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“Asset allocation” can mean lower tax rates…and you keep more money for your future
Capital gains and dividends have a lower tax rate,
and income in your RRSP is tax sheltered until you withdraw;
usually at a lower tax rate in retirement
(This article discusses financial issues and uses fictitious names of people for illustrative purposes.)
During this time of year, like most
investors, Steve and Rhonda Baker do quite a bit of thinking about the
taxes they will have to pay.
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Adena Franz
Portfolio Manager
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When we last visited with the Bakers, they were discussing their
strategy of directly donating securities to registered charities in
order to reduce their taxes. This is not the only method Steve and
Rhonda use in order to shrink their tax bill. They have been
investing since their early 20’s and have made the maximum
contributions to their RRSP each year and also invest in a taxable
investment account. Their goal, subject to acceptable levels of risk,
is to maximize their return from these investments. This by necessity
implies a need to minimize the government’s share of the wealth
their investments produce. With the help of their money manager, they
have become quite savvy in finding such strategies.
The Bakers have planned well for their early retirement. They
have plans to celebrate their withdrawal from the workforce by
travelling to Europe with friends. “We have big plans for our
retirement,” says Steve, “we want to travel and take scuba
diving lessons, but we still have our son to support while he finishes
school. We want to be able to do these things without worrying that we
will run out of money. So, we have to keep as much of our money
in our own pockets as possible.”
“One of the easiest ways to do that,” interjects Rhonda,
“is to avoid paying too much in taxes. Some people seem to ignore
tax avoidance strategies in the belief that high returns on their
investments are the only relevant concern in building a nest egg.
Our advisor convinced us long ago that we should be concerned about the
after-tax return on our portfolio. We want to minimize the tax we pay
and delay tax payments as long as possible.”
Steve and Rhonda sat down with their money manager and selected assets
to provide a reasonable level of diversification. As well, the
Bakers know that different tax rates and regulations apply to different
types of income and, with the advice of their money manager, they were
able to use this information to lessen their tax burden through a
strategy called “asset allocation”. An asset
allocation strategy involves dividing your predetermined investment
portfolio into tax-sheltered and taxable accounts, in order to delay
and reduce your tax payments. “We learned that fixed income
investments such as bonds, term deposits and GICs yield interest income
that is taxed at our marginal tax rate,” Rhonda explained,
“and since we are in the highest tax bracket (48.22% in Quebec),
these would be our most highly taxed investments. Our advisor suggested
that we defer payment of these taxes by allocating a percentage of them
to our RRSP. As we’ll be earning less during retirement, we
will likely be taxed less on them. In the meantime they are accruing
interest, tax-free.”
The majority of the Baker’s holdings are equity-based, and
dividend income from equity-based investments (capital gains and
dividends) are taxed at lower rates. They will have a percentage
of these investments in non-registered accounts. “We still
have methods of saving taxes on these, even if they are outside our
RRSP.” Steve said, “Capital gains, unlike other forms of
investment income, provide the possibility of tax deferral, since they
are only taxed when the investments are sold, and even then, they are
taxed at half of the rate imposed on interest income. In Quebec
the highest marginal tax rate on capital gains is 24.11%. As well, if
there are capital losses on any of these investments, it can be used to
offset capital gains, provided they are held outside your RRSP.
The other source of income from equities, dividends, is also taxed at a
favourable rate (29.69%) in comparison with interest income.”
The usefulness of this strategy requires that an investor have both a
tax sheltered (RRSP) and taxable accounts. The gains from this strategy
depend on the investors financial profile, the prevailing tax laws and
the type of assets in the investors portfolio. “Luckily, we have
had our money manager to advise us in the use of this strategy.”
says Steve, “I don’t know where we would be without
her.”
Adena Franz
is a Vice President and Portfolio Manager at MacDougall MacDougall
& MacTier Inc. She can be reached at 514-394-3771. The information
contained in this article is for general information purposes only. It
does not account for specific investment objectives or the financial
situation of any person reading it. Opinions expressed are those of the
author and do not necessarily represent the opinions of MacDougall,
MacDougall & MacTier Inc. Investors should seek professional advice
regarding the appropriateness of investing in any securities discussed
or recommended here and should recognize that statements regarding
future prospects may not be realized.
 MacDougall, MacDougall & MacTier Inc.
The Franz Group
1010 de la Gauchetiere Ouest, Suite 2000
Montreal, Quebec H3B 4J1
www.3macs.com
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