, that risk would diminish, giving Canadian governments an opportunity to raise tax rates themselves.
"Why not, if your next door neighbour is doing it?" Mr. Ireland asks rhetorically. "[Moving to]the States was an alternative. If that's not an alternative any more, that could allow whatever government is in power to push tax rates up without having to be afraid that they're going to lose [people]"
All good reasons why he believes wealthy investors should start or refresh their thinking about tax efficiency today, and start investigating strategies for minimizing taxes. "You want to try to anticipate [the changes]" Mr. Ireland says.
If you're not yet using a family trust, or a personal holding company, you should consider employing these strategies. If you're not yet utilizing customized insurance structures to shelter investment growth from tax, make it a priority to discuss such structures with your wealth adviser. These are perfectly legitimate, yet often overlooked, strategies that can save high-net-worth individuals tens or hundreds of thousands, or even millions in taxes over decades.
In addition, here are a few tax-savvy investments that have caught our attention recently:
Marret High-Yield Strategies fund: Run by Barry Allen, a 25-year veteran portfolio manager and one of the best corporate high-yield investors in the country. The fund pays distributions from its bond portfolio in the form of capital gains, via an innovative tax-swap mechanism, a feature that can cut a tax bill in half for those in the highest tax bracket. The fund can also short U.S. Treasury bonds, which we view as an essential profit-making feature in the months and years to come. Current yield is just shy of 8 per cent.
Mackenzie Sentinel North American Corporate Bond Class fund: This fund uses forward contracts linked to the Registered North American Corporate Bond fund to structure its monthly distributions as capital gains. Dan Bastasic, a 10-year veteran at Mackenzie, is at the helm.
O'Leary Canadian Income Opportunities fund: This closed-end fund invests in preferred shares, distressed debt and convertible securities. The portfolio should generate a good deal of its income in the form of tax-preferred dividends and likely some capital gains. Kevin O'Leary of CBC's Dragons' Den (one of the shrewdest investors I've ever met) heads the investment team.
Investors, especially high-net-worth ones, need to be more tax-intelligent about how their wealth is structured, as well as the investment efficiency of their portfolios going forward, or potentially pay substantially higher taxes in future.
Thane Stenner is founder of within GMP Private Client L.P., as well as Managing Director, Private Client. He is also bestselling author of ´True Wealth: an expert guide for high-net-worth individuals (and their advisors). He can be reached at firstname.lastname@example.org. The opinions expressed in this article are the opinions of the author and readers should not assume they reflect the opinions or recommendations of GMP Private Client L.P. or its affiliates.