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Wealth Preservation

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The concept of wealth preservation and the discussions that surround that concept usually happen with my clients either at or approaching retirement. Generally it’s a discussion that also happens concurrently with a risk tolerance analysis, but that doesn’t need to be the case. For example an advisor who’s hearing a young couple saying they want to preserve capital might confuse that with a conservative risk tolerance. Although that may be the case, it’s also quite possible that the client has a significant risk tolerance in the purest form of the discussion equity/fixed income ratio, but still wants to preserve wealth using defensive equity strategies. That client may have a need for higher returns, and a desire to preserve capital, and it may not be necessary, depending on risk tolerance, to move to a fixed income portfolio.  In other words, preservation of wealth and risk tolerance are not the same thing, and most advisors will often interchange the two. Assuming the discussion is actually one of preserving wealth, and not one of reducing risk tolerance, the below factors apply.

The preservation of wealth discussion usually happens at the late stages of saving or in the retirement years for most clients because that’s when they start drawing on their income or are starting to think about it. The easiest way to move to a preservation of wealth strategy is to change the asset allocation in a portfolio and to increase the fixed income component. The problem with that solution is that forces the client to be willing to accept reduced returns, and most people can’t afford that. In reality, in my view, there are better ways to do it without sacrificing returns.

Staying away from speculative stocks and sectors. This is a fairly simple and obvious one, but if investors want to preserve capital, they should stay away from speculative sectors, stocks that aren’t profitable, stocks that are trading a crazy multiples, and stocks that haven’t yet clarified or explained what their revenue model will eventually look like. Many of the pure growth plays in the markets would have these characteristics. If you can’t explain how your company is going to make money, if you aren’t currently making money, or if you don’t have a plan on how to monetize your idea, it’s probably best to stay away if preservation of capital is important. In this case, I would suggest sticking to sectors that have proven long term track records of generating profits and sustained growth, along with a slowly increasing dividend.

Replacing higher Beta equities with lower beta equities. Generally, this would be equivalent to replacing growth equities with dividend paying equities. For example, there’s an index that exists called the TSX Low Volatility index, and it targets the 50 stocks in Canada that have the lowest volatility. Not only has it historically done as good or better than the larger TSX index, but it has done it with less volatility. In theory, the way it protects wealth is that if ever there’s a market correction, the stocks should drop less than the broader index.

Adding Real assets to the portfolio. Specifically, REITs and Infrastructure are two sectors that I’ve liked for a long time. Real assets typically don’t correct as much in downturns, and provide consistent tax efficient income. If you actually take a step back and think about what you actually own when investing in these types of companies, you own actual buildings or infrastructure projects with proven long term cash flows. I always ask myself, in 20 years, what will my asset look like, and generally when considering these types of investments, they look good and have a strong likelihood of having kept its value.

Using alternatives such as Equity Linked GICs. This would be for a client who wants to have equity exposure while having the comfort of the guarantee associated with GICs. Clients can participate in the upside of the markets while having 100% of their principle protected. An easy way to preserve capital is to have the entire amount protected, and this allows for that.

Using a consistent rebalancing strategy. This is another oldie but goodie, and a simple way to protect capital. Every time the market rallies and your asset allocation get out of whack, by rebalancing, you take some profits off the table, reduce your exposure to markets, and protect yourself in the event of a market correction.

Turning trust into a trademark

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“There are many paths to success in the financial services industry. Some take the straightforward approach, laying a solid foundation through formal education and acquiring designations over years, with the clear goal of entering the field. Robert Tetrault has always worked as a professional, but he started out in a different field: insurance litigation.

“I was a practicing and active lawyer at the largest law firm in Manitoba – Aikins McAulay & Thorvaldson – and I realized that I wanted to advise people in a slightly different manner,” said the head of the Tetrault Wealth Advisory Group at National Bank Financial.”

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Planning your retirement today

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Nearly two-thirds of Canadians are concerned about retirement planning. The other third will worry about it later… but will it be too late? We discussed the topic with Natalia Sandjian, Financial planner.

Generally speaking, do people start planning their retirement too late?

People start to think about their retirement around the age of 50, and that’s far from ideal. You should start planning your retirement once you enter the job market. It’s important to know that ultimately, things will be easier for you if you start saving for retirement early. Compound interest will do a lot of the work for you… if you give it time!

Do people in the workforce see retirement differently than the previous generation of retirees?

Retirement isn’t considered to be the twilight years anymore, it’s a second life. Nowadays, new retirees think, “Now I can try something new!” They want to take on new projects, and keep working on the side, because they want to… or need to.

Has retirement planning become more complex?

Most of all, the reality is different. In some cases, people are retired for as long as they worked. In addition, workers need to be self-sufficient: private retirement plans are increasingly rare, or less substantial, and government pensions are lacking.

In addition to all of this, retirees have a higher debt rate. In the previous generation, mortgages were paid off at retirement. Now, people in their 50s and 60s are coming to see us to refinance their properties.

Since there is less guaranteed income and more expenses over a longer period of time, it has never been so important to properly plan your retirement to keep things simple.

Do your clients have retirement “dreams” that are sometimes… unrealistic?

Yes and no. Basically, clients want to maintain their lifestyle when they are retired.

A decline in their standard of living is by and large their greatest fear. They are afraid that they won’t be able to keep doing what they love. These are far from big, unrealistic dreams! In fact, people keep themselves from dreaming because they are too worried about the financial aspect of their retirement.

Rather, it’s their expected return on investment that is unrealistic: future retirees don’t understand all of the actions that they have to take to make their retirement goals a reality, even if they are reasonable.

What kind of questions do we need to ask ourselves when planning for retirement?

It’s not enough to put your retirement plans in writing. The numbers are important: you need to specify your ideal retirement age, calculate the cost of your current lifestyle (a good indicator of what’s to come), take stock of your current investments and estimate the private and government benefits that you expect to receive at retirement.

What are some common retirement planning mistakes that people make?

Number one: not thinking about it. Number two: not thinking about it early enough!

Of course, when you’re in your twenties and thirties, you have other priorities, like your house and children. You think, incorrectly, that you have enough expenses now and that you’ll invest in your retirement later.

Lastly, another mistake is to think that you can simply save without a plan. If you don’t have any goals, the chances of success are slim…

What specific strategies do financial planners propose?

Financial planners establish customized strategies that take into account clients’ priorities, lifestyles and personalities.

A thirty-something at the beginning of his career will have a pile of expenses, but plenty of time ahead of him. He won’t have the same investment strategy as a conservative woman in her fifties who wants to start making withdrawals over the coming decade.

How often should people update their retirement strategies?

For young people, every five years or with each major life event (birth of a child, marriage or divorce, an inheritance or new job, etc.). If you’re close to retirement, you could use a yearly review.

Smart savings tips for every age

In your 20s: Save regularly, according to your budget. An investment as small as $25 per month can make a difference at the beginning, and will get you in the habit of saving.

In your 30s: Don’t stop saving for retirement, even if this is the time in your life when you’re the most in debt and there’s the biggest strain on your income.

In your 40s: Keep up your savings habit by increasing your contribution according to your financial situation and a well-balanced budget that will leave room for savings and discretionary spending. Because if you make an effort all year long before contributing to your RRSPs, you can buy yourself a reward with part of the tax return you might get.

In your 50s: Make the most of your contributions, and even double them if you notice that you’re not meeting your retirement goals.

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The opinions in this article are those of the person interviewed. They do not necessarily reflect the opinions of National Bank or its subsidiaries. For any advice concerning your or your business’ finances, please consult your financial advisor or another professional as necessary (accountant, tax expert, lawyer, etc.).

Edited on 22 December 2016 by 

Big tax changes on the horizon for small business owners

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Rob Tétrault, B.A., J.D., MBA, CIM
Vice-President, Portfolio Manager

Cédric Paquin, B.Comm, CPA, CA, CFP
Wealth Planning Consultant

On July 18, 2017 the department of finance released a consultation paper they publicized as a crackdown on perceived tax loopholes for wealthy business owners.

Personally, we had an uneasy feeling as we read through the proposal. The changes will have significant adverse implications on tax planning strategies widely used for several years by many business owners; not just the wealthy ones! As tax advisers, we always felt the strategies we implemented were available (and encouraged) to compensate our business owner clients for the risk they take, for the jobs they create and for the fact they do not have job security, employment benefits, employer sponsored pension plans, employment insurance, sick days or vacation days. The latest Key Small Business Statistics released by Statistics Canada in 2016 revealed that small businesses employ 70.5% of the labor force in Canada, were responsible for 87.7% of net employment change, accounted for 27% of R&D and contributed an average of 30% to the GDP of their respective province. They are the backbone of our economy! How will these figures be impacted over the long term?

Here is a brief review of the tax planning strategies targeted by the proposal.

Income splitting and multiplication of the capital gains exemption

Corporate structures are commonly set-up with all family members owning shares of the corporation, either directly or indirectly through a family trust. Income splitting can be achieved by paying dividends to lower income family members. The capital gain exemption can be multiplied on the future sale of the business by allocating the capital gain incurred to various family members based on share ownership or per the discretion of the trustee(s) of the family trust.

The “kiddie tax” was introduced in 1999 causing private company dividends paid to minor children to be taxed at the top personal tax rate. Currently, income splitting with minors can only be achieved by paying them a reasonable salary based on the work they perform for the business.

Starting in 2018, the Department of Finance proposes a number of measures to extend the “kiddie tax” to all related family members, whether minors or adults. Dividends received from related private corporations will be subject to the highest personal tax rate unless the amount is reasonable in the circumstances based on the recipient’s labor contribution and/or invested capital.

The capital gain exemption will no longer be available to minors, will not be available for any family member if the capital gain is subject to the extension of the “kiddie tax” rules above and will no longer be available for gains that accrued while the shares were owned by a family trust.

Tax deferrals when passive investments are held inside of a private corporation

Incorporated business owners can take advantage of tax deferrals by leaving passive investments inside of their corporation. For example, a corporation that earns income eligible for the small business deduction pays a combined federal and provincial tax rate of 10.5% in Manitoba. An individual subject to the top personal tax bracket would pay 50.4% in tax. Therefore, a 39.9% tax deferral can be achieved by leaving excess funds inside a corporation allowing for better compound growth and a larger nest egg in the future.

The consultation paper proposes to eliminate the advantage of retaining income in a private corporation. While the Department of Finance did not release any draft legislation they did set out a number of different approaches under consideration.

While it remains to be seen what form the rules will take, they will no doubt result in significantly higher taxes for the majority of business owners. Alternative planning strategies such as individual pension plans (IPPs) and retirement compensation arrangements (RCAs) will likely become more popular in the future.

Converting dividends into capital gains

Much less common than the previous two strategies was a practice we knew was under scrutiny so the proposed draft legislation came in as less of a surprise. The strategy involved embarking on a series of transactions with the effect of converting highly taxed dividends income into lower taxed capital gains.

The consultation paper proposed draft legislation to expand current anti-surplus stripping rules to capture these transactions. Amendments to these rules are effective as of July 18, 2017.

Conclusion

These proposals, if and when they become law, will have considerable impact on tax and estate planning strategies commonly implemented by incorporated business owners. We will closely monitor and advise you of any significant changes or revisions to these proposals as they occur and once they are eventually enacted. No doubt, they will require a careful review of existing corporate structures as well as an analysis of future tax planning opportunities.

Please do not hesitate to contact us if you would like to discuss your situation in more detail.

This information transmitted is intended to provide general guidance on matters of interest for the personal use of the reader who accepts full responsibility for its use, and is not to be considered a definitive analysis of the law and factual situation of any particular individual or entity. As such, it should not be used as a substitute for consultation with a professional accounting, tax, legal or other professional advisor.