How a couple with a net worth of $10 million and annual income of $215,000 can pay $0 in income tax

We are all hearing the calls to tax the rich. The assumption being, if you are rich, you will pay a lot of tax, but is that always true?
Are you rich? Here’s how to tell — and why you should care

Here is an example of a couple with a net-worth of $10 million who are set up to pay exactly $0 in tax in 2015.

Here is how they would do it.

coupleTom and Mary are a recently retired, 65-year-old couple, living in Vancouver. British Columbia isn’t the only part of Canada where a $0 income tax bill is possible, though — the dream is alive in Alberta, Saskatchewan and the Territories, too. In Ontario, they would have no tax, but would pay $1,500 for the health premium, which is essentially a tax.

In West Vancouver, they live in a $3-million home, which they bought 20 years ago for $400,000. They also have a $1.4-million cottage near Whistler, B.C., and a $600,000 house not far from Phoenix, Ariz. That’s about $5 million of real estate assets.

They will pay no income tax on the growth in value of their home, but will ultimately have to pay capital gains tax on the Whistler and Phoenix properties — but only when they sell. Of course, they do pay property taxes, but no income taxes.

Tom is a retired lawyer and Mary is a retired accountant. Despite being tempted over the past few years, neither decided to set up a corporation. They wanted to keep things simple. As a result, their $5 million of investments looks like this:

— $4 million in a joint non-registered investment account: This account primarily holds stocks, roughly two thirds of which is Canadian stock. They don’t aim to have very high dividends on the account, but they still end up with a dividend yield of about 3.75 per cent. This is expected to translate into $50,000 of Canadian dividends and $25,000 of foreign dividends for each of them.

Typical stock holdings would be BCE Inc., Royal Bank of Canada, Enbridge Inc., Apple Inc. and Johnson and Johnson.

They still manage to generate about $5,000 each in interest income from money market funds and high interest savings accounts and their total investment income from dividends and interest on the account is $160,000. Because it is a joint account, all of this $210,000 in investment income can be split equally between Tom and Mary.

They left the income in the account to be reinvested, but for cash flow they sold and withdrew $240,000. This generated a total of $50,000 in capital gains.

– Tom and Mary also have $100,000 combined in their TFSAs and $900,000 combined in their RRSPs.

To balance of some of their investment risk, they have most of their TFSAs and RRSPs in bonds, preferred shares and some private mortgage funds. They have decided not to draw any money from their RRSP, but instead set up a RRIF account and moved $3,000 each to the RRIF. They then withdrew $2,000 each from the RRIF. The reason they did this was to take advantage of the $2,000 Pension Tax Credit. They can’t withdraw it tax-free, but they can withdraw the first $2,000 at a significantly reduced tax rate, and they want to draw RRSP/RRIF money whenever they can, at a low tax rate.

Because Tom and Mary are now 65, they have an option to take Canada Pension Plan and Old Age Security. They have decided to defer the CPP, but take the OAS and see how much might be clawed back.

Tom and Mary work with an investment counsellor who charges a one per cent fee on their investment assets. Of this fee, the amount that covers the taxable account is fully tax-deductible. As a result, they can each deduct the $20,000 of investment counselling fees from their taxes. They also receive some tax related and planning advice from the investment counsellor.

Tom and Mary believe in giving to charity, and as their wealth has grown, so has their charitable giving.

This year, they plan to give a total of $34,200 to various charities. While this seems like a lot of money, it represents 0.34 per cent of their net worth. In addition, Tom and Mary would rather direct some of their funds to charities that they like, and benefit from lower income taxes. Where possible, they donate shares of stock that have a large capital gain.

So where does this leave the $10-million couple when it comes to tax time?

The good news is that they pay a grand total of $0 in income taxes. Yes, you read that correctly: Zero.

The sort of bad news: They each get $4,800 of their $6,800 OAS clawed back. But they still get a total of $4,000 from OAS after tax.

Now, before you protest in front of their home, it is worth keeping a few things in mind.

Tom and Mary have paid a lot of taxes in their working years. They clearly made good incomes in order to attain the wealth that they have, and because they didn’t get aggressive with tax planning, every year they would have been paying a good percentage of their income in taxes.

In addition, just because Tom and Mary are paying $0 in income taxes in 2015 doesn’t mean that they will be able to do this for too much longer. They have several tax issues coming up in the years ahead.

These include their $900,000 of combined RRSPs, which they will need to begin drawing down after age 71, and it would likely make sense for them to draw some money down sooner than that. They will be paying some level of tax on all of that $900,000.

Tom and Mary also have a cottage and a U.S. residence that will likely face meaningful capital gains taxes when they are sold. They will likely also have higher capital gains taxes to pay on the portfolio in the years ahead. It is also possible that they may have some U.S. estate taxes to deal with on not only their Phoenix house, but also on the U.S. stocks in their portfolio. For now, though, they are OK holding the U.S. property. Finally, in B.C. they will potentially face probate taxes of almost 1.4 per cent on their estate.

What I find most interesting is that there’s no advanced tax deduction strategy used: Everything Tom and Mary are doing is pretty plain vanilla planning. The most important components — in addition to their deductions for charity and investment advice — are the focus on tax-efficient investments, ensuring that they have a good percentage of income from Canadian dividends and that they are able to take full advantage of income splitting.

The other positive is that Tom and Mary recognize that using capital gains and return of capital to cover cash flow needs is usually much more tax beneficial than trying to boost income by having higher investment yields.

As the saying goes, there really are only two certainties in life: death and taxes. Even if the rich can avoid paying any taxes for a period of time, just like the Mounties always getting their man, the Canada Revenue Agency is pretty good at eventually getting their taxes.

Ted Rechtshaffen
Written By:
Ted Rechtshaffen, MBA, CFP
President and CEO
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