Less tax means more return

You’re increasingly under pressure to justify the value you’re providing to clients when markets have been sub-par for the last 10 years. There’s uncertainty going forward and interest rates are abysmal.

My focus is to help clients and their advisors achieve the best after-tax returns, because at the end of the day, that’s what their financial plans are based on and that’s the money they can actually spend. Good returns aren’t good for much if they’re not tax-efficient.

A common mistake is to use the same asset allocation in each of a client’s accounts. The key is to look at the overall asset allocation when combining all accounts, including a spouse’s accounts. From there, decide what should be held where.

Interest-bearing investments attract the most tax for those in the highest tax bracket: 46% in Ontario, for example. Foreign dividends are taxed at the same rate. But Canadian dividends are taxed at only 29% and capital gains at 23%. So, simply by changing which accounts certain investments are held in, you can reduce tax and subsequently increase after-tax returns.

If someone has $100,000 in a non-registered GIC paying 3% and $100,000 in Canadian common shares paying 3% in dividends in their RRSP, you might consider cashing the GIC and buying $100,000 of Canadian common shares and simultaneously selling the common shares in the RRSP and buying a GIC. The annual tax savings would be $510. On $3,000 of income, this is a significant increase in after-tax returns.

Another common mistake is holding growth equities in an RRSP. The problem with growing an RRSP significantly relative to initial contributions is that the client’s getting a deduction on the contribution, but is then paying tax on the much larger withdrawals. Clients really don’t want the withdrawals to be too large. It would be nice to have a $2 million RRSP, but there’s a potential $928,000 tax bill associated with $2 million in RRSP withdrawals.

By contrast, investing in growth equities outside an RRSP results in only the capital gain being taxable to the client. Gains are 50% tax-free and can also be timed much more easily than RRSP withdrawals, which are mandated by the government after age 71.

Which spouse should own which investments? The dividend tax credit mechanism can make Canadian dividend income tax-free in many cases for those with modest income under approximately $38,000 in Ontario, depending on their other sources of income.

Clients like value and define value from an investment advisor as making them money. If you’re not able to do this because the markets aren’t cooperating, at least consider a meeting to talk tax and demonstrate how much money you’ll save them this coming April – and for many Aprils to come. If it’s not something you’re comfortable with or capable of on your own, consult a tax advisor or add one to your team. This shows you’re focused on the client’s bottom line and not your own.