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INVESTING
Top Ten Reasons
to Invest in No-Load Funds!
- I feel secure putting my hard earned life savings in
a mailbox and sending it to total strangers.
- I prefer the services I receive from faceless clerks
at 800 numbers to a local investment professional. I am
also very fond of automated phone answering menus.
- I have plenty of time to read financial journals,
investment magazines and Newsletters. My family
understands that my investment research is more important
than they are.
- I believe that publications which depend upon
advertising revenue from no-load funds can render
impartial and objective investment advice.
- I prefer being thought of as a computer entry rather
than a person.
- I feel that fund companies which sell to a mass
market care about me and understand my specific financial
goals, time horizons, and risk tolerance.
- I have nerves of steel. The 507 point market decline
on October 19, 1987 didn't concern me - neither do bear
markets.
- I can time the market and make fund switches with
laser precision. In fact, I plan to start my own psychic
investment hotline.
- I don't find the 4000+ no load fund alternatives
overwhelming. By reading 5 prospectuses a day I'll know
them all in about 26 months.
- I am not willing to pay fees for professional
services. In addition to managing my own investment
portfolio I also diagnose and treat my own medical
problems, represent myself in legal matters, and file my
own taxes.
Dividend Tax
Credit Explained
The net effect of the gross-up and dividend
tax credit is to tax dividends at approximately 7% if
your income is $29,590 or less, 25% if you income is
between $29,591 and $59,180, and 33% if your income is
more than $59,180.
The federal dividend tax credit is two-thirds of the
amount of the gross-up or 13.33% of the total you report
as dividend income. For most provinces, this dividend tax
credit is then increased by about 50% since the
provincial tax is calculated on a reduced federal tax. In
Quebec, a separate dividend tax credit is available for
9.85% of the grossed-up dividend in 1999 (rising to
10.83% in 2000).
If you're not a Canadian resident, you'll be subject
to withholding tax on the cash benefits.
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DEMUTUALIZATION OF
LIFE INSURANCE COMPANIES
Shares
If you receive shares, you won't have to report
any income until you dispose of them. The adjusted cost
base (cost for tax purposes) of the shares will be zero.
When you dispose of the shares, the entire amount of the
proceeds of the disposition, less any associated costs,
will be considered a capital gain. Since only 75% of
capital gains are taxable, the effective rates of tax on
capital gains are approximately 20% if your income is
$29,590 or less, 31% if you income is between $29,591 and
$59,180, and 37% if your income is more than $59,180. The
exact rates vary by province.
If the insurance company issues shares but gives you
the option of redeeming the shares by selling them back
to the company for cash, this amount will generally be
treated as a deemed dividend and taxed in the same way as
a cash payment (see above).
Since dividends are taxed at a lower rate than capital
gains, you may want to take a cash payment instead of
shares unless you intend to hold onto the shares for a
longer period of time. If you have capital losses to
offset the capital gain on the shares, you may want to
take shares instead of cash.
Making RRSP
Contributions
If you have RRSP contribution room
available and you want to contribute shares you received
as a result of demutualization, the contribution will be
treated as a deemed disposition and you'll have to pay
tax on the capital gain in that year. You will receive an
offsetting RRSP deduction for the full market value of
the shares. If you sell the shares and use the proceeds
to make an RRSP contribution, the result will be the
same.
If you're planning to contribute your demutualization
benefits to your RRSP, you may want to consider choosing
a cash payment instead of shares. Contributing cash will
create greater tax savings because, as a deemed dividend,
the cash payment will be taxed at a lower rate than a
capital gain.
Making Charitable
Donations
If you're considering donating your
demutualization benefits to charity, you may want to take
shares and donate them directly to the charity rather
than donating cash or selling the shares and donating the
proceeds.
Donating the shares directly is more tax effective
because the donation is a deemed disposition of the
shares and you only have to include 37.5% of the taxable
gain in your income when you make the donation, instead
of the usual 75%. You will still receive a donation tax
receipt for the full value of the shares.
If you want to make a donation but can't use the
charitable tax donation credit, you can minimize the
effect of the demutualization payment on any government
benefits you receive (see below). You would donate the
shares to a charity and elect to have the donation amount
and sale price of the shares equal the tax cost of the
shares, which would be zero. Though you will not have to
include the value of the shares in you income either.
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Effect on
Government Benefits
If you receive Old Age Security (OAS) or
Guaranteed Income Supplement benefits, the Child Tax
Benefit, GST Credit or other federal or provincial
financial assistance, demutualization proceeds included
in your income as a dividend or a capital gain could
trigger a clawback or reduction of you benefits. For
example, OAS is reduced by 15 cents for each dollar of
income over $53,215.
Certain Non-refundable tax credits claimed on your
personal tax return such as the age amount, spousal
amount and medical expenses may also be affected.
Effect on
Canadian-controlled Private Corporations
If you have a Canadian-controlled private
corporation (CCPC) that holds a life insurance policy on
any of its shareholders or employees, demutualization
benefits could jeopardize the status of your
corporation's shares as "qualified small business
corporation shares." The shares' status is important
because up to $500,000 of capital gains on qualified
small business corporation shares can be exempt from tax.
Generally, to qualify as small business corporation
shares at the time of sale, the business must use 90% or
more of the value of its assets in carrying on an active
business in Canada. Further, throughout the two-year
period before the sale, more than 50% of the
corporation's assets must have been used principally in
an active business carried on in Canada.
If your company has a significant amount of investment
assets, the demutualization benefit could disqualify your
corporation's shares as qualified small business
corporation shares.
If your corporation chooses to receive shares, when
you sell them, the 25% non-taxable portion of the capital
gain will be a credit to your corporation's capital
dividend account and can generally be distributed to
shareholders as a tax-free capital dividend. But if
accepting shares may affect shareholder's ability to use
the capital gains exemption, you may want to consider one
of the other benefits available, such as cash. Choose
enhanced insurance benefits or a reduction in premiums.
These are treated as deemed dividends, but will not
directly affect the company's investment portfolio.
If your private corporation chooses to receive cash or
another non-share demutualization benefit, it will be
treated as a deemed dividend. The dividend will be
subject to a special 33 1/3% tax rate, which is fully
refundable to the corporation when the dividend is paid
as a taxable dividend to shareholders.
We can help
You determine what form of demutualization benefits
will best suit your financial plans and point out ways to
help you minimize the tax you'll pay on your
benefits.
Note to Users: This information is of a general
nature. No one should act upon it without appropriate
professional advise after a thorough examination of the
facts of the particular situation.
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FINANCIAL PLANNING
What is a
Financial Plan?
Planning is bringing the future to the present
so you can do something about it now!
What (or who) is a financial planner? And do I need
one? These are prominent questions on the minds of
consumers and regulators these days as the financial
service industry continues to grapple with the monumental
changes taking place. And while there is indeed a lot to
debate in these questions, I think there is a better
question. What is a financial plan?
That's a surprisingly difficult question to answer.
Definition may range from a 100 page report outlining
cash flow, estate and retirement objectives, tax
planning, etc. on one extreme, to some scribbles on the
back of a napkin at the other extreme. And what's
troubling is the fact that in truth, both could be
right.
Perhaps an even better, more succinct questions is
this: What should a financial plan do for you? The beauty
in this question is that in answering it we define what
we want the exercise to accomplish, as opposed to how
many pages it will take to get there. It is, after all,
results we are looking for.
Here are the six key points in response to this
question. Use them to help you determine whether or not
your financial plan/planner is doing the job you
deserve.
- Any plan requires a goal or goals. Those probably
include retiring at a specific time with a specific
income, leaving a desired estate, perhaps making a
major purchase, or countless other objectives that may
be high on your list of priorities. Make sure the
goals used are yours and not some canned goal like
"70% of current income at age 65". The key point is
this. After your financial plan is completed, you may
be fuzzy on these right now. You shouldn't be at the
end of the planning exercise.
- No matter where you are heading, you need to
assess where you are now, and what you already have in
place for the journey. Your planner needs to know
this, and your plan should reflect an accurate
starting point. You may feel disorganized and
uncertain with respect to your present financial
situation, but you shouldn't when your plan is
completed.
- A financial plan should map out a strategy to
reach your stated goals. Heading in a general
direction doesn't cut it. Heading east over the
Atlantic Ocean is the right general direction to get
to England. But it's also the right general direction
to get to Spain, Africa,. Greenland and countless
other destination. Every step in every year of the
plan should be outlined in detail. If you never
changed your goals (which you will), and if all the
assumptions held true (which they won't), this should
be the only plan you will ever need.
- Your financial plan should convince you that your
goals are achievable. This is perhaps the most
important aspect of a financial plan, and the least
understood. A plan that leaves you doubtful that your
goals are achievable is all but worthless. In fact
it's worse than worthless, because it's discouraging.
Invariably a financial plan needs to be "reworked"
after the initial attempt to make sure that while your
goals remain inspiring, the strategy appears doable.
Get it right and your financial plan is like a
treasure map with a big X on it. From there all you
need is a shove.
- It needs to be understandable. If you don't
understand aspects of your financial plan, it's also
of little value. When you are putting together the new
barbecue, do you read the instructions in English, or
do you enjoy the challenge of trying the instructions
in the foreign language? If there's an investment
strategy or tax planning strategy that you just don't
understand, then change it. The one you understand
will always be the better on for you.
- Your plan should motivate and inspire you. You
won't see this in any financial planner's handbook (in
fact you may see the opposite), but if you aren't
motivated and inspired, how long will you follow the
plan? Success in anything consists in clearly
identifying what you want, and then going after it
with relentless confidence. When you are inspired to
reach your goals and know what to do, there is nothing
that can stop you. Whatever you desire shall be yours.
Sounds inspiring doesn't it? It should be.
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Calculating Your
RRSP Bottom Line
If you're wondering how tapping into your RRSP
might affect your retirement nest egg, read on.
Let's say you're a 35 year old investor with $30,000
in your RRSP you regularly contribute $3,000 a year and
you earn an average compound rate of return of 8% a
year.
Scenario 1: You
don't take any money out of the RRSP, but keep on
contributing $3,000 a year. By 65, you'll have
$696,068.
Scenario 2: you
borrow $20,000 from your RRSP to buy a home, spreading
the repayments over 15 years. You start repaying the
money right away, but you can't afford to set aside more
than $3,000 a year, so your repayment of $1,333 comes out
of that. You contribute the balance of $1,667 a year to
your RRSP in the normal way. By 65, you'll have
accumulated $478,714.
Scenario 3: Since
you don't have to start repaying a home-buyer's loan
until the second year following the year of withdrawal,
you defer the repayments for 20 years. Even though
everything else remains the same, you'll lose another
#32,000 just by not starting your repayments for two
years - your original $30,000 was reduced to
$10,000 after the loan, and by not making payments for
2 full years, you lose both the compounding interest
and the contributions. By 65, your RRSP will be worth
$448,526.
Scenario 4: You
borrow $20,000 from your RRSP for a down payment on a new
home, repaying the money over 15 years. But you put off
any further RRSP contributions until the homebuyer's loan
is repaid. After 15 years, you start contributing $3,000
a year to your RRSP again. In this case, you'll have only
$304,974 in your RRSP when you reach 65.
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LIFE INSURANCE
Transferring Corporate Owned
Insurance - To the Shareholder
Like many of the best-laid plans, insurance
needs often change, Consider, for example, a situation
where the shareholder is also a key employee in the
business. The corporation will require key person
insurance on the life of the shareholder while they are
active in the business. However, that key person
insurance may no longer be required if the corporation is
sold to a third party or if the active shareholder
retires.
When insurance planning for private corporations and
their shareholders, you must assess when policies should
be owned personally and when they should be owned
corporately.
If the insurance need changes from a corporate need to
a personal need, it may be desirable to transfer the
policy from the corporation to the shareholder. Of
course, you will want to structure the transfer to
minimize the cash flow requirements and income tax
consequences for both the corporation and the
shareholder.
There are two potential taxable events when an insurance
policy is transferred from a corporation to a
shareholder.
- The transferor corporation (i.e. the original
policyholder) will be deemed to have disposed of the
policy and the transferee will be deemed to have
acquired the policy at the surrender value of the
policy (i.e. CSV net of policy loans) pursuant to
subsections 148(7) and (9) of the Income Tax Act (the
Act). Under subsection 148(1) of the Act, the
disposition will be taxable to the transferor to the
extent the surrender value of the policy exceeds the
adjusted cost basis (ACB). Note that the deemed value
at disposition is determined without reference to the
amount the transferee actually pays.
- The transferee is deemed to receive a taxable
benefit under subsection 15(1) of the Act if the
policy is received for less than fair value (FMV).
This taxable benefit is then added to the transferee's
ACB (ACB is defined in subsection 148(9) on the
Act).
To avoid a taxable benefit, the shareholder should pay
FMV to acquire the policy. The advantages to this are
probably best illustrated by comparing two methods of
transfer:
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Gift of
Corporate-Owned Policy to the Shareholder
Assume the corporate-owned policy has
FMV=$100,000; CSV =$62,000; ACB=$76,000; and there are no
policy loans outstanding. Also assume the corporation
(OPCO) wants to transfer the policy to the shareholder
for $0.
- OPCO transfers the policy to the shareholder. The
shareholder pays OPCO $0. OPCO will be deemed to have
disposed of the policy and the shareholder will be
deemed to have acquired the policy for $62,000. OPCO
will have no taxable income since the CSV is less than
the ACB. The shareholder's deemed payment of $62,000
forms part of the new ACB.
- Since the policy is received for less than fair
value, the shareholder is deemed to receive a taxable
benefit of $100,000 (i.e.$100,000 FMV less $0 amount
paid). The shareholder's ACB will be $162,000 (i.e.
the $62,000 deemed in #1 and the $100,000 taxable
benefit).
If we assume the shareholder's marginal tax rate for
ordinary income is approximately 51%; tax payable on the
benefit would be approximately
$51,000.
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Transfer Policy
as a Dividend in Kind
Alternatively, assume the same set of facts as
in the previous example, but assume the corporation
(OPCO) wants to transfer the policy to the preferred
shareholder as a dividend in kind. A dividend in kind is
considered to be equal to the fair market value of the
assets transferred (i.e. the FMV of the policy).
- OPCO transfers the policy to the shareholder. OPCO
is considered to have paid a dividend and the
shareholder is considered to have received a dividend
of $100,000. OPCO will be deemed to dispose of the
policy and the shareholder will be deemed to have
acquired the policy for $62,000 (i.e.CSV). As in the
previous example, OPCO will have no taxable income
since the CSV is less than the ACB. The shareholder's
deemed payment of $62,000. Forms part of the new
ACB.
- The shareholder is not deemed to receive a taxable
benefit since the policy was received for fair value
(i.e. OPCO declared a dividend and then transferred
the policy as payment of the dividend. The shareholder
subsequently pays tax on the dividend). The
shareholder's ACB will be $62,000 (i.e. the $62,000
deemed in #1 and so taxable benefit). If we assume the
shareholder's marginal tax rate for dividends is
approximately 35%, tax payable on the $100,000
dividend would be approximately $35,000. Note that if
the shareholder and OPCO are both Canadian
corporations and if OPCO is controlled by the
shareholder, this dividend could be a tax-free
inter-corporate dividend.
Determining the
Fair Value of a Universal Life Policy
Revenue Canada has provided some guidance for
determining the fair value on an insurance policy in
various situations. The major factors that should be
taken into account are:
The cash surrender value of the policy,
The life expectancy of the insured, and
The state of health of the insured.
Revenue Canada goes on to say that, for example, the
value of an insurance policy could approach its face
value if it is known that the insured has a terminal
illness or is critically injured as a result of an
accident and not expected to recover. Conversely, the
fair value would be closer to cash surrender value if the
insured is in apparently excellent health.
To determine fair value in each particular case, it
will be necessary to apply "normal valuation practices",
taking into consideration all of the relevant facts.
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Summary
With proper planning, a shareholder can keep the
existing life insurance policy and minimize the tax
consequences of transferring ownership from the
corporation. In the above examples, the income tax bill
arising on the gift and resulting taxable benefit is
$51,000, while the tax bill associated with the dividend
in kind is $35,000. The examples above show that by
treating the transfer as a dividend in kind, you can gain
access to the preferred tax rate available on dividends
from Canadian corporations. In this way, the transfer is
carried out to effectively minimize the tax bill.
Where There's a
Will
People generally do not understand the ins and
outs of estate planning, and frankly, they'd rather not
consider these issues. After all, estate planning does
have something to do with dying, But they do want to make
the most of what they have and not pay any more tax than
necessary.
It's not only clients who do not understand estate
planning. Many investment professionals are not
comfortable with it either. Estate planning is
interdisciplinary, covering trust law, succession law,
taxes, family law and intestacy law, to name just a few.
It also includes your family situation and your needs and
personal values. It's the details, and how they all fit
together.
Consider this case: Martha had been widowed for two years
and had learned a lot, the hard way, about what should
have been done. Her husband never considered he might not
outlive her.
After her husband's death, she went to her lawyer and
prepared her will. Her children were 19 and 20 and, as
much as she loved them, she had a strong belief they
would squander their inheritance if they received it
before they could appreciate the value of money. "Easy
come, easy go," was how she put it, and her will
instructed her executor to hold the bulk of their
inheritance in a testamentary trust for them until they
were 30 years old.
After she had drafted the will, she became concerned
about probate fees. To lower the cost of probate on her
death, she had named her two children as the
beneficiaries of her RRSP, worth $400,000 and of her two
life insurance policies, one worth $300,000 and the
other, worth $100,000. She kept the house, worth
$200,000, in her own name.
Had she died with these instructions in place, the
children would have split the $400,000 from the life
insurance policies and the $400,000 from the RRSP. The
house would have gone into the estate and then been sold
to pay the taxes due on the RRSP. The children would have
received their inheritance outright, because nothing
would have flowed through the will and into the trust for
the children.
Her attempt to reduce probate (varying across the country
from zero to 1.5% of the value of the assets distributed
through the will) would have thwarted her desire to
protect her children and their inheritances.
Since Martha's overriding goal
was to keep her children from receiving too much too
soon, she revised her plan:
- On the $100,000 life insurance policy, the two
children were named as beneficiaries, so they would
each receive $50,000 outright on her death.
- Martha named her "estate" as the beneficiary on
her other life insurance policy and her RRSP.
- She set up a separate trust for each child.
- She then changed the wording of the trust so it
would pay on-third of the money out at ages 24 and 26,
and the balance at age 30, to give the children the
chance to learn how to handle money, without being
able to spend it all at once.
These estate planning steps will increase the probate
fees Martha's estate will have to pay, because the house,
the RRSP, to save the family tax even after her death. A
testamentary trust is taxed as if it were a separate
taxpayer. The income earned in the trust might pay tax at
a lower rate than if the inheritance were paid directly
to the children and the income added to the children's
tax return. Martha is able to protect her children's
inheritance without ruling from the grave.
Need some Help?
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Beneficiary
Designations
Choosing a beneficiary of the proceeds payable
under a life insurance policy can be on of the most
important decisions to be made when developing an estate
plan. For many, these proceeds from a substantial portion
of the estate available for distribution to heirs.
Therefore, it is important that the estate planning
objectives of the insured be carefully considered before
a beneficiary designation is made.
The legal framework for proper designation of a
beneficiary has been established by the Uniform Insurance
Act in each of the common law provinces and the Civil
Code in Quebec. This legislation also provides guidance
for resolving disputes when a designation is unclear or
ambiguous. In this article we will review some of the
important principles to keep in mind when advising
clients on this very important aspect of purchasing a
life insurance product.
How Is A
Beneficiary Designation Made?
The only legal formality required by life
insurance legislation for a beneficiary designation is
that it must be in writing. It is not even required to
have a witness to the signature of the person making the
designation. It may be made in the contract of insurance
or contained in an entirely separate document. Although
the beneficiary designation is most often found in the
contract of insurance, it is not unusual to see it
included in a will. In fact, the Uniform Act and Civil
Code contain specific provisions respecting the validity
of designations made in wills.
Can a Designation be
Revoked?
Generally, the designation of a beneficiary is
revocable and may be altered at any time by the insured.
It is irrevocable only if the insured so provides in the
declarations. However, in Quebec, a declaration in favour
of a spouse is presumed to be irrevocable unless
expressly stated otherwise. Remember that an irrevocable
beneficiary designation cannot be changed without the
consent of the beneficiary.
Does a beneficiary have to be
filed with the insurer?
A beneficiary designation is valid even though it is
not filed with the insurance company. However, if a
designation has been declared irrevocable, it is not
effective as such until the declarations is filed with
the insurer. Failure to file an irrevocable designation
does not invalidate it - the designation does
simply operates as an ordinary revocable beneficiary
designation.
An insurance company is entitled to rely on its most
recently filed beneficiary designation. An individual
named in an unfiled declaration will not have a claim
against the insurer if it pays the beneficiary on record
without knowledge of a later unfiled declaration.
Therefore, it is very important that all designations be
filed, and essential if it is an irrevocable
designation.
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How Should A
Beneficiary Be Identified?
It is important to properly identify the
beneficiary who is to receive the life insurance
proceeds. It is best to refer to the person by name,
although it is acceptable to describe the beneficiary by
relationship to the insured or the life insured. If there
is more than one beneficiary, the share of proceeds
allocated to each should be specified in the
declaration.*
If the designation is not
clear as to whom the insured intended to benefit, the law
will assist as follows:
- If the description of the beneficiary is both by
name and relationship and there is a conflict, the
name will govern,
- Designation of a "spouse" means a legal spouse and
not a "common law" spouse,
- A designation in favour of "children" will benefit
all children born to the measuring life at the time of
death of the life insured, whether or not born at the
date the designation was made,
- Designation of "my heirs", "my assigns", or "my
next of kin" will be considered a designation if
favour of the estate of the insured and not a
designation in favour of certain individuals.
Can
Insurance Proceeds Be Left "In Trust" For
Children?
In the common law provinces, insurance
legislation specifically provides that an insured may
appoint a trustee as a beneficiary. A designation of "X,
in trust for "Y" does create a trust relationship between
X and Y. X will be required to hold proceeds of the
policy in trust for Y. With nothing more X will be
governed by provincial trustee legislation as to how to
invest and administer the trust funds and Y will be
entitled to the insurance money upon reaching the age of
majority.
If it is desired that the insurance money be held in
trust for a longer period of time, or the insured wishes
to direct the manner and timing of payment of monies to
the beneficiary, a trust should be created. This can be
done in a separate trust agreement or in the insured's
will. Such a trust is often referred to as an "insurance
trust". The declaration of beneficiary should refer to
"X, trustee under a trust created by (name) on----,
1999." The declaration should clearly refer to the policy
for which the trust is being created, should expressly
revoke any previous designation, and should state that it
is an insurance designation under the applicable
provincial legislation. If these requirements are met,
the proceeds will flow directly into the trust and not
into the estate of the deceased, even if the trust is
created in the will.
In Quebec a formal document should always be drafted
creating the trust.
Summary
Careful consideration should be given in
designating the beneficiary of a life insurance policy.
The decision should not be made in isolation but in the
context of the entire estate plan of the insured. Once
decided, the designation should be carefully drafted to
ensure that all beneficiaries are adequately described,
and that the division of benefits is accurately reflected
if more than one beneficiary is named. If the proceeds
are to be held in trust for beneficiaries, a trust
document should be prepared to instruct the trustee
regarding administration of the funds as well as how and
when to pay monies to the beneficiaries.
* There may be different considerations in Quebec.
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