April Fools is a special time in our household. My daughter, in particular, loves it. I know that it is approaching because when I check the browser history on our computer, searches for the best practical jokes come up. Of course, I check the links out in an attempt to be a step ahead, but I still fall for such classics as an elastic holding the sink sprayer nozzle “on” and pointing in the direction of the person turning on the tap.
This year, I prepared for April 1st in another way. I considered whether or not to execute the spousal loan strategy for income splitting. On April 1st, the prescribed rate at which you can give a spousal loan will double to 2% making the strategy less efficient. I previously described two cases for spousal loans previously with the case of Dr. Strange and also the more moderate income Jones’.
We previously have not used a spousal loan because with our CCPC and income splitting via dividends, the hassle wasn’t really warranted. The opportunity cost of giving a dividend from my CCPC and paying tax on that now, instead of deferring it generally negated the benefit. However, with the new restrictions on income splitting and passive income limits within CCPCs, I wanted to look at this again.
Is a taxable account needed for us to meet our retirement goals?
We have $1.1M in our professional corporation and that would further grow over the next decade. With the new rules limiting passive investment income in CCPCs, we will want to use strategies to stay below the new active/passive income sliding thresholds. On the active income side, we have kept that down by paying salaries to my wife and I – counting as business expenses to lower our corporate active income. The other benefit of a salary, is that it gives us ~$35K/yr of RRSP room that we max out. We also max out our TFSAs at $11K/yr. That is $46K/yr of retirement savings.
That is a lot for most people. However, physicians need a much higher savings rate than the average person since we have a compressed saving time frame due to our late start and high start-up costs. It is very difficult to make up for the lost time of compounding returns. Further exacerbating this compression – I plan to scale back and stop working more than needed to cover my living expenses by around age 50 and want to have the option to retire in style at age 55, if I choose to. We need to save about $150K/year over the next eight years to meet those goals in that timeframe.
We live well enough below our means that we can pull off saving that much, but I need somewhere to park the extra $100K/yr.
If I were to leave that $100K/yr in my CCPC, then it could easily be $4.5M by age 55. The current proposed restrictions on passive income are not indexed to inflation, so I have left that estimate in nominal dollars (not inflation adjusted). While I think that there are ways to maneuver with that much in my CCPC, to do so would require incurring fees to use the financial products needed (like whole life insurance or corporate class mutual funds) or increased risk with the lower fee products (like swap-based ETFs). I also like the idea of better diversification against tax risk by spreading my assets amongst differently taxed accounts. Maybe I am paranoid, but just ask the docs 5 years from retirement who put everything in their CCPC about how that is working out for them with the recent re-writing of the rules of engagement by government. I think that with the demographics and the public’s expectations, that this is not the last we will see of that sort of action by governments.
The other option besides building up my CCPC, is to build money outside of the corporation in a “cash” or “taxable” account.
Since I want/need a taxable account, does it matter to have it in my wife’s hands?
I am well into the top marginal tax bracket (53.5%) and my wife is in a much lower one (29.65%) with her income as my executive assistant and billing agent. We are much better off having the growth in a taxable account taxed in her hands.
One of the problems with retiring “in style” is that to draw income, you will also trigger tax – RRSPs at the full rate, the non-eligible dividend rate for accessing money from the CCPC account, TFSAs are tax-free (but the account is relatively small), and taxable accounts are taxed at the favourable capital gains and eligible dividend rates. When we go to access the money from our various accounts, I will be drawing non-eligible dividends from the CCPC until age 65, at which point we can income split with dividends again. In that decade leading up to 65, my wife will be drawing from the taxable account to help split our income. Having that taxable account in her hands gives us a higher after-tax income compared to a joint account or one in my hands.
While having a taxable account and having it my wife’s hands makes sense for us, does it make sense to shift more money there from our CCPC via a spousal loan?
Up to this point, the idea of a spousal loan seemed like a real winner to me. It would spread out our wealth into more account types and be taxed in her hands rather than mine. If we just happened to have extra money laying around in our names, it would be a no brainer. I checked the cracks of the couch, the loose change drawer, and the washing machine. I only found $8.57 (yep some pennies) and an old hardened piece of cheddar. The dogs must be slacking. Further, we don’t play lotteries (a tax for the mathematically challenged) nor do we have any wealthy relatives to expect a windfall from.
For us, the benefit of a spousal loan needs to be weighed against the opportunity cost of giving myself a non-eligible dividend now and paying tax on that.
I really wanted to loan my wife enough dough that I could feel like the Godfather and make vague threats about a visit from my cousin Vinny to collect. Sadly, the reality is that poor Vinny wouldn’t stand a chance against my wife, even wielding a baseball bat.
Part of my wife’s financial resilience is her general attitude, but another part is the fact that we have already been very proactive in building a taxable account fully attributed to her. I pay for all living expenses and extra taxes while she funnels her entire income into her taxable account. Between that and the boost from a spousal home equity loan, she already has ~$1.1M in her taxable account. I would need to give a monumentally large loan to make a difference. Plus, her investment income will be already be quite substantial by the time that we retire, narrowing the difference between our after-tax incomes as time passes.
If I gave her a $200K spousal loan, with our planned savings rate and a real return of 5% after 2% inflation, we would have around $6M split almost evenly between our CCPC and my wife’s account. That is more than enough, even after tax, to fund a retirement in style, support worthy causes, deal with unexpected bumps in the road, and leave an inheritance (if my kids get me a good window seat at the nursing home).
However, to do that I would need to give myself a non-eligible dividend for $294K from the CCPC and pay $94K in tax now.
Whether we can make up for that upfront cost depends on:
- How much tax drag our CCPC portfolio has compared to her taxable account.
- If the tax drag in the CCPC is worse, then is our time horizon long enough to catch up?
- When we hit retirement, is there enough of a tax difference on accessing the money via the CCPC vs her taxable account to warrant the effort?
What do those factors look like for us?
When I used the case of Dr. Strange to illustrate usage of a spousal loan with a high income physician, it was basically a wash whether it was useful compared to just sticking with the CCPC as a sole strategy. Part of the reason for that was the tax drag on a CCPC portfolio. With an ETF tracking the TSX, spitting out a dividend yield of 2.8% and not triggering tax with capital gains, the tax drag on a CCPC portfolio would be 1.07%/yr. That would favour a taxable account with a lower drag of 0.61% in my wife’s hands. However, two other factors change that in our case.
First, the tax drag in our CPCC would actually be closer to zero because that 1.07% drag from tax on eligible dividends would go into our refundable dividend tax on hand (RDTOH) account. We would trigger the release of the refundable tax in our RDTOH account every year by virtue of the fact that I pay out dividends annually on top of my salary to fund my various financial indiscretions. There may be some drag from realizing capital gains as part of rebalancing, but I aim to keep that at a minimum and the same drag would apply to the taxable account. If RDOTH sounds like Klingon to you, then you are in good company, but should learn what it means. It is important to understand if you have a CCPC.
Second, our timeline is a short 13 years. Not only do you need enough years of growing a portfolio with lower tax drag, but the drag of the interest of the loan (even though only paid to me) gets better with time as the portfolio grows and inflation erodes it away. Her interest drag on the investment loan would start at 1% and only have decomposed to 0.68% in “current dollars” by age 55.
Third, we have already built a large account in her name and we plan on spending a similar amount of money when we retire to what we do now (a lot) or at least want the option to. Between her RRSP, spousal RRSP, and taxable account, she would pay similar tax on a similar income to me as we draw on our savings. We have already effectively accomplished the goal of intermediate term income splitting whether we use a spousal loan or not.
There is actually a fourth factor. I plan to arrange our CCPC portfolio to minimize what counts as passive income which will also ensure a low CCPC tax drag – but that will be a whole other post.
With the above factors, we decided not to bother with a spousal loan at this time.
This does mean that we are trading off the benefit of diversifying even further out of our CCPC from an account tax treatment standpoint. However, with our short time frame, already being well diversified, and using tax efficient investing strategies within our CCPC – the overall balance was in favour of not shifting more money at this point.
If the CCPC balance does become too large and unwieldy at some point (a nice problem to have), then we do have other options to deal with it as part of our estate planning to pass money on to our offspring and favoured charities. Doing this in a tax efficient way to maximize the good that our money does is much more likely to be our concern than running short of it. We definitely have first world problems, but we have also benefited from proactive financial planning and execution that has put us in this position.
Would considering a spousal loan be a good idea for you?
Feel free to let me know your thoughts in the comment section below. We did consult with our financial advisor and accountant before making our final decision on this matter. My suggestion would be that you do the same – especially if you are dealing with the complexities of a CCPC like we are.
Having a good accountant is like underwear – don’t leave home without it. It is also important to choose an advisor wisely to get valuable advice for a value price. You definitely don’t want one of the one’s Dr. Networth warns you about from his experiences.