Unlike any other government savings incentive program, the Tax Free Savings Account (TFSA), puts the onus on you to keep track of the amounts you contribute, withdraw, and replace. If you make a mistake or simply forget an amount along the way, the consequences could hurt. The TFSA rules are extremely strict and the penalties are severe.

The TFSA became available to Canadians in 2009, and as the years go by and the allowable contributions increase, the room for error expands, too, particularly if you open more than one account. If you withdraw funds from your TFSA and then replace some or all of the amount, the rules become even more complex and errors become a greater risk.

The most serious offence is to over-contribute. Even if you inadvertently contribute more than is allowed, Canada Revenue Agency (CRA) will penalize you one percent per month — that’s a 12-percent-per-year penalty — on the over-contributed amount, starting from the month the deposit was made into your TFSA. By the time CRA discovers the problem, as many as 18 months could have elapsed, and if you’ve made more contributions in the meantime, the penalty could be significantly painful.

Since TFSA contributions are made with after-tax dollars, the only reporting to CRA is from TFSA account providers. If you have more than one TFSA account and are not keeping close track of your own transactions, the only way you will find out that you’ve over-contributed is the penalty bill from CRA.

The Solution

To avoid errors in TFSA contributions, withdrawals, and replacement of funds — and the resultant penalties — designate one financial advisor to coordinate all transactions. Your Nakamun Advisor is well positioned to do that for you, particularly if you already have a number of TFSA accounts at different financial institutions.

Canada is one of the few countries with a triple-A debt rating. While our debt, unlike many nations’, is manageable, the priority of the 2013 Federal Budget is to eliminate the federal deficit by 2015/2016. Spending growth will increase by only 0.9 percent in 2013, the lowest rate of spending growth in 20 years.

“Canada Job Grant”

A Budget priority is to encourage and support training and job creation. A new program called “Canada Job Grant” could provide $15,000 or more per person for training and skills development. The federal government will provide up to $5,000, and the hope is that the provinces and employers will match the amount.

“Super Donation Credit”

A new, temporary “Super Donation Credit” is available to Canadians who have not claimed a charitable tax credit after 2007. Married or common-law couples are not eligible if either partner has claimed this tax credit since 2007, and only cash donations — not in-kind or property donations — qualify.

The “Super Donation Credit” provides an additional 25 percent federal tax credit on donations up to $1,000, which means 40 percent for donations of $200 or less, and 54 percent for donations over $200, up to $1,000.

More GST/HST Exemptions

The GST/HST exemption will be expanded to include publicly subsidized or funded personal care services to seniors and to those with disabilities requiring home care services, including bathing, feeding, and assistance with dressing and taking medication.

Tariffs Removed From Certain Sports Equipment

To encourage children’s fitness, tariffs on certain sports and athletic equipment — excluding bicycles — imported into Canada are eliminated after March 31, 2013.

Higher Capital Gains Exemption

The Income Tax Act currently provides a lifetime capital gains exemption of up to $750,000 of capital gains realized on the sale of qualified property, a small business corporation, or farm and fishing property. The Budget proposes to raise the lifetime capital gains exemption limit on the sale of qualified property from $750,000 to $800,000, starting in the 2014 taxation year. Starting in 2015, the capital gains exemption amount will be indexed annually to inflation. The government proposes to apply this increase to all individuals, even those who have previously used the exemption.

Proposed Elimination of Tax Loopholes

The government is focusing on eliminating tax loopholes and undue tax preferences, and cracking down on fraud.

•  Derivative Forward Agreements — the federal government is proposing changes to prevent the use of financial arrangements involving derivatives contracts that allow for the conversion of ordinary income to capital gains. These financial arrangements have become popular with tax-conscious investors. The proposed changes, which will affect investments that promote the re-characterization of income to capital gains as a significant feature, could eliminate the advantage of these products. This measure will apply to derivative forward agreements with a duration of more than 180 days, and entered into on or after Budget Day, March 21, 2013 or with terms that extend to or beyond that date

•  “Stop International Tax Evasion Program” (SITEP) — the government announced a new “bounty” program for Canada Revenue Agency (CRA) aimed at international tax cheats. CRA will pay up to 15 percent of the federal tax collected (not including penalties, interest, or provincial tax) to individuals who report significant international tax avoidance schemes that lead to at least $100,000 in tax assessments. Payment will be made after the taxes have been collected, and the “bounties” will be taxable

•  Changes for financial institutions —

•   Beginning in 2015, financial firms may be required to report international electronic funds transfers of at least $10,000 to CRA, in addition to existing reporting required to the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC) under anti-money laundering rules

•   Possible elimination of the International Banking Centre (IBC) rules that exempt certain financial institutions from tax on income earned from non-residents through designated branches in Montreal and Vancouver

•   Credit unions may lose their preferential tax treatment with the proposed phase-out of additional deduction against certain income earned

•  “Unintended tax benefits” related to two leveraged life insurance arrangements:

•   10 – 8 strategies — which involve investing in a life insurance policy and borrowing against that investment to create an annual interest-expense tax deduction for an extended period of time. If a life insurance policy or an investment account under the policy is used as security for a loan, and the interest rate on the investment account is set using the interest rate payable on the loan, or the maximum value of the investment account is set by reference to the loan, then the following income tax benefits are proposed to be denied:

•  deductibility of interest paid or payable on the loan that relates to a period after 2013

•  deductibility of a premium that is paid or payable under the policy that relates to a period after 2013

•  increase in the capital dividend account by the amount of the death benefit that becomes payable after 2013 under the policy and that is associated with the loan

In order to facilitate the termination of existing 10 – 8 arrangements before 2014, the Budget also proposes to alleviate the income tax consequences on a withdrawal from such policies when made to repay a borrowed amount under the arrangement, if the withdrawal is made on or after March 21, 2013 and before January 1, 2014

•  Leveraged insurance annuities (LIAs) — defined by the Budget documents as “an investment product that is acquired with borrowed funds and provides fixed and guaranteed income to an investor until the death of an individual”. Upon the insured individual’s death, the capital invested is returned as a tax-free death benefit. Currently, these annuities allow a portion of the income earned on invested capital to be tax-free, and interest on the money used to purchase the annuity to be tax deductible, as is a portion of the invested capital. Under the proposed changes, the LIA policy will be subject to annual accrual-based taxation and will no longer qualify for a deduction on any portion of paid premiums. These changes will not apply to funds borrowed to purchase an LIA before March 21, 2013

•  Elimination of Labour-sponsored Venture Capital Corporations (LSVCC) tax credit — in 2017. There will be no new federal registrations of LSVCCs. The tax credit will remain at 15 percent for 2013 and 2014, will drop to 10 percent for 2015, and then to 5 percent for 2016.

Extension of CRA Reassessment Period

The Budget proposes to extend the reassessment period to provide CRA with sufficient audit time in the following situations:

•  When taxpayers participate in tax shelters where the promoter is late in filing its information return — currently, CRA has three years to reassess a return, regardless of whether the required information has been received from the promoter. That reassessment period will be extended to three years from the date when the tax shelter promoter complies with its filing requirements

•  “Reportable” tax avoidance transactions — the reassessment period will be extended to three years from the time the required information return is filed

These measures will apply to tax years that end on or after March 21, 2013.

Testamentary Trusts

Testamentary trusts currently calculate tax using the graduated tax rates applicable to individuals, as opposed to inter vivos trusts, which pay federal taxes at the highest (29 percent) marginal rate. The government intends to review and possibly change the law to eliminate the tax benefits afforded to testamentary trusts.

Safety Deposit Boxes

The costs of renting safety deposit boxes will no longer be tax deductible after the 2012 tax year.

Higher Taxes for Non-eligible Dividends

The current gross-up/dividend tax credit system will be changed, resulting in higher taxes payable on non-eligible dividends.

Financial Consumer Code

To better protect consumers of financial products and to ensure the necessary tools are available for consumers to make responsible financial decisions, the government proposes the development of a financial consumer code. Prior to streamlining legislation and regulations, the government will conduct consultations.

Predatory Lending

The government will work with provincial authorities to ensure that predatory lending, including high-cost loans and payday lending, are effectively regulated.

Assessment of Tax Shelters

Currently, CRA cannot take collection action in respect of assessed income taxes and related interest and penalties where a taxpayer has objected to the assessment of tax shelters, and in particular charitable tax shelters. Many charitable donation tax shelters have been challenged and shut down by CRA, but the process can take years in litigation, resulting in significant delays in collecting taxes from affected taxpayers. The Budget proposes to allow CRA to collect 50 percent of the disputed tax, interest, and penalties pending determination of the taxpayer’s liability. This is intended to discourage participation in shady donation shelters and to ensure that the government is able to collect if it is successful in a dispute.

In our Winter 2012—2013 edition of Nakamun Advisor, we discussed certain financial advantages enjoyed by Canadian couples growing old together. Elements addressed included intrinsic economic values of Canada Pension Plan (CPP) and Old Age Security (OAS) benefit entitlements coupled with available personal, age, and pension tax credits. We illustrated the very real economic losses that impact the spouse who survives the other.

In addition to the loss of CPP and OAS income, and the income tax credits associated with the deceased spouse, the surviving spouse also faces the specter of having OAS income reduced by the universally detested OAS claw back calculations.

Simply put, any Canadian taxpayer whose taxable income exceeds $69,562 (2012 threshold) and who receives an OAS pension will be subject to the OAS claw back. The direct reduction in OAS benefit is 15 percent of the amount of taxable income in excess of $69,562. Once taxable income reaches $112,772 (2012) or more, the OAS benefit is completely clawed back.

When One Dies

When one of a couple dies, the surviving spouse’s income is reduced not only by the OAS formerly received by the deceased, but also by some or all of their own OAS if the claw back threshold is exceeded. Without the benefits of income splitting and double pension and age credits, the income being collected by the survivor alone is more likely to exceed the threshold than was
the couple.

Example: A couple earning household taxable income of $112,772 will not lose any OAS.

If one dies, and the household’s taxable income remains the same, the survivor’s OAS will be clawed back 100 percent.

Plan to Eliminate OAS Claw Backs

Several financial planning strategies are available for higher-income households to reduce, defer, or eliminate the negative impact of the OAS claw back provisions. The common element of each of these strategies is to reduce the amount of reportable taxable income. The most common financial products designed for this purpose are:

•  Prescribed Term Certain and/or Life Annuities (Joint)

•  Tax Exempt Permanent Life Insurance

•  Buy and Hold Equity-only Investments

•  Corporate Class Investments

Less common, but perhaps even more effective techniques include:

•  Testamentary Trusts

•  Spousal Trusts

•  Family Trusts

•  Investment Corporations

•  Inter-generationally owned holding companies

Each family’s situation is unique, and the most advantageous solution or combination of solutions is well worth exploring. Spending time and effort now to plan around the OAS claw back can ensure the surviving spouse continues to receive full OAS benefits for life. Your Nakamun Advisor can help you identify and implement appropriate solutions.

DID YOU KNOW?

Old Age Security (OAS) pension will be deferrable

Starting July 2013, those eligible for OAS pensions will be able to defer their benefits by up to five
years past the age of eligibility. Until the eligibility age increases, the voluntary deferral of OAS pension will be available to individuals between the ages of 65 and 70. Check with Service Canada for details.

Employees between ages 65 and 70, receiving Canada Pension Plan (CPP) must complete the appropriate form to stop contributing

As of 2012, anyone between the ages of 65 and 70 who is still working and collecting CPP benefits, must continue to make CPP contributions, matched by the employer, unless the “Election to Stop Contributing to the Canada Pension Plan…” form is completed and provided to the Winnipeg Tax Centre and the employer. The requirement to continue making contributions remains in effect until the first day of the month following the date the form is received.

In this week’s Money Makeover Column featured in the Winnipeg Free Press,  Bob Challis was asked to go over a couple’s finances to provide an analysis on their situation.

Homeowners “Tara” and “Reed” have concerns over whether they can afford to continue living in their dream home outside of Winnipeg. Tara says ”I’m working and I wonder how I’m ever going to retire. My fear is that for the next eight or 10 years I will work and when it’s time for me to retire we’re going to realize we can’t afford to stay here, so I’ve commuted all this time and then I have to move.”

Continue Reading

http://www.winnipegfreepress.com/business/finance/home-bittersweet-home-198576161.html

Looking back at 2012, investors around the world remained extremely cautious. Headlines continued to be dominated by the European debt crisis, the US’s inability to address its own debt issues, and China’s slowing growth. In the US, housing prices and unemployment continued to be problems.

The negative headlines on top of vivid memories of the effects of the 2008/2009 financial crisis were justifiable reasons for concern.

INVESTOR REACTIONS

Investors trying to find somewhere other than equities to put their money to work, have been pouring funds into asset classes they perceive to have less risk.

As the accompanying chart shows, cash flows into “long only equities” have plummeted since 2007 and flows into bonds have skyrocketed during the same period of time. To many people, this makes sense. Since the early 1980s, when interest rates peaked, bond holders have been rewarded by earning income and gaining capital appreciation, in some cases from declining interest rates. These same investors can look back to 2000 and in many cases, point to far higher returns on investments in bonds than in equities, and at far lower risk.

The Effects of Low Interest Rates

Central banks around the world have forced interest rates down to artificially low levels to try to stimulate growth. The US Federal Reserve announced that rates would not be raised until at least 2015.

We are now in an environment of negative real rates of return — after-tax rates of return on bonds or Guaranteed Investment Certificates (GICs) are less than inflation. What this means is that buying government bonds today almost guarantees loss of purchasing power, because after-tax growth on capital will struggle to keep up with inflation. This happened from 1940 to 1980, so the situation is not unprecedented. We are not suggesting for a minute, that you should not own this asset class, but you should be aware of the purchasing power risks.

Negative real rates will encourage more spending by the private sector. Low rates make housing more affordable and enable businesses to grow and hopefully, hire more people. Also, by accepting negative real rates of return, savers will carry more of the burden to assist governments in reducing their debt — when governments lower interest rates, in effect, they reduce the cost of their own debt, but at the same time, reduce everyone else’s purchasing power.

Effects of the US Election

The 2012 US election resulted in President Obama being re-elected, the Republicans remaining in control of the House, and the Democrats remaining in control of the Senate. This status quo escalated fears of the “fiscal cliff” materializing and increased uncertainty for investments.

US politicians failing to agree on how to reduce their debt created the “fiscal cliff”. Since they couldn’t agree, they pushed the problem down the road by saying if there is no agreement by the end of 2012, they would allow all the Bush-era tax cuts to expire and legislate significant spending cuts. The net effect, without some kind of modification, is that they would actually be legislating a recession.

Looking forward

Looking forward to 2013, there is still much uncertainty in key markets, and with the expectation of weak global growth, many investors will likely continue to be cautious.

However, not all is doom and gloom.

The US has recapitalized their banking system, a cornerstone to improving their economy. Evidence is mounting that the housing market is finally starting to recover. Corporate balance sheets have never looked better.

Europe is in the midst of a de-leveraging process that will take years, but in 2012, the European Union countries finally gave their central bank the tools to deal with the problems, by giving the bank the power to buy the debt of struggling countries. The Europeans are also just starting to recapitalize their banking system. Hiccups along the way are still inevitable, but now the Europeans, at least, have the ability to deal with these obstacles.

Late in 2012, China’s economy started to stabilize, which will be positive for global growth, particularly in commodities.

The biggest challenges will likely be driven by politics and policy decisions during the next year. The framework for recovery appears to have been put in place, but good policy decisions by politicians will be required along the way to avert another crisis. The private sector has yet to indicate willingness to pick up the slack when central banks start to withdraw their stimuli and begin to repair balance sheets.

Canada’s Income Tax Act, while often maligned, provides significant advantages to retirees, not only because of basic personal exemptions and graduated taxation rates, but also because of age and pension credits. These provisions, coupled with income security programs such as Canada Pension Plan (CPP) and Old Age Security (OAS) currently deliver about $36,600 per year to retired couples entitled to full benefits. Of this amount, just $1,550 income tax is payable (Manitoba 2012 rates). This leaves total spendable income from Government plans of around $35,000 annually, while both spouses are alive.

Actuaries tell us that in today’s economy, a 65-year-old male would need about $276,000 to assure an $18,300 annual income for the duration of his life, while a 65-year-old female would need about $301,000. Mathematically, $577,000 is the “value” of a couple’s combined CPP/OAS benefit at age 65.

HOWEVER…

Both spouses must live to their respective life expectancy, or longer, to realize the full value of the Government benefits. If one spouse dies early, the CPP/OAS income stream attached to the deceased person simply stops and household income becomes subject to higher tax. Unless the possibility of one spouse’s premature death is addressed, the economic reality of the survivor will change, for the worse.

When one spouse dies, a full set of income tax deductions disappears, pension and age credits are halved, and pension income splitting is no longer available. A much higher pre-tax income becomes necessary to support the same level of after-tax spendable income.

EXAMPLE

A couple, both aged 65 with $500,000 in RRSP/RRIF (split equally) and each entitled to full CPP/OAS benefits, could plan for combined after-tax income of $50,000 in retirement. This income includes government benefits and RRIF withdrawals. Ignoring inflation and yield, if both retirees live to their life expectancies,
they have sufficient savings.

However, if the male passes away at age 66 and the after-tax income need remains at $50,000, the surviving widow will run out of savings at about age 76, fully 10 years before her life expectancy! Alternatively, she would have to live with only $34,300 after-tax per year.

Minimize “Human Capital” Losses

One solution is to purchase permanent life insurance, while the couple is insurable and the premiums are affordable, in order to minimize “Human Capital” losses and address the income needs of the surviving spouse.

Talk to Your Nakamun Advisor

In future articles, we will look at other aspects of the intrinsic, yet very real economic worth of a person’s “Human Capital” during and after their lifetime. In the interim, please speak with your Nakamun Advisor for more details on how to alleviate the potential adverse impact on your spouse’s income security, should you die prematurely.

Changes to the Canada Pension Plan (CPP) that came into effect on January 1, 2012 have made calculations and decisions regarding when to start collecting retirement benefits more complex than ever, particularly for those between the ages of 60 and 70.

In this and subsequent articles, we will illustrate, through examples, the importance of carefully reviewing your options before making any decisions about CPP benefits.

Survivor Benefits

A surviving spouse or common-law partner may be eligible for survivor CPP benefits, however the combined retirement and survivor benefits cannot exceed the maximum retirement pension, which is currently $987 per month. If the surviving spouse is not receiving other CPP benefits, the survivor benefit is 60 percent of the deceased’s retirement pension.

Consider the following couple:

•   Bob — Is 60 years old, has contributed to CPP during employment years, and qualifies for maximum retirement benefit at age 65

Is planning to continue working for the next five years

Is considering starting to collect CPP now, even though the early retirement discount is 0.6 percent for each month between ages 60 and 65

Has sufficient RRSP contribution room to shelter CPP income

•   Alice — Is 59 years old, has contributed to CPP during employment years and qualifies for maximum retirement benefit at age 65

Scenario A — Fast forward to when Alice is 65 and Bob is 66:

Both Alice and Bob waited until age 65 to start receiving maximum CPP retirement benefits. Bob dies during the year after he started collecting benefits. Alice will receive no surviving spouse benefit because she is already receiving the maximum CPP retirement benefit.

Scenario B — Fast forward to when Alice is 65 and Bob is 66:

Bob started collecting CPP at age 60, elected no withholding tax at source, and contributed the full amount each month to his RRSP, which had sufficient contribution room. He earned 1.65 percent in a daily-interest RRSP and after five years, had approximately $43,000. When Bob dies, at age 66, his RRSP transfers tax sheltered to Alice.

From age 60 to 65, Bob continued to work and was required, under the new CPP rules, to contribute 4.95 percent of his salary. His employer was required to match that amount and the total contributed funds purchased a Post-Retirement Benefit, which boosted Bob’s CPP retirement income.

Before You Make CPP Decisions…

As you can see, decisions regarding your CPP benefits can have a significant financial impact and you should, before making your decisions, talk to your Nakamun Advisor, who can explain the implications of the options.

Whether you have accepted in advance or discover after an individual passes away that you have been named an executor, you can choose to decline. Just some of the reasons you might not want to serve as executor include:

•  You might be in poor health, in the midst of a family crisis, or simply too busy to take on the additional responsibilities

•  Significant disputes might be occurring in the deceased’s family, including a recent separation

•  The affairs of the deceased might be excessively complex, with assets in many jurisdictions, business interests, etc.

•  Serious creditor issues or a shortage of funds to pay the bills

Even if you have agreed, you are not obliged to serve as an executor. However, once the individual dies, you must decide quickly. If you choose not to be an executor, you must file a formal notice (in British Columbia the form is called “Renunciation of Probate”) that you have not done any work on the estate and you will not be acting as executor. The “back-up” executor would then serve, but if that individual declines as well, and/or there is no other back-up, someone else can apply to the Probate Court to act as “Administrator”, and in some cases, the estate is referred to the Public Trustee.

 US Citizens and anyone with a valid US Green Card living in Canada must still file a US tax return, whether or not they have earned income in the States. This is a US tax law and anyone who is required to and doesn’t file a US income tax return, could face serious consequences.

If you are a US Citizen or Canadian with a Green Card and have not filed the necessary tax forms, we urge you to contact your Nakamun Advisor to discuss the actions you should consider.