Q. My spouse and I are not too long ago retired and have a portfolio of about $2 million in dividend paying shares, pipelines, utilities and a few exchange-traded funds (ETFs) monitoring Canadian and U.S. excessive dividends shares in addition to S&P 500 and world fairness shares. We even have $900,000 in assured funding certificates (GICs) and high-interest financial savings accounts (HISAs). We’re additionally lucky to have outlined profit pension plans and annuities producing about $100,000 in revenue per 12 months. My query is, what ought to I be doing with our investments at this level? We gained’t seemingly ever spend all this cash. We have now two very profitable sons and 5 grandchildren. We’d wish to pay much less tax however who wouldn’t? Any ideas can be useful. —Thanks, Paul
FP Solutions: In case your objective is lowering your annual tax invoice, Paul, you could profit from a method that makes use of asset location to information asset allocation. Asset location refers to holding investments in several types of accounts based mostly on how they’re taxed to shelter sure forms of revenue.
In your case, nevertheless, you didn’t point out holding registered retirement financial savings plan (RRSP) property, which isn’t unusual for retirees with massive outlined profit pension plans. With out registered accounts, conventional asset location methods turn into considerably much less related if most of your investments are in taxable accounts. Usually talking, asset location tends to favour the next construction:
- Excessive-interest financial savings accounts and GICs are the least tax-efficient investments in non-registered accounts as a result of curiosity revenue is taxed at full marginal tax charges.
- Canadian dividend-paying shares are usually extra tax environment friendly in non-registered accounts as a result of dividend tax credit score, resulting in a lowered tax charge on Canadian dividends versus different revenue.
- U.S. dividend-paying shares generate international revenue, which can be taxed at full marginal tax charges like curiosity.
- Non-registered accounts profit from the preferential taxation of capital beneficial properties, together with the flexibility to offset beneficial properties with capital losses.
- U.S. shares held in a tax-free financial savings account (TFSA) are topic to a 15 per cent withholding tax on dividends, which isn’t recoverable.
Primarily based on these dynamics, your GIC holdings are seemingly the least tax-efficient a part of your portfolio. That mentioned, that is considerably by design. Usually talking, the extra certainty an funding gives, when it comes to revenue or capital, the extra seemingly its revenue will likely be absolutely taxable. Pension revenue is an effective instance. Whereas pension revenue is much less tax environment friendly than Canadian dividend revenue, the trade-off is the safety and predictability that comes from many years of contributions and deferred tax financial savings throughout your working years.
With roughly $2 million invested in world shares and $900,000 in money equivalents, your total portfolio allocation is roughly 70 per cent shares and 30 per cent money or money equivalents. Portfolios on this vary are usually thought-about balanced progress or growth-oriented portfolios.
As a result of we should always not let the tax tail wag the canine, it could not make sense to shift GICs into shares solely for tax benefits if taking over further threat is pointless. In truth, holding a significant money allocation has turn into more and more common in recent times. Many buyers have most well-liked money over conventional bonds, notably after world bond markets skilled double-digit declines in 2022. HISAs and GICs even have rates of interest which are akin to bond yields presently.
Reviewing your annual spending wants ought to assist decide whether or not portfolio changes are vital for sensible money stream functions or just to enhance tax effectivity. However your reference to “dividend paying shares” deserves some consideration. If you’re biased towards shares that pay dividends, you’re incomes extra of your return from revenue taxable yearly versus capital progress. Holding a inventory that pays a decrease dividend that will earn extra of its return from inventory worth appreciation over time could also be extra tax environment friendly. Particularly if you’re a buy-and-hold investor residing largely off your pensions.
Tax planning for retirees typically entails balancing the advantages of realizing taxable revenue immediately in opposition to leaving deferred taxes to the property afterward. Rebalancing a non-registered portfolio steadily entails triggering capital beneficial properties or losses, so bettering portfolio effectivity may imply step by step addressing unrealized beneficial properties over time.
One method is a partial “meltdown” technique, the place capital beneficial properties are deliberately triggered annually to scale back the longer term tax burden on the property. In case your unrealized beneficial properties are substantial, it could take a number of years to reposition the portfolio with out materially rising annual taxes.
Extra tax effectivity may be potential relying on how funding revenue is cut up between you and your spouse. In case your investments are collectively owned and revenue is already being reported evenly, notably in case your pension incomes are additionally comparable or eligible for pension revenue splitting, you’re seemingly already working pretty effectively from an income-splitting perspective.
If one partner has materially decrease revenue, nevertheless, it could make sense for that partner to reinvest their after-tax revenue into accounts held beneficially in their very own title, whereas the higher-income partner assumes a higher share of family bills with withdrawals from their accounts.
Because you talked about that you’re unlikely to spend your entire property, another choice is to deliberately improve spending throughout retirement. Doing so naturally reduces future property worth whereas permitting you to take pleasure in extra of your wealth throughout your lifetime.
You would additionally contemplate gifting funds to your grownup youngsters, which typically doesn’t set off any tax points in Canada aside from tax on capital beneficial properties. A present itself just isn’t taxable, nevertheless. Helping with registered training financial savings plans (RESPs) or in-trust accounts to your grandchildren may assist assist future training or monetary targets if that has not already been explored.
Lastly, charitable giving stays one of the efficient methods to scale back taxes in retirement. Donations generate precious tax credit and donating appreciated securities straight will be particularly tax environment friendly. By transferring securities in sort you’ll be able to keep away from triggering capital beneficial properties tax whereas nonetheless receiving a charitable receipt for the complete market worth of the donation.
General, your state of affairs seems much less about maximizing returns and extra about balancing tax effectivity, property planning, household targets and private consolation with threat — which is a lucky place to be in, Paul.
Andrew Dobson is a fee-only, advice-only licensed monetary planner (CFP) and chartered funding supervisor (CIM) at Goal Monetary Companions Inc. in London, Ont. He doesn’t promote any monetary merchandise by any means. He will be reached at adobson@objectivecfp.com.
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