Entries from October 2019 ↓

Compliance

By Wednesday afternoon – for the first time in a few years – US interest rates will be lower than those in Mapleville. Our central bank is universally expected to hold the line and make no cut. The Fed’s widely anticipated to trim once again by a quarter point. That’ll make three.

Donald Trump, who has the same formal monetary training as your mom, said Tuesday the US bankers “don’t have a clue.” He wants yuge cuts to the cost of money, claiming the Dow (now fluttering around record territory) could be 10,000 points higher if only people listened to him.

Ironically the Fed is cutting because of Trump’s trade war, which Scotiabank this week estimates is responsible for willowing out the US economy. Other than the spitting match with Beijing, things are kinda boffo in America lately. Unemployment at a 50-year low. Bidding wars in major cities. Acceptable corporate profits. Stock markets arcing to new heights. Girl astronauts getting their own suits. Tesla making big bucks. And US households (unlike us) are carrying far less debt than a decade ago, with a savings rate of 8.8%. Yes, peeps, that’s eight times higher than ours. Americans actually save more than $1 trillion every quarter, a lot of it flowing into 401k retirement plans and Roth IRAs (like our TFSA).

So yesterday’s dreary post detailed how everyone who does not read this blog is likely pooched. Debt is rampant. Cash flow is sucked off by servicing costs. Savings are minimal. Seven in ten families could not afford a new fridge if they had to pay cash for it. (You can charge one at The Brick and take 36 months to pay, but if you miss one payment, interest applies. It is currently “RBC prime + 33.29%. Yes, you read that correctly.)

Canada can’t lower its bank rate because citizens have no discipline. Just like their leaders. Cheap credit has inflated houses, lured millions into owing trillions and wiped out retirement savings. Given the election results we now face significantly increased public borrowing, more upward pressure on real estate values and, sadly, increased tax on the few (not the many).

If you think people with solid incomes and accumulated wealth should pay more, please enter the door on the left. Remove your pants, then wade through the vat of fire ants. Thank you.

For the rest of you, tax avoidance is critical. Yesterday’s blog made reference to those who have small businesses, professional corps, holding companies or other structures in which you earn cash flow. The Liberal plan was revealed last year when Bill Morneau stated clearly the tax advantage business owners enjoy should be (and will be) eliminated.

This led to the end of ‘income-sprinkling’ which means no dividends hived off to your spouse or kids. It also established a lid on the amount of invested retained capital a corp can have before taxes turn punitive. So now if your company kicks out more than $50,000 a year in passive income (earned through investments, not operations), there’s a target on your back. That equates to roughly a million in retained earnings. For every dollar above this amount earned passively, the corp loses $5 worth of income at the reduced small business rate. It sure adds up.

Since the precedent has been established, it’s now a minor move to amend the numbers. The next budget could chop that starting point to $35,000, or less, for example.

There’s a good chance the Libs (and their new friends) will target professionals and small businesses once again, since most people think they’re rich and screwing the system. So it’s probably a bad idea to be accumulating capital inside a corporate structure, where it’s a sitting duck. Also understand that paying yourself in dividends (rather than taxable salary) does not really save any tax. That’s because your corp pays tax at its rate, then the dividend is taxed in your hands, and the sum of the two equals the same tax you’d generate taking the income as salary.

But by collecting dividends (and not salary) you earn no RRSP room – which is a shame since that’s probably the safest place to keep money these days. Plus, when you take salary your corporation can write it off earned income, reducing or eliminating corporate tax. Given what’s likely to come, this is a worthy strategy. If your accountant doesn’t understand this and tells you to go for divvies, eschewing a fat RRSP for corporate savings, get a new one. It’s called compliance. By law your accountant works for the CRA.

Over the coming weeks, along with fetching canines and the gratuitous demeaning of moisters, wrinklies, people with GICs and anyone wearing a tattoo, this blog will focus more on tax avoidance. Until Peter MacKay saves us.

Abnormal

Normal people don’t read this blog, as you know. Apparently they’re all at home making Halloween costumes for their children from discarded fast food wrappers and tree sap. The picture painted by a new survey is, well, chilling. The masses are sinking into a morass of debt and delusion.

Here’s what polling done for MNP found (hope you’re seated…)

  • Almost half (48%) of people have $200 or less left at the end of the month after paying bills and servicing debt.
  • 47% say they won’t be able to cover basic living costs over the next year without borrowing more. Yes, more.
  • Seven in ten families couldn’t handle a problem – like a busted furnace, divorce or job loss.
  • The average that families have left per month after bill payments is $557.

And they all have a vote. But that’s another story. The key point is that mortgage rates are incredibly cheap and borrowing costs in general are near generational lows. We’re in year 10 of an economic expansion. Unemployment is the lowest in decades. Wage growth was robust last year. And yet household finances are crumbling before our eyes with a savings rate under 1% and an unprecedented level of borrowing. The pile of personal debt, at $2.2 trillion, is bigger than the economy itself.

“Unexpected expenses can plague people regardless of age or income but they’re most devastating for people who already have a large amount of debt,” says the company. “Our research shows that most households do not have enough cash for inevitable life events like a car repair.”

So what happens when the inevitable slowdown arrives? When wages flatline, jobs are lost, asset values fall and the economy contracts?

This brings us to Wednesday.

The Bank of Canada is slated to reveal its latest policy in an announcement, a report and then a media conference. Rates will not be cut, Mr. Market says. Maybe that’ll happen a little in December, but more sometime in 2020. Central bankers clearly understand any reduction in the cost of money will just encourage and facilitate more borrowing. Already the bank identifies excessive household credit as a major risk to the economy, and it’s not hard to see why.

This debt trap has ensnared so many people and at the most dangerous point in the economic cycle. Meanwhile government finances continue to erode, especially in light of the recent election (which is looking more and more like the last one for Andrew Scheer…). The federal deficit will balloon again to almost $30 billion, and at a time where the recession is still a distant threat. We could be looking at a far worse number in a year or two, putting more pressure on the central bank to hold the cost of money low.

What does this mean to the folks who come here?

Well, bond prices will probably be drifting higher in the future as monetary policy eases and rates come down to add stimulus to the economy. But at the same time bonds get more valuable, GICs yields will fade. Mortgage rates may dip a bit more, however in a slowing environment the impact on real estate is likely to be muted.

Of course we also have a US presidential election in the mix, and the odds are high that Tariff Man will turn into Art-of-the-Deal Man, with the China trade war diminished and equity markets plumped as a result. Markets are still betting Trump vs Warren/Biden will yield a Republican winner.

So, in other words, the future is clear as mud. The business cycle dictates contraction. Politics suggests otherwise. Central bankers are being pre-emptive. And there’s a lot of monetary and fiscal stimulus about to be unleashed.

But this much is clear: people who need to borrow to survive, or end up each month with but a few hundred bucks, are gambling. They’re at risk. It’s a huge indictment of our culture, in which 70% of people own expensive assets but have financed them with a sea of debt. As stated a few paragraphs ago, all these families vote. And they vastly outnumber us.

The inevitable then: tax increases.

Given our experience thus far with the T2 government, the new political reality of its need for NDP support, coupled with unbridled spending promises in the election campaign, how could it be otherwise? As stated here yesterday, triggering capital gains while the inclusion rate is 50% (instead of 75%) – especially on real estate – might be a useful strategy. Also ensure you’ve used your available RRSP and TFSA room. Maybe it’s time to trade in non-deductible and high mutual fund MERs for low-cost ETFs or tax-deductible advisor fees. Split income within your household, using a spousal RRSP, sharing pensions or holding a joint non-registered account. Gift your adult kids money for their TFSAs (no attribution o you) and lend your less-taxed spouse money to invest. If you’re a small business dude, don’t just take cash in dividends or keep a whack of it in your corp. They’re coming for you.

This blog has provided a lot of tax-avoidance advice recently. Take it. Most people never will. They will so regret being ordinary.