Paul*, 50, is a technology consulting entrepreneur whose personal income and that of his wife support a comfortable lifestyle with their three children in high school and college. But, about ten years after his retirement project, and the possibility of selling his block of shares in the SME that he manages with his partners, Paul is concerned about the absence of financial assets other than these shares in his contribution to the family wealth .
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This equity interest is valued at approximately $3 million. But it is a summary valuation whose real value will only be redeemable for sale on the resale of your block of shares.
Paul’s personal Registered Retirement Savings Plan (RRSP) and Tax Free Savings Account (TFSA) accounts have just $1,600 in assets. Paul has an unused contribution room worth $240,000!
- in a registered retirement savings plan (RRSP): $1,500 (cumulative amount of unused contributions: $166,000)
- in a tax-free savings account (TFSA): 0 (total amount of $81,500 in unused contribution room)
- in Registered Educational Savings Plans (RESP): $23,500 (2 children, ages 12 and 16)
- in advisory services SME shares: approximately 3 million (estimated value based on its recent results and comparable SME share transactions)
- Primary residence: approximately $670,000 (50% co-ownership with his wife)
- Residential mortgage balance: $272,000 (50% owned with his wife)
- personal credit card balance: approximately $3,000
- jobs and contracts: $135,000 (gross)
Main personal outlays:
- related to family residence: $36,000
- related to family lifestyle: $46,000
- personal tax related: $43,000
To remedy this situation, Paul plans to take advantage of a home equity line of credit on the family home, provided by up to $250,000 in accessible funds at a rate of approximately 4.5%.
By doing so, Paul believes he can maximize his tax advantages related to RRSP “catch-up” contributions during his years of highest taxable income.
“Is this a good way to quickly replenish my RRSP so I can benefit from the maximum “tax refund” during the few years of work before my retirement? And this, despite higher interest costs than ever before on a home equity line of credit? Paul asks.
Paul’s situation was sent for analysis and advice to Daniel Lanteigne, a financial planner and senior partner at Quebec-based consultancy Reverber Financial Strategies.
Mr. Lanteigne is also the outgoing Chairman of the Board of Directors of the Institut quebécois de planning financière (IQPF).
“Paul’s situation is similar to that of many entrepreneurs. His economic independence for retirement will materialize with the sale of his shares in the company ”, Daniel Lanteigne points out from the beginning.
In this context, he considers Paul’s question about the possibility of borrowing on a home equity line of credit to replenish his still-thin RRSP, while optimizing tax refunds on his contributions during his peak years, “very relevant.” . .
“The RRSP is one of the last tax havens for individuals and its appeal is undeniable,” recalls Mr. Lanteigne.
“In order to be profitable, the annual contribution to the RRSP must offer a possibility of tax recovery greater than the income tax that will be owed upon retirement, once retired. »
In his analysis of Paul’s situation, Daniel Lanteigne estimates that based on his current tax rate, he can expect to recover the equivalent of 41% to 47% of the order’s RRSP contributions, $20,000 to $40,000 per year.
“At first glance, that would be really cool,” admits Mr. Lanteigne.
“But there would be a way for Paul to be even better off fiscally if he waited to make his RRSP contributions with the liquidity from the eventual resale of his SME shares. »
How to do ?
Daniel Lanteigne recalls that as a shareholder-manager of an SME, Paul will be able to take advantage of the capital gains tax exemption for the sale of SME shares (ECGC, in tax jargon) for up to an amount of around $913,000, according to current criteria by 2022.
“In the event that Paul sells all his SME shares for $3 million during a year in which that is his only income, a capital gain of $3 million would result, of which half, or $1.5 million, would be then tax base for Paul, explains Daniel Lanteigne.
“However, you could deduct the equivalent of 50% of the exemption amount of $913,000 in connection with the ECGR, or approximately $456,000. This deduction would reduce his taxable income to about $1.04 million and his tax liability to about $525,000, says M Lanteigne.
“So if Paul supercontributed $160,000 to his RRSP, he could get back about $85,000 in tax relief. In the end, he could reduce the tax payable on the capital gain from the resale of his SME shares by about $440,000. »
Regarding the relevance of indebtedness to replenish an RRSP, Daniel Lanteigne considers that it would be an inadvisable approach for most people, both from a financial and fiscal point of view.
“I do not recommend borrowing to contribute to an RRSP because it entails financial costs and risks that often outweigh the short-term tax benefits,” summarizes Daniel Lanteigne.
On the one hand, he explains, the interest costs of a loan to contribute to a registered savings plan (RRSP, TFSA, RESP) are not eligible for the tax deduction of the cost of borrowing to invest for collection purposes.
In addition, borrowing to make “recovery” contributions and investments in savings or investment accounts implies a significant risk of concentrating purchases of financial assets at inappropriate times in the markets.
“Because it is very difficult – if not impossible – for individuals to anticipate movements in the financial markets, it is almost always preferable that they stick to periodic purchases for predetermined amounts,” says Daniel Lanteigne.
“This is what is known in financial planning as the “average cost method”, which constitutes a more balanced and less risky investment strategy for an individual. »
* Although the case highlighted in this section is real, the first name used is fictitious.
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