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Why investors should pay for all investment fees out of non-registered accounts

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December 19, 2019

The Department of Finance Canada’s recent letter to the Canada Revenue Agency (CRA) stating that paying investment fees for registered accounts out of non-registered accounts does not constitute a tax advantage is a big win for investors, who are now free to pay their investment costs from any source they choose.

There are various advantages for investors to pay all investment fees out of a non-registered account. At the core, though, investors will end up with more money, after taxes, if they pay all the investment fees for a tax-free savings account (TFSA) or registered retirement savings plan (RRSP) from assets held outside of those accounts.

So, how did this all come about? In 2016, the CRA announced at a tax conference that its position on paying investment fees for registered accounts from non-registered accounts constituted an unfair advantage. Furthermore, the CRA stated that as of 2018, any taxpayer who engaged in this activity would be subject to a special advantage tax equal to the amount of fees paid outside of the registered account. The implementation was then postponed a couple of times pending a review from the Department of Finance.

Then, the Department of Finance sent a letter this past August recommending that the Income Tax Act be amended to reflect its finding that there is no advantage to paying registered fees outside of a registered account and that such a decision by a taxpayer may not necessarily be tax motivated. In effect, it means the CRA will not penalize a taxpayer for paying investment fees for a registered account from a non-registered account.

For financial advisors and investors, there are various benefits to taking this approach, which is a way to increase assets with no added risk.

For one, investors may have investments that are less liquid in the registered account. So, paying for investment fees from a non-registered account can provide ease of cash management over the portfolio. In addition, paying all investment fees out of one account rather than from multiple accounts may be easier from an administrative perspective.

The main advantage for investors, though, is that registered accounts have an ability for greater compounding of returns than non-registered accounts because of the registered accounts’ tax-deferred or tax-free nature. That was the CRA’s main issue with this practice.

As an example, let’s consider an investor who has $100,000 in a TFSA and $100,000 in a non-registered account. Each account incurs investment expenses of 1.5 per cent, or $1,500, annually.

If all expenses are taken from the non-registered account, it results in more assets growing tax-free within the TFSA, as they’re not impeded by investment costs. Furthermore, it helps the investor save taxes as the capital base in the non-registered account will be lower, which will result in lower taxes against the income within that account as well as lower taxes on the capital gains when the funds are withdrawn.

The strategy is similar for an RRSP, except that the income from the RRSP will be fully taxable when it’s withdrawn from an RRSP or from a registered retirement income fund (RRIF) once the investor reaches retirement. Thus, the investor reduces the capital in the non-registered account today in favour of a much larger payment from a RRIF in the future. Although that payment will be taxable, it will presumably be when the investor is retired and in a lower tax bracket. In addition, as inflation will erode the value of money, it’s preferable to pay $1 of taxes in the future than $1 of taxes today.

Although the advantage in the TFSA is clear, the advantage for the RRSP will be dependent on many factors, such as an investor’s tax bracket now and in retirement, inflation and even potential changes in tax policy.

For investors, this may not be the top tax-saving strategy available, but they should take advantage of every opportunity to improve their returns and reduce their taxes – especially when it can be executed with a simple administrative change.

 

Reprinted from the Globe and Mail, December 18, 2019.

Matthew Ardrey
Presented By:
Matthew Ardrey
VP, Wealth Advisor
matt@tridelta.ca
(416) 733-3292 x230

The hardest financial question for most people to answer

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October 9, 2013 , , ,

ted_banner

When asking questions to clients, the one that usually stumps people is “How much do you spend in a year?”

They can answer about what they have, what they owe, how much they make, even how much insurance they have, but the discussion slows down considerably around spending.

In most cases, as the advisor, we don’t care what money is being spent on.  We just need to have an accurate sense of the total.

Not surprisingly, how much people spend has a big impact on their financial picture.

Take a scenario of a 60 year old couple. They have $500,000 in RRSPs, $500,000 in non-registered savings, and a $500,000 house with no debt. If they spend $90,000 a year, we estimate they will likely leave an estate of over $400,000.  If they spend $100,000 a year, we estimate they will run out of money in their lifetime.

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Even if they say that they know how much money they spend, we find that often this number underestimates the actual spend. There are always the ‘one-off’ expenses that seem to happen regularly. There is also the odd expense that is simply forgotten.

When they finally do an analysis, they often look at certain expenses and say “do we really spend that much on that?”

Other times, they will say, “that explains why we have had trouble saving more?” The review may lead to changes that lower expenses, or even without changes, will at least provide greater clarity as to why finances are the way they are.

 

Calculate your annual expenses – the most important number in financial planning. If you do nothing else to shore up your financial picture, understand what you are spending, and you will have answered the hardest financial question of them all.

 

I actually believe that the expense number is the most important number in financial planning.  We have all heard of people saying that they are working towards THE NUMBER. This is usually some amount of savings that — when achieved — will allow them to retire in style. What I have found is that the expense number can be the foundation to everything.  It is almost like the sports debate about offense vs. defense.  I view expenses as the defense, and income and assets as the offense. Just like in many sports, the offense gets the glory, but the game is won on defence.

I once spoke to someone in their early 60s. They told me that they have little savings and no pension, and that they are very worried about their retirement. When we went through their situation, I found the following. They were a married couple. They had $25,000 of RRSPs. They had a $400,000 house. They had no debt, and no pension. As it turned out, they are also likely going to be just fine financially. The reason is that they spend about $28,000 a year.

By the time this couple is 65, they will collect well over $30,000 a year indexed, based on CPP, Old Age Security and what is called the Guaranteed Income Supplement or GIS.

In addition, this couple can keep their house, go to a bank and get a line of credit of $100,000 secured by their house (likely very doable even with their low retirement income, but easier to get while still working), and use this line of credit as both an emergency fund, and also to possibly supplement their income by a few thousand dollars a year if needed.

The other alternative is to sell their house, invest the proceeds conservatively, and at 3%, generate $12,000 a year in additional income to cover off extra rental expenses.

The point is that with virtually no savings outside of their home, because of their low expense lifestyle, they are still in decent shape. They are potentially in better shape than the other couple with $1-million in savings, who live a $100,000 a year lifestyle.

Once you can properly answer the question “How much do you spend in a year?” then the rest of the financial order will fall into place. You can begin to get accurate advice on tax savings, appropriate investment asset allocation, and truly answer whether you will be at risk of outliving your money, or instead need to focus more on estate planning.

If you do nothing else to shore up your financial picture, understand what you are spending, and you will have answered the hardest financial question of them all.

Ted can be reached at tedr@tridelta.ca or by phone at 416-733-3292 x221 or 1-888-816-8927 x221

Reproduced from the National Post newspaper article 2nd October 2013.

 

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