My good friend Don has been worried about his retirement savings. He visited a financial adviser and told her: “I’m going to be retiring soon. On Friday, in fact. And I haven’t saved a dime. Here’s your chance to become a legend.” Don was hoping for a lot from this adviser – who is only human.
The fact is, there are few guarantees when it comes to boosting your portfolio. Wouldn’t it be nice to add a guaranteed additional 1.5 per cent to 3 per cent annually to your after-tax investment returns? This is possible if you take steps to minimize the tax on your portfolio. The additional after-tax returns can actually be calculated in advance.
Want a simple example? If you’re in the highest tax bracket in Ontario and earn interest income of 3 per cent, you’ll pay more than half (1.6 per cent) of that in taxes. If you simply earn that return in a tax-sheltered environment – say, inside your tax-free savings account (TFSA) – you’ll create additional after-tax returns of 1.6 per cent on those dollars. Additional after-tax returns are guaranteed. Here are 10 strategies to consider, to increase your after-tax investment returns:
1. Carefully choose asset location. Asset location refers to the entity in which you hold your investments, and can include a registered plan, non-registered account, corporation, trust, foundation or partnership. Highly taxed interest income is best earned in a registered plan or other location that may offer tax sheltering, such as a corporation with losses to use up.
2. Determine which hands to invest in. Should you invest in your own name, or the name of a family member? Perhaps investing in the name of your lower-income spouse (by way of a spousal loan) or minor child (through an in-trust account) can save taxes. Be sure to avoid the attribution rules.
3. Consider cash-flow over income. If you need your investments to make ends meet, you need cash flow from your portfolio, but not necessarily income. Income, such as dividends or interest, is generally taxable. Cash flow, on the other hand, may not be taxable if it comes in the form of a return of capital, or just partly taxable if it’s a systematic withdrawal plan in which you draw money from a growth-oriented investment (you’d pay tax on realized capital gains at half the rates of interest income as you liquidate the investment).
4. Defer tax on capital gains. Since we’re in the last half of the year, you may want to think twice before selling any investments that have appreciated in value. Deferring a sale until early next year will defer tax on any capital gains for a full year.
5. Utilize capital losses. If you’re going to realize capital gains, consider selling other assets that may have dropped in value to create losses to offset those gains, or use capital losses carried forward to shelter those gains.
6. Transfer capital losses where appropriate. It’s possible to transfer your unrealized capital losses to your spouse. This can make sense if you’ve got losers in your portfolio and your spouse has capital gains against which to apply the losses. Check out my article dated Sept. 28, 2017, on how to do this.
7. Minimize portfolio lock-up. If you hold on to an investment for a long time, you may be hesitant to sell it as the capital gain grows. This is called portfolio “lock-up.” You can avoid this problem by, for example, periodically triggering capital gains (and then reinvesting, even in the same investment) when you can offset those gains with losses, or if you go through a period of unusually low income.
8. Watch the rebalancing trigger point. When you rebalance a portfolio, you may trigger capital gains as you sell off assets that have become overweighted in your portfolio. The trigger point for rebalancing should be different (it might be sooner) in a registered plan where taxes won’t apply when rebalancing, and in a non-registered account where taxes may apply.
9. Diversify without triggering tax. If your portfolio becomes too concentrated in a single security or asset class, you can diversify without selling off your winners (and triggering tax) by, for example, borrowing to invest in different assets, where borrowing makes sense for you.
10. Avoid the superficial-losses rules. If you sell an investment at a loss, that loss could be denied where you acquire the same security in the period that is 30 days following, or 30 days prior to, the sale. Be careful so that you don’t inadvertently trigger the superficial-loss rules.
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.