Investment Tax efficiency for Canadian Investor

[Studesy]

I am in the process of selling my business and am interested in any advice / perspective other Canadians have to offer in regards to the allocation of various types of investments among various accounts.  Given that all tax advantaged accounts will be maxed (TFSA & RRSP), what is the most tax efficient way to hold the remainder of the capital? Inside a corporation, a trust, or held personally?

 

Now lets assume a variety of equity holdings to be allocated between these accounts;

 

1. Long term holds/compounders (companies I plan to hold for a long time)

2. Undervalued situations with a shorter expected timline

3. Special Situations (usually the shortest timeline)

4. Cash

5. Borrowed funds

5. US / Foreign equities

 

Which investment types should be held in which accounts?

 

I do plan on meeting with a tax planner but was hoping for any advice/ideas from others.

If anyone can chime in on this topic it would be appreciated. TIA

 

 

[bizaro86]

Special situations are great for TFSA, probably the fastest way to compound capital, and it makes a big difference not to pay tax on every transation.

 

Compounders are great for non registered funds, since if you don't sell you defer the tax indefinitely.

 

US stocks that pay dividends are a good choice for your RRSP, because then there is no dividend tax in US or Canada. TFSA is the worst place for US dividend stocks, because they take withholding so you're paying tax on your TFSA.

 

 

[rb]

Studesy, just like anything else the answer depends on the circumstances.

 

What is your income going to be after you sell the business? How much money do you need to spend? At what stage are you in life? Do you have kids? Is divorce a possibility for you? If you have kids do you have an inheritance plan? Do you want to protect the assets in case one of your kids gets divorced? Are you going to be living in different tax jurisdictions in the future?

 

The right answers in regards to allocation between different structures depend on the answers to the questions above and more. Holding companies and trusts are great tools that enable you to do lots of stuff. But they make sense in some situations and not in others.

 

Depending on the situation it can be a very bad idea to max out RRSP so you want to keep a good eye on that. Also don't keep long term compounders in the RRSP.

 

Generally what bizaro said is correct. He's wrong about that the worst place for US dividend stocks in the TFSA. In the TFSA you pay 15% on divvys and no tax on cap gain. If you held the stock in a cash/margin account you'd pay tax on divvys at your marginal rate (higher than 15%) and pay marginal rate tax on half the cap gain. TFSA is clearly a superior location.

 

[scorpioncapital]

The most tax efficient plan in Canada for both investment and income taxation is called 'non-residence'  ;D

 

Also while it's true that these registered plans have some benefits one negative is the inability to use leverage. The value of leverage is a question mark but it often is more than the benefits of the plans, especially as you can deduct the interest expense against all sources of income, thus potentially really lowering your tax bill. It isn't necessary for the cost of leverage to exceed dividend income so this is probably the one last decent tax break on investments.

 

 

 

[Studesy]

Special situations are great for TFSA, probably the fastest way to compound capital, and it makes a big difference not to pay tax on every transation.

 

Compounders are great for non registered funds, since if you don't sell you defer the tax indefinitely.

 

US stocks that pay dividends are a good choice for your RRSP, because then there is no dividend tax in US or Canada. TFSA is the worst place for US dividend stocks, because they take withholding so you're paying tax on your TFSA.

 

Thanks for the input. Mostly in line with what I was thinking.

[Studesy]

Studesy, just like anything else the answer depends on the circumstances.

 

What is your income going to be after you sell the business? How much money do you need to spend? At what stage are you in life? Do you have kids? Is divorce a possibility for you? If you have kids do you have an inheritance plan? Do you want to protect the assets in case one of your kids gets divorced? Are you going to be living in different tax jurisdictions in the future?

 

The right answers in regards to allocation between different structures depend on the answers to the questions above and more. Holding companies and trusts are great tools that enable you to do lots of stuff. But they make sense in some situations and not in others.

 

Depending on the situation it can be a very bad idea to max out RRSP so you want to keep a good eye on that. Also don't keep long term compounders in the RRSP.

 

Generally what bizaro said is correct. He's wrong about that the worst place for US dividend stocks in the TFSA. In the TFSA you pay 15% on divvys and no tax on cap gain. If you held the stock in a cash/margin account you'd pay tax on divvys at your marginal rate (higher than 15%) and pay marginal rate tax on half the cap gain. TFSA is clearly a superior location.

 

Thanks Rb. I know what you are saying about "each person's situation is different". Just looking for whatever big picture input I can. Have never spent much time looking at tax efficiency as the majority of my assets have been held withing my business and a separate holdings Co. That was created years back.

Definitely something I want to educate my self on more going forward. Cheers

[rb]

You're welcome. Feel free to ask whatever else you need to know. If you don't want to make it a public post you can PM me. I work a lot with these types of situations.

[Studesy]

 

Also while it's true that these registered plans have some benefits one negative is the inability to use leverage.

 

Leverage via long call options is possible though.

 

Also, when you speak of non residence, are you referring to setting up accounts in a offshore/tax free jurisdiction.... Or physically moving to one of these places?

 

Thanks again for the input.

[KCLarkin]

Generally what bizaro said is correct. He's wrong about that the worst place for US dividend stocks in the TFSA. In the TFSA you pay 15% on divvys and no tax on cap gain. If you held the stock in a cash/margin account you'd pay tax on divvys at your marginal rate (higher than 15%) and pay marginal rate tax on half the cap gain. TFSA is clearly a superior location.

 

Just to clarify on what rb is saying:

 

Let's assume you have income of $100k. Let's say you have dividends of $10k from US stocks and $10K from CAD stocks. And you can either put all of your US stocks in TFSA or Taxable.

 

Scenario A: CAD in TFSA, US in Taxable

 

CAD Div tax: $0

US-sourced tax (at 43.41% marginal rate): $4341

Total Tax: $4341

 

Note: I have ignored withholding tax and the corresponding foreign tax credit b/c I believe they will cancel each other out.

 

Scenario B: CAD in Taxable, US in TFSA

Cad Div tax (at 25% eligible dividend rate): $2500

US-tax (15% withholding tax): $1500

 

Total Tax: $4000

 

So the general advice to avoid US stocks in TFSA isn't always applicable.

[Studesy]

Generally what bizaro said is correct. He's wrong about that the worst place for US dividend stocks in the TFSA. In the TFSA you pay 15% on divvys and no tax on cap gain. If you held the stock in a cash/margin account you'd pay tax on divvys at your marginal rate (higher than 15%) and pay marginal rate tax on half the cap gain. TFSA is clearly a superior location.

 

Just to clarify on what rb is saying:

 

Let's assume you have income of $100k. Let's say you have dividends of $10k from US stocks and $10K from CAD stocks. And you can either put all of your US stocks in TFSA or Taxable.

 

Scenario A: CAD in TFSA, US in Taxable

 

CAD Div tax: $0

US-sourced tax (at 43.41% marginal rate): $4341

Total Tax: $4341

 

Note: I have ignored withholding tax and the corresponding foreign tax credit b/c I believe they will cancel each other out.

 

Scenario B: CAD in Taxable, US in TFSA

Cad Div tax (at 25% eligible dividend rate): $2500

US-tax (15% withholding tax): $1500

 

Total Tax: $4000

 

So the general advice to avoid US stocks in TFSA isn't always applicable.

 

Makes sense KC. So marginal tax rate really matters with this stuff. Lots of moving parts.

Cheers

[scorpioncapital]

I didn't think about the call option strategy, it sounds quite interesting. I guess you would buy a call at 1/2 the strike of the stock with 100% of the RRSP funds to simulate 50% margin leverage. You'd pay an implied interest rate a bit higher but you could move a leveraged taxable portfolio into an RRSP/TFSA.

 

Yes, I mean to change physical residency to a country that doesn't tax capital gains...however this may not be practical for all. This would be the ultimate tax efficiency.

 

However, I calculate that generally if you string out a decent amount of gains each year - and have minimal other types of income, your marginal tax on capital gains is generally no more than 15% so it may not be worth the bother unless there are other considerations.

 

 

[Studesy]

I didn't think about the call option strategy, it sounds quite interesting. I guess you would buy a call at 1/2 the strike of the stock with 100% of the RRSP funds to simulate 50% margin leverage.

 

Yes....you can also hold call options in TFSA. Not sure if this would be a better place than the RRSP for options or not though. I suppose if the options provided outsized returns over time...the TFSa may be best as there is no tax when the cash is taken out. I would never fill one of these accounts to accumulate excessive leverage....but I do like to lever up a bit (say 25%) if things get cheap enough.

Cheers

[EliG]

Generally what bizaro said is correct. He's wrong about that the worst place for US dividend stocks in the TFSA. In the TFSA you pay 15% on divvys and no tax on cap gain. If you held the stock in a cash/margin account you'd pay tax on divvys at your marginal rate (higher than 15%) and pay marginal rate tax on half the cap gain. TFSA is clearly a superior location.

 

Just to clarify on what rb is saying:

 

<snip>

 

So the general advice to avoid US stocks in TFSA isn't always applicable.

 

Makes sense KC. So marginal tax rate really matters with this stuff. Lots of moving parts.

Cheers

 

Moving parts:

- marginal tax rates on ordinary income and eligible Canadian dividends (these vary by province)

- actual dividend yields of your various holdings

 

This article shows how to attack the problem:

 

Asset Location Across Canada: Some Rules Are Made To Be Broken

 

 

[bizaro86]

 

 

Generally what bizaro said is correct. He's wrong about that the worst place for US dividend stocks in the TFSA. In the TFSA you pay 15% on divvys and no tax on cap gain. If you held the stock in a cash/margin account you'd pay tax on divvys at your marginal rate (higher than 15%) and pay marginal rate tax on half the cap gain. TFSA is clearly a superior location.

 

I put that poorly, sorry. While US stocks are better in a TFSA than outside, for most investors it would be wise to leave them out, since TFSA room is limited.

 

US dividends go from your marginal rate to 15%, while Canadian REITs or interest income goes from your marginal rate to 0%. Thus, if your TFSA is a small portion of investible assets (which I assume from the tone of the OP), there are probably better choices for the TFSA.

[Studesy]

Generally what bizaro said is correct. He's wrong about that the worst place for US dividend stocks in the TFSA. In the TFSA you pay 15% on divvys and no tax on cap gain. If you held the stock in a cash/margin account you'd pay tax on divvys at your marginal rate (higher than 15%) and pay marginal rate tax on half the cap gain. TFSA is clearly a superior location.

 

Just to clarify on what rb is saying:

 

<snip>

 

So the general advice to avoid US stocks in TFSA isn't always applicable.

 

Makes sense KC. So marginal tax rate really matters with this stuff. Lots of moving parts.

Cheers

 

Moving parts:

- marginal tax rates on ordinary income and eligible Canadian dividends (these vary by province)

- actual dividend yields of your various holdings

 

This article shows how to attack the problem:

 

Asset Location Across Canada: Some Rules Are Made To Be Broken

 

Great article. I was not aware of such differences between various province!

[rb]

I didn't think about the call option strategy, it sounds quite interesting. I guess you would buy a call at 1/2 the strike of the stock with 100% of the RRSP funds to simulate 50% margin leverage.

 

Yes....you can also hold call options in TFSA. Not sure if this would be a better place than the RRSP for options or not though. I suppose if the options provided outsized returns over time...the TFSa may be best as there is no tax when the cash is taken out. I would never fill one of these accounts to accumulate excessive leverage....but I do like to lever up a bit (say 25%) if things get cheap enough.

Cheers

Here's a nifty little trick. It makes a lot of sense to have a super levered TFSA with call options IF (big IF) you are sure those stocks are going to go up. So if BRK is at 1.2 BV the right move would be to have your TFSA chock full of BRK LEAPS. What this does is greatly stretch your TFSA room as the stock moves from undervalued to fair value. After this is done you'll have tons of TFSA room to accommodate your life's needs. This makes sense even if you have to hold lots of cash elsewhere in order to delver overall. TFSA room is very precious.

 

Caveats. Be careful at the big IF above. If the stocks go down you'll destroy your TFSA room. Also you need to be careful to avoid designation of a professional investor at which point you can't use TFSA.

[Studesy]

I didn't think about the call option strategy, it sounds quite interesting. I guess you would buy a call at 1/2 the strike of the stock with 100% of the RRSP funds to simulate 50% margin leverage.

 

Yes....you can also hold call options in TFSA. Not sure if this would be a better place than the RRSP for options or not though. I suppose if the options provided outsized returns over time...the TFSa may be best as there is no tax when the cash is taken out. I would never fill one of these accounts to accumulate excessive leverage....but I do like to lever up a bit (say 25%) if things get cheap enough.

Cheers

Here's a nifty little trick. It makes a lot of sense to have a super levered TFSA with call options IF (big IF) you are sure those stocks are going to go up. So if BRK is at 1.2 BV the right move would be to have your TFSA chock full of BRK LEAPS. What this does is greatly stretch your TFSA room as the stock moves from undervalued to fair value. After this is done you'll have tons of TFSA room to accommodate your life's needs. This makes sense even if you have to hold lots of cash elsewhere in order to delver overall. TFSA room is very precious.

 

Caveats. Be careful at the big IF above. If the stocks go down you'll destroy your TFSA room. Also you need to be careful to avoid designation of a professional investor at which point you can't use TFSA.

 

Yes...so true....and I agree leverage must be measured across all accounts....even if it only exists in one of those accounts.

[gokou3]

Also you need to be careful to avoid designation of a professional investor at which point you can't use TFSA.

 

How to avoid it? Tia.

[rb]

Also you need to be careful to avoid designation of a professional investor at which point you can't use TFSA.

 

How to avoid it? Tia.

Well ... as usual the rules are complicated. A good way to go about it is to structure your trades as those of a long term investor as opposed to those of a short term speculator. Your background, education and work experience factor in as well. It helps if you're not a financial type.

[scorpioncapital]

LEAPs in these plans sounds really good. I just regret I didn't use them when I had the chance during this last few years of the bull market, on the other hand, they are limited to a subset of capital and in the case of RRSP you really are locking in the funds unless you convert to RRIF and stream it out slowly.

 

I notice BRK has leaps but until 2020 - technically 2 years from now. I would imagine there are 2.5 year leaps that will come out soon later this year. The ony downside I can imagine with these is you must constantly monitor the situation to renew or cash them in...but this is not a big deal.

 

I also am wondering what leap pricing will do if rates rise. Right now for example a $140 strike BRK.B 2 year leap is about $86 (simulating let's say a 1.5x leverage rate)...it seems to be about 6% interest over 2 years. IB charges me around 2.7% (and rising). Let's say it's 3%/yr next 2 years, seems almost identical to the LEAP rate - and this would work best with a no dividend stock.

 

However I agree that if the stock is already overpriced when you do this strategy you're risking a capital loss without the ability to offset future capital gains against it. I also think in a rising environment, margin expense deduction becomes more valuable.

 

Overall, a good strategy. I think max TFSA today is like $60,000, so you could in theory migrate say $100,000 worth of Berkshire into the plan via options.

 

 

[investmd]

I am in the process of selling my business and am interested in any advice / perspective other Canadians have to offer in regards to the allocation of various types of investments among various accounts.  Given that all tax advantaged accounts will be maxed (TFSA & RRSP), what is the most tax efficient way to hold the remainder of the capital? Inside a corporation, a trust, or held personally?

 

Now lets assume a variety of equity holdings to be allocated between these accounts;

 

1. Long term holds/compounders (companies I plan to hold for a long time)

2. Undervalued situations with a shorter expected timline

3. Special Situations (usually the shortest timeline)

4. Cash

5. Borrowed funds

5. US / Foreign equities

 

Which investment types should be held in which accounts?

 

I do plan on meeting with a tax planner but was hoping for any advice/ideas from others.

If anyone can chime in on this topic it would be appreciated. TIA

 

I don't know enough about setting up a Trust and how that would work in your case - do get some professional advice on that one.

If you remove the Trust option, you are basically left with 1) taking $s out, paying a large amount of tax now and then investing $s vs. 2) allow $s to compound in corporation (if not affected by new tax laws) and thus deferring taxes. Usually option 2 turns out to be the winner. However, new tax laws trying to prevent passive investment in corp may change that :(

 

I agree with the RRSP comments - If one has a PC and stable income and ability to compound, no point in putting equities in RRSP. I'm 46y.o and have been taking $s out of RRSP. However, I do use my RRSP room for US equities that pay a dividend - ie: I would hold Apple in RRSP but not BRK.

[SharperDingaan]

Couple of other considerations .....

 

What are you going to 'do' after you've sold the business/retired?

Most folks would look at partnerships (spread the load AND the financial risk), funded from an RRSP (check the rules) in a series of tranches. It's really something to 'do', with the intent over time of paying yourself a cumulative salary > the cost of your purchase - and letting the RRSP absorb the business risk. Lots of possibilities, so talk with your adviser. 

 

Look at physical assets.

Most would 'buy up' (bigger/pricier house) via the primary residence, and sell 3-5 years later to capture a tax free gain (maybe); ideally the gain covers the cost of 're-decorating', you net out about even, and your 'significant other' ALSO has something to do. Variations on the same theme are being a landlord, or hotelier; and using the assets 'creatively' (talk to adviser).

 

Look at philanthropy.

Fund your own 'foundation' via an annual charitable donation, and use the proceeds to physically go to 'where ever' and do good works. All your costs are paid for by the charity, the government gives you a tax deduction to help the process along, and you get the satisfaction of having done something useful. The 'wealth exists to be used' approach.

 

Different strokes.

 

SD

 

 

[Studesy]

Couple of other considerations .....

 

What are you going to 'do' after you've sold the business/retired?

Most folks would look at partnerships (spread the load AND the financial risk), funded from an RRSP (check the rules) in a series of tranches. It's really something to 'do', with the intent over time of paying yourself a cumulative salary > the cost of your purchase - and letting the RRSP absorb the business risk. Lots of possibilities, so talk with your adviser. 

 

Look at physical assets.

Most would 'buy up' (bigger/pricier house) via the primary residence, and sell 3-5 years later to capture a tax free gain (maybe); ideally the gain covers the cost of 're-decorating', you net out about even, and your 'significant other' ALSO has something to do. Variations on the same theme are being a landlord, or hotelier; and using the assets 'creatively' (talk to adviser).

 

Look at philanthropy.

Fund your own 'foundation' via an annual charitable donation, and use the proceeds to physically go to 'where ever' and do good works. All your costs are paid for by the charity, the government gives you a tax deduction to help the process along, and you get the satisfaction of having done something useful. The 'wealth exists to be used' approach.

 

Different strokes.

 

SD

 

SD. It's good to hear some different angles on this.  With respect to sizing up in real estate....I'm too old for that! At 40, I'm looking to simplify and downsize and focus on quality of life....not so much "more" or "bigger" stuff!  I hear get what your saying on being creative in how your assets are utilized.

 

The foundation idea...which I really like, has crossed my mind and is something I plan to do at some point going forward. 

[bizaro86]

Depending on how much money you'd be putting in a foundation, it may make sense to get a donor advised fund at a community foundation. Way less administrative burden, and not very expensive. Biggest downside for folks here is you generally can't control the investments.

 

I have a fund at the Calgary Foundation and it's great. They take care of everything, you can donate appreciated securities, and you pick where the charitable distributions go.

 

 

[lessthaniv]

I do this too. DAF’s are a great options for many people.