WEALTH Matters ó WINTER 2008

ASSET SWAP

If you hold both registered investment plans (RRSPs or RRIFs) and non-registered plans, there is a good chance the holdings are not allocated across these plans in the most tax-efficient way. An Asset Swap moves assets between plans to save you taxes when you later withdraw money from these plans.

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Making lemonade

tax-loss selling

Asset swap

Tax free savings account

Many of our clients use Ďtax optimizationí when constructing their portfolios that include both RRSP/RRIF plans as well as open (non-registered) plans.† Because capital gains and dividends are taxed at much lower rates than interest income, it makes sense to hold these assets outside an RRSP or RRIF. Thatís because inside a registered plan, all returns are tax-deferred, but when funds are withdrawn from the RRSP/RRIF, they will be fully taxable, and the reduced tax rates on dividends and capital gains are lost. Therefore all interest bearing assets should be inside a registered plan and all the equities should be outside.

Letís look at an example. Letís say you have an overall target asset allocation of 50% equity and 50% fixed-income. As well, your investments are 50% in RRSPs and 50% in open plans. The easiest way to manage the assets is to have the asset allocation in the RRSP and the open plan be the same as the overall allocation as in the diagram below.

 

In a tax-optimized portfolio, we would increase the fixed income in the RRSP and increase the equities in the open plan so that the overall asset allocation across all plans remains the same, but the equities are held as much as possible in the open plan, as shown below.

Why go to all this trouble? The tax savings can be enormous.

If the amount to be re-allocated is $100,000, and the rate of return is 4% interest or 4% realized capital gains, at a 40% tax bracket, tax optimization will save $800 of tax in the first year. Compounded over 20 years, the tax savings are over $27,000. If the capital gains can be deferred for 20 years, then the improvement grows to almost $35,000.

Now that equity markets have suffered a sharp decline in the past 12-18 months, it is much easier to achieve a complete tax optimization. And if equities produce above-average returns over time as they have in the past, especially with a recovery factored in, the benefits of tax optimization should be even larger.

When we next meet to review your portfolio, we will show you how close you are to being tax-optimized, and will explain how you can execute an asset swap to bring you closer to the optimal allocation across plans

Also in this issue of Wealth matters:

Making lemonade

tax-loss selling

Tax free savings account

Mutual Funds and Segregated funds provided by Fund Companies offered through

Worldsource Financial Management Inc. sponsoring mutual fund dealer.

All other services provided by Page and Associates Ltd.

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