Building Wealth

For the first 30 or so years of working, saving and investing, you’ll be first in the mode of getting out of the hole (paying down debt), and then building your net worth (that’s wealth accumulation.). But don’t forget, wealth accumulation isn’t the ultimate goal. Decumulation is! (a separate category here at the Hub).

Real Life Investment Strategies #4: Business Owners should Leverage their Corporation for Retirement Savings

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Lowrie Financial/Canva Custom Creation

By Steve Lowrie, CFA

Special to Financial Independence Hub

When you’re immersed in running a business, thoughts of saving for retirement often take a back seat; Employees in the corporate world may rely on employer pensions, but as a business owner, the responsibility for your retirement falls squarely on your shoulders.

Starting your retirement planning early and consistently contributing allows you to benefit from compounding returns to steadily build your nest egg over time. Investing in your retirement can ensure you have the financial means to enjoy life post-retirement, whether it’s traveling, pursuing new passions, passing along a little financial freedom to family members, and more.

This blog explores how business owners can utilize their corporation (Canadian-controlled private corporations or CCPCs) to retain business income that exceeds operational and personal lifestyle needs.

Changes to Income Tax Rules (Capital Gains Inclusion Rate) can throw Business Owners’ Retirement Savings Plans into Chaos

The 2024 Federal Budget is a perfect example of how income tax rules can change, sometimes less smoothly and with less notice than what is reasonable.

Specifically, the 2024 budget included an increase in capital gains inclusion rate that affects:

  • Individuals with over $250,000 of capital gains in a tax year (only on the amount in excess of $250,000)
  • Corporations
  • Trusts

To make matters worse, the timeframe for any pro-active tax planning was very short and with few specific details before the tax changes became effective on June 25, 2024.

Many have also speculated that capital gain tax increase was a last-minute addition to a budget that was politically motivated and not based on sound economic policy.  Among the critics was none other than, Bill Morneau, the former Trudeau-Liberal finance minister.

There is also a high probability that there will be a change in Federal Government in 2025, which may bring a complete taxation review and reform.  Among the taxation reforms might be to roll back this tax increase.

Given this context and uncertainty, what should an individual with corporate investment assets do?

The best advice I can give you is to step back and view these tax changes versus your long-term financial goals, and to avoid making hasty decisions.  If there is major tax reform in the next few years, many individuals might find their hasty planning decisions to be very costly.

Even with higher capital gains inclusion rates, investing in your corporation still has many advantages.

Using Your Corporation for Retirement Savings still Provides you with Numerous Advantages

Retirees increasingly rely on their savings to sustain their lifestyle after leaving the workforce, presenting unique challenges (and opportunities) for business owners pre- and post-retirement. Over time, these corporations can accumulate investment assets and simply selling the business for retirement funds isn’t always the best option. The corporation can reliably serve as a source of dividends for the owner-manager in retirement. When a corporation is involved, it opens up another retirement savings and withdrawal option which, although advantageous, can be complex. We’ll walk though how saving within your corporation can be a great choice for business owners, but it is quite important to work with a competent independent financial advisor, accountant, and other professionals to determine the best retirement saving planning for each specific situation.

4 Reasons you should be Using your Corporation to Save for Retirement

  1. Tax Deferral

By retaining excess funds within the company, the initial tax benefit is that the income is taxed at a lower corporate rate vs. your personal tax rate – the extent of the advantage can vary depending on whether your corporation qualifies for the small business tax rate, which would be even more advantageous. Hand-in-hand, the tax benefit is also gained by the postponement of personal taxation. When funds are distributed to the business owner later as dividends, even with consideration of tax integration, the investment returns of the funds held within the company can generally more than compensate.

  1. Tax Deferral means more Money to Invest Today

By taking advantage of the tax deferral due to the reduced corporate tax rate, you have access to more investable capital today. This increased liquidity opens up the possibility of generating higher returns on your investments within the corporation, amplifying the potential growth of your wealth over time.

  1. Build Up Long-Term Value of the Corporation

If you plan to sell your corporation down the road, you can also take advantage of the Lifetime Capital Gains Exemption (LCGE), which Budget 2024 is proposing to increase to $1,250,000 (for dispositions after June 25, 2024) when you sell shares in the business.  Let’s say you sell a business for $2 million; the exemption amount means you wouldn’t pay tax on 62.5% of that profit. This translates to hundreds of thousands of dollars in tax savings.

In addition, the LCGE is a lifetime limit – so you can also choose to apply the exemption multiple times until you reach the limit. So, you have the option to sell shares over time and use the LCGE for multiple years until you’ve capped out. Figuring out how best to apply the LCGE can be challenging but worth the effort.

Lastly, with proactive planning, leveraging the lifetime exemptions of multiple family members can potentially mitigate or even eliminate the capital gains tax liability on higher-value businesses. A reliable professional financial planner and accountant can help you determine the best way to allocate and dispose of corporation shares to realize the optimal financial result.

  1. More Options for Savings & Withdrawal Streams = Flexibility

The most important advantage of saving for retirement within your corporation is that it gives you more options for both your retirement savings and investment options and your retirement withdrawal pools. Essentially, it gives you another tool in your toolbox. Most people are limited to three investment streams: RRSP, Tax-Free Savings Account, and Non-Registered Investments.

The corporation gives you a 4th pool of funds to work with – for both saving and withdrawal.  This allows for the flexibility to optimally select the best pool of funds for savings and withdrawal over time. For example, in any given year, your lifestyle needs may drastically change, so saving within the corporation gives you one more place to pull money in a way that best works for you. The following year, you have the flexibility to change it up in a way that works better. You don’t need to be limited to only 3 pools of your savings.

Another option that saving within your corporation opens up is the way you withdraw your money – during your prime working years, as you ramp down, and into retirement. Business owners can take money out of the corporation via dividends or salary.

Dividends are not tax deductible for the corporation. But with dividends, there are also no payroll taxes. Dividends also allow for more flexibility around how much you withdraw from the corporation and when. This is a great advantage for changing needs dictated by your personal lifestyle needs.

Withdrawing from your corporation via salary is advantageous due to the tax deduction for the corporation. In addition, salary withdrawal creates personal RRSP investment room. However, you would need to pay CPP at both the personal and corporate level. In addition, other payroll taxes would be required to be paid by the corporation.

Considerations when Saving for Retirement in your Corporation

With so many advantages to saving within a corporation, it may seem like a no-brainer. However, I need to point out some things you should consider as you use your corporation as a retirement savings pool.

Firstly, there is some extra complexity that comes with managing that extra stream of savings, which makes your reliance on a trusted accountant and financial advisor even more important.

Obviously, there are extra costs that come with owning an incorporated business, but if you are reading this blog, you are already paying these expenses. But, due to the extra complexity of managing more, there might be slightly more costs associated for your accountant. Although more cost, it is likely minimal and wouldn’t offset the advantages.

Another consideration about saving in your corporation is how you plan to retire: selling your business, winding down, succession, downsize, family takeover, etc. Thinking about the right path for the specific situation results in questions (and answers) about the best way to proceed. Continue Reading…

Canada’s Great Companies make the HLIF ETF worth consideration

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Image courtesy Harvest ETFs
By Ambrose O’Callaghan, Harvest ETFs

(Sponsor Blog)

Many Canadians are watching closely as their neighbour to the south prepares to hold a crucial Presidential election in November 2024.

Meanwhile, Canada’s federal election is still more than one year away. Canada continues to contend with economic, social, and political issues that are faced in varying degrees by its partners in the G7. These issues include managing immigration, aging populations, and housing affordability. Its central bank also seeks to strike a balance in monetary policy after raising interest rates to combat inflation.

In this piece, we’ll look at how the Canadian economy has fared over the past year. Moreover, we will look at an exchange-traded fund (ETF) that offers exposure to Canada’s great companies. Let’s jump in.

Where does Canada stand in the fall of 2024?

From an economic standpoint, Canada finds itself in a difficult predicament. The OECD chart below illustrates that Canada has fallen behind many of its peers in the post-COVID-19 pandemic era.

 

Source: Organization of Economic Cooperation and Development (OECD), 2024 Household Dashboard, accessed October 6, 2024.

Canada’s Real GDP per capita ranking compared to its peers, especially stand outs like the United States and Italy, has been abysmal. This is coupled with dismal employment statistics that have shown rising unemployment. Even positive jobs data is skewed by government hiring in some cases.

Indeed, unemployment in Canada has climbed from a low of 5% in 2022 to 6.5% in its latest reading. Royal Bank of Canada Deputy Chief Economist Nathan Janzen recently stated that unemployment would continue to rise to 7% by early 2025. That is nearly a percentage point higher than pre-pandemic levels.

The Bank of Canada (BoC) is in a tough spot as it battles a weak economic environment and a housing supply shortage that has kept prices elevated. Now, the BoC finds itself in a position where it will need to employ further interest rate cuts. However, in doing so, it runs the risk of re-inflating the housing price bubble.

Why should you trust Canadian companies?

Canada has been in a rut economically in recent years. However, the forward price-to-earnings ratio difference between the S&P TSX 60 and the S&P 500 show that publicly traded Canadian companies still offer attractive value at this stage. Continue Reading…

To Hedge FX Risk, or not to Hedge

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To Hedge FX Risk, or Not to Hedge: Currency markets are notoriously difficult to call but can meaningfully impact portfolio returns. ETF Strategist Bipan Rai provides a detailed framework for investing outside the Canadian market.

Image Getty Images courtesy BMO ETFs

By Bipan Rai,  BMO Global Asset Management

(Sponsor Blog)

Admittedly, using a spin on a famous Shakespeare quote to start a note on currency hedging1 is verging on trite. Nevertheless, if Hamlet were running a portfolio of overseas assets, his primary concern would have to be the “slings and arrows” of currency markets — which are notoriously difficult to call but can meaningfully impact portfolio returns.

For Canadian investors, looking abroad provides several benefits. The most important is diversification, whether it’s through access to other regions that are less correlated with Canadian markets or to other products that aren’t available domestically.

However, investing abroad also means taking on foreign exchange risk given that international assets are priced in currencies other than the Canadian dollar (CAD).

For illustrative purposes, consider Chart 1, which shows the total return for the S&P 500 in U.S. dollars (USD) and in CAD terms for Q1 of this year. In USD terms, the index was up 10.6% over that time frame, but since that period also corresponded to weakness in the CAD relative to the USD (or USD/CAD moved higher) the index outperformed in CAD terms (up 13.3%). That means that Canadian investors would have fared much better leaving their USD exposure unhedged ex ante.

Chart 1 – S&P 500 Total Return for Q1 2024

Source: BMO Global Asset Management

Now let’s look at an alternative period in which the CAD strengthened against the USD. Chart 2 shows a comparison of the total return for the S&P 500 from April 2020 to April 2021 (in which USD/CAD was lower by over 11%). During that period, the total return index outperformed in USD terms by close to 20%. In this scenario, an investor who had hedged their FX risk would have been in the optimal position.

Chart 2 – S&P 500 Total Return Between April 2020 – April 2021

Source: BMO Global Asset Management

As these examples show, currency risk is a key consideration for any investor who wants to look beyond Canada for diversification. That risk can cut both ways, which amplifies the importance of hedging decisions. In our minds, the decision to hedge foreign exchange (FX )risk (including the degree to which foreign exposure is hedged) comes down to the following:

  1. An investor’s view of the underlying currency pair
  2. Whether the currency pair is positively or negatively correlated2 with the underlying asset

In this note, we’ll make a brief comment on the first point but focus largely on the second one. as we feel that should be given more weight for hedging decisions.

FX Markets are Tough to Call

Taking a view on the underlying currency pair is easy to do — but difficult to capitalize on.

Indeed, foreign exchange markets are notoriously fickle. One reason why is the relationship between predictive factors and currency pairs is rarely stationary. For instance, a lot of market participants tend to use front-end (2-year) yield spreads as a proxy for central bank divergence in the spot FX market. Chart 3 shows the current correlation between those spreads and the different CAD crosses, and as expected, the relationship isn’t consistent from a cross-sectional perspective.

Chart 3 – Correlation Between Two-Year Spreads and the CAD Crosses

* * Correlation window is 2 years. The CAD is used as a base currency for this analysis. The spread is tabulated by subtracting the foreign 2-year yield from the CAD 2-year yield. Source: Bloomberg, BMO Global Asset Management.

We can also see this by looking closer at the relationship between a factor and a currency pair over time. Chart 4 shows the rolling 100-day correlation between USD/CAD and the price of oil (proxied by the prompt WTI contract3) going back ten years. Note how frequently the strength of the correlation (as well as the sign) changes over time. Continue Reading…

Don’t mix Politics & Investing but financial community thinks a Trump victory more positive for Stocks

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Top investment executives told a webinar held Wednesday morning that investors should not mix Politics and Investing. Even so, while market observers at Franklin Templeton view the upcoming U.S. election as essentially a “toss-up” they seem to believe that a victory or sweep by the Republicans’ Donald Trump would be more positive for stocks than a Kamala Harris win.

Grant Bowers, portfolio manager and Senior Vice President for Franklin Equity Group, said “it’s a 50/50 tossup for the presidential winner. Both candidates are well known so it’s not surprising” there’s been little market volatility in the runup to the November 5th election. Generally, he’s bullish no matter the outcome.  The economy did well in Trump’s first term while a Harris victory would be a continuation of Biden policies. The real differences are on tariffs, fiscal policy and regulation. “The most likely outcome is a split government” but there would be more volatility if there is a sweep by either party.

Of course, it’s quite possible that investors won’t know the official outcome for several weeks. If the process of counting votes drags on and there are legal challenges like there were in 2020, investors can expect more protracted volatility.

Sonai Desai, Chief Investment Officer for Franklin Templeton Fixed Income said the U.S. economy is set to do “quite well. I agree there’s a reduced probability of Recession: that’s not our baseline for a while.” If there’s a Republican sweep and broader tariffs measures introduced by Trump, “that might limit the Fed’s appetite for massive rate cuts.”  Her baseline is that even with a Republican sweep, there won’t be a literal imposition of tariffs: that didn’t happen in 2016, so “I don’t think we will get the full range of cross-the-board tariffs.”  Either way, the mighty U.S. consumer will “continue to consume and I don’t see that changing with the Election.”

Clearbridge’s Jeffrey Schulze

In the very long run, of course, any short-term market volatility from elections is likely to be a blip, which is why Franklin Templeton tells clients not to mix investing and politics.

In an analysis released early in October, Clearbridge Investments Head of Economic and Market Strategy Jeffrey Schulze, CFA, showed the following annual returns for the S&P500, all positive for equities no matter which party wins and whether or not they get full control or are in a divided government. Based on that, the best outcomes for investors would be a Democratic president with a Divided Government or Full Control by a Republican president.

“We view a Trump win, likely coming in a sweep scenario, as net positive for equities as it preserves favorable corporate tax treatment and builds on tax elements that expired,” Schulze wrote in the October 1st update, “A Harris win, likely coming with a divided Congress, would be mildly negative due to fewer provisions of expiring tax legislation getting extended due to political gridlock.”

Trump win likely positive for Stocks

“In aggregate, we view a second Trump presidency under a sweep scenario as net positive for equities. The expectation is for a more favorable corporate tax regime and less of a regulatory burden, both of which should boost corporate profits. Conversely, there is the potential for increased tariffs and retaliation from U.S. trade partners … We view U.S. stocks as best placed under Trump, with banks and capital markets, as well as the oil and gas complex, well positioned due to lighter regulation. Aerospace and defense is also likely going to benefit as well as biopharmaceuticals. Areas that could see pressure are restaurants and leisure, due to the less availability of labor, as well as EVs, autos and clean energy producers.”

Harris win might be “mildly negative” for Stocks

A Kamala Harris win would be less positive for U.S. stocks, Schulze writes: “We see a Harris win as mildly negative to equities should she preside over a divided Congress. It will be more of a headwind to the markets should we see a Democratic sweep as she will then be able to implement higher taxes on corporations and high-income individuals, as well as push a more ambitious regulatory agenda. However, tax credits for low-income individuals would provide an offset, creating an economic boost to this segment of the economy.Tighter regulation could weigh on biopharmaceuticals, banks, capital markets, energy as well as mega cap technology. But again, we caution against basing investment or portfolio positioning solely on the regulatory environment. Areas to be bullish about under Harris would be consumer discretionary, specifically restaurants & leisure, home building and building products.”

Generally, Franklin Templeton continues to advocate a “stay the course” stance for investors geared to the long term. The chart below shows that going back to 1944, the U.S. stock market has risen steadily over time regardless of which political party is in the White House.

 

 

Stephen Dover, chief market strategist and Head of Franklin Templeton Institute, acted as Moderator in Wednesday’s webinar, fielding audience questions. He also wrote a U.S. election update earlier this month, headlined “Uncertainty Reigns.”

He concluded back then that the election remains  “too close to call. A divided government in Washington, DC, with no single party controlling the White House, Senate and House of Representatives is likely … Investors should gird themselves for uncertainty and potential bouts of volatility preceding and following election day. It is quite possible that the outcome for the presidency will not be settled until the December 17 certification deadline.”

Dover expects market uncertainty to continue well past November 5th, if not until January’s inauguration of the ultimate winner.”Legal challenges, some of which have already commenced, add to uncertainty. Re-counts, delays and disputes over certification of results, alongside courtroom litigation are virtually assured if state election outcomes are close. Various legal and procedural challenges are likely to endure until at least December 17, which is the deadline for state certification of the presidential election results and the official nomination of state electors to the Congressional certification on January 6, 2025.”

However, Dover says his basic investment conclusions remain unchanged. They are as follows: Continue Reading…

What are Canadian Depositary Receipts (CDRs) and should you invest in them?

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Are CDRs the better way to hold U.S. investments? What are the pros and cons?

TSInetwork.ca

Canadian Imperial Bank of Commerce (CIBC)’s Canadian Depositary Receipts (CDRs) give investors the opportunity to buy shares and/or fractions of shares in any of a number of U.S. or other foreign companies, in bundles that start out trading at a price of about $20 Cdn. each.

CDRs come with a built-in hedging feature that reduces exchange-rate fluctuations. This feature costs you 0.60% of your investment yearly.

CDRs let you invest small sums in U.S. or other foreign stocks, some of which have exceptionally high per-share prices. (For instance, Nvidia recently was trading for $475.06 a share.) Note, though, that with highly liquid stocks like Nvidia, or the other shares underlying CIBC’s CDRs, investors can easily buy, say, just one or two shares if they want.

CDRs represent shares of U.S. or other foreign companies but are traded on a Canadian stock exchange in Canadian dollars.

CIBC currently offers about 47 CDRs that trade on Cboe Canada (formerly NEO Exchange). Here’s just a few of them:

  • Alphabet Canadian Depositary Receipts – GOOG
  • Amazon.com Canadian Depositary Receipts – AMZN
  • Apple Canadian Depositary Receipts – AAPL
  • Meta Platforms Canadian Depositary Receipts – META
  • Microsoft Canadian Depositary Receipts – MSFT
  • Netflix Canadian Depositary Receipts – NFLX
  • Nvidia Canadian Depositary Receipts – NVDA
  • PayPal Canadian Depositary Receipts – PYPL
  • Starbucks Canadian Depositary Receipts – SBUX
  • Tesla Canadian Depositary Receipts – TSLA
  • Visa Canadian Depositary Receipts – VISA
  • Walt Disney Canadian Depositary Receipts – DIS

Cboe Canada is recognized by the Ontario Securities Commission.

An individual CDR is not intended to equal the cost of a single share. Instead, each new CDR started out trading at around $20 Cdn., representing ownership of one or more shares and/or a fraction of one share of the underlying stock, depending on the stock’s price. As mentioned, shares of many of the largest companies in the world trade at significantly higher prices, although some trade much lower as well.

Dividends paid on the shares underlying CDRs will be passed through to CDR investors in Canadian dollars when received, based on the current foreign exchange rates.

The main negative about CDRs is the Fees

CIBC charges no direct management fees for CDRs. However, the CDRs are hedged against movements of the U.S. dollar relative to the Canadian dollar. That means the Canadian-dollar value of the CDRs rises and falls solely with the movements of the underlying stock.

Of course, hedging has costs: and hedging against changes in the U.S. dollar only works in your favour when the value of the U.S. dollar drops in relation to the Canadian currency. If the U.S. dollar rises while your investment is hedged, that reduces any gain you’d otherwise enjoy, or expands any loss. Continue Reading…