Couples Should Choose Joint Accounts

About a month ago I had a great discussion with a blog fan about tax considerations for couples investing in Cash/Margin Accounts. The CRA directs you to allocate investment income in Cash/Margin accounts according to your contributions to those accounts.

Seems straightforward, but what if you have a joint chequing account and a joint investment account? Must you allocate according to income level? Do you use individual accounts instead to keep a clean paper trail? What about estate issues?

Disclaimer: This is broad, generalized content for information/educational purposes only. Talk to a CPA or lawyer for your unique situation.

Keeping It Together

God forbid anything unexpected happens, but we know smart people prepare for the worst and live for the best. Joint accounts are the must-have choice for anyone in a long-term relationship (those in valid relationship contracts aside).

In the worst situations, joint accounts can be legally accessed and used by either party. No wills, probate, and beneficiary concerns.

If one party dies, assets in joint accounts are not subject to any taxation on death. Under most circumstances, they are seamlessly assumed by the other account holder. This means no disposition of any assets in any accounts (except registered accounts like RRSP and TFSA).

However, with individual accounts the opposite is true. Not only can access to individual accounts belonging to a deceased person be a nightmare, the assets are deemed to be disposed of and can trigger substantial taxes on any gains. The last thing a grieving partner needs is a fight with the bank, assets locked up in probate, and a massive tax bill.

Regardless of your account structure and tax considerations, always have a legal will and powers of attorney done if you're in a relationship.

Spouses With Similar Incomes

If you're both in the same tax bracket and expect to be for the foreseeable future, I would say it is quite easy. Stick to one joint chequing with one joint Cash/Margin account and state your contributions to the investment account at 50% for each partner.

Foreign stocks and bonds can be invested in swap-products, so the only immediate concern is Canadian dividend income. For this portion, use swap ETFs if you're high income and use regular ETFs if you are lower income.

If you realize any investment income, split the income evenly between spouses to keep taxes low. As long as you consistently claim the income at 50% each, it shouldn't raise any red flags with the CRA.

If questions come, it would be easy to explain that a couple with similar incomes would contribute to investment accounts evenly. Consistency is the key!

Spouses With Different Income Levels

If one spouse earns substantially more money than the other spouse you should keep two joint chequing accounts and two joint Cash/Margin accounts. Make sure all accounts are still joint accounts because of the estate issues!

Have one joint chequing account for each spouse and ensure that the income from each spouse goes into their own account. Avoid mixing the two!

Also open two joint Cash/Margin accounts, one for each spouse. This ensure a nice, clean paper trail for the CRA! One spouse will invest in one joint Cash/Margin account, the other spouse will invest in the other joint Cash/Margin account. Due to the difference in income, the investments held in each account could be quite different for tax efficiency reasons.

Example Scenario

Adam and Bernie are a married couple. Adam earns $150,000 while Bernie earns $25,000. All of Adam's income goes into their own joint chequing account (Chequing A). All of Bernie's income goes into their joint chequing account (Chequing B).

As the higher earner, Adam will pay all household expenses, including Bernie's income taxes from Chequing A. Then Adam will contribute evenly to a personal RRSP (for Adam's benefit) and Spousal RRSP (for Bernie's benefit). Then Adam will contribute to both their own and Bernie's TFSA accounts.

Following this Adam will invest in joint Cash/Margin account A. However, due to Adam's higher income level, Cash/Margin A should be invested in swap-products only to defer capital gains income until retirement.

Bernie's income goes into Chequing B and all of it should be used for investing. Bernie will put all of the income into Cash/Margin B. In Cash/Margin B, they will invest in a Canadian index ETF paying dividends—XIC.TO for example—because these dividends are unlikely to be taxed at Bernie's income level.

This method of using two joint accounts for each account-type will keep things easy for estate purposes, granting full and swift access to all accounts while avoiding dispositions on death.

It will also keep a neat paper trail for the CRA should any questions be raised on who contributed to which account and who owes the taxes on the investment income.

Separate joint accounts will also allow tax optimization because Bernie is investing everything, resulting in a more balanced retirement income among each spouse despite wildly different working incomes.

If you use this method, be careful never to mix things up! If Adam starts moving money to Bernie's accounts, the clean paper trail will collapse and questions can be raised. Proper planning and discipline is everything here!

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The Smith Manoeuvre: Canadian Tax Deductible Mortgage

Most Canadians are best off paying their minimum mortgage payment and investing the extra money. At our currently low interest rates, investing beats the pants off paying down the mortgage aggressively.

What if I told you there's a way to kinda do both and save gobs of money in tax? It's my take on the Smith Manoeuvre (SM), a strategy developed by British Columbian financial planner. I want to give full kudos to the late Fraser Smith for sharing this strategy. If you want to really learn the intricacies of this strategy before implementation, buy the book like I did. You can also get it at most public libraries.

The Smith Manoeuvre Guide

The Smith Manoeuvre is an advanced strategy that takes a bit of knowledge to implement. Operational management of several accounts linked to the strategy, careful accounting, and financial discipline are key to making the Smith Manoeuvre pay off big time.

Here are the detailed steps to implement the strategy:

  1. Obtain a re-advanceable HELOC style mortgage. You need to have at least 35% equity in your home first! Make sure the HELOC is structured so you have two separate parts: a nondeductible portion for your house mortgage and a revolving, re-advanceable, tax deductible portion for investing.
  2. Start a online chequing account. Free is best so use Tangerine or PC Bank.
  3. Sell your current taxable (not TFSA/RRSP!) investments and pay down your house mortgage portion of the HELOC.
  4. Start a new Cash/Margin Account with a brokerage. Make sure it is separate from any other Cash/Margin Account you may have! You need a clean paper trail for the CRA.
  5. Make regular mortgage payments and put all extra money towards the house mortgage portion of your HELOC.
  6. Borrow back the newly available money from the investment loan side of your HELOC by making a transfer to the Cash/Margin Account.
  7. Use investment loan money to purchase Canadian dividend paying stocks. Make sure the dividends get deposited in your separate online chequing account.
  8. Use the dividends and new investment money to pay down your house mortgage portion.
  9. Borrow back newly available money from your investment loan portion and transfer to your Cash/Margin Account.
  10. Borrow from investment loan portion, transfer to chequing account, and send back to investment loan portion to pay he interest expense on the investment loan portion.
  11. Claim Canadian dividend income in the exact same manner that you deduct interest expense from taxes! Either to the highest income earner or split between both if in the same tax bracket. Always claim investment income and deduct interest expenses in the exact same proportions.
  12. Adjust the investment loan for any Return of Capital distributions paid by your ETF, REIT, or stocks.
  13. Deduct all interest paid for investment loan portion ONLY in the tax return of the highest income earner (or split between both if in the same tax bracket).
  14. Apply tax refund to house mortgage portion, borrow back under the investment loan portion, and invest in your Cash/Margin account.
  15. Repeat steps 5 through 14.
  16. Final considerations when strategy is complete.

The SM Strategy Effects

In this admittedly complicated strategy, you are basically shifting your debt from non-deductible mortgage interest expense to a fully deductible interest expense for investing. All with no extra monthly cost to you.

There are numerous steps to achieve the strategy. To get an idea of the money flow, here is a diagram of the accounts and steps involved. It's a lot of money movement!

Source: TheRichMoose.com

The Smith Manoeuvre does not make you debt-free. Instead, you maintain your debt level at a maximum of 65% of your stated house value, but you can grow a massive investment account alongside your loan. Combining tax savings and investing is a powerful force which generates substantial wealth over time.

This strategy is more risky than simply paying off your mortgage and building an investment account on the side. However, as I will show in my next SM post, the risk is manageable and the rewards can be significant.

Once the strategy is complete (your mortgage portion is paid off), you can either keep the loan going for the huge tax benefits or you can slowly wind down the loan.

Comments & Questions

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Comments containing links or "trolling" will not be posted. Comments with profane language or those which reveal personal information will be edited by moderator.