Golombek: Technically, this is a Canadian session, but there are concepts that will apply in the U.S. as well. I work at CIBC, which is one of the big banks in Canada. I do financial planning, advanced planning, tax planning and estate planning for high-net-worth clients in Canada. MDRT asked me to come down because we do have 50 or 60 Canadians who are attending the conference, and they wanted to have at least one session that had a Canadian context.

I am dual licensed in Canada and the United States. I have a CPA out of Illinois and a CPA out of Ontario. Where I can, I will try to make some comment on the U.S. side as well. How many people are U.S.-based? OK, so most people, actually, which is interesting.

In my conversations with clients, we look at a whole bunch of things. Usually, I meet with clients, and they want to talk about: How can I reduce taxes? How can I plan my estate? How can I plan my retirement? We usually have a discussion at the beginning of how much money they need, how much they really need to retire.

Could you ever have too much money? Could you have not enough money? An example I gave yesterday in my track talk is that we met once with a client who had just sold a company for $200 million, and I said, “You probably won’t run out of money unless you start buying private jets and a boat and all that.” He stopped and said, “Actually, I bought a boat, and I bought a jet and I have seven people on staff. It’s costing me $4 million a year just to run my boat and my jet.” Therefore, I said, “You could run out of money.”

I think that’s an issue that we’ll start with. We do some financial modeling. Education planning for many of our clients is very, very important in terms of saving for post-secondary education. There’re a number of ways to do it. In the U.S., of course, we have the 529 plans. In Canada, I’ll talk about RESPs, the Education Savings Plans and the ability to even front-load some of those plans.

No. 3, income splitting. In Canada, very different than in the U.S., we don’t file joint tax returns. Therefore, there are opportunities to income split with a family member, and I’ll show you a couple of strategies that we use with spouses, and even with kids, to pay for things like private school, summer camp and additional types of expenses for children.

Philanthropy planning. I think this concept will apply equally both in Canada and the United States. We often talk with our clients about philanthropy. When they’ve got enough money for themselves, and they’ve got enough money for their kids and grandkids, what do they do with the rest of it? They often don’t want to leave it directly to the kids. They look at charity. I’ll go over some of the tax rules for charity — some of the big, missed opportunities in my view, in terms of donating appreciated securities, executive stock options, sale of a private company and even donations of life insurance. Again, I’ll focus on the Canadian tax rules on that. Some of the rules are very similar in the U.S.

Then I’ll talk about foundations, public foundations, donor-advised funds and private foundations. Many of our clients who are high-net-worth clients have more than one home. They have a vacation home, so the concern in Canada is we have something called the “principal residence exemption.” When you die or when you sell a home, the gain is tax-free. If you have more than one home, you have to choose. There really is some planning that’s available in terms of a vacation home, and I’ll go through some strategies.

Life insurance is a big one. I often talk about life insurance for high-net-worth clients, and I call it “insurance for people who don’t need insurance.” These are high-net-worth individuals who have more than enough money. They’re never going to run out of money, and yet we believe that life insurance is one of the asset classes they absolutely should have. I personally like it as a replacement for fixed income, whether it’s GICs in Canada or CDs in the U.S.; we’re getting very low interest rates, 2 percent, or maybe a little bit higher now. This is a great alternative. Some of it is guaranteed. I’ll show you an example with universal life. Some of it depends on the dividends of the life insurance company. I’ll show you an example with whole life.

Then, the other thing that we often talk about is annuities. In fact, in Canada, the tax rules are very favorable for annuities. The biggest problems that clients face with annuities is to say, “Well, interest rates are low. Do I really want to buy an annuity now?” The problem is, what if a client dies five years into the annuity, after the guarantee? Let’s say it’s a five-year guaranteed annuity. It’s a life annuity, but after five years, that’s it. What happens to all the money? What we do is to couple the annuity with permanent life insurance, and we actually get a guarantee. You’ll see that the effective rates of return, because of our unique Canadian tax rules, are over 5 percent. That’s equivalent to a 2 percent GIC, or guaranteed certificate of deposit. You’ll see some numbers there. [visual]

On the U.S. estate tax planning side, I’ll go over the big picture here in the U.S., but it’s also an issue for Canadians who own U.S. situs property. Canadians who own U.S. stocks in a Canadian portfolio, or who own U.S. real estate like a Florida condo or an Arizona condo, and they die, it could be a serious issue. There are calculation issues, which I’ll go over, both for a U.S. person and a Canadian. Then I’ll show you some solutions that we’re using in Canada to avoid the estate tax.

Finally, at the very end, some non-tax issues on the estate planning. I’m going to cover the use of a testamentary trust, a trust created in a will, to be able to protect inheritance in case of a remarriage or in case of kids who are not doing what you want them to do. And I’ll show you some strategies that we’re using in many of our wills, in Canada at least, which I think should apply equally here in the U.S.

We have a very small group. If you have a comment or question, certainly put up your hand and shout out. I’ll try to address it. I may not be an expert in the U.S., but I’ll do my best.

Audience: My understanding is that some of these Canadian brokerage firms collect Canadian tax.

Golombek: The question had to do specifically with, let’s say you’ve got a Canadian, and they own U.S. stocks. The question was if they own the U.S. stocks for a U.S. New York brokerage firm, clearly we have a problem. What if those same U.S. stocks are owned by, you can say TD, I’ll say CIBC, our own brokerage firm, is it a problem? The answer’s yes, because you own the U.S. situs property. Even though the physical custody of those stocks is in Canada, those stocks are still U.S. situs, and therefore you potentially could have a U.S. estate tax liability on that. That’s why I want to show you some strategies that for many of our high-net-worth Canadians, if they’re buying individual U.S. stocks, what they’re doing is they’re holding it through Canadian holding corps so that they own shares of Canadian corps.

In terms of income tax, it doesn’t matter where you hold the stock, you have to pay income tax just in Canada, if you’re Canadian, on U.S. stocks, absolutely.

I’m going to go over all of this stuff. Let’s begin with retirement planning. The question I ask is, How much is enough? We often work with high-net-income individuals. These are partners in law firms and accounting firms. The debate is like, what percentage of preretirement income does someone really need? The numbers that we hear, like if you need 50 percent of your income, you’re not going to have to go to work; you don’t need clothing; you don’t have transportation. Some people say it’s 90 percent because you’re going to travel all around the world, and you’re really going to enjoy your retirement. We add up all the sources of income.

In Canada we have the Canada Pension Plan; it’s about $13,000 a year. We have Old Age Security, which is about $7,100 a year, although if you’re high-income, you could completely be clawed back on that. We have RRSPs, which are similar to 401(k)s and IRAs. We have Tax-Free Savings Accounts, TFSAs, which are like Roth IRAs in the United States. Then, of course, for most of our clients, the biggest source of their retirement funds will be their nonregistered account — your typical investment accounts, your brokerage accounts. With this pool of assets, we come up with how much they really need.

I have an example. [visual] This example is based on a real scenario. We’re working with one of the major law firms in Toronto. We’re working with some of the partners. These partners were making $500,000 to $600,000 a year, and we sort of were asked to project. We did a seminar to project their needed retirement assets. They’re looking at their lifestyle; they’re about 45 years of age. They retire mandatory at age 60, and they have 15 years left to accumulate assets. They have an RRSP, again, that’s like a 401(k) of $300,000, and they’re maximizing the maximum limit they can put in. In Canada, it’s $26,000 a year. They’re assuming, let’s say, an overall rate of return of 5 percent.

That would be a balanced portfolio where you’ve got 60 percent equity, it’s 40 percent fixed income, and we’ve got basic rates, so return on inflation assumptions. We assume that to find the lifestyle they’re accustomed to, with the two homes and the traveling and the vacation and to help pay for kids’ education and all that, they need $300,000 a year to maintain their current lifestyle upon retirement, which seems very high, but when you look at some of the numbers and what these people are spending, it was actually factual. We asked them, “How much do you guys need to be saving? You’re making $600,000 a year on average. How much do you guys need to save every year?” We start off with saying, “If you’re saving $150,000 a year, you’re actually going to run out of money, and run out of money by age 76, so it’s not enough.”

Of course, no one’s saving anywhere close to $150,000 a year. Most of these people are spending all their money. They’re paying almost half in taxes; they’ve got nannies; and they’ve got kids in private school, and it’s very, very expensive. Then we say, “Well, what if you saved $250,000? You’re getting better. You could run out of money at age 90, but again, that’s still not perfect. If you really want to be sure that you’ll never run out of money, you actually need to be saving about $300,000 a year to make the money last guaranteed.” Of course, no one’s saving anywhere near that. People are saving $25,000, $35,000, $45,000 a year. They’re building up equity in their home. The question then is, they’ve got a fully paid-off home, but they have no money for retirement, so what do they do?

You get into reverse mortgages, which people don’t really like because the rates on them are high. This is an issue that we sort of start off all our conversations with. We make sure that even if you’re very high-net-income and you’re making $500,000, $600,000, $700,000 a year, are you actually saving enough money on an annual basis? We run through modeling; we use software. This is simple Excel spreadsheets, but we use advanced financial planning software to have that discussion, even with clients who are very, very high-net-worth and high-net-income.

Audience: You’re assuming at age 95 that the person has the same active lifestyle as age 65.

Golombek: No, I’m not assuming an active lifestyle; I’m assuming the same amount of spending. Maybe they’re spending on home nursing care, things like that. The things that we spend money on obviously change. Someone who is age 60 who wants to travel all over the world and go on cruises has a very active lifestyle. By age 80 or 82, stats show that they stop traveling almost altogether, and then you’re looking at retirement homes, and again, these are high-net-worth people. In most cases, we’re seeing retirement homes costing $12,000 a month, $15,000 a month or more in many of our client scenarios. We’re talking about funding that. That alone is going to be $150,000 to $170,000 year.

Audience: Or their kids?

Golombek: Or funding their kids who don’t have enough money to buy their first home and things like that. That’s how we built these projections.

Audience: What about at age 90 for long-term care?

Golombek: Long-term care is good in some situations to cover the costs of this. Again, certainly the market in Canada is not what it is in the U.S., and it tends to be a very expensive product, and most people don’t buy it.

Audience: Right, exactly.

Golombek: That’s the bottom line.

Audience: For a 50-year-old today, a high-income earner who probably takes better care of themselves, maybe better than the average person, is age 100 a fair number anymore, or should that be pushed up to 110?

Golombek: Well, I think 100 is high. I mean, most people are working until their early 90s in the models that I’ve seen. I take it to 100 personally, and I say, “If you can actually make your money last to 100, you’re like a 98 to 99 percent accuracy for a male nonsmoker.”

Audience: The single biggest mistake advisors are making today is they’re using age 95 as life expectancy.

Golombek: Wow, good to know. I hope it’s true. As long as people are healthy, right? That’s the key.

Audience: Well, right.

Golombek: That’s right. OK, great. Thanks. Income splitting. Again, this is Canadian specific, and I’ll go through this relatively quickly if you’re not all from Canada, because in Canada, we don’t file joint tax returns. There’s an incentive to split income among family members. We have very high tax rates. Just to give you an idea where we compare to the United States, we have five federal tax brackets, starting at 15 percent on the first $46,000, and we go all the way up to 33 percent for income over $200,000 a year. Then, on top of that, of course, we have provincial taxes.

Unlike the United States, where some states don’t have any tax, like Florida has no personal income tax, your top rate in Florida is 37 percent. Where I come from in Ontario, our top rate in Ontario, when you add the state tax, or provincial tax, to the federal rate, is actually 53.5 percent. That kicks in at incomes of over $220,000 in Ontario. If you’re earning regular income, like interest income of GICs or CDs, your tax rate is 53.5 percent on the high end. That’s $220,000 a year. I think your top rate kicks in at about half a million a year, and of course you’re U.S. dollars. We’re Canadian dollars, another 35 percent on the currency; we’re very heavily taxed in Canada. That’s why there’s a big incentive to split income in family members to the extent that you can.

Audience: These are individual tax rates?

Golombek: Yep.

Audience: There are no joint returns?

Golombek: There are no joint returns. These are individual returns, absolutely, yeah. We also have different types of taxation depending on how the investment income is earned. I know in the United States, you have long-term capital gains rates of 20 percent; you have dividend rates as well that are lower. So in Canada, we have a 50 percent inclusion rate for capital gains. For example, if your top rate is 53.5 percent, half of that is 26.8 percent. That’s our capital gains rates, similar to the gains, and we have no holding period in Canada. In the U.S., it’s got to be over a year. In Canada you can have it for three days. As long as you’re not a day trader; a day trader would be like business income, but as long as you’re holding it for a few days, or whatever, you get the capital gains treatment. Then we have dividend income sort of somewhere in the middle, dividends from public or private companies.

Audience: What about real estate income?

Golombek: Real estate income is passive investment income and it’s considered, like interest income, ordinary income. It’s passive income, absolutely. All right? One of the examples that we often show clients, is if you’ve got, let’s say a husband and wife, and one of them is high-income, and one is low-income. There is a way to actually do some income splitting, even though we don’t file joint returns. This example of Jack and Diane—we’ll assume that Diane is the high-income earner, and Jack is a low-income earner. We’re going to assume that we’re going to loan money over at half a million dollars a year. Now, if we just gave the half a million dollars over — so Diane’s our high-income earner at 53.5 percent, and Jack’s our low-income husband at 20 percent — the Canadian tax rules attribute the income back to the original person, to Diane. If we actually loan the money and charge equivalent to the CRA, or the IRS, CRA’s prescribed rate, which is 2 percent, we can actually income split the difference.

If we assume a rate of return of 5 percent, and again, it would be unlikely the 5 percent would be really interesting. It would be a mix of capital gains, realized, unrealized, some dividends, some interest and a balanced portfolio. Again, 5 percent return on half a million is $25,000. We pay 2 percent interest on a loan, that’s $10,000. The interest, by the way, is tax deductible to Jack because he borrowed the money for the purpose of earning income, but it is taxable to Diane. Really, our spread, our opportunity is $15,000. Again, if Diane was in the top bracket of 53.5 percent, and Jack was in the bottom bracket of 20 percent, it’s about a 33 percent spread. That’s going to save $5,000 a year of income tax.

Audience: Year-to-year that makes sense, but long-term, does that loan or interest rate eventually creep up?

Golombek: Great question. The question was, does that interest rate eventually creep up? Actually, in Canada, there are very unique rules. The rules in Canada say that under the Canadian Tax Code, you only have to use the rate at the time the loan was originally established. That’s why we’re actually advocating the strategy today. It was actually better nine months ago when the rates were 1 percent, but rates are now 2 percent. If you lock in the rate today, you can use that rate for the duration of the loan.

Audience: Does the accumulation of that rate over 15 years, let’s say, offset the benefit of that single year? Does that make sense?

Golombek: No, well this is a savings you get every single year. So it’s $5,000 every single year on an annual basis.

Audience: I see.

Golombek: Yeah, so it actually compounds. We actually have clients doing this at $1 million, $2 million to build this up. You can do this with children as well. Again, we have rules in Canada preventing income splitting with minor children, so I would never loan my 12-year-old half a million bucks because he’d never pay me back. What I would do instead is set up a trust. I’ll show you an example of that. Let’s say we’ve got a couple here with $1 million of capital. They’re invested in the stock market. They’re getting a dividend yield of 4 percent yield, approximately. These are blue chip stocks, and they’re paying tax at the top rate of about 39 percent in Ontario, so they’re netting about $24,000. They’ve got a couple of kids. The kids are in private school, you see how they’re dressed for private school, and that’s costing them, let’s say, $24,000 a year. [visual] They have to earn $40,000 to pay $24,000.

If instead, we set up a family trust, and we loan money to the family trust, let’s take the million dollars in capital. We’re loaning that to the family trust. We’re charging the prescribed rate of 2 percent, and what we’re doing now is having the income earned inside of the trust and then paid out to the kids. If the kids have no income, then the entire amount of dividends that we pay out from the trust is tax-free to the kids. Effectively, when you add the tax that the parents pay, and you have the distribution of that money to the kids, we end up with about $29,000. In other words, that’s the same $5,000 more every year, simply by using a trust. Many of our wealthy families, in Canada at least, are using family trusts right now to split income to pay for all the kids’ private school. Certainly, it can pay any of the expenses of the kid.

We have some clients who are using it to pay for a nanny. We have other clients who are using it to pay for the kids’ portion of the family vacations, which can be quite extensive and expensive. This is a very common income-splitting strategy that we’re using, to be able to split income among children.

Audience: Can you do a loan out of a corporation?

Golombek: It doesn’t work. People ask me all the time, “Can you do a loan out of a corporation?” It doesn’t work, because in Canada we have the shareholder loan rules, which say if you take money out of a company and you don’t pay it back within 24 months, it’s considered to be income of the person, under the shareholder loan rules.

Audience: That applies to trust as well?

Golombek: No, different rule. Well, you can’t get the money out of the corporation, that’s the problem. Again, the reason, if you understand the rationale, the rationale for that is you have corporate income in which you’ve paid a low rate of corporate tax. The second layer of tax comes out as a dividend. The government doesn’t want people just loaning all the money out to yourself for the next 30 years.

Audience: I get that.

Golombek: That’s why you can’t do it. Any money that comes out of the corporation as a loan could be caught by the shareholder or employer loan rules.

It has to be a real third party, arms-length party, with a commercial rate of interest; then you’ll be OK. Yeah. All right? Let’s move on now. These concepts here will apply equally in the U.S. and Canada when it comes to charitable giving. This is one of the biggest conversations we have for the high-net-worth clients because they really do have more than enough money, in many cases, and they really are thinking, Do we really want to give all this money to the kids? We really encourage our clients to be strategic about their philanthropy.

Again, some of the trends over the next 20 years that we looked at recently are projections that there’s going to be a $10 trillion wealth transfer of which a significant share, estimated to be around $50 billion, will be geared toward philanthropy. In fact, this is a bit of an opportunity for families to discuss how they want to be remembered from a legacy perspective, whether children, grandchildren, etc. We always have a conversation about philanthropy.

The question I ask when I meet with a client is, “Look. After you’ve carefully planned for yourself and for your family — and that can be kids, grandkids, trust, the whole thing like that — think of charitable giving as another child. Then ask yourself, What are you interested in from a philanthropy perspective? Is it religion? Is it health care? Is it education? Have you shared those interests and values with your family members? Do you want your children to continue doing what you’re doing?” That leads to a discussion in a few minutes of whether it’s worth setting up a foundation. Again, we’ll talk about private foundations versus public foundations and donor-advised funds in just a moment.

A lot of people think, at least I used to think, that tax planning is a major driver for philanthropy. After all, you get a tax deduction in the U.S., or you get a tax credit in Canada, when in fact, that is actually not true. When you look at the survey and the data of why people give to charity, it’s actually at the bottom of the list. The No. 1 reason people give is to support a cause they feel passionately about or that benefited their loved ones. I would say this is very common in the case of universities, giving significant gifts back to the universities. We have many foundations of the universities and the billion-dollar rates in the U.S. People want to give back.

They want to share their good fortune among their community. They’ve done very well. They want to name a wing of the hospital after themselves. Maybe they’ve been treated in that hospital. There are very specific reasons for giving major gifts. Community projects are big. So again, we see this with local women’s shelters; we see this with local events and various smaller communities across Canada where you’ve got a major person who has made it well in business and wants to give back to the local community center. It gets named after them, a wing, things like that.

Sometimes filling gaps in government support. In fact, only 11 percent consider the tax benefit as something as a motivation to give. Again, I’m not advocating giving for tax benefits, but I’m saying that if clients are interested in giving, they really should be doing it in the most tax-efficient manner possible because that leaves more money, either for themselves or for the charity, depending on which way you want to look at it.

The biggest missed opportunity, which I think is as equal in the United States as in Canada, is the gifting of appreciated securities to charity. The easy way to do this is to get a client’s tax returns. I know we might not have access to Trump’s tax returns, they’re saying now, but if you can get a copy of your own client’s tax returns, actually you’ll learn a lot from their returns. I’m sure you’ve seen other presentations where they actually walk you through a tax return and show you what you could learn about the assets that you think you might have, but really don’t have. Why do you have so much income, and I only have these assets, and where are your other assets?

That’s not for today, but one of the things I like about the tax returns, the Canadian returns, is that we look at the donations, and we say, “Are they nice round numbers? Are you giving $5,000 to this charity, and $8,000 to this charity, and $7,000 to this charity?” If it is, then they’re missing the biggest opportunity, which are gifts of appreciated securities. You know that when you give gifts of appreciated securities, they are not nice round numbers. They are the value of the shares on the day of the donation. This is a massive missed opportunity. I am on the board of two foundations in Toronto, one of a hospital and one of a community foundation. I actually asked them two weeks ago to pull some data because we’re going into our final fundraising campaign in December, before the end of the year, to get their tax receipts, their tax credits.

I asked them to pull me a list of all the donors they consider major donors who give over $10,000 a year. I said, “How many of those people are giving gifts of securities?” They had about, in this pool it was, I think, 1,200 people giving over $10,000 a year to this hospital, and the percentage was 7 percent. To me, that’s shocking. How is it possible that an individual who can afford to give $10,000 a year to charity does not have a pool of securities, which they could be giving? If you’re at that level of wealth that you’re giving $10,000 a year to one charity, you must have some assets. Why are their advisors not talking to them about the gifts of securities?

Audience: Why should you give away a security that could double over the next two years?

Golombek: Great question. So this is the issue, this is the misunderstanding. Why would you give away a security that could double in the next two years? If you give away the security, you pay no tax on the capital gain, take the cash that you were going to use to buy the donation, and buy back the security on the same day. Then you haven’t missed any appreciation in the market, and you bumped up your basis to fair market value. Let me show you an example. [visual] You’ve got shares of $1,000. Your cost base is 60.

Audience: The same thing happens with $10,000. Sometimes the $10,000 can be taxed higher than the capital gains.

Golombek: No, no. The rules are the same. You get a donation, in Canada at least, you get a donation credit for the same $10,000 either way. I’ll show you an example. Let me show you the numbers. You’ve got a scenario with a client who wants to give $1,000 to charity. They have two choices. They can write a check for $1,000, or they can sell stock that’s gone up in value from $600 to $1,000, and they have a capital gain of $400. If they were to sell the shares and donate $1,000, their capital gain would be $400. In Canada, the tax on that is just over 20 percent. It’s about 25 percent, about $107. They make a donation of $1,000, and they pay tax on the gain, their donation receipt in Canada is worth 50 percent. They get back 50 percent as essentially a tax credit on their return, so on a net-net basis, the cost of making that donation is $600.

If instead we donated that appreciated security directly to the charity, the capital gains tax is zero. We still get a receipt for $1,000, worth 50 percent, and we’ve reduced our cost to $500. If you really like the security, take the $1,000 that you were going to donate and buy back the security on the same day. You’ve saved $100 of tax, you’ve bumped up your basis to fair market value and you got the same tax receipt. This is the No. 1 missed opportunity in philanthropy that we see with our clients, and we see this every single day.

You wash out the tax completely. You bump your portfolio every single year to fair market value, bought for the amounts that you’re donating. OK? Now you can do the same thing with stock options. If any of your clients have, let’s say, publicly traded stocks and they’re executives in companies, they’re getting employee stock options. We have the same rule. Again, let’s say this individual’s got options to buy the shares at $60, and they’re going to exercise when the price is $100, so they have a $400 gain. The goal is to make a $10,000 donation. Again, they have two choices. They could exercise the options and then donate $10,000 to charity, or again, the rules in Canada, which I think are consistent with the U.S. rules, and you have to just check this, but I think they’re the same, is that if you donate the shares on option exercise in Canada, it is a 30-day period. Within 30 days, you actually pay no tax on the stock option gain.

Let’s take it through the numbers. If again we were to exercise the stock options at $6,000 and they’re worth $10,000, we have a $4,000 option gain, and our tax on that is about 25 percent. We get a donation receipt for $10,000, that’s worth 50 percent less the tax, and our cost is about $6,000, so very similar to the previous example, multiplied by 10. If instead we were to exercise our stock options as the executive, and then donate the proceeds to charity, we actually have no tax at all on the option gain, and we get a receipt for the 50 percent. We’ve reduced our cost to $5,000 on the gift.

You cannot gift the stock option directly, it’s a problem. You exercise the option, within 30 days you gift the shares to charity.

Audience: [inaudible]

Golombek: It doesn’t work for retirement money because all retirement money — you’re talking about registered plans? Like 401(k)?

Audience: RRSPs

Golombek: Yeah, with RRSPs, any withdrawals out of that are fully taxable.

Audience: Right, so can you donate?

Golombek: You sure can, but you’re not getting this benefit. You’re just getting a straight deduction. The way it works in Canada is if you want to donate your RRSP to charity, it’s like a withdrawal. Effectively, you pay no tax on it. If you have an RRSP worth $1,000 and you want to give it to charity, you have an income inclusion of $1,000, you have $1,000 donation, and it mostly offsets each other. In some provinces, there’s a slight cost, because the donation rate’s not high enough, but it’s basically a wash.

Now, let’s take it a step further. We’re often engaged with our high-net-worth clients when they’re selling a business. That’s usually when we get called in: “Jamie, can you fly out to Vancouver? We have a client who’s selling a business for $30 million. They want to know what to do.” We talk to them. Obviously at a bank, we’re trying to get that money in. We’re trying to manage those assets, so we go out and meet with the client.

We talk about philanthropy. We talk about charitable giving, and we tell the client the key is to make the donation in the year that you sell the company because the problem is that the year after you sell the company, it may not have any income anymore. They might have a little bit of income from investing the money, but if you’ve got a $20 million to $30 million gain this year, this is the year that you want to match your donation. I got a call this afternoon from a client who just sold their business and they are rushing to make a donation this year because they heard me speak at a different seminar about making donations this year. They don’t understand why they have to do it this year, so let me show you.

Say you’ve got a private company and you’ve got a capital gain of $10 million. We talk to the client and say, “Would you consider giving 10 percent of this gain to charity?” They say, “Absolutely, I’ve got lots of money. I’m going to give 10 percent of it away.” This is the year that they have the big tax bill, so rather than writing a check for about 25 percent of the gain, about $2.5 million to the government next April when they file their return, if they donated that million dollars, again we’re not donating the shares. We’ve sold the shares. The client has sold the private company shares to another buyer. They’ve got $10 million; they’ve got the cash; they’ve got the gain; they’ve got the tax bill. If we give $1 million to charity, we can save about 50 percent on that.

This is the year that they have the big tax bill. Let’s pretend they don’t do this, and they pay their tax of $2.6 million. Now, they’re sitting in the bank with $7.3 million, and they’re earning 3 or 4 percent on that money. Next year, their income’s $200,000. What are they going to do with a $1 million tax donation receipt? It’s not going to work. Again, we always remind our wealthy clients that you can get a carry forward for five years, but again, you have to have enough income.

You get a credit for the fair market value of what you’re giving. In this scenario, we’re giving $1 million of cash. [visual]

We’re deducting out of straight income. It’s the equivalent of a donation credit; it’s worth 50 percent.

Audience: If you donate securities held in a corporation?

Golombek: That’s my next slide.

Audience: Yeah, OK. Thank you.

Golombek: It’s even better. There’s a loophole, which I’ll show. Yeah, triple dip. Triple dip. I’ll show you why. This is my next slide. [visual] Say we have an individual who owns a corporation, and they often ask us, “Should I be giving personally? Should I give through my corporation?” The rules are very different for corporations. Corporations still get a credit. They get a deduction for the amount that they give, but if the corporation, we’re talking about a private company, has appreciated securities that have gone up in value like I showed you earlier, we call it the triple dip because I think there is actually a mistake — not a mistake, but they haven’t fixed it yet — a loophole in the Canadian tax law.

If you have private company shares, first of all, let’s say you have shares that are worth, my previous example, $1,000, the cost base was $600.

The corporation gets a deduction for the amount of the donation, so that’s the first dip.
There’s no capital gains tax on that $400 gain, so the corporation saves its corporate tax on the gain.
We have, in Canada, this concept of the Capital Dividend Account, which is a notational account that tracks the nontaxable portion of gains and allows the corporation to pay out a tax-free dividend to the shareholder later on. This effectively allows for, let’s say in the case of life insurance, if life insurance proceeds are owned by a corporation on death, then $1 million goes into the corporation and allows us to pay out the $1 million as a tax-free capital dividend to the shareholder because life insurance proceeds are supposed to be tax-free.

We’ll take a look at this example. [visual] If my donation is tax-free at $400, we get a credit to the Capital Dividend Account, which then allows the corporation to pay out an additional $400 later on, what otherwise would have been taxable dividends as a tax-free capital dividend. That’s the third benefit, which I think is unintentional. People have been talking about this for 10 years now. They might shut it down one day, but this is something that we talk to all of our high-net-worth clients about if they have appreciated securities in their private company, or their holding company, or their investment company.

Audience: Do you have situations where, or recommend where, you get the low-cost base shares personally, and then you flip them to the corporation?

Golombek: You can do that, yeah. Use a section of U5, you transfer it in tax-free, yep. All right, then finally life insurance. There are two ways to give life insurance. Again, these are the Canadian rules. I assume they’re the same in the United States, but you can correct me if I’m wrong. There are two ways to give. Most commonly, you own the policy. The client owns the policy. They name the charity as the beneficiary of the policy, so every year, you’re making the premiums on the policy. You’re not getting a donation receipt for that, but on death, the donation is issued for the fair market value of the death benefit. Ultimately, this can reduce taxes for the estate on, let’s say, an RRSP and capital gains tax as well. This is the most common way to do it.

In other situations you may be able to speak to the charity, and you can buy a policy, personally, and then donate the policy itself to the charity, where the charity becomes the owner of the life policy. You get a receipt for the cash surrender value, so if you’re talking about permanent insurance you own whole life, there might be a cash surrender value. You get an immediate donation receipt for that, and then every year, the premiums that you pay on the policy are effectively a donation. You’re getting a donation credit every year for your life insurance premiums because the foundation or the charity owns the policy.

Audience: When you pay the premiums every year, do you pay the premiums to the insurance company or do you pay it to the charity?

Golombek: I think you pay it to the insurance company because they own it. Again, I don’t know off the top of my head, I just know that we talk about it a lot, but it’s not the more common way that we see people do it because having been involved on the boards of a couple of foundations, they’re worried, from a policy perspective, on what to do with these policies if the person stops making the premium payments. One of the issues that we deal with on the foundation boards that I’m on is, do we really accept the policy, because what if one day the person stops making the premium payments? Now we have to decide, as a board, do we continue to pay? How healthy is the guy? Is he going to die soon? Do we continue paying the premiums on the policy, or do we stop and let the policy lapse?

Audience: One of the things you might want to consider doing, or talking about, especially on the guarantee contracts, is having a very short pay period.

Golombek: Right.

Audience: Typically, I do a lot for the ADL Foundation in the United States. That foundation is always the owner and beneficiary of the contract [inaudible] single pay or short lender.

Golombek: Right.

Audience: No more than 10.

Golombek: You eliminate that risk of not paying the premium.

Audience: The policies are paid up, and then the foundation’s owner and beneficiary [inaudible 00:41:16].

Golombek: Right.

Audience: There’s one bit of funkiness, where you’ve got this fair market value consideration on [inaudible] contracts and such.

Golombek: Yeah.

Audience: You can even donate term policies, where somebody’s in inclement health.

Golombek: We’ve seen actuarial values on some of that, yeah.

Yep. Now, they took it away. There was a loophole a couple years ago, where you could actually sell it to your own corporation and take the cash out. They changed that law a couple of years ago to stop people from doing that. Now, you’re dealing with arms-length charity; it’s not a problem.

Audience: It works pretty good in certain circumstances.

Golombek: Yeah, yeah. All right, let me move on. We still have a lot to cover. On the issue of charitable giving, I often say, when talking to clients, they ask me, “Should I do a public foundation?” A public foundation? I say that private foundations are public, and public foundations are private. What I mean by that is that in Canada, you can go onto the website for the Government of Canada, to CRA, Canada Revenue Agency, similar to the IRS, and you can Google the name of any of your friends and neighbors to see if they have a charity.

For example, Conrad Black — you can Google his family foundation, and you can actually pull up copies of all his charity returns. You can see all of his money, how much he’s got in the charity. All the income, all the assets. It’s all public documents — the addresses of the shareholders, all that information is available to the entire Canadian population. Many of our clients don’t want that kind of publicity. Some do want the publicity. I once spoke to a client, and I said, “You know, with a public foundation, you can set up a donor-advised fund. You have privacy there.” He said, “Privacy? I don’t want privacy. I want everyone in my town to know that I gave back money to the hospital.” People sometimes want the publicity.

The nice thing about public foundations or donor-advised funds is that they’re available through the banks, through Fidelity, through all the other corporations, community foundations. And they’re doing all the investments, administration, minimum fees. Sometimes you get to, as the advisor, manage the money in the donor-advise fund, so you can actually continue to get a fee on that portion of the assets managed in the foundation. And the nice thing is that it really is a one-stop shop for charitable giving because then you can allocate. In Canada, the rule is that you only have to allocate 3.5 percent a year of the fair market value to other charities.

In other words, by allocating money to a foundation, either public or private, you get an immediate tax receipt, you get the same benefits for the appreciated securities, like no tax, and all the income in the foundation is going to be tax-free forever, with the only requirement to distribute 3.5 percent. Again, I think that public foundations work very well as donor-advised funds, but some people still want the private foundation. The 3.5 percent is on the capital, so if the opening fair market value on January 1 is $1 million, then you have to give $35,000 away in that calendar year. All right?

Let’s talk about the vacation home, which is an issue for many of our wealthy clients. When you die, there’s a disposition in Canada of fair market value, or when you gift property away, there’s a disposition. The exception is if you give it to your spouse, but anyone else, if you give your property away to your kids, you can have capital gains tax. The capital gain is calculated as the proceeds less the cost, plus any renovations. That’s your capital gain. It’s a loss. You can’t claim it. It’s personal use property, and if you have a gain, the problem is what do you do about the tax?

Many of our clients approach us and say, “I’ve got these two properties: one in the city, one in the country. What can I do about the issue?” The issue is that in most places, if you have one residence, it’s not a concern, because in Canada we have principal residence exemption, and there’s no dollar limit on it. Each couple can sell one home at any point in their life, and then they can buy another one and sell the second home, but at any given point, if they own one home, the entire gain can be tax-free on sale, or on gift, or on death. There’s no concern at all for principal residence.

Audience: Is the person living in the house?

Golombek: Yeah, they, or a relative, have to be living there. It can’t be a rental or commercial property.

Audience: This just happened last week. I have a little old lady next door who is 92 years old. The doctor finally said to her, “You can’t live in the house anymore.” Now, the care home becomes her principal residence.

Golombek: It’s questionable. I would say that if she still owns the home and it’s not being rented out or anything else, then I would argue that she’s only not living there because, from a medical reason, she’s not able to live there. I would argue it’s still a principal residence for her.

If you email me, I’ll look it up. I think there was an opinion from CRA rulings on that exact issue, that if someone is not living there just for the sole purpose that medically they can’t live there, it still can be considered a principal residence.

Again, you’ve got special rules for change-of-use rule that allows you up to five more years to still claim the principal residence, as long as you haven’t claimed tax depreciation. I’ve got lots of material on this; I can send it to you. Absolutely. The issue then is, what if you have more than one principal residence? Again, it doesn’t mean where you principally live; it just has to be a place where you ordinarily reside. Even one day a year, by the way, it’s considered to be ordinarily residence, as long as it’s not rented out on a permanent basis to somebody else.

In Canada now, as of last year, the CRA, the revenue authority, is starting to track this more and more because now in Canada, until last year, when you sold your home, you didn’t report it on your return because it was tax-free. Starting last year, the Canada Revenue Agency requires you to report the disposition of your principal residence, even if you’re claiming the exemption. This is going to be a lot easier for the government authorities to start tracking. The question then is, when we meet with our clients, and they’ve got, let’s say, a cottage, or a vacation property and a city home, the issue comes down to, “When I sell the first one, do I not report it, or do I report the gain and claim the full exemption, or do I save it later on for the sale of my second home?”

That’s really an issue, because you’re going to have to look at the gain per year, the potential for future increases, and then how many more years are you going to hold the second property until you sell it? Again, we work with clients on this. Sometimes we use life insurance, particularly on a cottage. If there’s a vacation home that they want to pass to the next generation and they know there’s going to be a big tax bill, well there’s not any cash in the estate to pay for the tax bill because it’s gone up enormously. We see this in Whistler, British Columbia; we see this in Muskoka in Ontario, where prices have gone up dramatically. We’re often recommending permanent life insurance strategies to be able to fund the tax liability on death, so that we can pass on the vacation home tax-free to the next generation. In some cases — there’s even a commercial in Canada for this — you can actually get the kids to pay the premiums on the policy because they know they’re going to inherit the vacation home. We’ve seen that before as well.

What about education planning? Many of our clients are interested in funding postsecondary education. In the U.S., we have 529 plans; in Canada we have RESPs. What people don’t realize is the opportunity to overfund the RESP. Again, I’ll just spend a few minutes here. This is purely Canadian tax, but basically, we have this plan where you can contribute to the plan. There’s no deduction for the plan, but if you contribute $2,500 a year, the Canadian government will match that with a Canada Education Savings grant of $500 a year. Over about 14 years, you’ll hit the maximum of $7,200, which is a legislated maximum, and all the earnings in the plan are completely tax sheltered until the money’s taken out for college or for university, any kind of postsecondary education.

A typical strategy with a typical client is we tell the client to contribute when the kids are born. The problem is that parents complain they don’t have any money, they can’t do it or they wait and they wait. We finally say, “If the kid’s 10, you better start now, or you’re never going to catch up and get your maximum grants.” Effectively, we work it out mathematically, so they’re doubling up every year to get all the grants of $7,200. And if we just use a reasonable rate of return of let’s say 3 percent, that’s very conservative, this would pay for four years of education at $13,000 a year. Again, I can show you the same thing. If we started at age zero, put in the same $36,000, get my same 20 percent government grants, $7,200, grow it at 3 percent, now we’ve boosted four years of education at $16,000 a year.

What most of our high-net-worth clients are missing, especially if they’ve got one, two, three or four or more children, is the opportunity to maximum fund the RESPs at the beginning. Again, you can put in up to $50,000 per child. I would never put in the $50,000 on day one because then you lose all the grants for the next 13 years. What we actually do is work backward. We say, “Let’s put in $16,500 in the year of birth, then max them out $2,500 every year thereafter.” We’ve got our $50,000 in there. We’ve got our maximum matching on $7,200 total, and again, if we grow this at 3 percent, now we’re looking at $23,000 a year for four years of education.

Audience: What if you just put in the $50,000 and forgo the grants?

Golombek: I’ve written an article on that. The question is, What if I just put in the $50,000 and forgo the grants? We can prove mathematically it doesn’t work because, again, if you have the $50,000 right now, you should put $16,500 there, put the $33,000 somewhere else. When you add the two together and combine it, you’ll actually have more money in the RESP. I have an article I can send you that actually looks at the math specifically on that question. The question then is, when you take the money out, what happens to the RESP money? Well, the contributions are after-tax dollars. You always get them out tax-free. It’s only the income that’s taxable, so in my example, we have about $22,000, so for four years of education, that’s about $90,000 in the plan.

If we’re taking out $90,000, the $50,000 is out tax-free. It’s the $40,000 that’s taxable to the child, $10,000 a year, and again, in Canada, they would pay no tax because of the basic amount that we have in Canada, and they get a credit for tuition. Tuition in Canada is very, very cheap, $6,000 a year on average, so again, they have more than enough credits. In most cases, these education plans are completely tax-free because the contributions are after-tax dollars, and all the income is taxable to the student, who has very little tax.

All right. Let’s get to the insurance stuff now. There are three strategies that I talk about with clients every single time, and I talk about insurance for people who don’t need insurance. Again, I’m not the insurance guy at my office, but I’m brought in on very high-net-worth cases to look at the tax angle behind the insurance. We’ve got very qualified insurance people at the office who deal with this stuff every day. I’m not out there selling term and group and health and all that stuff. I’m only looking at high-net-worth case studies, and I call it insurance for people who don’t need it, purely as a tax shelter.

The best way I’m going to show you is through a number of examples. Again, all these are about maximizing the value of the estate. They’ve got more than enough money than they need. Yes, there are strategies where I can take any of these policies, leverage them and get retirement income. I don’t show any of that. Not that I don’t necessarily believe in it, but I’m an accountant, very conservative, very, very straightforward. I want to show you stuff here that’s completely guaranteed, has zero risk, doesn’t involve leveraging, doesn’t involve anything at all. It’s very simple mathematics. I’m going to show you all the sources. We’re using publicly available quotes that you can replicate yourself.

Here is my first example. [visual] We’ve got a couple who are 65 and 67. They’ve got $1 million. That’s what they’re willing to commit to insurance. They don’t need this money for retirement. They want to leave it to the kids. Our tax rate in Ontario is 53.5 percent. They’re very conservative. Everything is in GICs, which is like CDs, guaranteed zero risk, guaranteed capital, rate of return is guaranteed, and they really have two choices. They could take this and continue investing in these low-rate income deposits, or they could shelter it all in a permanent insurance policy.

What we’re going to do is No. 1, we’re going to show you a comparison of the million dollars just invested at 2 percent, earning just $20,000 a year, will lose 53 percent of it in tax. How much can we accumulate at life expectancy? Then we’re going to start with a UL policy. We’re going to take $1 million and every year we’re going to take 10 percent of it, $100,000 over every single year. We’re going to move it over into the policy and we’re going to start with a death benefit of a $1 million. Again, mathematically, what does it look like? Well, you can see, if we look at the GIC, it’s very easy. Where am I coming up with the numbers? You’ve got $1 million. The first year at 2 percent is $20,000. Lose 53 percent tax on $23,000, and it’s about $11,000. At the end of the first year, you’ve got $1.9 million, after tax. Very simple math, right? We just keep doing the same thing at life expectancy here, joint life expectancy at 90.

Let’s take the same amount of money, and we’re going to do the UL strategy. Again, the UL strategy’s going to say we start with $1 million of GIC. We’re going to put $100,000 into UL in year one, so then we have a $900,000 GIC and a $1 million death benefit. On an after-tax basis, we start anywhere, if you die in the first year of the policy, of course you have the biggest benefit. Of course you’re dead, but you have the biggest benefit, $2 million on an after-tax basis, and then gradually, this decreases to about $1.7 million. You can see that in total, we can increase the estate value if you die, the year after you apply the policy by a million bucks, which is pretty much the face value of the policy, up to about half a million dollars if you live to life expectancy. This is very simple. Guaranteed UL.

Audience: What would the return rate have to be in a, what do you call it? [inaudible] investment, equal to the UL?

Golombek: It’s a good question. I haven’t done it in this example. I have done it in a couple of slides on the insured annuities strategy, where the effective IRR was 5.5 percent. I assume it’s similar around there, but I’ll show you the numbers in just a minute.

In my insured annuities strategies, because of the taxation, it’s actually 5.5 percent.

Audience: Is there something to take on a little bit more risk?

Golombek: I want to show you to take more risk. I’m going to convert this to whole life in a second. This is guaranteed UL, zero risk. OK? Let me show you the same example with whole life.

Again, this is using Sun Life quotes, OK? Same thing, we’re going to do the exact same strategy. This time we’re going to compare it to whole life. We’re going to take $100,000 a year, put it into whole life strategy. Again, we don’t have the guarantee here in terms of the dividend scale, so we’re going to use the current dividend scale, and then we’re going to do the same thing; we’re going to take 2 percent off. Again, to be conservative, we’re going to show the illustration at current dividend scale, what the insurance company has been paying for the last 30 years, and then we’ll drop it by 2 percent and show you how this compares, OK?

Again, we’ll start with a GIC. GIC, same numbers, shouldn’t have changed at all. [visual] If we’re going to run it on the whole life, and this is the whole life with the current dividend scale, you can see right away, instead of having $1 million, we have $2 million starting on day one, and we have $2.8 million at the end of the day. If we drop the dividend scale by 2 percent, we’ve got anywhere from $2 million to about $1.9 million, so we’re down by about a million. You can see again, if you’re willing to take some of the investment volatility or risk associated with a whole life policy where it’s based on the performance of the underlying assets of the insurance contract, obviously you’re going to get, potentially, a higher return.

It depends on the client. If the client wants the guarantee, the guarantee that they’re not going to lose money, and they have guaranteed values on the policies, we’ll go UL. Guaranteed UL to 100. If the client says, “You know, I’m comfortable with more upside,” then we’ll look at the whole life. I’ll just show you some stats. [visual] These are all taken from the Sun Life most recent report. This is their dividend rate. In one year, it’s about 6.25, 6.7, 7 percent over 10 years. It’s 7.77 percent over 25 years. Again, this is just an example that we use to model this. We use all the major providers in Canada in terms of life insurance. We do quotes; we show illustrations to all of our clients. We’re completely independent, so I just chose this because the numbers look really good based on the numbers.

Audience: Can you split it?

Golombek: Of course, you can split it, absolutely. Split it among more than one company if the numbers are big enough. Again, this just shows you the returns, compared to the S&P, or a five-year GIC, or even inflation. You can see obviously, that you get very low standard deviation, low-level volatility for pretty significant returns.

Let me show you my third idea. We talk about annuities. As soon as we mention “annuity,” most clients say, “I’m not interested.” That’s what most people say to me. Annuities have a bad reputation, and in fact, people say since interest rates are so low, not as low as they were last year, but they’re pretty low, why would I ever buy an annuity in a low-interest-rate environment?

If you start reading some of the academic research that’s being done in the U.S. and in Canada, most financial advisors will say that it’s worthwhile annuitizing a portion of your wealth, so that there is some regular income and capital. It’s always coming in every year for the rest of your life to pay for your minimum expenses, whether that’s nursing care, health care or something like that, so that you know you won’t run out of money, because longevity risk is one of the biggest concerns that people have right now. I don’t want to risk outliving my money. If you can buy an annuity with even a small portion, and again, I don’t go more than 30 percent with clients; 30 percent is high.

In other words, they’ve got $10 million; they’ve never put more than $3 million into an annuity. I think that’s high, but people are doing 10 to 15 percent into an annuity. The nice thing is that if they don’t want to lose the capital because of the guarantee, let’s say that after five years, the guarantee’s gone, then we could insure the annuity with permanent life insurance like I just showed you. Let me show you an example. [visual]

GIC’s regular income — this is like a CD in the United States. A fully taxable income, you get your estate value at the end of the day. With an annuity, what we’re doing is taking half a million dollars. We’re going to a life insurance company and saying, “Sell me an annuity.” We shop it around. We get the possible annuity rate. Then we say, “How old are you?” and we go out and buy a permanent life insurance, term to 100 policy, and we insure the half a million dollars that it pays out at the end of the day to the estate. What we do is use the annuity payments to pay the premiums on the life insurance policy.

Audience: Are there guarantees?

Golombek: Yeah, there’re guarantees.

Audience: Immediate annuity?

Golombek: If we’re doing immediate annuity with guarantees, like a five-year or 10-year just in case, right?

The nice thing, and the reason why this works by the way, is that certainly in Canada, and again, I can’t speak to the way U.S. taxes annuity, I think it’s a little bit different, but the way it works in Canada is you get straight-line tax treatment. In fact, most of the money that you’re getting back is a return of your capital and it is actually nontaxable. You’ll see this in my example.

Ben is 70, lives in Quebec and pays tax at a 53 percent rate. He wants to increase his cash flow from fixed income. He’s got two choices: half a million bucks in a GIC at 2 percent, or a personal insured annuity. He wants to make sure that half a million is still there at the end of the day for his relatives.

GIC, very simple math, right? It’s $10,000 of income tax, rate of 53 percent, $4,700 a year left. At the end of the day, if he dies, we have a tax-free capital. It’s a GIC; it doesn’t go up in value, so there’s no income tax on it in Canada. It’s worth half a million dollars. Your yellow is your cash; your red is your tax. [visual] On $10,000, which is about 2 percent interest income, I’m netting cash of $4,700.

Let’s contrast that now with the insured annuities strategy. With the insured annuity, we go to a life insurance company. In this case, I think we went to Manulife for the annuity, and we went to Sun Life for the policy. We price the annuity, about $35,000 a year. What’s interesting is, of the $35,000, only a small amount of it is taxable. In fact, the tax on the $35,000 is actually only $2,000 every year, straight line for life. It never changes. Again, we’re buying life insurance for a 70-year-old. It’s very expensive, so we priced it out with Sun Life. It’s $20,000 a year. We’re using the cash from the annuity to pay the insurance policy premiums every year, and then we pay some tax. We’re actually netting from a cash flow perspective, the yellow, which is $13,300, pay $2,000 in tax, $20,000 on a life insurance premium.

Just to remind you, how does this stack up? It’s really quite incredible. I actually had to triple check this last week, to make sure that it’s correct, but it is correct. In the first example, we had after-tax cash of $4,700. [visual] In this example, we have after-tax cash of $13,300, both with guaranteed estate values. The reason why this works is because the insured annuity combines a very tax effective life annuity, which is taxed very low in Canada on a straight-line basis. Think about it like a mortgage. If you take a mortgage out today and you start amortizing your payments, the beginning of your mortgage, most of your payments are interest because you’ve got a very big balance, and as you start to pay down the principal, more is principal — you’ve seen these charts, I’m sure, on the computer.

Annuity’s backward because you give them the capital, and then when you’re starting to receive the income in the beginning, most of the return you’re getting is income. You’ve got the biggest portion invested there, and they’re giving you a rate of return on that, so theoretically, your tax should be very high at the beginning of an annuity and very low at the end of annuity. In Canada, it doesn’t work that way. They actually level it, and that’s why you get this boost of the effective tax rate of return. How good is this? If you look at the effective rate of return, it’s 5.7 percent. In other words, you have to go out there and find a guaranteed investment that would pay 5.7 percent every single year to match the annuity strategy.

That’s why, again, I think this is massively overlooked in our market, and it’s something I talk about in every single client meeting, if clients are looking for tax-effective solutions for regular cash flow as an alternative to fixed income. We have some clients who don’t have any fixed income, in which case they don’t look at this. They want all equities, they’re willing to take risk, but I think it’s an interesting strategy.

Audience: Does it work just as well with a prescribed annuity?

Golombek: This is a prescribed annuity. Absolutely, this is a prescribed annuity. It does not work, by the way, with corporate money.

Audience: Is there a program that runs these scenarios?

Golombek: There is. I don’t have my own program. All the life insurance companies have the software. It’s updated in real time with real annuities.

Audience: If a Canadian buys a U.S. annuity, because we’re kind of running out of annuities in Canada, my understanding is a lot of companies are pulling out because they can’t actually invest in annuities. Can you buy U.S. annuities? Are they taxed the same?

Golombek: That’s a good question. I’d have to check on that and get back to you. There are certainly concerns with some of the U.S. policies, like life insurance policies, because again, we have to make sure that we have an exempt policy in Canada as well. In terms of U.S. annuities, again, I’m not sure how that would work. I think typically speaking, they have to be Canadian to qualify for the treatment. Do you know off the top of your head? The question was, if you buy a U.S. annuity, would it qualify for the treatment, and it wouldn’t be prescribed. I don’t think you can get the same tax treatment in Canada if you’re using a U.S. annuity.

Audience: Are the funds registered?

Golombek: These are nonregistered money.

Audience: Does it work for registered money?

Golombek: It doesn’t work. It doesn’t work for registered money because registered money, when you buy a registered annuity, the entire payment is taxable, just like a withdrawal from an RRSP or a RIF. This works for nonregistered money.

Sometimes you can get an impaired annuity, which makes a higher payout, but you wouldn’t be able to buy the insurance to protect the value, so just get a longer guarantee.

Audience: What about a joint policy?

Golombek: Yeah, if you have a couple and only one of them is insurable, then we can do a joint policy, absolutely, joint last, absolutely. First to die last, absolutely. We can become creative, for sure.

All right. U.S. estate tax — so this is an issue for Canadians who own U.S. property. Obviously, it’s an issue for high-net-worth U.S. individuals as well. The U.S. estate tax has actually been around for just over 100 years, and the tax rate has varied. Now, the top rate is 40 percent, but actually it was as high as 77 percent about 40 or 50 years ago. The exemption has also been high. The exemption has been as high as $50 million. It dropped to zero in that one year, and then it came back right now, where it doubled recently to $11.2 million as a result of the Trump changes last year. Right now, $11.2 million U.S. is the exemption, so if you die with under $11.2 million, you don’t pay U.S. estate tax.

In Canada, it works a little bit differently. In Canada, the exemption is prorated. I’ll show you an example based on U.S. property to worldwide property. [visual] I’ll show you how that works in just a second. This is the formula under the Canada-U.S. tax treaty. If someone is Canadian and not a U.S. person or U.S. citizen, and they die owning U.S. securities, they get the $11 million, but it has to be prorated by the ratio of their U.S. situs assets divided by their worldwide estate. I’ll show you a mathematical example. [visual] If we’ve got an individual who has a U.S. condo in Florida worth $1.5 million, and they’ve got other assets in Canada that are worth $13.5 million, our total value is $15 million.

I’m going to show it first for our Canadian person. I’m going to show you for a U.S. person in just a second. In Canada what we would do is calculate the tax on only the U.S. property, so the $1.5 million. When we run the tax on that, it’s about $545,000. Then we get a credit, and the credit is on $11 million. It’s about $4.4 million, but we have to prorate the credit by the ratio of U.S. to worldwide. U.S. to worldwide here is 10 percent, so 10 percent of the credit is $442,000. So a Canadian in this scenario dying, owning a Florida condo, would owe $103,000 of U.S. estate tax.

If the same individual was a U.S. person living here in the U.S., the entire $15 million would be subject to the estate tax. This applies in Canada to U.S. persons. If a U.S. person living in Montreal has $13 million in Montreal and $2 million in Florida, they’re in a big problem because then they’re looking at a $1.5 million estate bill. They get the full exemption, but then their entire estate is taxable.

Audience: Over and above the exemption?

Golombek: Over and above the exemption, yeah.

Audience: What about dual citizens?

Golombek: Yeah, so dual citizens, I was just saying. Dual citizen, you’re caught by the U.S. rules. A dual citizen is subject to U.S. estate tax on their worldwide assets when they die. Remember, 99.9 percent of our clients don’t have to worry about this because they’re not worth $11.2 million U.S. dollars. It’s only the top 0.01 percent of people who have a net worth of over $11.2 million that have to worry about the estate tax, but this seminar is for high-net-worth, so that’s why I’m explaining it.

Strategies. For investments, clients of ours are subject to this because they’re high-net-worth, and they’ve got U.S. stocks. We’ve seen the following:

Sell them. Instead of owning the U.S. stocks when you die, sell them before you die, or instead, use a pooled product, like a mutual fund or a segregated fund. We don’t own the individual securities.
Many of our clients are gifting them away during their lifetime, or either using a Canadian fund or, ideally, transferring it to a Holdco. In other words, if you die and you don’t own the U.S. stocks directly, but instead you own shares of a Canadian holding company that in turn owns the U.S. stocks, you’re fine because on death, you own Canadian Holdco shares, even if they won the U.S. securities. That’s something that we often look at for high-net-worth clients who want individual securities in the U.S. Again, it doesn’t matter if it’s in a U.S. brokerage account or a Canadian brokerage account.

For real estate, we do not like the Canadian corporation, so we do not advise our Canadian clients buying Florida real estate to use in corp because of the personal benefit rules. The rules say that if you’re using corporate dollars to pay for a personal residence, there’s an imputed shareholder benefit equal to fair market value rent, while that property’s available to rent throughout the years, so we don’t like that.

Audience: What about commercial property?

Golombek: Commercial’s altogether different. I’d say, certainly for commercial property, there’s no problem with a personal shareholder benefit. People use corporations for that all the time. We do use corporations for commercial, but for residential real estate vacation properties, the most common strategy now is the Canadian trust. You fund the Canadian trust, you have the Canadian trust buy the U.S. side as property, so that on death you don’t own it, you’re not subject to the estate tax. Another strategy, again, is nonrecourse debt, if you can find it. In other words, if you get a lender to lend against a property, you can deduct that for U.S. estate tax purposes. My understanding, it’s very hard to get and it’ll only loan up to 50 percent of the value anyway.

Life insurance I think is a great solution. If you calculate the estate tax liability, you want to pass it on to the kids, you can buy permanent insurance, term to 100, something that will guarantee the payout on that estate tax, and then finally, for clients who have a worldwide estate, just over to the exemption, $11.2 million. Let’s say they’ve got $12 million, $13 million, $14 million or $15 million, they may want to make lifetime gifts to reduce their estate below the $11.2 million, so that they get the full exemption on the property. Again, we have materials on all this stuff.

Estate planning using testamentary trusts, again I think these values and all these ideas apply equally in the U.S. and Canada. These are non-tax ideas. In a will, you can set up a testamentary trust that allows for the distribution of the assets at later stages. We see this very commonly with large inheritances, particularly with life insurance, the use of a life insurance trust. Instead of giving millions of dollars to kids who are 18, we have clients who wouldn’t give money to the kids on the day they turn 40, so you can set up a life insurance trust that has distribution of those assets at later stages, so maybe you give half at age 25 and maybe give the other half at age 35.

We sometimes have what’s called “spendthrift beneficiaries.” We’re worried that beneficiaries will spend the money inappropriately. In some cases, the beneficiaries could have an addiction.

Audience: Just a quick question on the state of distributions. Is that an issue that a beneficiary wants to wrap up the trust?

Golombek: Again, you have to make sure based on the case law, that particular case you’re referencing, is if there’s no other preconditions on that particular trust, then the law says that a beneficiary could demand that the trust be won out, so we always make sure that we have contingent beneficiaries in there that theoretically have an interest so that they cannot collapse the trust.

Audience: What about a younger child or issue?

Golombek: Yeah, a younger child, issue, or future issue, or grandchild, or something like that. We draft appropriately to avoid that exact problem. The third point was spendthrift beneficiaries. Again, you’ve got a beneficiary with a gambling addiction, alcohol, drugs or just not good with money. You set up a trust to manage the inheritance, so that ultimately the money can be paid, let’s say, for shelter, for education, for housing, but the kids actually don’t have access to the money themselves.

Motivating the behavior of the beneficiaries. We call this the “matching incentive trust.” For wealthy families, they are often worried that if they leave large amounts of money to their kids who are doing very well, they’re, let’s say, working, that the kids will just drop out of life, stop working and start living on the trust fund. The parents don’t like that. What the parents can do is set up conditions in the will with a testamentary trust to say to the kids, “Hey kids, if you want to get any money from my trust, you better prove each year that you’ve earned at least the same on your own.”

Every year, the kid brings in a copy of his tax return to the trustees of the trust, and if the kid makes $50,000, the trust matches that with another $50,000, sometimes with a multiplier. The kid makes $50,000, the trust pays out $100,000. If the kid makes zero, he doesn’t get anything from the trust. Again, it’s a way of incenting the kids to continue working by showing some employment income, business income or professional income on their return. Parents love this idea; kids don’t like it as much.

Finally, protecting the kids’ inheritance in case of remarriage. Very typical scenario, right? Especially if you’re dealing with second families. Spouse A dies and leaves the money to spouse B. Spouse B dies and leaves the money to the kids. My oldest concern is, “What if I die, leave the money to my wife, and one day after I’m gone, my wife decides to remarry, and then she dies? Will she end up leaving all my money to some new guy whom I never even met? Hopefully, never even met. My kids could end up with nothing.” What I could do is set up a testamentary trust in my will and give my wife access to the income while she’s alive. I still have to leave her some of the property out of the family law rules of the province, probably 50 percent of it, but the rest of the money is inside the trust and available to the kids of the first marriage. See how there’re no arrows anywhere joining the second family? [visual] Cut them off completely from the value of my estate.

Audience: Also, that second family guy’s probably a lot younger than you are.

Golombek: Absolutely, they could live much longer. Absolutely, he could have other kids and things like that. Again, these are some of the ideas that we regularly talk about when we meet with high-net-worth clients.

In summary, we talk a little bit about how much money they need and how much they’re spending. We always do cash flows. We ask to do cash flows, but sometimes they don’t want it. But we ask clients, “Could we do a cash flow projection for you to make sure you don’t run out of money, make sure you’re saving enough money?” We look at making sure their kids’ education is properly funding. We look at their minimization strategy through income splitting.

We then turn toward retirement planning to make sure they’ve maximized all their plans. We look at permanent life insurance as a solution, UL, whole life and insured annuities. We talk a little bit about philanthropy in terms of being strategic in their charitable giving. Would they consider setting up a foundation?

Then finally, we do touch on the estate planning, making sure wills and power of attorney are up to date, and make sure that they’re using some of these more advanced strategies, using trust to protect the inheritance.

Jamie Golombek, CPA is the managing director of tax and estate planning at CIBC.