A few years ago, Prof. David Weale, at the University of Prince Edward Island, was teaching an overcrowded class. So, he offered a grade of 70 per cent to any students who would just go away, as long as they paid their tuition. As it turned out, about 20 of the 95 students accepted the offer. Mr. Weale was later suspended by the university. Pretty low – the grade Mr. Weale offered, I mean. His conduct? Perhaps that was low, too (although Mr. Weale didn’t regret his approach to dealing with chronic overcrowding – which evidently worked).
If you were to ask Bank of Canada Governor Stephen Poloz how low one can go, he’d likely tell you at least 0.75 per cent. I’m talking about interest rates, of course. Last week, the Bank of Canada reduced the overnight rate by 50 basis points, to 1.25 per cent, and announced another surprise 50-basis-point cut on Friday.
Low interest rates can mean good news for taxpayers. Here are five ways you might benefit as interest rates decline.
1. Loans to your spouse
If you’re in a higher tax bracket than your spouse, consider lending your spouse money to invest. If you charge your spouse the prescribed rate of interest on the loan, then the attribution rules (which can cause you, and not your spouse, to pay tax on any income on the loaned funds) won’t apply. The prescribed rate is currently just 2 per cent – which you can lock in indefinitely on the loan.
The prescribed rate is based on the average 90-day T-bill rate for the first month of the prior quarter (rounded up to the nearest per cent), so we know it will remain at 2 per cent for the second quarter of 2020. And it could be even lower for the third quarter. You could make a spousal loan today, then repay it and advance a new loan at the lower rate.
2. Employee and shareholder loans
Consider borrowing money from your employer if possible, or from your own corporation. You see, you may be able to borrow at no or low interest. Sure, you'll face a taxable interest benefit at the prescribed rate, which is already low. If that rate drops in the near future, your taxable benefit will be reduced as well. Your taxable benefit will also be reduced by any interest you actually pay on the loan. Further, if you use the loan for investment purposes, or to buy a vehicle for use in your employment, you'll be entitled to a deduction for the amount of the interest benefit. The rules around shareholder loans are complex, so talk to a tax pro if you're in this boat.
3. Borrowing to invest
If you borrow money to invest, you can generally deduct the interest costs – and tax deductions are in short supply for most. As interest rates fall, it becomes easier to profit from borrowing to invest because your break-even rate of return declines as well. Now, I understand that some people will shudder at the idea of borrowing to invest when markets are in such turmoil. But keep in mind, there comes a point where declining markets present a buying opportunity. Further, borrowing to invest should always be done prudently, starting with a long-term time horizon, which can soften the impact of short-term volatility. Borrowing to invest is not for everyone. Check out my articles from Jan. 14, 21 and 28, 2016, at www.globeandmail.com for more on the myths, rewards and risks of borrowing to invest.
4. Borrowing for your RRSP
It’s time to think about contributing to your registered retirement savings plan (RRSP) for 2020. If you have significant unused RRSP contribution room, and you’re behind in saving for retirement, it could make sense to take out an RRSP catch-up loan to make a contribution. Most banks will lend you money at prime rate to contribute to your RRSP, so use of the money is pretty cheap.
5. Refinancing your debt
If interest rates continue to fall, it could make sense to refinance your debt at lower rates. In the case of a mortgage, there may be a penalty involved but, even then, there have been cases where the interest savings from refinancing could leave you better off. And if you happen to have non-registered investments available, consider liquidating some investments, paying down some of your debt, then reborrowing at lower rates to replace your investments. You’ll be able to deduct the interest costs on the new debt, which will save you tax dollars.
Tim Cestnick, FCPA, FCA, CPA(IL), CFP, TEP, is an author, and co-founder and CEO of Our Family Office Inc. He can be reached at firstname.lastname@example.org.