January 1994
the CEN-TAPEDE Pages 29-32 david ingram's US/Canadian Newsletter January 1994 Parts of these newsletters have been reproduced by major institutions. If you wish to use part or all of the newsletter in your own "in-house" publication, we will allow its reproduction if a request is made in writing by fax to (604) 649-4759. Voice calls to david ingram should go to (604) 657-8451. On the other hand, if YOU have a situation you would like included, I welcome all submissions and will give editorial credit. THERE'S NO SUCH THING AS A FREE LUNCH!
LET ME EXPLAIN
A few days ago a client (with her skeptic husband) was in the office to talk about their finances. Her fee for service was $374.50 (GST inc) 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 they sell something.
That is the major problem with the system as it exists now. Licensed salespeople can only sell the products for which they are Licensed. 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 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.
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.
No one should buy an RRSP until they have 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 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.
Further charts, etc., on the subject can be found in my 1989 ULTIMATE RRSP BOOK (Prentice Hall) and / or david ingram's INVESTMENT GUIDE from HANCOCK HOUSE. This last book is hard to find but there are some copies available and COLES for one can get hold of it. It will also be available within a month, electronically, on the INTERNET. See separate sheet to sign up for the INTERNET and be part of the worldwide computer world.
But back to RRSP's and the problems of US citizens or 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. Most 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 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. Since 1977, Canada's Citizenship Act allows the American or Brit, or Australian, or German, 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 previous citizenship, 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 the 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 $100,000 tax free capital gain, or the Canadian dividend tax credit (Canada does not recognize the tax free status of a US IRA either just to be fair). 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.
If the plan is a Life Insurance type of plan where the payment of monthly or annual payments is required, there is another problem if and when the US citizen moves back to the States. US law says that if they keep on making payments to the Canadian RRSP while living in the US, the RRSP's tax free status does not exist. If the US citizen resident makes one more payment, the whole Canadian RRSP earnings become taxable on the US return. You might say that would be a rare occurrence, but we had over 42 of them in 1993 alone.
All were sold by "financial planners" who had no business dealing with US citizens. Seven of the purchasers were ministers here on temporary assignments.
So, I reiterate, if you or your client is a US citizen or "green card" holder, be real careful about selling or buying an RRSP.
2. Canadians working 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, my client saved less than $50.00 of Income tax this year by buying a $12,500 RRSP.
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.
While writing the previous paragraph, I received a call from Australia from a tax client who had sold a lot of US stock to take advantage of the $100,000 tax free gain. He had just discovered the 20% withholding in the US (which could be more after he return is filed.) He would have been better off allowing the extra 20% to keep on working for him. However, he was warned that he should take advantage of his tax free gain "NOW" by a friend.
Since the amount of tax lost in these case 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, 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.
the CEN-TA GROUP
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