Archive: Personal Finance/ Estate Planning

Effect of Holding Companies on Split Income

income

In 2017, new rules were introduced limiting the use of income splitting which allowed people the ability to income split with family members. The new rules were called Tax on Split Income (‘TOSI”). TOSI applies to situations where a family member has not contributed or worked in a family business and is applicable depending on age. For family members under 18, income splitting is restricted. The rules are less restrictive to family members 18-24 years old and less restrictive still for family members over 24 years old. There is also a special exclusion for those whose spouse is 65 years or older and was active in the business.

The details of the rules are beyond the scope of this article. However, we would like to highlight one corporate structure that has unexpectedly been caught in these rules: a structure where an operating company is owned by a holding company, the holding company is owned by an owner/operator and his/her spouse and adult children (over 25 years old), and the family members are not active in the business.

There is a special exclusion from TOSI dividends known as “Excluded Shares”. Excluded shares are defined as a corporation that is owned by the taxpayer where the following conditions are met:

  1. It is NOT a professional corporation.
  2. Less than 90% of the business income from the most recent fiscal year is from the provision of services.
  3. The individual taxpayer owns 10% or more of the votes AND 10% or more of the value of the company.
  4. 90% (all or substantially all) of the income of the corporation does NOT come from other related businesses.

The rules state that even if the 10% shareholding test is met, holding companies do not meet the test of Excluded Shares for a few reasons.

Firstly, they earn no business income. As per “b” above, it states that less than 90% of the business income is from the provision of services. CRA interprets this to mean that the corporation must have business income in the first place and that 90% of that business income is not from services. If a holding company only earns dividends from its subsidiary and/or investment income on its assets, it earns no business income and will therefore not qualify as an excluded share.

If the Holdco earns fees from the operating company so as to earn business income, the test in “d” would be a problem. The business income must come from a non-related business.

Bottom line is that having a holding company can be a problem to avoiding TOSI.  Seek the advice of your advisor to determine your exposure to TOSI and tax planning options.

Contributed by Howard Wasserman, CPA, CA, CFP, TEP from Segal LLP, Toronto. This piece was produced as a part of the quarterly Canadian Overview, a newsletter produced by the Canadian member firms of Moore Stephens North America.

This article is from the quarterly Canadian Overview, a newsletter produced by the Canadian member firms of Moore Stephens North AmericaThese articles are meant to pursue our mission of being the best partner in your success by keeping you aware of the latest business news.

5 Things To Ask Your Accountant When Facing a separation or divorce

divorce

Separation and divorce are becoming more and more common in our society. It is important to consult and include your accountant in your divorce or separation proceedings since there are important financial and tax considerations that must be considered. Failing to do so may result in either an immediate tax burden or one that will appear a few years later.

Here are important issues to discuss with your accountant:

1. Spousal and Child Support

Spousal and Child Support and two separate forms of support. The first is paid to support the spouse and the other for the children as the wording implies. It is important to itemize your Separation Agreement to distinguish both child and spousal support. This is because spousal support is considered a tax deduction to the payor (the person actually paying the other spouse), and taxable income to the payee (the spouse receiving the support). Child support, however, does not have any tax ramifications.

Also, the tax implications may differ for both parties if an amount is paid on a periodic basis or as one lump-sum.

Your accountant can advise you on how to structure your support.

2.  Canada Child Benefit (CCB)

CCB is calculated based on the adjusted family net income. Therefore, both parents’ income is considered by the Canada Revenue Agency (“CRA”) to calculate the CCB.

In the event of a divorce or a separation of more than 90 days, it will be important to advise CRA as soon as possible of the change in marital status which will change the adjusted family net income and therefore change the CCB payments.

In order to be able to balance your budget post-separation or divorce, you should consult with your accountant to determine what each parent will be receiving in CCB.

3. Capital Gains Tax

When a couple is negotiating a possible sale of their former family residence during their divorce proceedings, they may need to consider capital gains tax following the sale. Different factors must be considered, such as when the home was purchased, and how much equity the parties have accumulated in the property since they have lived there. Your accountant should be able to advise you regarding whether or not you need to be concerned with capital gains tax and what you can do to plan around it.

4. Cashing Out Retirement:

Many times, one spouse intends to cash out their retirement account in order to buy another spouse out of a different asset. There are commonly tax consequences to transactions like these, and the couple should speak to their accountant about how to avoid negative tax ramifications.

5. Trading Assets:

There are often many different types of assets involved in a separation or divorce mediation. People own real estate, investment property, stocks, bonds, retirement and investment accounts, pensions, antiques, and more. Because of how diversified some people’s investments are, it is important to consider that all assets are not created equal. Some retirement accounts, for example, are pre-tax and some are post-tax. Therefore, if someone gets a home with $100,000 in equity and the other gets a retirement account that will be taxed when they take the money out that is currently worth $100,000, these assets may not be worth the same. This depends on the specific tax consequences that flow to each individual asset. It is important to also take into account the hidden tax costs that may be associated with an asset that will be transferred in a divorce proceeding.

Contributed by Valérie Marcil and Carl-Philippe Finn-Côté from Marcil Lavallee. This piece was produced as a part of the quarterly Canadian Overview, a newsletter produced by the Canadian member firms of Moore Stephens North America.

This article is from the quarterly Canadian Overview, a newsletter produced by the Canadian member firms of Moore Stephens North AmericaThese articles are meant to pursue our mission of being the best partner in your success by keeping you aware of the latest business news.

Fraud: Better Safe than Sorry

fraud

No companies are safe from fraud, no matter how big they are or what industry they’re in. According to the International Trade Council, 5 per cent of revenues (representing US$800 billion worldwide) are lost to internal or external fraud.

The most common fraud tactics include corruption, misappropriation of assets, and financial statement fraud. And with cybercrime on the rise (the Online Trust Alliance reported an 18.2 per cent in reported breaches in 2017 compared to 2016), fraud prevention and detection measures are becoming more and more important.

The various costs of fraud

In Canada, the total financial losses due to fraud[1] have reached an average of $200,000 in 2018. It should be noted that this average may be under-estimated, especially because a lot of fraud goes undetected by companies, and some firms are too embarrassed to report fraud — especially if it came from an internal source.

Organizations without effective fraud prevention and detection measures expose themselves to serious consequences that go beyond cost: it could affect employee morale, the company’s reputation, business relationships, and share price. All that to say that the cost of establishing a fraud prevention and detection system are almost always going to be lower than the cost of not establishing one.

Fraud detection methods

While there are many fraud prevention and detection measures a company can take other than a system, including employee education, a culture of honesty and third-party support in this area, a system is considered the most effective detection measure, with an effective rate of nearly 50 per cent[2], as demonstrated by these 2018 findings on the reasons for fraud compiled by StatsCan.[3]

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The forensic accountant’s role

A forensic accountant familiar with the specific risks in your industry can help you establish an effective system. They know fraudsters’ tricks, how to detect them and how to create a system that neutralizes them.

Contact us to learn more about setting up a fraud prevention and detection system specifically for your company.

Contributed by Jacqueline Lemay, CPA, CA, CA-EJC, CFF, from Demers Beaulne. This piece was produced as a part of the quarterly Canadian Overview, a newsletter produced by the Canadian member firms of Moore Stephens North America.


[1] According to cases included in the Report of the Nations – 2018 Global Study on Occupational Fraud and Abuse, Association of Certified Fraud Examiners (hereinafter “ACFE”).

[2] Statistics Canada, Fraud Against Businesses in Canada: Results from a National Survey, by Andrea Taylor-Butts and Samuel Perreault, 2007-2008.

[3] 2018 ACFE study.

This article is from the quarterly Canadian Overview, a newsletter produced by the Canadian member firms of Moore Stephens North AmericaThese articles are meant to pursue our mission of being the best partner in your success by keeping you aware of the latest business news.

Protecting your personal financial information – the Equifax cyberattack

info-secure

News about another successful cyberattack, on government or on a private company, in a single country or worldwide, is now almost routine. What such events usually have in common is a desire by the hackers who perpetrate the attacks to profit by it — either by demanding payment from the entity whose systems have been compromised, or by obtaining confidential personal information about individuals, which the hackers can then use fraudulently or sell to others who wish to do so.

In September of this year, the credit reporting firm Equifax announced that it had been subject to such a successful cyberattack, and that attack was especially concerning, both because of the nature of the information Equifax holds.

Most Canadian adults have used credit at one time or another. Whenever an individual obtains and uses credit — whether through a credit card, line of credit, car loan, or otherwise, the financial institution which provided the credit provides information about that credit use to a credit reporting agency like Equifax. The information provided includes the original amount of the debt, the payment history, whether any payments were made late, and the current balance. The file held by the credit reporting agency also includes personal identifying information about the individual, which can include the individual’s social insurance number (SIN). Such information is accumulated throughout the individual’s financial life and is used by credit-granting institutions to assess an individual’s creditworthiness whenever he or she makes an application for credit.

It’s readily apparent that credit rating agencies have a great deal of personal and financial information about individuals and it was that information which was compromised in the cyberattack on Equifax which took place between mid-May and July 2017. Equifax has confirmed that personal and financial information of about 100,000 Canadians had been accessed in the cyberattack. (That number is subject to change and increase, as the investigation continues.) The information accessed included individuals’ names, addresses, credit card numbers, and – most ominously – SINs.

Equifax has committed to contacting, by mail (not e-mail or phone), the 100,000 Canadians whose personal information has been compromised. It will also be providing such individuals with credit monitoring and identity theft protection for a period of 12 months, at no charge. Individuals who are not contacted but have questions can contact Equifax at 1-866-699-5712 or by email at EquifaxCanadaInquiry@equifax.com.

Anyone whose personal and financial information is stolen, whatever the circumstances, has good reason to be concerned. And, given the number of instances in which Canadians routinely provide such personal and financial information, online or otherwise, the chances of being affected by an information security breach continue to increase.

As a practical matter, there is really nothing individual Canadians can do to ensure that companies, institutions and governments which have and hold their personal information are not subject to a cyberattack or other information breach. What Canadians can (and should) do is to restrict the personal and financial information which they provide to others to that which is required by law or absolutely necessary in the particular circumstances. And there are a number of steps which individuals can take to protect the personal identifying and financial information which they do disclose, and so minimize the risks that such information will misused or that they will become victims of identity theft.

Perhaps the most important of those steps is the need to protect one’s SIN. Having someone else’s SIN can give an unauthorized person significant access to additional information about that person, and can even allow them to impersonate that person, especially online, where bona fides can often be established simply by providing requested personal identifying information.

The circumstances in which Canadians are legally required to provide their SIN are relatively few. We need to include on the annual tax return, we must provide to financial institutions where the individual holds an interest-bearing account, a registered retirement savings plan, a registered education savings plan, or a tax-free savings account. There are not many other instances in which providing one’s SIN is required.

Online shopping is now ubiquitous and, of course, purchasing anything online requires an individual to provide a method of payment, which is usually a credit card number. The major online shopping sites have security protocols in place, but the reality is that providing one’s credit card number online will always carry a risk. There are ways to minimize that risk. Individuals who shop online on a regular basis might consider obtaining a credit card which is used only for online shopping, and which has a relatively low credit limit.

For those who wish to obtain personal information about someone else for fraudulent purposes, all forms of social media are, of course, a gold mine. Everyone has heard of the need to exercise caution with respect to the personal information disclosed on social media. What many don’t recognize is the need to consider the totality of information that is being “shared” on all social media platforms in the aggregate, not just on a single site like Facebook, Twitter, or Instagram, or in a single post on any of those sites. Anyone seeking to collect personal information about an individual for identity theft or other fraudulent purposes will certainly put together information from all available sources. And, while a single piece of information disclosed in passing, or in isolation, may not seem to pose a risk, it doesn’t take much information to create that risk. For instance, no one would post their bank account number on social media. But, someone who posts on Facebook about their frustration with a particular interaction with their (named) financial institution has created an opportunity for someone to approach them (weeks or months later) with fraudulent intent, purporting to be from that financial institution and asking them, for instance, to confirm their bank account number as part of the bank’s regular fraud prevention program. And too often, recipients of such approaches don’t consider that the caller might have obtained information about who they bank with from a months-old social media post. Such fraudulent approaches rely on the fact that most recipients don’t think to verify the authenticity of the call or the caller.

Not disclosing one’s SIN unless legally required to do so, and taking care when online shopping or in posting on social media are only some of the precautions which can be taken to protect one’s personal information. There are many others, and there’s a lot of information available on how to protect yourself and what to do if your personal or financial information falls into the wrong hands. The following websites are a good place to start:
www.rcmp-grc.gc.ca/scams-fraudes/id-theft-vol-eng.htm and https://www.getcybersafe.gc.ca/cnt/prtct-yrslf/prtctn-dntty/index-eng.aspx

 

Disclaimer

The information presented is only of a general nature, may omit many details and special rules, is current only as of its published date, and accordingly cannot be regarded as legal or tax advice. Please contact your Segal advisor at 416-391-4499 for more information on these subjects and how they pertain to your specific tax or financial situation.

Know the Tax Implications of Dividend Income

lores_investment_folder_file_amIf you are planning to buy shares in a company in the hope of receiving regular dividend payments, take some time to review how the Canada Revenue Agency (CRA) taxes income from directly held shares.

The first step is to realize that your tax bill on dividend income will depend on where the company is located. The CRA treats domestic and foreign dividend income differently.

For a conservative portfolio, you might look for disciplined, well-run, profitable companies that have a record of regularly boosting their payouts.

You can find blue-chip stocks that provide yields competitive with short-term bonds and Guaranteed Investment Contracts.

But remember, companies can cut their dividend outlays for any number of reasons and that can cause the stock’s price to slide.

Domestic Dividend Income: If you own shares in a taxable Canadian corporation, you are eligible to take a dividend tax credit aimed at preventing double taxation. Dividends are paid out of a company’s after-tax earnings, which means that when you get your payout, the company has already paid taxes on it.

Foreign Dividend Income: Taxation is more complicated when you receive dividends from a foreign company, although you may be eligible for a foreign tax credit. The tax due on foreign income is based on treaties between Canada and the countries where the companies are domiciled. Generally, Canadians will pay tax on foreign dividend income in Canada and get credit for foreign taxes withheld.

More than 750,000 Canadians hold U.S. investments directly or through a registered account. American companies generally withhold taxes on your dividend payments but the exact amount depends on whether you certify that you are a Canadian resident. When your Canadian tax return is prepared, you may receive a foreign tax credit.

The tax credits for Canadian dividends make them a very tax-efficient source of income for most Canadian investors.

Taxation of dividend income can be complicated and it’s best to consult with your tax adviser, who can ensure you pay the least amount of tax possible.

Put Trust into Your Financial Plans

Regardless of your age, you should be planning financial goals. One of the most efficient ways is through trusts that can help save tax dollars and provide for your heirs.

Here are just some of the ways trusts can be used to maximize your wealth:

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Words of Caution

The CRA has said it launched a special project to audit domestic “inter vivos” trusts to ensure they are set up and managed according to the relevant legislation.

Among the potential targets:

  • Promissory note: Has one been issued to the beneficiaries and it is enforceable?
  • Trustee withdrawals: If trustees have withdrawn money for personal use the CRA could challenge the deduction taken or asses a taxable benefit to the trustees.
  • Twenty-One year rule: The CRA may check to see if the trust has paid the required taxes on accrued capital gains every 21 years..
  • Proper records: The agency may check to see if all the proper accounting records have been kept, minutes taken and that the original settlement property can be produced.

Failure to be in compliance with all the necessary trust and income tax rules might result in tax liabilities, penalties and interest. The worst-case scenario would be for the CRA to determine the trust never existed, in which case all benefit and growth would accrue to the original shareholder.

Support for Your Spouse

You can set up a trust (as provided by your will) to supply a source of income for your spouse and defer taxes. Property transferred to a spousal trust on death does not trigger capital gains taxes until the trust sells the property or the beneficiary spouse dies. Assets transferred to trusts are deemed to be disposed of at their fair market price, which can create tax liabilities.

A spousal trust is a good choice when: a spouse lacks financial expertise; requires long-term care; or you wish to ensure that children are beneficiaries of your estate on the death of your spouse.

Transfer Assets to Children

Assets transferred to a trust for children can still be subject to tax in the hands of the parent transferor, if that parent can control the ultimate disposition of the assets during their life time. This is why inter vivos trusts are usually created by grandparents, with an adult child as trustee and using an asset that is not subject to attribution.

That way, the adult child can continue to control the assets, a strategy often used as part of an estate freeze – a way of freezing the tax liability on assets. You will have to pay capital gains tax on any increase in the assets’ value to the time of transfer (or freeze), but the remaining taxes on any further increase in value are deferred until the trust sells the assets.

Keep in mind that living trusts have a deemed 21-year life span after which accrued gains in the trust are taxed.

Also, remember that depending on how the property is acquired and the nature of the income earned by the children’s trust, income attribution or “kiddie” taxes may apply if minor children or grandchildren are beneficiaries.

Manage Inheritances

If you are concerned that a child or grandchild won’t be able to handle an inheritance wisely until a certain age, a trustee can professionally manage the money until the beneficiary reaches a specified age.

Care for Children

A trust can ensure that minor children are cared for after your death. If you have children with disabilities, a trust can provide the income for their needs. If you have adult children, setting up a trust to take care of their financial needs can cut taxes. The child is responsible for taxes on trust income that is paid out, possibly at a lower rate.

Trusts have many other uses and can be complicated. So contact your accountant to discuss the ways you can effectively maximize your wealth by creating trusts.

Dealing with a Layoff or Forced Retirement

lores_hr_cost_cutting_fired_terminated_envelope_job_employment_words_amIt doesn’t matter whether you’re employed in the private or public sector - companies and government agencies equally struggle to boos the bottom line and stay within tight budget constraints.

Those efforts can sometimes result in downsizing. With little notice in many cases, employees are presented with severance packages or incentives to retire early.

If that unfortunate scenario occurs, you may not be in the state of mind, or have sufficient knowledge, to properly evaluate the offer. Downsizing packages often involve decisions that go beyond severance pay, including benefit replacement and pension considerations. A qualified financial planner can help you assess the package and consider the following issues:

Family finances. Income uncertainty can be a challenge, especially if you’re facing post-secondary education costs for children and other major ongoing expenses, such as a mortgage. The impact on your spouse, especially if he or she is still working, should also be addressed.

Tax planning. Your package may include a significant lump sum, which means you need a strategy to minimize taxes. For example, you might review your RRSP contribution limits and consider using the “retiring allowance” to defer much of the income tax as possible. Or some of the money could be applied to your spouse’s RRSP. In some cases, an employer may agree to make payments over two years. Proper planning in this area is essential, as some of these tax-planning opportunities are only available during the year of severance.

Spending habits. Compile a budget to track monthly expenses. A budget also helps you make changes to your spending patterns. You may decide to impose some restrictions and consolidate debts to reduce interest costs.

Pension choices. This can be one of the most critical financial choices. You should fully understand pension options, because the decision is permanent. If you plan to draw on your pension, determine whether a single or joint life pension is needed, as well as whether you want a guarantee on future income.

If you’re not at pension age yet, you may elect to have a deferred pension or take a “commuted value” out of the plan to rollover to your own locked-in RRSP.

Group benefit replacement. Determine if any employee benefits will continue. You may have to add to your budget premiums for health, dental, life and critical illness insurance to replace lost benefits. An assessment of whether to “self-insure” some of the costs or pay premiums to an insurance company to cover the potential risk needs to be completed. You may be able to apply to become a dependant under your spouse’s group insurance plan. Some coverage, such as disability insurance, will be discontinued because you’re no longer employed.

Income and asset review. By calculating your assets and potential sources of income, you can determine any shortfall in your budget. Income from your spouse or partner may help defray expenses. Consider all assets and sources, such as RRSPs, savings, and Canada Pension and Old Age Security. Review investments. Your risk tolerance has probably changed as a result of your unemployed status.

By using the services of a qualified financial professional, you can get the most out of your severance or early retirement package. Call our firm for help developing a realistic plan that reflects your personal situation and allows you to get on with life.

Don’t Gamble With Your Retirement

The consensus is, as increasing numbers of baby boomers start to retire, nearly 30 per cent of modest-income and middle-income earners are not saving enough to be able to replace the recommended 90 per cent of pre-retirement expenses once they stop working.

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Risks to Consider

While you discuss your plans with your accountant, be certain you take into account these risk factors:

  • Inflation: Price rises over the long term pose a serious threat to your retirement income stream. The gradual gains in the cost of living erode your purchasing power. Structure your investment portfolio to keep pace with inflation.
  • Healthcare: Canadians are living much longer than before because of advances in prescription drugs, awareness of healthy lifestyles and improved healthcare. While it’s great that we can enjoy life longer, for many retirees, this may mean outliving their savings.
  • Rates of return: When you build your investment portfolio, you and your adviser generally use average rates of return. Be certain they are realistic. You may be counting on an eight per cent return but average out to just five per cent.
  • Taxes: It may be difficult to get your head around this concept, but it is possible that you can put too much money into your RRSP. Registered plans and funds, when combined with government or company pensions, life annuities, rental income, and part-time business income, can leave you with a hefty, and unnecessarily high, tax bill. If retirement income sources bump you up into the top tax bracket, each dollar you withdraw from your RRSP may be slashed by as much as 50 per cent after taxes.

In fact, a lot of Canadians simply admit that they are doing a poor job at building savings.

That doesn’t mean that Canadians are going to live in retirement poverty. Not at all. According to the Organization for Economic Cooperation and Development, Canada has the second lowest poverty rate for senior citizens after the Netherlands.

The problem, instead, is that many retirees won’t be able to maintain their current lifestyles after they stop working. They may not be able to spend as much going to restaurants, taking vacations or driving the same class of car.

If you are in your late 40s, early 50s or even older, and feel you are not putting enough aside for a comfortable retirement, you still have time to speed up your savings and build a substantial safety net for the years after you stop working.

First, calculate your total savings and the precise amount you will need for retirement, taking into account the potential risks outlined in the right-hand box. Knowing how short you are from your needs can help motivate you to change your savings behavior. Then consider and discuss with your accountant, these tips and how they might fit into your retirement-planning strategy:

1. Utilize your peak earning years to substantially boost savings. Typically, the final years of employments are peak income years. Rather than enhancing your lifestyle with each pay increase, put pay raises into savings vehicles. Look for ways to downgrade your lifestyle without crimping it, add the savings to your retirement fund. Making this change now also means you are likely to be more satisfied with a lower lifestyle when you stop working.

2. Consider asking your non-working spouse to take a job. If your children are out of the house or don’t require much supervision, it may make sense for your spouse to work and put all the earnings toward retirement. Alternatively, or in addition, you might want to take on a second, part-time job or start a business for additional income.

3. Sell your house. If you can sell your current home and get by in a smaller dwelling, you can reduce living expenses and put the difference in savings.

If you are like many Canadians, the bulk of your retirement income may come from withdrawals from Registered Retirement Savings Plans (RRSPs) or Tax-Free Savings Accounts (TFSAs), or both. Ask your accountant how you can make the most of these plans.

One advantage of the TFSA is that the more you put into one the more money you can live off of tax-free during retirement.

Consider that you may actually be at the same or a higher marginal tax rate after you retire (see right-hand box about risks). If you are likely to bump up into a higher bracket, ask your accountant if it would be reasonable for you to delay RRSP contributions and make the most of a TFSA.

For middle-aged individuals, a combination of the two accounts might benefit you. The current low limit on TFSA contributions won’t let you accumulate enough for retirement, but it does offer more planning flexibility in estate and retirement income planning.

In any event, consider contributing the maximum to both types of tax-advantaged accounts. If your employer offers group plans, take advantage of them and the company’s matching contributions.

The following chart compares the features of TFSAs and RRSPs and can help guide your discussion with your accountant and your ultimate decision:

TFSA RRSP
No need for earned income to build contribution room Earned income is needed to be able to contribute
Annual contribution limit for 2017 is $5,500 Contribution limit is 18 per cent of previous year’s earned income or the limit set by Ottawa, whichever is lower
You need not contribute every year but can accumulate room You need not contribute every year but can accumulate room
Withdrawals, including investment gains or interest, are tax-free Withdrawals, including deposits and investment earnings or interest are taxable
Contributions are not tax-deductible Contributions are deductible and provide a refund at your marginal tax rate
Withdrawals are added to the next year’s contribution limit Early withdrawals are not added to the contribution limit and are taxed heavily
Need not be converted to a Registered Retirement Income Fund (RRIF) Must be converted to an RRIF at age 71, and minimum annual withdrawals are required
Withdrawals are not used to calculate OAS clawback RRSP and RRIF withdrawals are income used in calculating the OAS clawback

Need to Increase Your Retirement Cash Flow?

lores_mortgage_options_types_rates_lengths_terms_mbRetired people sometimes find themselves in a cash bind, but there might be a solution for homeowners in the form of a reverse mortgage. You’ve probably seen ads on television or in magazines about this type of mortgage and wondered if it could work for you. Reverse mortgages can be a useful tool for seniors who have built up equity in their home and are looking to supplement their cash flow in retirement but they are not for everyone.

What Is a Reverse Mortgage?

A reverse mortgage is a loan secured by a home, like any other mortgage. Unlike a regular mortgage, no re-payment of the loan is required until the home is sold, the last surviving spouse dies, or the owner moves out.

Additional Requirements:

  • You must be at least 62 years of age.
  • The home must be your principal residence.
  • Any existing mortgage must be paid off by the proceeds of the reverse mortgage.

Why Is It Called a “Reverse” Mortgage?

A regular mortgage balance decreases over time as payments are made, until finally it is paid off. In a reverse mortgage, the balance increases over time due to interest charges. This is the reverse of a regular mortgage.

How it works: Depending on your age, marital status, and the property, you can unlock as much as 40 per cent of the appraised value of your home. (See right-hand box for additional requirements.)

Let’s say you’ve paid off – or nearly paid off – a conventional mortgage and the home is valued at $300,000. You could wind up with a tax-free $120,000 cash advance. You can take the money in a lump sum or in instalments over the time you remain in the home.

Payments aren’t due until the home is sold or the surviving spouse dies, although you can opt to pay the mortgage earlier. The lender makes its money by recovering the principal and interest when the home is eventually sold.

On the face of it, these mortgages appear to be a good deal for several reasons:

  • The money received is not taxable.
  • The cash advance doesn’t affect government benefits programs such as Old Age Security and the Guaranteed Annual Supplement.
  • Payments are deferred as long as you remain in the house.
  • The mortgage will never exceed the fair market value when the house is eventually sold.
  • You can use the money any way you want (in fact, you can use the money to buy an annuity or purchase life insurance to pay off the reverse mortgage, which means you can still leave the home free of debt to your heirs).
  • You can still sell the house if that becomes necessary, although there may be an early repayment penalty.
  • If you choose to pay the mortgage interest annually, the payment may be tax deductible if the borrowed money is invested.

However, before deciding a reverse mortgage is the tool for you, there are some disadvantages to consider:

  • Interest rates are as much as two percentage points higher than on a conventional mortgage. For example, if conventional mortgage rates are five per cent, a reverse mortgage could cost you seven per cent. The rates are set annually and based on the rate for one-year Government of Canada bonds.
  • Interest continues to accumulate, so in theory the loan, plus interest, could eventually exceed the value of your home. If you sell the house, proceeds will be used to repay the debt and you would have nothing left.
  • Set-up, appraisal and legal fees can run from about $1,800 to as much as $2,300.
  • You cannot move to another home and keep the loan, which means you can’t rent out the place and still keep the reverse mortgage cash advance.

Proceed with Caution: If you think a reverse mortgage might work for you, consult with your accountant first. Generally, a reverse mortgage is a last resort alternative for homeowners.

Life Insurance Policies as Investments

lores_insurance_policy_director_officer_board_mbUniversal life insurance and whole life insurance can be an attractive investment tool in the right circumstances.

Technically, the policies are life insurance policies, not investments, and the returns are generally slightly lower than mutual funds, but they have four significant advantages:

  • Proceeds are life insurance and thus not taxable.
  • The policy can specify a beneficiary and thus avoid probate fees.
  • The value of the investment grows tax free.
  • The policy is “creditor proof” because it isn’t subject to seizure by courts as other investments would be.

By paying more than the minimum premium, policy owners build up a surplus that can be put into various investments the insurance company holds on their behalf. The value of those investments is added to the face value of the policy when the insured person dies. That provides a tax-free payment of life insurance proceeds to the beneficiaries.

Since the life insurance company — not the policyholder — holds the investments the growth is not taxed the way other investments would be. This tax sheltering is similar to an RRSP, with the advantage that when the policy is eventually paid out on the death of the policyholder, there will be no tax on the proceeds.

You may also borrow money from the surplus in the policy at a low interest rate. This would allow you to finance your retirement from that surplus with tax-free money because the funds are in the form of a loan rather than income.

The loan is automatically paid off at death, reducing the insurance proceeds by the amount of the loan.

While the return on investment isn’t generally considered stellar compared to other investments because of the life insurance premiums that must be paid, these policies can be an attractive option if you need life insurance for estate planning purposes.

The actual life insurance cost (called the Cost of Pure Insurance) is very similar to term life insurance, and the policies offer the ability to accumulate a surplus that is invested to your advantage as the face value of the policies increase.

The underlying investments available in a life insurance policy have greatly increased over the past few years. Virtually any mutual fund is available through one carrier or another, along with annuities and GICs.

Talk to your financial advisor regarding these products if you think that you might benefit from universal life or whole life insurance.

Universal vs. Whole Life Plans

When discussing investments in universal or whole life insurance plans with your professional adviser, it’s important to know how the two plans differ.

Both contain four elements:

  • Mortality Cost: The part of the deposit that covers the pure cost of the life insurance death benefit.
  • Administration charge: This is the charge for administering the policy and premium tax.
  • Savings or Investment: The amount remaining after the above two charges are deducted. You will be provided with an illustration of how your savings will grow, often called the Cash Value, Fund Value, or Cash Surrender Value of your policy.
  • Return on the savings: This is the interest rate that is credited annually to the cash value in your account.

In addition, some policies guarantee that the costs will not change and guarantee a minimum return on investments.

Whole Life Insurance

These policies have a level cost that does not increase each year. Your first payment will be the same as your last payment. However, whole life policies disclose neither the mortality nor the administration costs.

Once those two costs are covered, the balance of the premium is the savings or investment portion. The returns depend on excess interest and investment earnings, savings in mortality costs, the operating expenses and the insurer’s board decision on what to pay.

Whole life policies also don’t disclose how they calculate returns on your savings portion and you cannot choose where the money is invested.

Universal Life Insurance

These disclose both the mortality charges and the administration charges, which are often guaranteed not to change for the life of the policy. These policies, in their newer forms, also offer a list of investment options that are similar in some ways to mutual funds. Some are even designed to reflect well-known funds and are even managed by mutual fund managers.