Throughout his career, Robert Gorman has worked with clients who are wealthy and those who aren’t. For anyone wondering whether the rich are different from you and me, he has an answer: When it comes to strategies in retirement, yes.
Put simply, most retirees have a narrow definition of risk, says Mr. Gorman, who is the chief portfolio strategist for TD Waterhouse.
“Most folks draw what I call a mental line in the sand when they retire,” he says. They worry about keeping their capital intact but do so on decidedly nominal terms. They might invest in guaranteed investment certificates, for example, which are low in risk and returns.
The rich, on the other hand, will consider investments more broadly, factoring in the impact of inflation and taxes. Faced with GICs that have a 2-per-cent return, Mr. Gorman says, wealthy investors know that the interest will be offset by inflation, also at 2 per cent, and that GICs are taxed as income, the highest tax rate.
In other words, he says, wealthy investors will figure out that if they buy the GICs, “they will be net losers.”
While most retirees worry about whether they have enough money and how to make it last, a growing number of high-net-worth people struggle with their own set of issues. Should they work on expanding their wealth or just preserving it? And which tax and investment strategies can help them meet their goals?
The first major advantage of people who have more than enough assets to fund their retirement is a long investment time horizon, says Jon Palfrey, the Vancouver-based senior vice-president of private clients and foundations at asset management firm Leith Wheeler Investment Counsel Ltd.
They have enough assets to cover their income needs for life, so they don’t have to worry about short-term returns. They focus on the future instead, thinking about how their assets can benefit future generations or charities.
Generally, Mr. Palfrey says, that means they can build portfolios with a greater weighting of equities. The advantages there include “tax advantages with dividend tax credits and how capital gains are taxed compared to savings, deposits, interest-bearing investments and everything else,” Mr. Palfrey says.
The tax rates for capital gains and dividends are roughly half those of ordinary income, he says. The other advantage to dividends is that, currently, dividend yields are higher than bond yields.
Betty Tomsett, the Toronto-based director of wealth management at Richardson GMP Ltd., says wealthy investors who are retired should think twice before increasing equities in their portfolios because of the economy and “the serious bear market right now.”
Her advice? A conservative asset mix. “Protecting the capital now ensures you have funds to go shopping with later” when the market improves, she says.
She points out that Ontario investors in the highest marginal tax bracket are subject to tax hits of about 24 per cent for capital gains, 32 per cent for dividend income and 48 per cent for interest income. Of these, dividend income is the most attractive – the hit on capital gains may be lower but holding additional equities in this market carries too much risk, she says.
Investors should also consider structured products in the fixed-income area that pay out “return of capital” – which would be taxed as capital gains – or corporate class mutual funds, which allow you to switch from one fund to another within a company without incurring a tax penalty, Ms. Tomsett says.
For Mr. Gorman of TD Waterhouse, the current financial markets are unusual historically, so a lot of the old rules need to be set aside for now. Typically, he says, the stream of income you receive from fixed-income investments such as bonds is greater than that from dividend stocks. He cites the example of 10-year Government of Canada bonds, which historically have had a higher yield than dividends for the big five banks. Today that GOC 10-year bond yield is close to 1.8 per cent; Toronto-Dominion Bank’s dividend is 3.7 per cent, and that’s the lowest of the big five.
Add in the tax advantages of dividend income, and Mr. Gorman believes that investors should build a portfolio heavily weighted in dividend stocks.
In addition to asset mix, Mr. Palfrey says his firm also advises clients on how to structure their assets to minimize taxes. Among the strategies is owning assets jointly with a spouse with right of survivorship “so you can avoid probate and pass your assets to your spouse and avoid issues if someone becomes incapacitated.”
Other strategies include deferring capital gains where possible – for example, by maintaining a low turnover in your portfolio or by not realizing gains in highly taxed years.
Mr. Palfrey also suggests putting highly taxed securities in tax-sheltered investments – bonds in your registered retirement savings plan, for instance – and setting up trusts for your spouse, children or other family members.
Jason Safar, a Mississauga-based tax specialist at PricewaterhouseCoopers LLP, describes two basic types of trusts as “goal posts.” One type of trust is well defined and outlines who gets how much of the income generated by assets and who the beneficiaries of the assets eventually are. The other is more discretionary, with all decisions made by trustees.
Most trusts, he says, fall somewhere between those goal posts.
The advantages to trusts, Mr. Palfrey says, are income-splitting or using them to help with capital-gains exemptions.
Some provinces impose surtaxes on high incomes, Mr. Safar says. Ontario, for instance, recently brought in a new tax on those earning more than $500,000. If you’re in that tax bracket, he says, it may pay to set up a corporation for your assets instead of holding them personally.
But for all the options available to help wealthy clients, the most important decision involves answering one question: “If you have enough money to live comfortably, what’s going to happen to the rest?”
The options, he says, are give it to charity or to family – either now or later.
Make those decisions, he says, “and then you can drill back into tactics.”
Paying by province
Where you live in Canada makes a big difference on how much tax you pay. Here are a few combined federal-provincial tax rates for 2012, by province:
If you live in B.C., you pay:
- 43.7% on ordinary income
- 21.9% on capital gains
- 25.8% on eligible dividends
If you live in Alberta, you pay:
- 39% on ordinary income
- 19.5% on capital gains
- 19.3% on eligible dividends
If you live in Ontario, you pay:
- 48% on ordinary income
- 24% on capital gains
- 31.7% on eligible dividends
Source: PricewaterhouseCoopers LLP
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