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IPP – Why so many dentists have set this up to save taxes in 2018 and beyond

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As a dentist you know that from time to time you may be presented with a challenging case of a difficult extraction.  As a Wealth Advisor and Financial Planner, I can tell you we are also often presented with a case of a potentially difficult extraction but instead of it being a molar, our challenge is to how best extract funds in the most tax efficient manner from the Dental Professional Corporation (DPC) of a practicing dentist.

One of the methods which has become more popular, especially given the recent tax changes involving Canadian Controlled Private Corporations (CCPC), is the Individual Pension Plan or IPP.

An IPP is a defined benefit pension plan tailored to small business owners such as dentists.  It allows for the DPC, as sponsor of the plan, to fund a defined benefit style pension for the dentist and even their spouse if they are also employed by the practice. Thus, extracting corporate funds and directing them to a source which will provide tax efficient retirement income.

The amount of annual funding is similar to an RRSP in that it is a percentage of T4 earnings to a maximum annual limit; however, for an IPP that limit is even higher than the RRSP contribution limit – and grows each year.  In addition to the annual funding, the company can also contribute any past service earnings as well as a lump-sum terminal funding at retirement.  All these contributions are tax deductible to the corporation.  Like an RRSP, your investment choices are broad and any income or capital gains generated inside the plan are sheltered from taxes, but unlike an RRSP, all of the administration fees and investment management fees are tax deductible expenses to the corporation.

Because an IPP is a formal pension plan, it must be registered with the provincial government and must make annual filings and reporting.  In addition, a triennial valuation must be performed by an actuary.  The plan administrator will generally perform all these requirements and the cost for these is customarily included in the annual administration fee, which is tax deductible.

At retirement the plan can be set up to provide a regular stream of income by way of a pension or the commuted value of the pension can be transferred to a Locked-in Retirement Account or LIRA.

The difference in value over an RRSP at retirement can be significant.  One projection we had calculated for a 55-year-old dentist and his 50-year-old spouse had them with over $1 million more in the IPP than if they just went the RRSP route at retirement.

This will not only allow them to extract more money from the company in a very tax efficient manner, but it will also provide them with a known pool of capital at retirement, which will provide them with a predictable income stream through retirement.

Upon death of the annuitant the remainder of the plan can be transferred to a surviving spouse or if there is no surviving spouse, the annuitant’s estate.

However, there are some drawbacks to an IPP.  The most common drawback is that it limits contribution room to an RRSP. However, this limitation isn’t a major one for dentists since the bulk of retained earnings, is destined to provide for a retirement income in the future. Some of the other drawbacks are because regular contributions are required to be made, this can be problematic for businesses that don’t have regular income streams.  Another small limitation is that funds within the IPP can’t be accessed before the age of 55, but for most dentists these constraints are not an issue.

At TriDelta Financial we recognize that the recent tax changes, IPP’s have become a very effective tool for extracting funds efficiently from your DPC and should be given serious consideration by every incorporated dentist over the age of 45.

Alex Shufman
For more information, please contact:
Alex Shufman
Vice President, Portfolio Manager and Wealth Advisor
alex@tridelta.ca
(416) 733-3292 x 231

Arlene Pelley
For more information, please contact:
Arlene Pelley
Vice President, Wealth Advisor
arlene@tridelta.ca
Edmonton office: (780) 222-6502

Should you contribute to your RRSP, TFSA or pay down debt

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Lorne Zeiler, VP, Portfolio Manager and Wealth Advisor at TriDelta Investment Counsel spoke with Catherine Murray on BNN’s Market Sense. Lorne discussed the tax benefits of RRSP contributions, at which income levels RRSP contributions are most advantageous and he also reviewed strategies for consolidating and reducing debt.

Click here to watch the full interview.

Lorne Zeiler
Written By:
Lorne Zeiler, MBA, CFA
VP, Wealth Advisor
lorne@tridelta.ca
416-733-3292 x225

When Cashing in Your RRSP Can Increase Your After-Tax Income

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Contributing as much as possible to your RRSP has typically been considered the best way to plan for retirement.  But, when you consider after-tax income, there might be times when cashing out part of your RSP can increase your after-tax cash flow, reduce future taxes and help ensure that you qualify for Old Age Security (OAS) payments.

RRSP contributions offer two main benefits: 1) Tax deferred growth: money invested in RRSPs grows tax-free until the money is drawn down, typically when converted into a RRIF – after age 71.  2) Income tax arbitrage: Since the RRSP contributions are fully tax deductible and the RRSP withdrawals are fully taxable, investors are able to significantly reduce their taxes by contributing to RRSPs in their working years when incomes and marginal tax rates are higher and then pay income tax at a lesser rate when withdrawing from an RRSP or RRIF in retirement.  For example, a 45 year old earning $110,000 a year is able to reduce her taxes by 43.4% for every dollar contributed to her RRSP, but if her income in retirement is $60,000, she will be paying tax at 31.2%, a net after-tax benefit of over $0.12 on every dollar.  But, there are opportunities where income tax arbitrage favours withdrawing funds from an RRSP.  Two examples are illustrated below.

Wealthy Widow / Widower

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Linda and Frank provide a good example of the potential after-tax benefits of RRSP withdrawals for widows (and widowers).  Linda and Frank were married for 35 years.  Both had worked most of their lives, and neither was entitled to a pension other than the Canadian Pension Plan (CPP).  Both had also amassed RSPs of over $500,000 each.   Frank recently passed away and Lisa at age 66 decided to retire. 

Lisa’s income, which had been $100,000/yr., suddenly declined to about $20,000 in retirement.  Her marginal tax rate dropped from over 43% to just 20%, but her RRSP, which was now combined with her husband’s, increased to over $1,000,000.  If she chooses to begin withdrawing money from her RRSP at age 66, when her tax rate is substantially lower versus waiting until age 71 to begin her RRIF, she could save substantial after-tax dollars and significantly reduce her OAS clawback.

Assuming, modest 4% growth per year, Lisa’s RSP will be worth over $1,300,000 by the time it is converted to a RRIF and she begins her withdrawals at age 72.  Since the minimum withdrawal rate at age 72 is 7.48%, she will be required to withdraw over $95,000 per year, bringing her total income to well over $110,000 when including CPP payments and small cash investments.  She will have to pay over $30,000 of that money back to the government each year in taxes AND likely forgo over $6,000 per year in OAS payments as they begin being clawed back with incomes above $70,954. 

If Lisa instead took out approximately $50,000 per year from her RSP from age 66 -72 she and her estate would save over $145,000 in taxes and reduce OAS clawbacks by over $55,000 (assuming that she lives until age 85). This is a net benefit to her and her estate of over $200,000 in after-tax dollars.

High Income Earning Spouse

RRSP withdrawals can also be highly beneficial for couples where one spouse earns substantially more than the other, providing over $11,000 in after-tax income in the example below. 

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Jeff and Sarah are a couple in their early 40s.  Sarah, a graphic designer, decided to work part-time to be home more often with her kids.  Jeff, a lawyer, earns $170,000 per year.  Sarah earns $30,000.  Jeff spends most of his salary to cover family costs, so he has over $50,000 of RRSP contribution room remaining and is rarely able to max out his contributions.  Sarah has an RRSP of $50,000. 

If Sarah cashes out $20,000 from her RRSP in year 1, $20,000 in year 2 and $10,000 in year 3 and Jeff uses those same funds to make his own RRSP contributions, the couple could save $11,420.  The reason the benefit is so large is that Jeff pays tax at the marginal tax rate of 46.4%, so each $1,000 contributed to an RRSP provides an after-tax benefit of $464.  Sarah’s average tax rate on the withdrawal would be 24.4% or a cost of $244 for every $1,000 withdrawal.  Therefore, every $1,000 that Jeff contributes to his RRSP and Sarah takes out from hers provides a net after-tax benefit of over $220.  The strategy makes most sense for couples where one spouse earns substantially more than the other, that spouse has a large amount of RRSP room remaining and he/she is unlikely to use that room for many years.  There will be withholding tax charged on Sarah’s RSP withdrawals, which can be claimed back when she files her tax return. 

Spousal RRSP plans are a further way of utilizing this same strategy to increase a family’s after-tax income.  Jeff is able to take a full tax write-off for every dollar contributed to a spousal RRSP.  But after three years, any withdrawals from a Spousal RRSP will be attributed from a tax perspective to Sarah.   Consequently, by Jeff contributing $20,000 a year to a Spousal RRSP for Sarah and then Sarah withdrawing that same sum at least 3 years later, the couple can increase their after-tax cash flow by $4,400 per year.

Taking funds out of RRSPs during years where earnings have declined substantially, e.g. if you decided to take a prolonged vacation or sabbatical, or if you are out of work for an extended period of time, may be another way of benefitting from income arbitrage.

RRSPs are a great way for investors to save for retirement, but there are occasions as described above where partially cashing them out can increase overall client wealth.  During the financial planning process, our objective is to ensure that each client’s retirement goals are met by focusing on the appropriate investment mix and by using the most effective strategies available to increase after-tax cash flow and the value for their estates. 

To find out more about this and other tax effective investing and planning strategies, please contact Lorne Zeiler at 416-733-3292 x 225 or by e-mail at lorne@tridelta.ca.

Lorne Zeiler
Written By:
Lorne Zeiler, MBA, CFA
VP, Wealth Advisor
Lorne can be reached by email at lorne@tridelta.ca or by phone at
416-733-3292 x225

YearEnd Checklist for your Investments and Taxes

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The stores are filled with Xmas themed shopping and the end of the 2013 year will soon be upon us.   During this season of family and friends, we need to find time to address the end of year tax and investments action list.    Some things to remember at this time:

 

  1. Capital Gains and Losses – review any investments you have already sold during the year to estimate your current capital gain or loss position.   Then consider selling some of your remaining investments to offset that gain or loss before the end of the year.   Note:  if you are working with a financial advisor that does this for you, make sure they are aware of any capital loss carry-forwards from prior years.
  2.  Rebalance your portfolio – Asset allocation is the key to a portfolio’s success, not just in return but also in managing risk that fits your needs.    To maintain the right asset allocation you need to rebalance it regularly.    If you work with a financial advisor that has your total portfolio, they will likely perform this rebalancing for you.   If you have many financial advisors/accounts, you should check that your total portfolio stays in balance with your asset allocation goals.   If your rebalancing generates any capital gains or losses, go back to paragraph 1 and look at the rest of your holdings to consider offsetting them.
  3. RRSPs – Did you contribute what you intended to this year?    Most years you have until 60 days after yearend to make your RRSP contribution and still count it in the current tax year.   However, if you turn 71 in 2013, you only have until December 31, 2013 to make that last contribution.
  4. Tax Installments – if you are required to make tax installments in a tax year, Dec 15th is the date for the last installment for individuals.  If you need to sell investments to make the installment payment, go back to paragraph 1 and include an evaluation of your already realized capital gains/losses when deciding which investment to sell.
  5. Charitable Donations – if you are considering making a charitable donation, consider completing the donation before December 31st in order to be able to claim the deduction in 2013.   Remember that donating publicly traded shares with an unrealized capital gain allows preferential tax treatment.   Also note the “First Time Donors Super Tax Credit” for donations after March 21, 2013, which enhances the federal tax credit for individuals who have not donated since the 2007 tax year.
  6. Other Tax credits – most tax credits need to be paid out before December 31st in order to include them in the current year’s tax calculation.    Some of these include:
    • Political contributions
    • Tuition fees and interest payments on student loans
    • Medical Expenses
    • Childcare and Children’s fitness/non-fitness expenses
    • Alimony and maintenance expenses
  7. Business Owners – if you own an incorporated business, review your salary/dividend mix with your financial advisor and determine the best structure of any remaining payments before December 31st.  Pay your family members a reasonable salary for work performed in 2013.
  8. TFSA withdrawals – if you need to withdraw funds from your TFSA in the next 3-6 months, consider doing so before December 31st, 2013.   If you withdraw the funds before the end of 2013, you will be able to repay them in 2014.   If you withdraw the funds in 2014, you will have to wait to repay them until 2015.
  9. RESP contributions – if you have not yet contributed $2500 to your child(ren)’s RESP, consider doing so before December 31st to receive the $500 CESG gov’t contribution.   Remember the maximum lifetime grant per child is $7200 and contributions when the child is 16 and 17 have special rules to be eligible for CESG grants.  Go to  www.cra-arc.gc.ca/tx/ndvdls/tpcs/resp-reee/ for more details.
  10. RRIF/LIF – make sure you have received your minimum annual withdrawal amount before December 31st.   The financial advisor or institution holding your RRIF/LIF can help you with this.   Also, if you turned 65 this year, consider transferring enough of your RRSP/LIRA into a RRIF/LIF in order to take a $2000 withdrawal each year, which you can offset against the Pension Tax credit.   Remember to consider pension splitting with your spouse.

 

Full Service financial firms such as Tridelta Financial Planning will include the above and other year-end strategies in their total service package to increase the efficiencies of your financial plan.   Having all of your investments managed by one full-service financial planner will also better enable them to maximize your opportunities for these strategies.

Lorne Zeiler
Written By:
Gail Cosman
Senior Wealth Advisor
Gail can be reached by email at gail@tridelta.ca or by phone at
(905) 399-2035

Managing the Drawdown of your RRIF/RRSP

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Many of us have worked hard all of our lives to build up our retirement nest egg in our RRSP funds. We’ve been successful enough to build a RRSP nest egg in excess of $1million to see us through our retirement.

Now we are at the stage of flipping the RRSP into a RRIF and managing the drawdown of our funds, which requires a balance between CRA’s required minimum withdrawal, lifestyle needs, longevity, and tax efficiencies. Some things to consider include:

  1. You can flip your RRSP into a RRIF as early as 60 and as late as 71. Once you’ve changed it into a RRIF you must make the minimum withdrawals per CRA or face penalties. You can leave your funds as RRSPs during your early 60’s, still make withdrawals to meet your lifestyle needs, but not have to meet CRA imposed minimum standards.

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    At age 65, when you are eligible for a pension income tax credit, you may want to consider transferring a portion of your RRSP to a RRIF to take advantage of this credit.

  2. Historically we’ve been taught to leave our RRSP untouched as long as possible to maximize the benefit of the deferred tax bill. However, you are eligible for Old Age Security (OAS) payments after age 65, which are income tested.

    You might be better off to start your RRSP withdrawals in your 60’s so that when age 71 hits and you have an annual Required Minimum Distribution (RMD), you’ve reduced the total RRIF and subsequent annual RMD to the point that it is under the income threshold for OAS clawback. Alternatively, if your RMD is large enough that your OAS will be clawed back 100% for the balance of your life, you could trigger a one-time liquidation of a portion of the RRIF now, to get your RMD below the OAS clawback threshold.

    Finance professor Moshe Milevsky says Canada’s Required Minimum Distribution (RMD) rates from tax-sheltered accounts are higher than most countries, including the U.S. At age 75, Canada’s RMD is 7.85%, versus 4.37% for the U.S., 6.31% for the U.K., 6% for Australia and 3% for Ireland. Canada’s RMD is also highest at age 90: a whopping 13.62%, versus 8.77% for the U.S., 6.31% for the U.K., 11% for Australia and 3% for Ireland. (Financial Post)

    There are tax strategies that you can use to reduce the taxes on a one-time significant RRIF withdrawal.

  3. When the first spouse passes away, the RRIF/RRSP passes to the surviving spouse (assuming that is the beneficiary choice) without tax consequences. However, when the second spouse passes away the remaining RRIF/RRSP is dissolved and taxed at normal tax rates. In Ontario, the estate of an individual leaving a RRIF/RRSP greater than $509,000 to anyone other than their spouse will be subject to the maximum tax rate of 49.53%. Imagine an estate with a RRSP/RRIF of $1million – and half goes to Ottawa.

    There are tax and estate planning strategies to help manage this tax bill – either before you get to that stage or at the time of passing.

Most of us have a goal, while we are still employed, to build up our retirement nest egg to fund a comfortable lifestyle in our retirement. Once you have retired, you now need to manage the drawdown in a tax efficient manner. It’s not just a matter of calculating what your minimum RMD is each year.

If you work with a financial planner, discuss with them options you can put in place now on how to minimize your taxes and maximize the value of your estate. TriDelta Financial has expertise to assist you with tax strategies, which may save huge dollars. Contact us for a no obligation consultation.

Gail can be contacted by email at gail@tridelta.ca and by phone at (905) 399-2035.

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