February 1997
the CEN-TA PEDE
david ingram's US/Canadian Newsletter Pages 215-223
US / CANADA TAX INFORMATION - NEWSLETTER
CANADIAN BUDGET NEWS (a tiny bit) Page 215
There's No Such Thing as a Free Lunch Page 215
Types of Licences Allowed for Salespeople Page 215
Maybe You Should NOT Have an RRSP Page 216
US Citizens and Residents and Green Card Holders and RRSP's Page 217
Canadians Working Overseas and RRSP's (likely should not have one) Page 218
US Retiree Pensions Received in Canada No Longer Taxable by States Page 218
CANADIAN BUDGET NEWS
Paul Martin's Feb 18, 1997 budget was the blandest I have seen in my 31 years in this business. He cheated a bit by announcing the Canada Pension Plan increases a week earlier but before you start yelling, remember that the U.S. rate is already 15.3% and there is no total cap as there is in Canada. Going up to 9.9% with a cap is nothing compared to the U.S.. Remember this when you look at the low federal tax rate across the border in Washington State.
The GOOD NEWS part of the budget will take some planning, but should be taken into account if you wish to make a significant charitable donation. Paul Martin has changed the taxable capital gains on stock donated to a charity to 37.5% from 75% which cuts the tax in half or less for most people. The wrinkle is that one still gets a charitable deduction for the full value of the stock. In an extreme case where a person with $80,000 of other income had bought a stock for $100 and gave it to a charity at a value of $1,100, his tax would be $152.13 on the taxable $375.00 of the $1,000 profit. At the same time, assuming he had at least another $200 of charitable deductions, his tax refund for the $1,100 charitable deduction would be $569.48. In other words, he is $152.13 ahead of the game by donating the stock directly, rather than selling it and making a charitable donation separately,
Much of the following is a reprint of the January 1994 CEN-TAPEDE, one which I considered one of my best and still appropriate for today. I send it out now to catch everyone "after" they have purchased their 1996 RRSP in a hurry and are still sitting back thinking, "What have I done?" - Maybe I should have paid down the mortgage! Maybe I should have paid off my Visa bill! Maybe I should have bought a recreational/retirement property in Sechelt. Maybe I should have bought my mutual funds "OUTSIDE" the RRSP.
Because it is difficult to find a licenced person who will give you unbiased advice, I send this now to suggest that come May or June or July, you should come in to see myself or George Hatton, expect to pay a fee, and really analyze what you have, why you have it, and where it should really be. The message starts with:
THERE'S NO SUCH THING AS A FREE LUNCH!
LET ME EXPLAIN
In January 1994 a client (with her skeptic husband) was in the office to talk about their finances. Her fee for service was $374.50 (GST inc - now $535 in 1997)) and when we were finished, she and her husband agreed that they should not buy an RRSP this year but use their money for a better purpose. After all, they could carry the deduction forward to the next year or the next seven years.
She then told me that I was the fourth "financial planner" she had seen and the only one that had taken the time to explore the alternatives. EVERYONE else had said "buy this plan, or buy this plan". I asked her how much the others had charged. She said they were all free consultations. I said that she had her answer. The only way that they can get paid under those circumstances is if the consultant sells you something.
That is the major problem with the system as it exists now. Licenced salespeople can only sell the products for which they are licenced. The Securities Commissions make it difficult for a licenced person to charge for his or her services other than by commission. If your consultant is licensed to sell mutual funds, he makes nothing if you buy real estate. BC, Ontario, Manitoba and most other state or provincial laws only want to allow the following combinations of licences:
1. A mutual fund sales licence plus a life insurance sales licence, or
2. A life insurance licence plus a general insurance licence, or
3. A general insurance licence and a real estate licence.
4. A securities licence plus mutual funds.
In other words, one cannot have a real estate licence and a mutual fund licence at the same time. Since all these occupations are usually paid by commission (with the exception of mutual funds at most banks), the only way that the person you are dealing with can make any money is if they sell you something in their discipline.
Imagine the scene as the mutual fund/life insurance salesman / financial planner arrives home for dinner and tells his or her spouse about his or her day. "Well honey, I met with this nice couple with $10,000 to put into an RRSP. I would have made $400 if I had sold it to them, but after spending four and a half tough hours with them, I finally convinced them that they would be better off paying off their mortgage. Boy, it's sort of ridiculous though. I could have sold them the RRSP in ten minutes and made $400, but it took four hours extra to talk them out of it and make nothing, but I sure feel good. Well, yes Hon, I know that our mortgage is due, and your car hasn't started for a month, but I really feel good knowing I did my best job for them. Maybe the next people I talk to should really have an RRSP now and I can make some money."
I make $100,000 a year - What do you mean, I should not buy an RRSP?
Although some members of the CEN-TA GROUP sell RRSP's, the focus of this issue is on: "When you or your client should NOT have an RRSP". When I wrote the first published book on the new rules for RRSP's and Pension Adjustments for PRENTICE HALL, I had a hard time getting excited about RRSP's.
I seem to spend more time dealing with people who have bought an inappropriate RRSP, than with happy people who are now sitting back reaping the rewards of their purchase. In the last year, I have likely seen problem RRSP's sold by every major financial institution.
In some cases, the person who had sold the problem RRSP had been trained by members of the CEN-TA GROUP. The reason? For three years the Institute of Canadian Bankers hired a CEN-TA GROUP person to teach Personal Financial Management classes to employees of some credit unions and five of the six major chartered banks.
In one case, I was addressing a class of CIBC financial officers at a class in Burnaby. I started the class by saying that if the members could not find fault with my logic, they would all have to go back and resign their positions because they could not represent the bank and the client at the same time. So far as I know, no one resigned. I still stand by my position.
Few people should buy an RRSP until they have paid off their mortgage, car loan, credit card bills, and other non-deductible consumer credit. In practical terms, this is impossible. One has to start somewhere. BUT, when I run into someone with money in an RRSP and a consumer debt at Eaton's or an outstanding VISA / MASTERCARD amount, I find it easy to show that they would likely be better off cashing in the RRSP and paying the tax to get rid of the non-deductible 20% loan.
Many retailers make more money on the credit extended, than they do on the sale of the product. Department store credit managers would not go far if they spent all their time in intense consultation telling people to cash in their $2,000 RRSP to pay cash for their $1,000 purchase.
And imagine a banker telling the next 50 people walking in the door that they would be better off to cash in their $100,000 RRSP (at the bank) and pay off their $50,000 mortgages (and pay $50,000 tax as well).
Look at the mathematics for the bank. The bank would have $5,000,000 less on deposit and have to find borrowers to borrow $2,500,000. Since the Bank Act allows the bank to "lever" money on deposit by up to 5 or 6 times, the bank is allowed to loan out up to $30,000,000 because of the $5,000,000 on deposit. If the bank made only 1% on the $30,000,000, it would mean that the bank had lost the potential of earning $300,000 per year for as many years as the money remains on deposit.
I ask you, how long would a banker keep his or her job if they told everyone they were better off to pay off their mortgage than to buy an RRSP. For years, CBC's MARKETPLACE was the only major institution to actually state this publicly. Then, miraculously, I listened to Fred Snyder of REGAL CAPITAL PLANNERS say the same thing and give me credit for it. I fell in love with Fred at that point (proof I come cheap). The CEN-TA GROUP and Fred's REGAL CAPITAL OFFICE are now associated. I regularly hear from people that they have taken a class from Fred at BCIT and are always pleasantly surprised to hear Fred's views.
I am also making the assumption here that the individual is dealing with debt type RRSP's and does not have equity funds paying 45%. However, If the person has equity type funds paying 45%, then I can make another, and likely better argument that the equity fund should not be in an RRSP either. The person should borrow the amount of the tax refund from the bank. However, this takes a couple of hours to explain.
But back to RRSP's and the problems of US citizens, dual country purchases or people working out of the country.
1. US Citizens who may be going back to the States should be cautious about RRSP's. Many should not have one and they are particularly vulnerable if they have one which requires continuous payments after return to the US (such as a registered whole life policy).
US citizens or GREEN CARD HOLDERS living in Canada must continue to file a US income tax return EACH YEAR that they remain a US citizen. US CITIZENS DO NOT lose their citizenship when they become a Canadian Citizen unless they want to lose their citizenship. Since 1977, Canada's Citizenship Act allows the American, Brit or Australian, etc., to keep their old citizenship when taking out Canadian Citizenship. Before that date, one had to renounce their US citizenship. However, even if the person did renounce their U S citizenship prior to 1977, the US courts ruled that if an American renounced their citizenship when becoming a citizen of another country, it didn't really count unless they did something specific "IN ADDITION" to show that they really wanted to give up their US citizenship. Therefore, there are literally one to four hundred thousand or more Canadians who are still US citizens and do not really know it.
When a US/Canadian files his or her Canadian tax return, there is usually enough tax paid that there is no tax to pay to the US unless there are large dividends or capital gains in Canada. The US government does not recognize the tax free status of the Canadian RRSP, the $500,000 tax free capital gain on the sale of a farm or small incorporated Canadian business, or the Canadian dividend tax credit. When the American prepares his or her US return, the paperwork around an RRSP is awesome (to also be fair, the worst case I have seen of this involved Australia, but that was only one; I have seen 300 US situations). The US/Canadian must report all the earnings within the RRSP on his US return and it might be taxable because there is no foreign tax credit to offset the tax. Failing that, he or she can claim the benefits of the US/Canadian Income Tax Treaty which requires reporting the interest but does not require it to be taxed until it is withdrawn from the plan.
Up until 1995, one could not put money into an RRSP when actually residing in the U.S. This meant that if you were living in Blaine and working in Vancouver, buying an RRSP reduced your Canadian Tax, but you had to pay tax to the U.S. on the internal earnings of the RRSP. This is no longer true and any American resident should buy a Canadian RRSP when it is to their "REAL" advantage to do so. Just remember that it is sometimes hard to determine if the RRSP does make sense for an American resident.
So, I reiterate, if you or your client is a US citizen or "green card" holder, be very careful about selling or buying an RRSP.
2. Canadians working a full calendar year overseas under the auspices of an OVERSEAS EMPLOYMENT TAX CREDIT should NOT buy an RRSP. An OTC allows the Canadian to exclude 80% (up to a total of $80,000) of his or her earnings from Canadian Income Tax when working out of the country. However, it is subject to Alternative Minimum Tax. A specific example is that at $100,000 of earnings, one client saved less than $50.00 of income tax this year by buying a $12,500 RRSP. When he takes it out, he will owe up to $6,500 of tax.
We had this situation with dozens of people working in China, Chile, Saudi Arabia, Kuwait and another 10 or 12 countries. While it is true that (in the future) the individual will get a credit for the AMT paid, the net effect is that the individual only got a 25% deduction for his or her RRSP and it comes over years in the future. If the person simply buys the Mutual Fund and allows his RRSP contribution room to build up, he or she can deduct it in the future at 50%. These inappropriate RRSP plans were sold by Banks (including two people we trained), Credit Unions, Financial Planners, and just plain old salespeople.
Since the amount of tax lost in these cases is usually in the $3,000 range, be careful. Find a specialist, or do not deal with an out of country worker. If you need help, George Hatton, CA, Sonja Clark, CA, CPA, LLB, D'Arcy von Schleinitz or myself would be pleased to assist (for a fee of course) at (604) 649-4755. A quick question on the phone is usually no charge.
WITHHOLDING TAX
Since 1991, there is always a 25% withholding for RRSP's withdrawn while the owner is a non-resident of Canada. A good argument can be made for taking the money out while a person is a non-resident of Canada.
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NEW LEGISLATION APPLIES TO U.S. PENSIONS PAID "OUT OF STATE"
Until the end of 1995, 15 states including California and Oregon would tax a non-resident on pension earnings which were paid to a non-resident of the state when the pension had been earned while working in that state. This means that (for instance) a retired professor from Berkeley who was living in Sechelt, would have to file a California tax return and report his world income because of his Berkeley pension.
This is not true from January 1, 1996. As of that date, retirees no longer have to pay state tax on pension income received when they do not reside in that state.
This only applies to regular and periodic payments from the pension. If you were to retire from California to Washington or British Columbia and take a lump sum payout of pension benefits, the state still gets its tax.
the CEN-TA GROUP
david ingram
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