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:
- 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.
- 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.
- 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.
- 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.
- 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.
- 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
- 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.
- 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.
- 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.
- 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.
Initial Investments close November 30th
At TriDelta, we have watched closely as Canadians search for income in a low interest rate world. One issue we have found is that many Canadian income funds are overly concentrated – with a heavy weighting in Canadian REITs (Real Estate), Canadian Financials, and Canadian Utilities. This over concentration in a few sectors adds unnecessary risk to investors.
This month, we are proud to launch our High Income Balanced fund. Initial investments will need to be in by the end of November. This unique fund will feature a 6% annual target distribution, and will generate income and returns through a few diverse investment strategies.
- U.S. Stock strategy – We are using an options enhanced index strategy that has generated higher long-term returns by reducing (or minimizing) losses in a down market.
- Canadian Stock strategy – Manager has flexibility to invest in quantitative strategies and sectors offering best total return opportunities, enhanced by a variety of options based strategies to add tax efficient income. Because of the use of options we are able to generate income from all sectors of the market – not just traditional real estate, utilities and financial services.
- Enhanced Fixed Income – We are able to generate yields today of over 8% on conservative bonds. Within our fund, we are able to borrow at just 1.65%. This variable rate is based on a rate that is 0.65% plus the Bank of Canada Overnight Lending Rate, which is currently at 1.00%. Outside of the fund, for individual accounts borrowing costs are currently at 4%.For example: We invest in a conservative BCE bond trading at par ($100) with a coupon of 3.95% & maturing in:
|Spread on Borrowing
||2.30% (3.95% – 1.65%)
|Spread on Borrowing $2
||4.60% (2 times 2.30%)
|Total Income if we borrow $2
||8.55% (3.95% + 4.60%)
While the borrowing cost is variable, according to the latest from the Bank of Canada announcement, they now have a ‘neutral’ stance on growth, and we don’t believe there will be a meaningful rise in short term interest rates for some time. There is also an additional opportunity to boost gains by investing in Global bonds with higher yields.
- Institutional Style Income Investments – We plan to add institutional investments that generate steady income. These are pension-style investments in real estate or infrastructure that are not available to individual retail investors – usually because they require several million dollars from each investor.
Who Can Buy The Fund
This fund is available to anyone but with some hurdles.
If you are an accredited investor (this usually means your household has over $1 million of investable assets or your personal annual income is over $200,000 or household annual income is over $300,000), you can invest in the fund with a minimum initial investment of $25,000.
If you are not an accredited investor – the minimum initial investment is $150,000.
We are capping the initial investment at $500,000 per household.
Why Have We Launched a Fund?
As noted, there are a few investment strategies that we feel are very beneficial to our clients, but are more efficient or lower cost in a pooled fund structure. These would include certain options strategies, the significantly lower borrowing costs which allow us to take advantage of advanced income strategies, and lower trading costs on larger bond transactions.
The TriDelta High Income Balanced Fund is structured to benefit TriDelta clients.
For TriDelta clients, the fund itself will have a 0% management fee. Clients will be charged a fee as per our current fee schedule. This means that depending on the size of your household assets at TriDelta, the fee could range from 0.75% (for assets above $5 million) to 1.95% (for the first $250,000 of investment assets). In certain cases, this will also make the fund fees tax deductible.
For those investing only in the fund (or with less than $250,000 of investments with TriDelta Investment Counsel), the management fee will be 2.00%.
There will be an administration fee within the fund for all investors that is capped at 0.50% per year. This administration fee includes all trading costs as well as other costs to the fund such as legal and accounting.
It is worth noting that most funds managed with these advanced strategies have a fee of 2% PLUS what is known as a performance bonus, which can meaningfully add to the fees. Our fund will have NO performance fees and for TriDelta Investment Counsel clients, will have a fee of under 2%.
The TriDelta High Income Balanced Fund will aim to add to income returns, with a 6% distribution target, and a goal of 6% to 10% long term returns (over a 5 year plus time horizon). This fund is appropriate for those with a medium-high risk tolerance, and it is intended to be a good complement to your existing portfolio and goals.
If you are interested in learning more about the fund, please contact TriDelta Financial through your Wealth Advisor or through our offices in Toronto at 416-733-3292 x221 or in Oakville at 905-901-3429, so we can include you in our November 30th investment.
For more information on the fund, view our Fund Overview here.
So you are one of the invisible aliens living in Canada – you walk and talk like a Canadian; you enjoy watching hockey, maybe have joined a curling club, and the word “eh” has crept into your vocabulary no matter how much you try to stop it. Maybe you are a permanent resident, maybe you are even a Canadian citizen; however as long as you are a US citizen or possess a US green card, the IRS continues to have an impact on your financial choices.
Most Americans living in Canada file an annual 1040 with the IRS and feel like they have complied with the reporting requirements. Because tax rates in Canada are higher than those in the USA, filing the tax return probably didn’t cost you any additional taxes because the foreign (Canadian based) tax credit offset anything you owed to the IRS. So you’ve done your job, big check on the IRS box, right?
Not quite. Here are a few ways that the IRS and their filing requirements affect your investment strategy in Canada:
- TFSA (Tax Free Savings Accounts) – one of the new and popular tools in Canada which allows you to invest after tax dollars and earn income (whether interest, dividends or capital gains) tax free in Canada. However, the TFSA was introduced after the last US/Canada Tax Treaty was signed; so it was not covered under the treaty. Instead they are treated as “grantor trusts” in the USA, requiring extra reporting and subject to US taxes.
- Foreign (ie., Canadian) Mutual Funds and ETFs are considered Passive Foreign Investment Corporations (PFIC) by the IRS. When held outside of an RRSP, they are subject to a tax and interest regime. This extra regime applies when a distribution or gain is 125% of the average distribution for the prior three years. There are options requiring extra tax filing that may overcome this issue, however the extra paperwork can be onerous and the tax consequences severe depending on the situation. It is typically not in your best interest to invest in foreign (ie., Canadian) mutual funds or ETFs. One way to avoid the issue: invest directly in the stocks and bonds rather than in funds.
- Foreign (ie., Canadian) bank account reporting of your Canadian bank accounts has become increasingly complex. You are required to submit both a FBAR to the US Treasury (if your aggregate value exceeds $10,000), and a Form 8938 to the IRS (if your balance was greater than $200,000 on the last day of the year or greater than $300,000 at anytime during the year).
- Dividend, Interest Income or Capital Gains – Investment income is treated differently between the two countries (eligible dividends vs ineligible dividends; ordinary dividends vs qualified dividends, short-term vs long-term capital gains, tax-free interest income vs taxable income). Your investment strategy needs to consider the tax consequences in both countries to ensure you do not end up with unexpected tax costs.
This is just an introductory review of how the IRS impacts your investment strategy. There are many strategies that can be employed to minimize your taxes in Canada and the USA depending on your circumstances. Please consult with a tax accountant specializing in US taxes to help address your particular needs. And please consult with a financial advisor you trust and who is experienced in the complexities for Americans investing in Canada.
Gail Cosman, after living 8 years in Connecticut, returned to Canada in 2006. Her husband is both an American citizen and a Canadian permanent residence. For the last 7 years they have dealt with the increasingly complex tax and reporting requirements from the USA. They have learned from personal experience the impact the IRS has on investment strategies. Gail works with Americans in Canada to reflect the tax consequences of both US and Canada in their investment strategies.
Why Do Bonds Trade at a Premium?
Bond pricing is a function of a number of moving parts: namely, coupon rate, market interest rates, credit quality, and term to maturity. As a result, bonds often trade at a premium or discount to their maturity value (usually $100); this can cause confusion and frustration for investors.
We outline some of the key elements of bond pricing and its relationship to current market interest rates so that you can better understand how bonds are priced. As mentioned in Part 1 “Risk Management Series – Bonds” in between the date when a bond is issued until its maturity date, its market price (the price at which the bond trades in the market) will fluctuate.
When a bond is issued, its coupon rate (interest rate paid on the bond) is reflective of the current market interest rate environment for bonds of similar quality and that have a similar term to maturity. E.g. if Royal Bank of Canada issues a 5 year bond maturing on September 30, 2018 and the market interest rate for similar bonds is 3.0%, then the coupon rate on the Royal Bank of Canada will be approximately 3.0%.
If interest rates decline after a bond was issued, then any bond paying a higher coupon rate than the market interest rate should have a premium value. For example if market interest rates for 5 year bonds decline from 4.0% to 3.0%, then a bond that pays a coupon rate of 4.0% is now worth more, because the investor is receiving 1.0% more in payments per year than the market rate. Consequently, the bond with the 4.0% coupon should trade at a premium (trade at a higher price than it was issued at) to balance out the higher fixed interest payments.
In order to determine how much of a premium (or discount) each bond should trade at, fixed income (bond) portfolio managers compare bonds of similar quality with similar maturity dates using a calculation called Yield to Maturity (YTM). This calculation determines the total return an investor can earn on a bond purchase based on: 1) the bond’s current market price, 2) its coupon rate, 3) maturity date and 4) maturity value (usually $100.00).
For example, let’s say Royal Bank issued a 10 year bond in September 2008 paying a 5% coupon rate with a maturity date of September 30, 2018 (Bond A). Royal Bank also issues a 5 year bond on September 2013 that matures on September 30, 2018 with a coupon of 3.0% (Bond B). So even though the bonds were issued on different dates, they currently have the same maturity date and as such are quite comparable.
Bond A should trade at a premium because from now until maturity, Bond A investors will receive 2% more each year in interest income than Bond B investors ($10 in total benefit over 5 years). Based on the yield to maturity calculation, Bond A would have to trade at the premium price of $109.22 to offer a total return of 3% per year for the investor (the higher price offsets the higher interest payments). Consequently, bond investors today may notice that many of the bonds in their portfolios were bought for prices well above their $100 face values, but that these bonds likely have higher coupon rates. Bond A’s premium will decline each year (also known as price decay) as it approaches maturity, because it is one less year that you are collecting the higher coupon rate. To get a fuller picture, investors need to look at both purchase price AND the coupon rate offered by each bond.
The objective of the portfolio manager is to provide the greatest total return to the investor, which includes both the loss (or gain) on the value of the bond PLUS the interest payments received. If the portfolio manager feels they can earn a higher total return by buying a bond with a higher coupon rate, but it trades at a premium, they will do so. In the example above, if he can buy Bond A for $108, they could earn 3.25% per year for their clients vs. just 3.0% by buying Bond B. A large part of a fixed income portfolio manager’s job is to perform these types of comparisons to try to attain higher total returns for clients.
Another reason that a bond may trade at a premium is to reflect accrued interest. Most bonds only pay interest two times a year (semi-annual payments). For example if the bond was issued in December, it will make coupon payments in June and December; if the bond was issued in March, it will make coupon payments in March and September. But, if you buy the bond on the market in between those coupon payment dates, you essentially are getting additional payments.
For example, if a bond makes payments in June and December and you buy the bond in May, you will have held the bond for one month, but you will have received 6 months’ worth of interest. Bond prices reflect this benefit, typically by adding the accumulated amount of interest owing to the purchase price of the bond. For example, if a $100 bond is paying a 6% interest rate (paying $3 twice a year) and the investor buys that bond at the end of April, there is $2 of interest already built up, so the bond should trade for $102.
Bond pricing, performance and payments are often quite complex and difficult to understand, because unlike equities where investors generally look primarily at its current market price vs. purchase price to see if they made money on their investment, bonds require analyzing both the purchase price AND coupon payments received. As described above, there are many times when a bond investment may appear to have a negative return from a price perspective, but has often provided a positive return once you have included the coupon payments.
Illustration of Pricing of Bonds A and B from the article
Bond A Pays a 5.0% coupon. Bond B pays a 3.0% coupon. Both bonds mature in 5 years, September 30, 2018.
|Annual Coupon Payments
|September 30, 2014
|September 30, 2015
|September 30, 2016
|September 30, 2017
|September 30, 2018
||Bond A trades at premium due to higher coupon payments
Here is a little known pension fact.
When interest rates are low, the present value or commuted value of your pension is high. When rates are higher, your pension’s present value is lower. The difference could mean getting $250,000+ more on a full pension if you retire today, than if you retire when rates are 2% higher. Even better, someone can take the cash today, invest the funds, and in a few years when interest rates are higher, they can buy an annuity to effectively lock in a better pension.
What this means to you is that if you are close to or considering retirement with a fixed or defined benefit pension, with interest rates still near historic lows, you should take a hard look at whether it makes more sense to take the cash instead of the pension.
Of course, every situation is different, so here are 6 factors to consider before making the big decision to either take the pension or the cash.
- When do they think you will die? This is a serious question without a definitive answer. Having said that, your current health plays a significant part, along with looking at the health of your parents and siblings, and that of your spouse. A traditional pension is worth $0 after the pensioner and their spouse have passed away. If that is going to happen 10 years after retirement, that is a lot of money that will disappear. In a nutshell, if you think you will live well into your 80′s, taking the pension is likely a good bet. If you think that you will be lucky to reach 75, then taking the cash is very likely the better option.
- What rate of return do you need to outperform your pension? A financial calculation needs to be made based on life expectancy to determine what rate of return would be needed on the cash, to be equal to the value of the pension. Sometimes this break even rate is as low as 2% or 3%. In these cases, taking the cash is likely the better option as you’re likely to have at least 4%+ annual returns over time, possibly over 7%. This can add hundreds of thousands of dollars to your wealth. If the break even number is 5% or higher, meaning you need to get better than 5% annualized returns to end up better, then the pension is probably a better bet on this factor – because of the guaranteed nature of pensions.
- How healthy is the organization and its pension plan likely to be for the next 35 years? This answer would be based on a number of factors facing the company in the future. One important one is how well the plan is funded today. The credit rating agency DBRS released a major report on pension plans last month. One of the more interesting items is that it listed the major Canadian firms that were most underfunded as a percentage of its pension requirements. The following 12 companies were all underfunded by more than 30%. The numbers show the percentage funded as of December 31, 2012.
- Magna International 55.4%
- Catalyst Paper Corporation 60.3%
- Canadian Oil Sands Trust 62.1%
- Barrick Gold Corporation 63.1%
- Agrium 64.6%
- Talisman Energy Inc. 67.4%
- Norbord Inc. 67.7%
- Toromont Industries Ltd. 68.0%
- Emera Inc. 68.3%
- Suncor Energy Inc. 68.7%
- TransAlta Corporation 69.3%
- Imperial Oil Limited 69.7%
Some major US companies appear even worse:
- Moody’s Corp 47.0%
- Tesoro Corp 51.2%
- Masco Corp. 56.3%
- U.S. Bancorp 56.7%
- Stryker Corporation 56.8%
- American Airlines 57.0%
- Procter & Gamble 58.8%
If your company or its pension is in trouble, you can expect your pension to get squeezed. This could mean accepting 90 cents on the dollar, or losing some inflation indexing or health benefits. In some cases, the “guaranteed” pension, isn’t so guaranteed after all.
- How much flexibility is needed on cash flow? Pensions are great because they provide consistent cash flow, but what happens if you want to spend $100,000 in your first year of retirement, but will only need $40,000 in your 20th year. The pension isn’t flexible on that front. What if you want to help one of your children with $50,000 today? This cash flow flexibility can open be of value. This also has some tax implications in that you have no flexibility to adjust income for tax reasons based on your personal circumstances. For some this won’t be a meaningful issue, but in certain cases, especially with sizable inheritances, your financial situation may change during retirement, and you may want the flexibility to adjust. When you get into the Old Age Security zone, in some cases this flexibility will allow you to receive more or all of your OAS for many years.
- Do you want to leave money to your kids? As mentioned, one of the drawbacks of a pension is that when you are gone, so is the pension. One option some people use to make their pension last into the next generation is to have the pensioner take out life insurance. The basic strategy is that where possible, if the retiree is in decent health, it makes a lot of sense for them to take a pension with no spousal benefit. This will make the monthly pension amount higher than any other option. The problem is that if the pensioner passes away early, what happens to the spouse? In this case, the spouse is well taken care of because they will receive a meaningful life insurance payout in place of the spousal pension (which is usually about 60% of the pension value). The other possibility here is that if the pensioner outlives their spouse, they will benefit from receiving a higher monthly pension for their entire retirement, and there will still be a life insurance payout for their beneficiaries.Depending on your lifestyle needs and the portfolio performance, taking the cash may be more likely to leave you with more of an estate, especially given that a traditional pension is guaranteed to be worth $0 upon the death of both spouses.
- Tax Planning. One potential negative of taking the cash is that in many cases only a portion of the funds will be tax sheltered in an RRSP or RRIF or LIRA. Another portion may be considered taxable income in the year received. For a large pension, this could mean a one-time taxable income of several hundred thousand dollars. Fortunately, there are some tax strategies which can lower the tax rate on that lump sum by over 10% or effectively cutting the tax bill by over 20%. With the pension keep in mind that every dollar is taxable, but there isn’t usually any large lump sum related tax hit.There is no question that a defined benefit pension brings a level of security that is comforting to retirees. Having said that, even the pension is not fully guaranteed. When you look at the current level of underfunding, and then think about how many major companies have gone bankrupt over the past 20 years (Nortel, Kodak, Lehman Brothers, etc.), you realize that there is some real risks that you will be receiving some meaningful percentage less than 100 on your “guaranteed” pension.When you factor in your likely longevity, a financial analysis, cash flow flexibility, estate issues and taxes, it is not an easy decision to make. When you add in the rare benefit of low interest rates and the impact that can make on enhancing the lump sum value of your pension, taking the cash should become a meaningful consideration to think about. One other strategy for couples where both will have a defined benefit pension, is to keep one pension and take the cash on the other. Usually you would take the cash for the person who may have weaker health or is with a shakier organization.While the big benefit of a pension is that you will have an income for as long as you live, most people can achieve the same thing with an income oriented portfolio with a low long term risk profile. A portfolio of large companies with low debt ratios, and a history of increasing dividends, along with individual bonds and select preferred shares should be able to provide a similar experience to a fixed pension.The bottom line is that the pension decision is among the most important financial choices you will ever make. Take the time and get the information you need to make the right decision for you and your family.
Ted can be reached at email@example.com or by phone at 416-733-3292 x221 or 1-888-816-8927 x221
Reproduced from the National Post newspaper article 7th August 2013.