Your client has follow-ed your advice. She has maxed out her RRSP, paid off the mortgage, bought appropriate insurance and has set money aside for emergencies.
Now she wants to invest additional cash toward retirement in a way that’s tax-efficient. Depending on your client’s time horizon, objectives and risk profile, there are several options:
> Corporate-Class Funds. With a corporate-class structure, each fund is a different class of shares within a corporation. For instance, Class A shares might be the Canadian equity fund, the Class B international equity. As a result, unitholders can switch from fund to fund without leaving the corporation and triggering taxes.
“In some ways, it’s similar to an RRSP, inasmuch as you’re moving things around without ever triggering a capital gain,” says Aurele Courcelles, senior specialist of tax and estate planning for Winnipeg-based Investors Group Inc.
The tax-deferred switching between classes also allows unitholders to grow their money faster, says Jamie Golombek, vice president of tax and estate planning at Toronto-based AIM Funds Management Inc.: “The tax-deferred effect of this compounding is very powerful.”
Another benefit of the corporate structure is that the family of funds is treated as a unit for tax purposes, requiring only one tax return, Golombek says. So, any losses in one class or fund can be set against gains in another, minimizing or eliminating the need to make capital gains distributions at yearend.
Corporate-class funds may also be available in T-series, which allow for tax-efficient monthly distributions. Distributions are treated as return of capital, which is not taxed but reduces the unitholder’s adjusted cost base. The upside is that there is no sale and a tax event is not triggered. The downside is that, with reduced capital, future growth is also potentially reduced. In addition, a declining ACB can lead to higher capital gains taxes down the road.
Not everyone is sold on the merits of the corporate-class strategy. “Corporate-class funds are good for the right person,” says Chris Reynolds, president of Mississauga, Ont.-based Investment Planning Counsel. “But they’re not the silver bullet everyone thinks they are.” His firm offers corporate-class funds, but Reynolds has some reservations.
He contends that if investors are utilizing proper portfolio management, there should not be a lot of switching from investment to investment. “Corporate-class funds actually encourage investors to switch,” Reynolds says. “If you construct a portfolio that’s a good buy-and-hold, capital gains-producing portfolio, you’re going to defer taxes anyway. As long as you don’t do a lot of trading, it’s as good as any other strategy.”
Another issue is that when all the money is eventually drawn out, a fairly large tax liability may remain. “There’s something to be said for paying taxes as you go,” Reynolds says. “If a client has already maximized his or her RRSP, paid off the mortgage, etc., the client more than likely will be in the same tax bracket in retirement as he or she is in now.”
That mitigates the benefits of tax deferral.
> Leverage. Some experts suggest that borrowing funds for investment is a solution for clients who have maxed out their RRSPs, have at least a 10-year time horizon before retirement, have high net-worth and can handle risk. Clients fitting that profile can take out a loan with a long amortization — say, 20 years — and deduct the interest paid on the money borrowed to invest.
“If you amortize over too short a period, your payments toward the principal are too high and you can’t get the full value of the tax deduction,” says Reynolds, adding that the strategy of borrowing to invest should be left to clients who have the discipline and disposition to handle it.
Other experts are more skeptical of the suitability of leverage as a strategy for most investors. “If you add leverage to the equation, you’re adding a whole other level of risk,” Golombek says. “It becomes a behavioural finance issue. If the market crashes, then all of sudden the investor wants out. Leverage, more than anything, can destroy the client/advisor relationship.”
But all agree that leverage should be used only to invest in a conservative portfolio with a long time horizon. “You can’t say, ‘I want my money in a year’,” Courcelles says. “You don’t want to open yourself to a short-term loss,”
@page_break@> Insurance. Another way to invest for retirement outside of an RRSP is by purchasing a universal or whole life insurance policy. These policies have an investment component, the cash value which accumulates over time, tax-free, until withdrawal. But the client has to have a need for insurance before choosing it as a way to invest, as there are costs and fees related to purchasing insurance.
It’s possible to overfund the investment portion of the insurance policy, allowing the policyholder to build up assets aggressively in a tax-deferred vehicle, either for the policyholder or to leave to the estate. Again, the time horizon is a factor in purchasing a policy for need and for investment, as there are surrender fees involved in withdrawing from the cash value in the first 10 years. IE
For well-heeled clients
Three strategies for building non-RRSP assets
- By: Rudy Mezzetta
- November 12, 2007 November 12, 2007
- 13:27