With almost nine million Canadians affected by job loss or pay cuts and more than 60% of small businesses experiencing revenue decline of 20% or more during the Covid-19 pandemic, 2020 could be a low-income year for many of your clients.
As a financial advisor, you’re well placed to help clients overcome this challenge, says Wilmot George, vice-president of tax, retirement and estate planning with CI Investments Inc. in Toronto.
When a client loses their job or experiences an unexpected drop in income, George says, your first priority is to help them avoid a cash-flow crunch by creating a plan for meeting their short-term liquidity needs. Ideally, your client won’t have to take on debt to finance those needs.
Once your client’s short-term needs are taken care of, you can help them take advantage of potential tax efficiencies that may result from making less than in a typical year, George says.
Clients can use a number of tax-efficient strategies to increase cash flow, reduce taxes payable or get a bigger tax refund, depending on the client’s circumstances.
Blair Evans, director of tax and estate planning with IG Wealth Management in Winnipeg, says carefully reviewing each client’s situation is important when determining whether they expect their decline in income will be temporary or extend into future years.
For many clients, one of the most common tax-planning tools is an RRSP.
“If they have [already] contributed to an RRSP, it would make sense for them to defer their tax deduction in the current year to a year when their income is higher,” says Frank Di Pietro, assistant vice-president, tax and estate planning with Mackenzie Investments in Toronto.
Typically, tax deductions related to RRSP contributions can be carried forward indefinitely. “[Clients may] get a bigger deduction if and when their income rises to pre-Covid levels [depending on their pre- and post-Covid tax bracket],” Di Pietro says. “The higher the tax bracket, the greater the deduction.”
Clients who won’t make an RRSP contribution because of a decline in income should think about the opportunity they are forgoing to get a head start on tax-free growth in their investments, George says.
Married clients or those in common-law relationships have more options if their spouse’s income is unaffected in 2020.
The Canadian tax system, George says, “looks at individual and not combined income.” Therefore, any opportunity to shift income from the higher-income spouse to the lower-income spouse can be tax-efficient.
For example, the higher-income spouse can make a spousal RRSP contribution once they have made their own RRSP contribution, provided the higher-income spouse has sufficient RRSP room.
The contributing spouse will benefit from the tax deduction and receive a tax refund, while the lower-income spouse will benefit from tax-free growth in their RRSP. However, Di Pietro cautions, “spousal contributions are more of a long-term consideration” and should not necessarily be used when there is only a temporary change in circumstances.
In certain cases, married clients who are collecting pension or RRIF income might have still been working to supplement their incomes, with one partner earning more than the other during the year. George advises that such clients, as long as they are 65 or older and living together, can consider splitting their pension or RRIF income to reduce their total taxes payable as a couple. Typically, the spouse with the higher pension income can elect to split eligible pension income received in the year with their spouse or common-law partner, which can result in a significant reduction in taxes payable.
In addition, Di Pietro suggests, clients can choose “to extract [more] money out of their RRIF” to meet cash-flow needs and end up paying less taxes than they normally would in a regular year.
Blair suggests that clients can also engage in tax-loss selling to free up additional cash flow. Not only can losses be carried forward indefinitely, they “can be carried back for up to three years to offset any gains that were made in those years,” he says, and thus can result in a tax refund.
In a similar vein, clients can trigger additional income, George says, by selling investments that have appreciated in order to realize capital gains. In a low-income year, those clients will pay less taxes on those gains by virtue of being in a lower tax bracket.
George also suggests that a low-income year could be a good time for clients to sell investments held in a non-registered account and use the proceeds to buy back those investments within a TFSA. The taxes those clients pay will be less in a low-income year, while the investments will benefit from tax-free growth. However, George cautions, “clients should manage how much” they withdraw from investments “to keep income low.”
Di Pietro says that a high-income spouse may also choose to “lend the value of a portfolio” to a low-income spouse at a prescribed rate of interest. In this case, all investment gains and income on the portfolio would be taxed in the hands of the low-income spouse, he says.
This strategy makes sense for clients whose income will be affected over the long term. Di Pietro adds that the strategy works best if the portfolio’s value had declined at the time of the loan, as a deemed disposition of the assets will be triggered at the time of the transfer.