Investment Archives - Foresight Financial

Impact of Higher Capital Gains Inclusion Rate on Financial & Estate Planning

by Foresight Financial | May 1, 2024 | Accountants, Blog, buy sell, corporate, Family, financial advice, Financial Planning, incorporated professionals, individuals, Investment, tax

One change proposed in the April 16, 2024 Federal Budget is raising the inclusion rate on capital gains from 50% to 66.7%. For individual taxpayers, the initial $250,000 of capital gains remains taxed at the 50% inclusion rate. However, for corporations and trusts, the increased inclusion rate applies to all capital gains. These adjustments are slated to come into effect starting June 25, 2024.

What does this mean for individual taxpayers?

Income taxes on realized capital gains are increasing. For example, in B.C. with a top marginal income tax rate of 53.5%, taxes paid on capital gains under $250,000 are taxed at 26.75%. Now, for gains over $250,000 the tax rate increases to 35.85%. For most taxpayers, many of whom would not realize over $250,000 of capital gains in a taxation year, this change will not have any impact. However, for those who do realize such a gain the additional tax could be significant.

Consider someone who has just sold recreational property. If the amount of gain on that Whistler ski cabin, for example, was $500,000, the tax payable on the transaction will increase from $133,750 to $156,500. If that same property had been held in the family for generations the increase in taxes, with the new inclusion rate, could be substantial.

The same will be true for BC residents who own rental properties or investment portfolios that they wish to sell and generate profit. For each $100,000 of capital gain over the $250,000 limit they will pay an additional $9,100 in income tax.

The biggest potential impact of the increased inclusion rate on capital gains will be in estate planning. When a taxpayer in Canada dies, he or she is deemed to have disposed of all their capital property at fair market value. For estates with a large amount of non-registered investments, rental, and recreational property as well as other appreciable capital property, the inclusion rate of 66.7% will increase the final tax bill considerably.

What does this mean for owners of private corporations?

For private corporations (and trusts) there is no reduced inclusion rate for the first $250,000 of gain. Every dollar of realized capital gain is taxed based on an inclusion rate of 66.7%. Using the ski cabin in the first example, if that property had been held in a corporation, upon its sale, the full $500,000 would attract tax based on 66.7% inclusion, increasing the total tax payable to $179,150.

Many successful professionals earn their income in a private corporation retaining surplus income not required for immediate expenses to accumulate corporately for future use. The proposed tax increases on both corporate investment realization and shareholder access to proceeds have been substantial.

There is a vehicle for Canadian-Controlled Private Corporations (CCPCs) known as the Capital Dividend Account. This notional account allows a tax-free flow of the non-taxable portion of capital gains to the shareholder. The amount of tax-free capital dividends has now been reduced because of the increased inclusion rate. For instance, if a corporation realizes a $500,000 capital gain (using the example of a B.C. company with a 50.7% investment tax rate), the corporation’s tax liability would be $169,084, compared to the previous $126,750 with a 50% inclusion rate. Prior to June 25, 2024, the tax-free capital dividend flowing to the shareholder would be $250,000, decreasing to $166,500 thereafter. Consequently, more tax paid within the corporation translates to fewer tax-free proceeds for the shareholder.

For corporations, capital gains will increase their Adjusted Aggregate Investment Income (AAII) more quickly due to the higher inclusion rate. This will have the effect of accelerating the erosion of the Small Business Deduction (low rate of tax on the first $500,000 of active business income) which is reduced by $5 for every $1 of AAII.

Planning Opportunities and Strategies

What are some planning tips and strategies that can be used to mitigate the effect of these new provisions?

If you are holding investments with more than $250,000 in deferred capital gains, consider declaring them prior to June 25, 2024. This will require careful consideration as it will require tax to be paid sooner than originally expected. It may also have some Alternative Minimum Tax implications so take this strategy under advisement;
Consider a further diversification of your investments to limit capital gain exposure. Cash value life insurance, in particular Participating Whole Life, has been growing in popularity for several years, primarily due to its stable growth and tax-exempt status. This product could prove beneficial in a re-allocation of current investments;
Permanent life insurance products have long been used in providing necessary estate liquidity to pay taxes at death. With estates now having a possibility of higher taxes due to the higher inclusion rates, the amount of life insurance held for this purpose should be increased;
For owners of private corporations holding capital investments, consider allocating some of those investments to personal ownership to take advantage of the lower inclusion rate for up to $250,000;
Corporations should also consider diversifying and re-allocating corporate surplus to a tax-exempt life insurance policy owned by the corporation. This will shelter those investments from high passive corporate investment income tax as well as help protect the Small Business Income Tax rate on the first $500,000 of active business income;
You may also want to reassess corporately owned life insurance to help provide for the estate liquidity needs of the business owner, since the death benefit of the policy in excess of its ACB can be paid to the surviving shareholder or family tax free from the Capital Dividend Account.

As in previous budgets, there is currently no draft legislation enacting the provisions of the April 16th budget. Once enacted, however, the terms of the budget impacting the inclusion rate of capital gains will be effective June 25, 2024. It would be prudent to discuss your planning and develop strategies sooner rather than later.

Optimizing Wealth Through Asset Re-Allocation

by Foresight Financial | Apr 3, 2024 | Blog, Investment, life insurance, tax

If you are an active investor, your investment holdings probably include many different asset classes. For many investors, diversification is a very important part of the wealth accumulation process to help manage risk and reduce volatility. Your investment portfolio might include stocks, bonds, equity funds, real estate and commodities. All these investment assets share a common characteristic – their yield is exposed to tax. From a taxation standpoint, investment assets fall into the following categories:

Tax-Adverse

The income from these investments are taxed at the top rates. They include bonds, certificates of deposits, savings accounts, rents etc. Depending on the province, these investments may be taxed at rates of approximately 50% or more. (For example, Alberta 48.0%, BC 53.5%, Manitoba 50.4%, Ontario 53.53%, Nova Scotia 54.0%).

Tax-Advantaged

These investments are taxed at rates lower than those that are tax-adverse. These investments include those that generate a capital gain (stocks, equity funds, investment real estate, etc.), or pay dividends. The effective tax rate on capital gains varies depending on province from approximately 24% to 27%. For non-eligible dividends, the range is between approximately 37% to 49%.

Tax-Deferred

Tax-deferred investments include those investments which are held in Registered Retirement Savings Plans or Registered Pension Plans (such as an Individual Pension Plan). One advantage of these investments is that the contribution is tax deductible in the year it was made. The disadvantage is that the income taken from these plans is tax-adverse as it is taxed as ordinary income and could attract top rates of income tax.

The growth in cash value life insurance policies such as Participating Whole Life and Universal Life is also tax-deferred in that until the funds are withdrawn in excess of their adjusted cost base while the insured is still alive, there is no reportable taxable income.

Tax-Free

Very few investments are tax-free in Canada. Those that are tax-free include the gain in value of your principal residence, Tax-free Savings Accounts (TFSA’s) and the death benefit of a life insurance policy (including all growth in the cash value account).

While Canada is not the highest taxed country in the world (that distinction belongs to Belgium) it is certainly not the lowest. (According to the Organization for Economic Co-operation and Development, Canada sits as the 23rd highest taxed country in the world). It is also true that in addition to the taxes Canadians pay while they are living, the final insult comes at death.

Generally speaking, you have three beneficiaries when you die. You have your family, your favourite charities, and the Canada Revenue Agency. They all take a slice of your estate pie. Most people would rather leave more to their family and charities than pay the CRA more than they need to.

As our estates grow, they include funds that we intend to leave to our children and possibly to charity. They also include funds we are likely never going to spend while we are alive.

The secret to optimizing the value of your wealth for the benefit of your estate is to reallocate those assets that you are never going to spend during your lifetime from investments that are tax-exposed to those that are tax-free.

One of the best ways to do this is through life insurance. As mentioned earlier, assets which are tax-free include the death benefit of a life insurance policy. Systematically transferring funds from the tax-exposed investments to, for example, a Participating Whole Life Policy, not only eliminates the reportable tax on the funds transferred, it greatly increases the overall size of the estate to be left tax-free to your beneficiaries – your family and your charities.

Case Study

Let’s consider Ron and Sharon, aged 58 and 56 respectively. They have been told that they have a liquidity need of approximately $1,000,000 which would become payable at the second death. They are also unhappy about the taxes they are paying annually on their investments. They elect to reallocate some of their assets to a Participating Whole Life policy for $1,000,000 last-to-die policy with premiums of $35,000 per year for 20 years.

Over this period, they will transfer a total of approximately $700,000 of investments exposed to income tax to a tax-free environment. If we assume that their life expectancy is 34 years, the Whole Life policy will have grown to a death benefit of approximately $2,630,000*. This represents a pre-tax equivalent yield over this period of approximately 11%. Not only is there more than enough to pay the tax bill but there are funds left over for the family and any charitable donation they wish the estate to make.

In addition, with the transfer from a taxable to tax-free investment, income taxes that would have been paid during their lifetime has also been reduced. Along the way, the Participating Whole Life policy has a growing cash value account which could be borrowed against should the need arise. At the 20th year for example, the cash value of the policy (at current dividend scale), would be approximately $1,071,000.

This case illustrates only one example of how it is possible to optimize the value of an estate through asset re-allocation. By using funds you are never going to spend during your lifetime, you can create a much larger legacy to benefit others while reducing the total cost of your tax bill.

If you would like to investigate this concept to determine the value it can provide you and your family, please be sure to contact me. As always, please feel free to share this information with anyone you think would find it of interest.

* Values shown are using Manulife’s Par 100 Participating Whole Life policy assuming the current dividend scale with premiums paid for 20 years.

Are You On The Right Track?

by Foresight Financial | Jan 3, 2024 | Blog, Investment, Retirees, retirement, rrsp, Tax Free Savings Account

In bull markets, some investors develop unhealthy expectations as to the long term yields their investments should provide. Ten years ago, some came to accept returns as high as 15% to 20% per annum as the base return their fund and portfolio managers were expected to provide. Of course, these expectations came crashing back to earth in 2008 as the bull was chased away by a very large bear. Today, many fund managers are of the opinion that double digit returns are going to be very difficult to achieve with any consistency over the long term.

Is it time for us to lower our expectations?

If we have to accept lower rates of return, do we still want to be exposed to the same previous level of risk? There can be tremendous volatility in the equity markets and, as a result, many wonder if they are on the right track with their investment strategy.

4 Questions to ask yourself about your investment strategy

What are my goals?

If we don’t know what the target is, chances are it is going to be difficult to hit it. It is important to have an understanding of what we are investing for. Are we accumulating for shorter term goals, such as the purchase of a house, the education of our children? Or is the major objective to save for retirement? Perhaps it is a combination of these goals. If we know why we are investing and what the time frame for accumulation is we can determine how much risk is acceptable.

What is my risk tolerance?

This probably will depend on where you are in the life cycle. Investors who are in their 20’s to mid-30’s usually tolerate greater risk as they have sufficient time to make up any losses. In the middle years, especially when trying to save while raising and educating our children, steady growth with less risk is often the approach. At retirement, investors usually become extremely risk adverse as this is the time that capital is turned into income to replace earnings.

What are my retirement needs?

Converting capital into a consistent income might be the objective for the retirement years. For example, if we know what our fixed expenses will be, providing a guaranteed investment income that covers these expenses will help us to enjoy a comfortable retirement. While GIC’s might guarantee the capital, it only guarantees the interest rate up to the maturity date. Current interest rates are so low, nervous investors who would be comforted with guarantees may wish to consider a Guaranteed Minimum Withdrawal Benefit plan from an insurance company.

Are my investments tax efficient?

With a registered plan (RSPs, IPP’s etc.) all investments are treated the same – tax deductible going in (highly tax efficient), totally taxable as income coming out (highly inefficient). Even though deposits are not tax deductible, Tax Free Savings Accounts (TFSA’s) are highly recommended due to the fact that all growth is tax free and can be withdrawn at any time with no tax payable.

Looking at non-registered investments, usually the higher the risk the more tax efficient the investment. Pure capital gains are taxed at the lowest rate, guaranteed income (such as a GIC) at the highest rate. Dividends are taxed somewhere in the middle. There are many types of financial vehicles and most of them are appropriate in the right circumstances. Employing effective portfolio allocation can ensure that you are not unduly affected by equity volatility, fluctuating interest rates, or high rates of income tax.

Knowing the answer to these four questions should go a long way in determining whether or not you are on the right track. Having a full understanding of the options available to you is important.

There is nothing as certain as uncertainty. We live in very turbulent times with respect to the investment climate and developing an investment strategy during this time can be a very daunting and confusing task. Given that there are now investment vehicles that deal specifically with many of the issues facing investors today, discussion and consultation has never been more important.

As always, please feel free to share this information with your family and friends.

Whole Life Insurance – A Whole New Asset Class

by Foresight Financial | Oct 1, 2023 | Blog, Investment, life insurance

The recent developments in investment markets and the volatile performance that has resulted have brought about a new appeal to an old workhorse. For investors looking for a diversification in their investment portfolio and a more tax-efficient fixed income investment alternative, a compelling argument can be made for the use of Whole Life Insurance.

Why is Whole Life Insurance a good investment?

The tax-advantaged steady growth, combined with significant estate benefits, are the primary reasons why Participating Whole Life is now being thought of as a new asset class.
Unlike other accumulation policies such as most Universal Life policies, mutual funds and other equity investments, the cash and dividend value of a Whole Life policy cannot decrease as long as premium payments are made.

Who should consider Whole Life Insurance as an investment alternative?

Anyone looking for stable returns on their investment portfolio.
For those that have corporations and are accumulating surplus, the use of Whole Life in the corporation not only provides the same stable, tax-deferred returns but also provides opportunities for Capital Dividend Account planning.

What Is Whole Life Insurance?

It is permanent life insurance protection – meaning it won’t expire before you do!
It has level guaranteed premiums for the life of the policy. (Shorter premium paying periods are often available.)
It has tax-advantaged cash value growth.
It can pay annual dividends (participating whole life).
Dividends can be taken in a number of different ways but the option most often selected to provide the maximum tax-advantaged growth is “paid-up additions.”
The assets of the participating pool are professionally managed and largely in fixed-income investments. Management fees are extremely low (some as low as 0.07% management fee), and the funds have very little volatility.
This combination of guaranteed cash value and the non-guaranteed portion from the dividend account grows tax-deferred. At death, it is paid to the beneficiary tax-free.

Can I access the cash value of the policy?

During the lifetime of the insured, the cash values can be accessed by way of partial or total surrender or policy loan.
Income tax may be payable on withdrawals. However, one alternative to avoid paying income tax is to use the policy as collateral and borrow from a third-party lender. And if structured properly, the interest on the loan may be tax-deductible.

Favourably compares to a long term, high yield bond

Today most portfolio managers recommend that a prudent investor have a diversified portfolio with a significant portion in fixed-income investments, such as bonds, term deposits, etc.
Many investment managers suggest one-third to 40% of an investment portfolio be in these types of investments for balanced growth.

Including participating whole life in your portfolio can produce some significant results and reduce overall volatility.

Whether investing as an individual or via a corporation, the significant results that can be achieved by using Participating Whole Life are worth investigating.

Connect with me if you think you would benefit from this strategy, and as always, please feel free to share this article with anyone you think would find it of interest.