Author: Ted Rechtshaffen
Published Date: August 13, 2021
Source: Financial Post
Link: https://financialpost.com/personal-finance/five-wealth-building-ideas-in-an-era-of-low-interest-a
nd-potentially-higher-tax-rates
To tap these opportunities Ted Rechtshaffen looks at the entire financial picture — investments, tax, debt,
real estate and insurance
Taking a snapshot of the world can sometimes present ideas that are especially valuable based on the
current environment. We like to look at the entire financial picture — investments, tax, debt, real estate, and insurance — when
doing this since it can take combining a couple of disciplines to create a wealth-building opportunity. Today, the key underlying themes are very low interest rates; the risk of increasing tax rates, especially
capital gains tax; and another opportunity to profit from an eventual global demand recovery.
With all that in mind, here are the five wealth-building ideas to consider.
Flow-through shares and specialized flow-through shares
In a nutshell, flow-through shares take advantage of federal and sometimes provincial tax credits that
support exploration and development. They work particularly well for individuals with taxable income of
more than $250,000 and for those wishing to do larger ($25,000-plus) charitable donations.
The net results of flow-through shares are generally very positive after-tax, but they also spin off a lot of
capital gains because of the way they are structured for individuals. This is all factored in, but if capital
gains tax rates go up in 2022, it will definitely weaken the benefits of personal flow-through shares in the
future. But if you happen to be carrying capital losses, flow-through shares are an even more compelling
investment, even if your income is less than $250,000.
One weakness of traditional flow-through shares is that you have to hold onto a mining stock for a period
of time that you may not want to take on. To solve that issue, there are specialized flow-through shares
that allow you to sell the shares right away at a loss, but it eliminates all unknowns and investment risk.
As a result, you know to the penny the benefit that you will receive from purchasing flow-through shares
versus not doing so. Because of potential increases in capital gains tax rates in 2022, 2021 may be the last,
best year for this type of strategy.
Borrowing money to generate income
If you borrow money to generate income, the borrowing costs of those funds are tax-deductible. If you
borrow money on a home equity line of credit, you might be able to get a rate of prime or 2.45 percent. If
you are locking in a five-year mortgage, the rate can be around 1.35 percent for a variable mortgage and
2.2 percent for a fixed one.
If you are in the 50-per-cent tax bracket and use these funds to generate income, your after-tax cost of
borrowing is 50 percent less than posted above. At its cheapest, your after-tax borrowing cost could be
about 0.67 percent. The question is whether you believe you can earn more than 0.67 percent after-tax on
this borrowed money?
The funds can be used to buy an income property, maybe a condo or duplex that can be rented out. The
funds can be used to invest in a variety of stocks, real estate income trusts, preferred shares, and mortgage
investment corporations, which have an annual yield of five percent or more. In some cases, the income
can be tax-preferred.
None of these investments are without some risks, but when the hurdle rate is only 0.67 percent, or even
1.67 percent, the odds of building some wealth with the bank’s money are certainly in your favor.
Investing in energy and financial services
Two sectors that have been undervalued for quite some time from an investment perspective are energy
(old school energy) and financial services. These sectors have already had some very solid stock market
growth during the past year, but we believe there is more growth ahead, especially since some have pulled
back over the past couple of months.
From an energy perspective, even a huge player such as Suncor Energy Inc. is compelling: it is expected
to have its fifth straight quarterly earnings increase; it is trading around $24 but was $31 just seven weeks
ago; it has a forward price-to-earnings ratio of 9.4, from 24 in the summer of 2018; it has a dividend yield
of 3.4 percent and that translates into a payout ratio of just 32 percent, suggesting a dividend increase is
very possible; the stock hit $51 in July 2018 when the average oil price for that year was US$61.34, and
its stock price is now around $24 when oil is US$68.50.
From a financial services perspective, Manulife Financial Corp. is a company that has underperformed for
a while. It is trading in the low $24 range and hasn’t been a great stock for the past dozen years. Having
said that, there are a few things going for it.
It has a forward price-to-earnings ratio of just 7.5, a dividend yield of 4.7 percent, and a payout ratio of
just 35 percent. The company also has a pretty good record of raising dividends, so it wouldn’t be a
surprise to see a dividend increase in the coming year. It should also benefit from a post-lockdown
economy for both mortality and disability reasons on the insurance side, as well as from a general
increase in interest rates, which should benefit its net interest income.
Even if Manulife doesn’t do a lot of price appreciation, a 4.7-per-cent dividend yield that is likely rising
overtime will certainly cover off a few bills, or your 1.35-per-cent to 2.45-per-cent borrowing cost to
invest in the stock.
Both these stocks pay out Canadian dividends. In Ontario, if your net income is $200,000, your tax rate
on these dividends would be 32.1 percent. However, if your net income is $40,000, your tax rate would
be zero. This leads to the next idea.
Making spousal loans
In Canada, you can gift funds to adults without any tax impact or attribution back to you. The exception is
if the funds are going to your spouse since the government wants to avoid pushing taxable income to a
spouse with a much lower income.
Having said that, you can make a spousal loan. This is a demand loan that can be paid back at any time.
The government sets what is known as the prescribed rate of interest at the time of the loan. Today, that
rate is at an all-time low of one percent.
There are two ways to really benefit from a spousal loan. The first is when one spouse is in a much higher
tax bracket than the other due to employment income. You would then loan money to the low-income
spouse from the high-income spouse, and have the funds be invested in the name of the low-income
spouse.
The low-income spouse does have to pay (and report) the one-per-cent interest payment to the
higher-income spouse, but that amount can be made up very quickly when one spouse is paying a tax rate
of zero on Canadian dividends and the other would be paying 32 percent.
The other way this works is if you are retired and, for a variety of reasons, one spouse ends up having
significantly more non-registered investments in their name or when corporate dividends are payable only
to the higher-income spouse. It could be from an inheritance or simply years of income where the funds
were held in their name only.
For some income sources, such as pensions and registered retirement income funds (RRIFs), the income
can be split 50/50. However, in this situation, you would want to use a spousal loan to better balance the
income.
Using life insurance in a corporation to minimize taxes
This one is a little more complicated, but it is one of our favorite tax minimization strategies. Briefly, if
someone has or will have sizable investments in an active corporation or holding company, one of the big
challenges is to get money out of tax efficiently. Using life insurance for a portion of the assets, we have had
situations where the individual will be at least 100-per-cent better off after tax on the insurance proceeds
than not using the insurance, whether the person dies in five years, 25 years, or 50 years.
What this might mean is that if the after-tax insurance proceeds coming out of the corporation after 25
years is $1 million, the after-tax equivalent of investing the funds at 5.5 percent a year for 25 years
(rather than putting those same funds into life insurance) would be less than $500,000.
Finally, always remember that interest rates move, sectors go in and out of favor and tax rules evolve.
These changes mean there are always ways to look at the current landscape and find ways to benefit.
Today is another one of those days, and these five strategies are looking particularly good at the moment.
Ted Rechtshaf en, MBA, CFP, CIM, is president and wealth adviser at TriDelta Financial, a boutique
wealth management firm focusing on investment counseling and estate planning. You can contact Ted
directly at tedr@tridelta.ca
