Financial Preparations 2017-2018

As 2017 is quickly winding up, it's time to make some financial decisions. Here's a list to keep you on track.

Asset Allocation Adjustments

If you're not making regular contributions to your investments any more, or if those contributions are small relative to your total investments, it might be time to re-balance to your desired asset allocation targets.

Re-balancing should take place once or twice a year and the end of the year is as good a time as any. Other memorable dates might be around a birthday or anniversary. Re-balancing is an important component of tactical asset allocation portfolios. The long-run effect is you are selling high and buying low, reducing risk and increasing returns.

Tax Loss Selling

If you've had any investments in non-registered accounts only that performed poorly over the year, now is a good time to get rid of them and lock in the capital loss (which can be carried forward indefinitely to offset future capital gains).

There are just a few asset classes that performed poorly this year, but you may have a bad investment in an oil stock or some losing positions in a "fun account". Now is the time to get rid of these, lock in the loss for future tax benefits, and hopefully learn your lessons in speculation.

If any losing holdings are part of your long-term, well-thought-out investment plan, sell and substitute for a comparable (but slightly different) low cost ETF. For example, if you lost money in the energy sector holding iShares XEG.TO, sell it and replace with BMO's ZEO.TO to get similar exposure in a slightly different index product.

Tax Gain Selling

In particular circumstances it can be very beneficial to lock in capital gains for tax purposes in your non-registered account only. If you had no taxable income this past year, or your income was drastically lower and in a low tax bracket, you should consider realizing capital gains now.

For example, let's say you and your wife retired last year in Alberta with enough money in a savings account to pay for all your 2017 expenses. Your investments total $1 million, of which $500,000 is in a taxable account. You have zero realized income for 2017 at this point beyond $10,000 in Canadian dividends. You also realized a 10% return this year, translating to a $50,000 unrealized capital gain for this year.

Contrary to popular thought which preaches indefinite deferral is best, you should actually realize that gain now, pay the taxes owing, and reinvest in a similar ETF. Your tax bill would be $0, and you still have a total of $550,000 invested in your account. However, now your cost base is increased by the $50,000.

You locked in a gain, legally paid no tax, and will never pay tax on that increase in wealth again. If the market drops, you would also claim capital losses on the new, higher cost base which could further offset future capital gains tax.

This strategy can be very lucrative when done right!

Spousal Loans

Spousal loans can be a great tool to move investment income from a high earning spouse to a low earning spouse, thereby reducing the overall tax bill and helping to ensure both spouses can achieve equal income in retirement. It's generally only worth the hassle if the income gap is large, or if the loan is for a considerable amount of money.

All loans must be properly recorded in a promissory note and the interest rate has to be equal to or higher than the prescribed rate for employees and shareholders. The loaned money must be invested in a non-registered account. Here's how it works:

Fred and June live in B.C. where Fred is a asphalt worker who works 4 months of the year and earns $20,000 while June is a lawyer who makes $200,000. Fred tops up his TFSA and saves the rest (as he should), while June fills her TFSA, RRSP, pays all the household expenses, and still has $50,000 a year for savings. She has accumulated $300,000 in her investment accounts.

June makes a $300,000 loan to Fred at the current prescribed rate of 1%. Fred invests this money and must pay June $3,000 a year in interest payments. However, Fred earns 2% in dividends and 4% in unrealized capital gains on the investment.

Fred's total income goes up $6,000 at negative tax rates (Canadian dividends in B.C.), but he deducts the $3,000 interest cost at his marginal tax rate from his $20,000 income. His tax bill is much lower now and his assets are much higher. The capital gains will also be taxed at much lower rates at his income level, and he's far more likely to benefit from tax gain/loss selling strategies.

June's income goes up $3,000 from the interest income, but drops the $6,000 in dividend income. At her tax bracket, dividends are taxed at 28% anyways so her total tax bill is actually lower as well. She also is not in a position where she might be forced to realize capital gains or other investment income at high tax rates as her investments are now all sheltered in RRSPs and TFSAs.

You can play around with this strategy for your own situation using my favorite tax calculator. Because of the extremely low prescribed interest rate, there has never been a better time to use this strategy!

CRA's My Account

This is a simple housekeeping item that everyone puts off. If you haven't already, sign up online for My Account with the CRA. It's free, it's easy, and all your tax details will be in one convenient place.

With this account, you can check previous year's tax returns, you can look up your RRSP and TFSA contribution limits, and you can use it to set up online payments to and from your chequing account.

The Wonderful TFSA

The increase has been announced! You will be able to put another $5,500 into your TFSA account in 2018. That's $11,000 in new contributions for a couple, or a total of $57,500 in cumulative room per person if you were 18 years old in 2009. Make the most of this tax-free forever account!

If you finally woke up and plan to actually invest your TFSA money instead of getting that pitiful 0.5% at your local bank, or are planning to switch to a new brokerage or advisor for your TFSA, now is the time to make your move to avoid the transfer fees some firms charge. Here's how:

  1. Complete the paperwork to open a new TFSA account at a brokerage
  2. Sell your investments in your old TFSA
  3. Transfer/withdraw the money from your old TFSA before December 22 and put it in your regular chequing account
  4. Enjoy Christmas season and wait patiently
  5. In January 2018, put the money into your new TFSA account up to your total contribution limit
  6. Invest the money in your new TFSA by purchasing growth assets like stock ETFs

Simple, simple rules: withdraw in 2017 from old account, wait, then contribute in 2018 to new account. Never do both in the same year or the CRA will classify it as if you contributed twice to your TFSA. This avoids the weird double contribution penalty situation some people have found themselves in.

RRSP Housekeeping

It's time to take a look at that RRSP account. If you're retired and planning to draw income from your RRSP, make the appropriate withdrawals before the end of December. (I believe the 27th is the last day this year to ensure the transaction settles).

I'm a big fan of income tax targeting for retirees. Basically that means strategically realizing income from various sources to target an acceptable income tax rate. For example, if you've targeted an acceptable tax rate of 10% in retirement and so far all you've earned is some Canadian dividend income and a small amount of capital gains, it could be worthwhile to increase your taxable income on paper by withdrawing a strategic amount from your RRSP, paying the tax on the withdrawal, and investing that money in your TFSA or non-registered account instead where future taxes will be lower.

You should also get ready for the so-called "RRSP season" in the start of 2018. If you are planning on going back to school, are saving for retirement, or a downpayment on a house purchase, you can contribute to your RRSP up to the end of February 2018 and have that contribution count against your income tax in 2017. This means you get your refund shortly after your contribution is made as most people do their tax return in March or April.

If you're making regular contributions to your RRSP throughout the year, be smart and complete a T1213 form today for your contributions in 2018. It takes a few minutes and a postage stamp, but you will see higher paycheques all year long as your tax deductions are reduced.

If you get a big tax refund cheque in April, you've really given the government an interest free loan. This is not ideal!

Smith Manoeuvre

If you own your own home and have at least 35% equity in the property, you should consider setting up a Smith Manoeuvre. This strategy uses home equity to invest in higher growth assets while helping you save thousands of dollars in tax over your lifetime.

It takes some work and careful planning to set up the Smith Manoeuvre properly, so the holidays can be a good time to tackle this job.

If you already have a Smith Manoeuvre in place, now could be a good opportunity to clean up your accounts and get your paperwork in order for tax season. If you're invested in assets that pay RoC income, you might opt to sell those and invest in assets that pay dividend income only so you don't have to make those tedious RoC adjustments.

Blog Housekeeping

Thanks for reading this blog and sharing with your friends! I'm currently averaging around 600 unique readers and nearly 2,500 page views per month—a huge increase having started from nothing in January. By the end of 2017, I will have about 6,000 visits and 15,000 page views over the course of the year!

I will continue to play with the format of the blog posts, so expect some changes throughout 2018. It's been a lot of work researching information and writing posts, but I've learned a lot myself in the process and I feel it's making me a better manager of my own money.

If you have any suggestions on how I can improve the blog, or any financial-type questions you feel deserve a blog post, feel free to leave a comment.

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