On the Money with Dynamic Funds

PARTICIPANTS

Daryl Diamond
Chief Retirement Income Strategist

David De Pastena
Vice President of Portfolio Solutions

David De Pastena: You're listening to On the Money with Dynamic Funds, the podcast series that delivers access, insights, and perspective from some of the industry's most respected active managers and thought leaders. From market commentaries and economic analysis, to personal finance, investing and beyond, On the Money covers it all, because when it comes to your money, we're on it. Welcome to another edition of On the Money. I'm your host, David De Pastena, Vice President of Portfolio Solutions. Today we're going to take a deep dive into the taxation of the paycheck portfolio approach for retirement income planning. To unpack some of these questions, my guest today is Daryl Diamond, Dynamics' Chief Retirement Income Strategist. He's also one of Canada's pioneers in creating efficient retirement income. He's got over 44 years of experience, and he's a bestselling author.

Daryl Diamond, it's great to have you here.

Daryl Diamond: David, wonderful to be with you today.

David: As Canadians, taxation is a big topic for us, and I've heard you say that taxation of income and assets is of great importance for retirees. Tell us, what do you mean by that?

Daryl: In terms of greatest importance, in our opinion and from our experience in putting together income streams for retirees, taxation is one of those factors that becomes a large determinant on capital preservation, ultimately, which in turn leads to the sustainability of the retiree's income. Those are two very important factors as it relates to making the retirees comfortable that they're not going to live their income. From that perspective, taxation is of great importance in delivering that after-tax cash flow efficiently.

David: It's really about how much you keep, not how much you make?

Daryl: Yes. It has always actually been that way through our working lives as well, but it's magnified in retirement because we're drawing from those personal assets rather than seeing a paycheck deposited in the bank during our employment years. Secondly, for retirees, if you think about it for a moment, you're drawing money from assets that you own, assets that you've taken a lifetime to build. As a simple example of the impact of taxation and why it is such an important issue for retirees, you'll see on your quarterly investment statement that, as a simple example, from your RIF account, there was a $3,000 withdrawal for the month. You look at your bank statement and you see that only $2,000 of that $3,000 showed up. The point here, David, is retirees are very vigilant on where money is being spent, and that issue of taxation is literally in their face every month, every quarter, semi-annually, yearly, because it's evident to them that that is being taken away from what otherwise would be money of theirs to spend.

David: Should retirees really be thinking about their net cash flow versus their income for their needs?

Daryl: If anyone in their employment years was spending what they were paid before tax, they'd be in large trouble in no time. The same is true, if not more significant, at the time you're retired and drawing from your own assets. In that context, it's always looking at the scenario from the point of view of delivery of money after tax. What can you spend out of what we're generating as far as a paycheck?

David: We all know that not all income is taxed the same way. Can you give us some different types of income streams and how they're taxed, and maybe some examples for our listeners to understand how all of that works?

Daryl: Just putting it in relatively simple terms, for advisors listening to this podcast, and even those people who are consumers or retirees that have taken the opportunity to tune in, it is significant to know the difference in terms of a couple of factors. First of all, what you have, as you referred to it before, after tax to spend. The second is the impact of the delivery of income on a number on your tax return called the net income calculation. It's line 23600 on your tax form. Let me give you a simple example. In terms of the different forms of taxation that you talked about, there's what we would call taxation in the form of regular income, and that would include a lot of things really front and center for many retirees, which would be CPP payments, OAS payments, QPP in the province of Quebec, a pension that they may be receiving income from, interest and foreign dividends or income from non-registered accounts also fall under that regular or fully taxable income category.

We then move into what I would refer to as tax-favored income. Those streams include eligible dividends from Canadian publicly traded corporations, as well as non-eligible dividends that come from, of course, income derived from small business, and or holdcos, holding companies. We have realized capital gains, half of which is taxable, as you know, half of which is not taxable.

Then we get to that last column, which to us is a bit of a magic column, and where we have as advisors certainly the opportunity to do some creative and constructive things in blending all of these different forms of income together. That would be income that we would deem to be non-taxable. As an example, it could be payments or regular income streams taken from a tax-free savings account, or it could be, through some offerings through fund companies, what would be referred to as a return of capital, either in the form of a distribution or in the form of something like a T-series option, which is unique to the income space and incredibly effective for higher income earners.

David: You mentioned Canadian dividends and dividend income. For Canadians, dividends are an important part of the revenue stream. I'm curious, should retirees be avoided eligible dividends, given that they're grossed up by 38% in the calculation for total income?

Daryl: It comes down to what are the details of the circumstances involved. In the numbers we have run, and we've done some examples to sort of prove to ourselves through tax calculators what the impact of that is. Really the bottom line is, because of the tremendous benefit once the eligible dividend tax credit is applied, retirees should not be worried about giving up some of their OAS income in exchange for more tax-effective income. No one likes to look at their statement and see that they've repaid X amount of dollars of what would have otherwise been OAS income. If you look at the net after-tax result, especially as we're moving up the amount of taxable income, you're actually ahead if you have eligible dividend income. You're ahead at the end of the day in terms of your total after-tax income, even though you may have lost some of the OAS payment.

Don't hesitate to use eligible dividends in the investment portfolios for non-registered capital, even within corporations or holdcos, because really at the end of the day, if you're flowing those dividends through taking them as income, it is more than an even trade-off. You're actually ahead on a net after-tax basis to incorporate that eligible dividend income into your situation.

David: That's great to hear that dividends still have a place in a portfolio, but I'm curious, with the alphabet soup of types of accounts from RSPs to TFSAs to Liras, how are different accounts and the types of taxation treated? How are different account types taxed?

Daryl: First of all, let's understand, and you're right, there are a number of different types of potential sources of regular income. Let's pick out some of those, and I'm going to deliberately isolate them into two groups. For example, you might have a scenario where we have CPP, OAS, RIF, LIF, R-LIF payments, regular pension payments, and I just want to set those in one grouping, because if you think about it, those are all fully taxable sources of income, but they're also sources of income, David, where there are restrictions or less flexibility than you would have in non-registered investments, TFSAs, and those non-restrictive types of sources of income. What do I mean by non-restrictive? There's rules. OAS, CPP, pensions, income from RIFs, LIFs, they all play by certain rules, and there are restrictions as it relates to flexibility. There are restrictions as it pertains to the rules that recipients must follow. The most common point, I guess, for RIF and LIF income is just that there's a minimum withdrawal that must be paid out once the actual RIF or LIF contract is started.

In terms of taxation, the fully taxable sources of income also tend to be the least flexible, and that's really important as people are moving out on the age curve and want some options and want some flexibility. Non-registered TFSA accounts, those have far superior degrees of flexibility, and they're also far more tax efficient.

David: Those non-registered accounts in our TFSA give us a lot more flexibility to play with different instruments. I'm curious, would you put different types of investments for different types of accounts, like bonds and registered accounts, as an example?

Daryl: It's one of the things that we look at from the point of view of vigilance, and you bring up a couple of points. Yes, it is something worth considering, that we have the least tax-efficient investments in those instruments, like a RIF and LIF, to name them specifically, that are sheltered and more effective. One could argue for TFSA, and maybe some allocation could be there as well, but where we like to have some growth in a TFSA is really predicated upon the fact that we don't have those same rules of minimum withdrawal and full taxation as we do on a RIF-LIF type of an account.

If we're looking at the overall aggregate of investable capital, ideally we want to have fully taxable investments in something that is shelter, and the more tax-favored investments such as eligible Canadian dividends and the potential for realized capital gain sitting in our non-registered accounts. That's the way we would normally balance it for a client so that we weren't as concerned about each particular account as we were with the overall asset allocation matching what the client's investment tolerance actually was.

David:Based on what we've covered so far, how do you determine which assets to use to deliver income and which to defer? That's a big question for retirees.

Daryl: What you would find, if we had about four or five other advisors on this podcast, you'd find that everybody has varying ways of how they would approach that as an advisor. That's the art, if you will, in the art and science of retirement income planning. You're going to get people that have preferences in terms of how, from an advisory perspective, preferences in how they approach it, and a lot of that is based upon the experience they've had in putting income together for clients.

Our view in putting together income streams for people, we tended to take an approach that we call layering because it gives a visual to the client that we've got so much coming from CPP. On top of that, so much from OAS, so much from a pension, so much from taxable distributions from non-registered accounts that are going to happen annually in varying amounts and also in varying degrees of different types of taxation. Our preferred approach, to answer your question, is that we would take an overall view of what amount of capital we might have in registered accounts versus non-registered accounts. Our preference was to use the least tax-efficient and the least flexible, and I mentioned CPP, OAS, RIF, LIF as least flexible. We'd like to establish a base of fully taxable income with those least tax-efficient, least flexible sources of income. When I say a base of income, maybe up to close to the start of the second federal bracket if we're working in most situations. That is just simply us looking at it and saying we want to use the least tax-efficient sources of income at the lowest tax rates.

David: Thanks, Daryl, for digging deep into the taxation of the paycheck portfolio approach. This is another edition of On the Money, and on behalf of all of us at Dynamic Funds, we wish you all continued good health and safety. Thanks for joining us.

You've been listening to another edition of On the Money with Dynamic Funds. For more information on Dynamic and our complete lineup of actively managed funds, contact your financial advisor, or visit our website at dynamic.ca. Thanks for joining us.

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