Tax planning is an important component of financial advice for both financial advisors and investors, but that focus tends to sharpen when there are signs of slower economic growth that could lead to lower or even negative investment returns.
“In a low-return environment … there is often a greater emphasis on taxes,” says John Natale, assistant vice president, tax, retirement and estate planning services, at Manulife Investment Management in Toronto. “If you can squeeze out a bit more on a return on an after-tax basis, it can make a big difference – especially over the long term.”
But it’s not just saving taxes that advisors and investors should focus on. Tax deferral is also important, Mr. Natale says. “By paying less in taxes now, you have that money working for you – and hopefully growing and compounding over time.”
Advisors can demonstrate their value to investors by discussing the tax strategies investors can take advantage of to improve their long-term financial well-being, he says.
Russell Investments Canada Ltd.’s 2019 Value of an Advisor Study, published in May, suggests that advisors will add 0.66 per cent in value from tax-efficient planning and investing to an investor’s portfolio – apart from investment gains – this year.
“Advisors have to take a holistic approach,” Mr. Natale says. “They have to look at the quality of the financial investment and all of the factors that go into that … [as well as performance] from an after-tax perspective.”
Here are five tax-saving and tax-deferral strategies that advisors should consider to help clients improve their financial well-being:
1. Realizing capital losses
Mr. Natale says he’s no stock picker and wouldn’t tell a client when to buy or sell a stock, but says there can be better times than others to let go of losing equities to realize capital losses to offset capital gains.
“I would review [the client’s] portfolio and look for potential opportunities, if it makes sense, especially before year-end,” he says, adding that capital losses must be applied first against any capital gains realized in the year, but any excess capital losses can be carried back for up to three years.
“You want to be strategic,” Mr. Natale says. “While some investors will want to carry back capital losses the full three years, if possible, before that [last] year falls off the table, others may want to carry them back to a more recent year – for instance, if they’re in a higher tax bracket that year and it will generate greater tax savings.”
2. Spousal loans
Some advisors recommend a form of income splitting through a spousal loan using non-registered assets to help reduce a family’s overall tax bill. The goal is to shift future investment income from the spouse earning a higher income to the one with a lower income to take advantage of that spouse’s lower marginal tax rate.
“Any investment growth is taxable in the lower-income spouse’s hand,” says Mr. Natale.
The strategy is best suited for couples in which one person earns a much higher income, he says. “It’s a cost-effective way to potentially generate fairly significant tax savings, especially over time.”
With a spousal loan, the Canada Revenue Agency prescribes a set interest rate every quarter, which is currently 2 per cent. The rules state the borrower spouse has to pay the interest by Jan. 30 of the following year.
Tannis Dawson, vice president of high-net-worth and business succession planning at TD Wealth Advisory Services, says investors have to make sure they pay their interest on time.
“If they forget to pay one year, then they’re offside ... and they can’t use it going forward,” she says.
3. Spousal registered retirement savings plans (RRSPs)
Spousal RRSPs allow married or common-law couples to save for retirement and split income to lessen their overall tax load.
Ms. Dawson says spousal RRSPs are gaining importance at a time when fewer workers receive company pensions.
Spousal RRSPs work best when the higher-income earning person contributes to the spousal RRSP and receives the tax break, which reduces the couple’s overall taxes in a given year. The contribution will count against the contributor’s own RRSP deduction limit, but the other spouse’s limit isn’t affected. What’s more, the other lower-income spouse can also contribute to their RRSP if their marginal rate is higher now compared to retirement.
The idea is to equalize retirement savings between both parties and allow the investments to grow tax-free until they’re withdrawn, Ms. Dawson says.
Setting up a spousal RRSP is also a good strategy for the lower-income spouse if they want to draw from their retirement savings before age 65 and don’t have their own RRSP.
“People thought because pension-income splitting came in [during the 2007 taxation year] that we don’t need spousal RRSPs, but that’s not necessarily the case,” she says.
4. Pension-income splitting
This strategy allows higher-income earning spouses to transfer up to 50 per cent of their eligible pension income to their lower-income earning spouses for tax purposes. This includes income from a registered company pension plan, except for Quebec provincial tax purposes. Couples can also split income from their registered retirement income funds, but need to be aged 65 or older to do so. Pension payments from the Canada Pension Plan, Quebec Pension Plan or Old Age Security Pension aren’t eligible for this particular form of pension-income splitting.
David Boyd, vice-president and portfolio manager with the Boyd Wealth Management Group at BMO Nesbitt Burns Inc. in Windsor, Ont., says pension-income splitting is a good strategy for couples looking to lower their overall tax bill in any given year.
Only one spouse can split their pension income in a particular year, but Mr. Boyd says it doesn’t have to be the same spouse or percentage of income that’s split each year.
“You can choose what’s best, depending on your personal circumstances,” he says.
5. Set up a family trust
Many parents set up trusts to control how the money is disbursed to their children and to help protect those assets from being lost in the event of a child’s divorce. But trusts can also help reduce taxes, Mr. Boyd says.
“You can do income splitting through a trust. In the right circumstances, you can spread income among family members who are taxed in a lower tax bracket, therefore reducing the family tax as a whole,” he says. “It’s a strategy that’s becoming increasingly popular.”
For investors who have a living trust, also known as an inter vivos trust, the cost of probate for any assets held in the trust can also be bypassed.