 |
Registered or non-registered? That was the calculation. Budgets have a funny way of upsetting calculations, however.
Twas ever thus, one might argue, with calculations sometimes changing slowly and sometimes quickly. Remember the gradual raising of the foreign content limit for registered plans? Then one day it was gone. Remember the reduction in the capital gains inclusion rate, not once but twice in the same year?
And each time there were complications. While investors chafed as foreign markets boomed, the industry responded with RSP clone funds. So successful did they become, or rather, so successful did the derivatives instruments used by institutional investors become, that the federal government had little choice but to drop the restriction. Yet that reopened the question of optimal foreign exposure, which had conveniently settled at around the 30% limit or so.
Of course, the rising fortunes of the Canadian dollar made that a moot point for some.
Similarly, the double cut in capital gains forced a new set of calculations. Was the RSP dead? Some pundits thought so. Of course, they ignored both the impact of tax-free compounding and the RSP tax refund. Another wrinkle: Were dividends, unloved throughout the late 1990s and now disadvantaged vis a vis capital gains, still worth pursuing for all but the most cautious investors?
Moot again as high-flying tech stocks crashed and steady dividend yielders, not to mention income trusts, powered ahead. Until, of course, the next budget change, which undercut income trusts and forced the federal government to address the double taxation of corporate earnings.
And now, welcome to the brave new world of asset location. Instead of the choice between registered and non-registered, the 2008 budget’s introduction of tax-free savings accounts adds a third option: tax-free investment income.
In the United States, with its plethora of tax-assisted vehicles, from 401 (k) to Individual Retirement Accounts to Roth IRAs, the calculation of where to put what asset to get the best after-tax yield has elicited some debate and a lot of actuarially inclined mathematics.
Now it comes to Canada. A few years ago, when the capital gains inclusion rate was reduced the question became pointed: Why put assets that would yield capital gains in an account whose withdrawals would be taxed as interest? Still, it was a two-option universe, subject to asset allocation decisions: bonds inside and stocks outside.
TFSAs change that simple calculation. Why not put interest and dividend-paying assets in the TFSA? There’s no tax on withdrawals. What about stocks? As with an RSP, there’s no potential for deducting capital losses. So the emphasis will be on finding steady performers with low volatility.
This is where advice gets interesting is in determining the balance and types assets among all three accounts: open, registered and tax-free.
Of course, client resources will play a part, since potential tax-assisted contributions will rise. Some clients will be able to put $20,000 in an RSP and $5,000 in a TFSA, or $50,000 for a couple in the top income decile. But others will not. Imagine the tinkering among options. Better to save the RSP room for a higher tax bracket, or go with the deduction now (and put it in a TFSA)? Now factor in a mortgage.
Spending decisions will be affected too, since TFSAs won’t be subject to the attribution rules. This enables income-splitting among spouses, and with adult children. And this is just touching the surface when it comes to way TFSAs may alter what had been settled thinking. The spreadsheets and decision trees are going to get more complicated.
Naturally, the product universe will change too. RSP clone funds flourished when returns on foreign assets seemed high compared to returns on Canadian stocks. Now they are a memory. Similarly, TFSAs could undercut the proliferation of T-class products, some of whose income is simply tax-free return of capital.
Who says the business of giving advice isn’t challenging.
Filed by Scot Blythe, Advisor’s Edge Report, scot.blythe@advisor.rogers.com
(02/27/08)