After I published my last Q&A column a few weeks ago, I was deluged with new questions from readers, covering a wide range of issues. Here are some that I found to be of special interest.
Q – I’ve read not to buy mutual funds before year-end to avoid paying tax on capital gain distributions. Does the same caution apply to buying REITs in December? – T.J.
A – No. The problem with mutual funds is that many make only one capital gains distribution per year, in December. That amount can sometimes be significant and the tax implications costly.
For example, suppose you buy 100 units of a fund for $10 each in early December. The company then announces a capital gains distribution of $2 per unit two weeks later. You receive the distribution, but the net asset value (NAV) of your unit drops by the same amount to $8. You still have $1,000 in assets, but now it is divided between $200 cash and $800 in fund units. And the $200 distribution is taxable if received in a non-registered plan.
REITs make payments monthly, so the cash flow is spread out evenly over a full year. This is a very different scenario from mutual funds, so the same caution does not apply. – G.P.
Q - My question is about convertible debentures. I think they often get overlooked by investors and investment advisors. Can you recommend any ETFs that might be added to a self-directed RRSP? – Jerome D.
A – There are two Canadian ETFs that are worth looking at.
The first is the iShares Convertible Bond Index ETF (CVD). It has been on the Recommended List of my Income Investor newsletter since September 2014 and shows a three-year average annual rate of return of 4.9 per cent to Oct. 31. The second is the First Asset Canadian Convertible Bond ETF (CXF), which has a slightly better three-year record at 5.5 per cent annually. However, it has not done as well as CVD so far in 2018.
If you want to cast your net farther, consider the U.S. iShares Convertible Bond ETF, which trades on the BATS exchange under the symbol ICVT. It invests in U.S. dollar denominated convertibles with outstanding issue sizes of more than $250 million. Among the top companies in the portfolio are Microchip Technology Inc., Tesla Inc., Dish Network Corp., and Twitter Inc.. This fund’s three-year average rate of return to Oct. 31 was 9 per cent. Year-to-date (as of Nov. 15), the fund has gained 3.2 per cent. – G.P.
TFSA has not done well
Q - I have a TFSA and have contributed the maximum allowable since inception ($57,500). I have used this account to invest in higher risk/higher beta holdings in my overall portfolio, preferring to have interest bearing investments in my RRSP and dividend paying securities held in my cash account to allow me to benefit from tax advantages for capital gains and dividends.
Unfortunately, while I have had some winners in my TFSA portfolio, I have generally had investments held there which have not panned out as well as I would have liked. I know I cannot write off capital losses incurred in the TFSA against income or against capital gains generated in my cash account, but here is my question.
If I liquidate all assets and withdraw all funds in the TFSA, effectively closing the account (proceeds would be about $40,000), and if I waited until the following calendar year, would I be entitled to contribute to a new TFSA an amount equal to the lifetime contribution limit (currently $57,500 plus amounts for 2019 and beyond as they become available) since I would have no other TFSA investments. Or would my contribution limit be capped at the amount I withdrew plus any future years' contribution limits for 2019 and onward? – Mark C.
A – You would only be allowed to contribute the amount you withdraw plus the 2019 contribution limit (which will likely be bumped to $6,000 due to inflation).
Check out the Canada Revenue Agency’s contribution rules.
You will see that you are limited to the current annual limit plus withdrawals made in the previous year and any unused contribution room you may have. The key word is “unused.” You used all your contribution room over the years. Closing the TFSA does not change that. – G.P.
Q – This coming spring I will be turning 71 and need to consider options in moving to a RRIF in 2019. To avoid having to make taxable withdrawals from a RRIF in 2020, may I use my partner’s younger age (63) to defer setting up a RRIF until she turns 71 in 2026? If this is possible, how do we do it? – M.C.G.
A – You can use your younger partner or spouse’s age in determining the minimum amount that must be withdrawn from a RRIF each year, but not in deferring withdrawals.
Here’s how it works. At the time the RRIF is created, you elect to have your partner’s age apply for purposes of calculating the annual minimum. This is the only opportunity to do this.
Let’s suppose the RRIF has a balance of $100,000 on Jan. 1, 2020. You will be 71 on that date so if your age was used, the minimum withdrawal that year would be 5.28 per cent or $5,280. However, if you use the age of your partner, and we assume she will be 64 on Jan. 1, 2020, that would reduce the minimum withdrawal to 3.85 per cent, or $3,850.
This action would reduce the amount of money you receive annually from the plan, thereby cutting your tax bill. – G.P.
Q – My wife is a dual citizen of the U.S. and Canada. Every year we have to hire an accounting firm to report to the IRS because she owns a TFSA in Canada. Should we just sell the TFSA to avoid this intrusion of the IRS into our lives? We pay more to the accounting firm to do our taxes than we generate in returns from our TFSA. – Allan C., Ottawa
A – Unfortunately, your wife is legally required to file a U.S. tax return, whether or not she has a TFSA or any other income to report. This is a requirement of all U.S. citizens, no matter where they live, and the IRS has been cracking down on non-filers. Consider the fee paid to the accounting firm as an insurance policy to keep the IRS off your back, which I can assure you is a very unpleasant experience.
You might ask them if collapsing the TFSA would reduce your preparation fee. I doubt it but it’s worth posing the question. – G.P.
Q - What asset distribution would you recommend for my wife and I. We are retired at the age of 65. Beyond CPP and OAS, we collect $1,800 per month in a pension and have $550,000 in RRSPs plus $300,000 in cash savings. – Bill Z.
A - At your age, the textbook formula is to err on the side of caution and protect your assets. That suggests an asset mix of 55 per cent-65 per cent fixed income, 25 per cent-35 per cent equities, and the balance in cash. Based on your question, you already have at least 35 per cent of your money in cash, so you’re really asking what to do with the RRSP investments.
The answer to that depends on your lifestyle and whether you are content with drawing down your cash balance if you need extra income. If you are okay with that, then I suggest that 70 per cent of your RRSP assets be invested in low-risk, income-generating securities. These would include preferred shares, REITs, and blue-chip dividend paying stocks, like banks and utilities. Invest the rest of the RRSP in fixed income securities.
Your total asset mix, including your cash holdings, would then be 45-per-cent equities, almost 20-per-cent fixed income and about 35-per-cent cash.
I would note that your cash is on the high side. You can get a better return on that money by investing all but the amount you’ll need over the next year in laddered GICs. – G.P.
If you have a money question you’d like answered, send it to me at email@example.com. Please write “Globe Question” in the subject line. I can’t guarantee a personal response, but I’ll do my best.
Gordon Pape is Editor and Publisher of the Internet Wealth Builder and Income Investor newsletters.