Q. My wife and I are nearing the end of our working careers. We are big planners and have a financial plan that we have been successfully working with for over 15 years. My wife will be retiring from teaching in two to three years with a full pension. As a part of our plan I left my job this May prior to my 50th birthday to pull my Pension (I know this is a controversial move, but did I mention our 15-year plan?), I am planning on returning to work for the next few years.
My question is around flow-through shares as investments. With my Pension withdrawal, a good portion of it is taxable, pushing my taxable income to $440,000 of which $220,000 will be at a combined Fed/ON tax rate of almost 54%. I have maxed out both our RRSPs and TFSAs so I’m looking at flow-through investments to recoup a good portion of those tax dollars.
I have found several investment firms, including some flow-through niche players. What are the risks, other than the investment going to zero? If it did, are there capital losses here that I could leverage later?
A. Hey Stacy, if you are comfortable with the risk of your investment going to zero then Flow-through shares may be just the thing for you. Actually, they may not decline and you may even make some money.
Let’s start with forgetting about the investment risk and talk more about why you may want them.
Flow-through shares invest in small start-up resource companies without enough profits to write off their expenses, but those companies are allowed to pass their expenses off to shareholders who can deduct them from their income.
In simple terms, if you invest $440,000 into a Flow-through investment, it would be like your $440,000 is paying the expenses of the small start-up, and because you are paying the expenses you can write off the full $440,000 from your income. Does that sound like the type of investment you’d like to make?
Most flow-throughs have a fixed lifespan, generally two years, and at that time your money may be converted to a capital class mutual fund. The whole amount is considered a capital gain when you sell, so only 50% is taxable.
Summarizing those two paragraphs, you’ll invest the $440,000 and deduct an equal amount from your taxable income so no tax is paid on the $440,000. You won’t be able to withdraw any money over the two years until it is flipped to the mutual fund, and this is liquidity risk. Then any money you draw from the fund will be considered 100% capital gain income of which only 50% is taxable. Assuming a positive investment return there’s the potential for large tax savings. If there are negative returns you will be able to use the capital losses to offset gains.
The other risk you face is the Federal Government may raise the capital gains inclusion rate which would mean the tax on capital gains may not be as tax-advantaged as it is now.
Stacy, based on your age that seems like a lot of money that can’t be transferred to your RRSP. I’d double check the figures with the human resources department if I were you.
You mentioned you’ll be going back to work? Is there any chance it would be your own business, incorporated? If so you may want to investigate or explore a Personal Pension Plan (PPP). With a PPP you may be able to transfer your current pension plan to a PPP with no tax consequences.
I know you are being guided by your 15-year plan and I haven’t seen it so I don’t know how important the $440,000 is to your plan. My suggestion Stacy is when you’re investigating the flow-through shares, base your investment decision on your comfort level with the risk-reward trade-off and your assessment of the underlying investments, and then look toward the tax savings.
Allan Norman is a certified financial planner and Chartered Investment manager in Barrie, Ont. Allan can be reached at email@example.com
This commentary is provided as a general source of information and is intended for Canadian residents only. Allan offers financial planning services through Atlantis Financial Inc.
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