Case study: Financial planning for a year abroad

This article appears in the June 2020 issue of Advisor’s Edge magazine. Subscribe to the print edition, read the digital edition or read the articles online.

This article is the second in a four-part series following Natalia and Wilson through continuous life stages, read part 1.

The situation

Natalia Meyer* didn’t go back to teaching high school. Before her maternity leave ended, she started a master’s in education part-time; by the time her second child was born, she was enrolled in a PhD program. Lionel is now 13 and Barbara is 11. Since completing her studies, Natalia has been a senior administrator at a local college, earning $120,000 per year. She bikes to work from the duplex she bought for $1 million with her common-law partner, Wilson Eto, before Lionel was born.

Wilson’s company, which sells men’s grooming products directly to consumers online, was recently acquired by a multinational consumer packaged goods company. His $200,000 annual salary as the brand’s managing director with the multinational was almost double what he made as vice-president with the boutique. However, after a year in the role, Wilson has been deemed redundant. He receives a $250,000 severance package.

Through her college, Natalia has the opportunity for a one-year secondment at a university in Mendoza, Argentina. Her late father was born and raised there before moving to Toronto as an adult. Natalia sees it as an opportunity to connect with her roots, and for an adventure before the kids start high school. While Wilson is nervous about being out of the job market for a year, he reluctantly admits it’s a chance to consider his next steps from a distance.

After talking it over with the kids, Wilson and Natalia decide to do it.

Natalia’s salary in Mendoza won’t change, and will go farther given the cost of living, which is about $2,600 per month for the family. Still, they’re worried about living on one income, especially since they want to use the opportunity to travel. The family will need to find a rental; they plan to rent out their own house in Toronto.

Between mortgage payments of $2,500 per month and Natalia’s years at school, they haven’t added to their savings since they bought the house. They still have an unpaid mortgage amount of $400,000**.

How can the family prepare for a year abroad?

*These are hypothetical clients. Any resemblance to real persons is coincidental.

**Based on a five-year fixed mortgage at 2.89%; 30-year amortization

David Harris Investment advisor, Cumberland Private Wealth, Toronto

Marvin Khoshkhassal Tax partner, MK & Associates Tax Services Ltd., Vancouver

James McCreath Portfolio manager, BMO Private Wealth, Calgary

Answers have been edited for length and clarity

Marvin Khoshkhassal: We can assume they’re Canadian residents for tax purposes: Natalia’s employer is from Canada, their ties are more in Canada than Argentina, and the move is short term (the contract is for one year).

There’s definitely room for tax planning. Wilson’s severance pay will be treated as employment income — subject to Wilson’s normal withholding rate based on his tax bracket, and also subject to deductions (such as employment insurance and Canada Pension Plan contributions).

How much tax Wilson pays depends on how his employer pays his severance. If Wilson gets his severance as a lump sum, he could ask his employer to transfer some or all of the severance directly to his RRSP with no income tax deducted.

However, he must have enough contribution room available to transfer the non-eligible severance pay, which is for employment years after 1996; otherwise there will be high penalties. Eligible severance pay, which is for employment years prior to 1996, can be transferred to the RRSP without impacting contribution room. The employer will provide further information.

Wilson can also ask for the severance as a deferred payment over two or more years. Since he’s going to be off work for at least a year, it would make sense for him to ask his employer if they can defer payments to two calendar years.

Let’s assume he’s going to be unemployed for two years. If he splits his severance pay and receives $125,000 each year, he will already be in a high tax bracket — 43% combined federally and provincially in Ontario. Every dollar after $100,000 will be taxed at 43%. If he can defer his severance, only $25,000 would be taxed at 43%, instead of $150,000 if he takes it all at once.

James McCreath: There’s always a risk of employer insolvency, which factors into whether Wilson wants to receive that payment in a lump sum or over two years.

MK: If he has enough available contribution room, then he doesn’t have to take that business risk and he can transfer the full severance into the RRSP. That would be the best scenario. He can take it out whenever he wants to and pay tax on it.

Also, Natalia can deduct moving expenses to and from Canada. She should claim reasonable amounts for moving expenses, household items, transportation costs, storage costs, travel expenses, meals and accommodations, and temporary living expenses up to 15 days.

Financial planning

David Harris: One of the first things they can do is create a monthly budget. Their monthly cost of living should include their mortgage in Canada and any other continuing expenses.

The average cost of living in Argentina is $2,600 a month, and their mortgage is $2,500, so we have a monthly budget of $5,100 per month, or $61,200 per year. Since they want to travel when they’re in Argentina, let’s plan for another $20,000, bringing their yearly total to $81,200.

Natalia’s after-tax income would be $83,755 based on a 43% federal and provincial tax bracket, so they’ll be OK for the year.

They can use some of Wilson’s severance for a rainy day fund covering three months of expenses.

JM: Whatever excess capital they have from the severance that they don’t need for a rainy day fund I would split between paying down debt and long-term investing for retirement. Wilson has a TFSA, which would be the natural place to put it if the RRSP ends up being maxed out.

DH: Natalia and Wilson will also rent their home out to offset some of the mortgage payments.

MK: When you change your principal residence to an income-producing property, however, this is considered a change of use to a business property, which means there’s a capital gain after selling for the year they rented it out.

They can request that their principal residence not be considered a business property. If the family makes this election under subsection 45(2) of the Income Tax Act, they still have to report their net rental income. However, they can claim any capital cost allowance on the property.

While this election is in effect, they can designate their property as their principal residence up to four years, even if they don’t use the property as their principal residence. But they have to be residents of Canada for tax purposes, and they can’t designate any other property as their principal residence.

Should Wilson work?

MK: Income tax in Canada is imposed on worldwide income, so he has to report any income earned during the year. However, there’s a treaty between Argentina and Canada. If Wilson pays any income tax in Argentina, he may get the foreign tax credit in Canada, so he’s not paying tax in both countries.

But working in Argentina might put him in a situation where they might not be considered residents of Canada, because it would definitely link him more to Argentina than Canada.

Resident status is not defined in the Canadian Income Tax Act. It’s based on facts, and the courts look at it case by case. If they’re not residents, then all the tax planning we’re talking about would basically backfire. Their RRSP contribution would probably become taxable at the highest rate, and they won’t be able to use the election on the principal residence. I would be worried about that.

DH: If Wilson doesn’t work in Argentina, he can leverage his existing network online for future business plans or job opportunities. He could consider continuing education, maybe going to school part time. It might cost a little bit extra, but improving his skillset over the course of the year could be another option.

JM: He’s also got the opportunity in Argentina to learn Spanish. When he comes back to Canada, that could be of great value.

Insurance considerations

JM: They should look into health insurance, and whether they need supplemental insurance. It depends on what type of insurance Natalia is getting from her employer while she’s in Argentina.

And they should check with their provider to make sure they have proper insurance to drive abroad. If there’s an accident in Argentina, they must have proper coverage.

Finally, if they’re renting out their home in Canada, they’d want to get rented dwelling insurance, which covers off a number of risks associated with renting your principal residence.

DH: With Natalia being the primary income earner, and Wilson having no immediate plans to return to work, she should have disability insurance, whether that’s through the college or supplemental insurance. It’s a big problem for the family if something happens to Natalia, especially with the ongoing debt payments they have to make.

Planning for the move

JM: A big element of what they’ll face is their cash management while they’re in Argentina. I wouldn’t classify Argentina as the most stable of economies, so there’s some currency risk. Natalia would want that sorted out in her contract, in terms of what currency she’s being paid in. She’ll want to establish a local bank account, but also want multiple avenues for addressing access to capital. She’ll want to keep the majority of capital that isn’t required for day-to-day living purposes back in Canada, and have easy access to those funds.

Finally, they should just enjoy themselves. Not every decision makes entire financial sense. Above all the numbers, they’re there to experience a new culture.