My wife and I are in our early 70s and have significant unrealized capital gains in our joint investment account. Is it advisable for us to cash in our gains now and pay the tax, or should we wait until we both die, when others will do it for us? The purpose of selling now would be to minimize the significant amount the Canada Revenue Agency will demand from the executor of our estate. We would then reinvest the net proceeds into similar dividend-paying stocks to continue financing our retirement lifestyle. We could repeat this exercise again in 20 years if luck is still on our side.
I can understand why you might see some merit in triggering capital gains now instead of waiting until you’re gone. Even though only half of capital gains are currently included in income, your estate could potentially end up paying a big chunk of tax at your highest marginal rate if all of your accumulated gains land on your final tax return at once.
However, in most cases, it’s still better to wait.
“This is a classic question,” Jamie Golombek, head of tax and estate planning with CIBC Private Wealth, said in an e-mail.
“The short answer is that it rarely makes sense for tax reasons alone to crystallize capital gains and voluntarily pay tax today, versus paying it down the road – especially if your intention is simply to buy back the same stocks.”
There are several reasons that waiting could be more advantageous. One key consideration is that, depending on how long you and your spouse live, it could be decades before the gains in your portfolio are taxed.
When someone dies, the “deemed disposition” rules of the Income Tax Act treat the person’s assets as if they were sold and the capital gains realized. However, couples get a break in this regard: If the shares are left to a surviving spouse or partner, he or she can take ownership of the assets at their original cost base, which defers the capital gain until the spouse dies or sells the shares.
“So, unless you need the capital from the sale of the stocks to fund your retirement lifestyle (versus living on the dividend income from those stocks), deferring the realization of the capital gains as long as possible can make sense – assuming you’re comfortable with the stock selection itself,” Mr. Golombek said.
It’s also important to consider the potential reduction of government benefits if you were to trigger capital gains, which would increase your income while you are alive.
“You really need to compare your marginal effective tax rate today to the expected rate in the year of death, taking into account the fact that if you realize capital gains in any particular tax year, this may result in a loss of income-tested benefits – such as Old Age Security, the Guaranteed Income Supplement or the age amount credit – in those years, which could result in a higher marginal effective tax rate,” Mr. Golombek said.
Another important consideration is that, if you trigger capital gains early and pay the tax, you will have less net capital available to invest, potentially for many years. This will not only cut into your dividend income while you are alive, but will also very likely reduce your portfolio’s growth and the eventual value of your estate.
Whether the tax savings will make up for the lost investment opportunity depends on many factors, including your current and future tax rates, your portfolio’s rate of return and how long you and your wife live, Mr. Golombek said. Any increase in the capital gains inclusion rate – which was one of the New Democratic Party’s campaign proposals – would figure into the decision as well.
Mr. Golombek suggests that you meet with a financial professional who can crunch the numbers based on your ages, incomes, rates of return, size of your estate, health and predicted longevity to see whether paying some tax prematurely makes sense for you.
“In my experience, it rarely does,” he said.
I have been considering simplifying my portfolio by reducing the number of stocks I own and transitioning into more exchange-traded funds. I have looked at several, such as iShares Core Growth ETF Portfolio (XGRO), BMO Growth ETF (ZGRO) and Horizons Growth TRI ETF Portfolio (HGRO), each of which is essentially a “fund of funds.” The quoted management expense ratio for these ETFs is quite low, but I wonder if the quoted figure also accounts for the MERs of the underlying funds?
When you invest in an ETF that holds other ETFs, you pay only the MER of the fund you own directly. Securities laws prohibit fund companies from double-dipping on expenses.
As an example, XGRO holds eight other stock and bond index ETFs, with MERs ranging from 0.03 per cent to 0.22 per cent. You would only pay XGRO’s own MER of 0.20 per cent, which includes the fund’s annual management fee, administrative costs, marketing, taxes and other expenses.
E-mail your questions to email@example.com. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.
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