We hope you enjoyed your Thanksgiving weekend!
In this week’s economic update, we’ll be unpacking the increased volatility and declines in prices across many sectors. We also examine the strength of the U.S. and Canadian dollar, oil prices, and bond yields – and address what has driven this new bout of angst.
We are also sharing insights from Elinesky Schuett’s own Elvis Henrique, our wealth planning expert, who is discussing some of the considerations that U.S. persons living in Canada should be mindful of – specifically, we’re taking a high-level view at what you need to know if you’re a U.S. person with registered savings plans in Canada.
Economic Update
The month of September proved to be challenging for global investors, with increased volatility and declines in prices across most sectors. Notably, the technology sector, a standout performer for most of the year, wasn’t immune as it too fell victim to declines. On the other hand, the U.S. dollar strengthened against most major currencies, as it often does during periods of broad market weakness. The Canadian dollar was the exception as it largely kept pace with the greenback, due predominantly to rising oil prices. Meanwhile, bond yields have risen (while bond prices have fallen) meaningfully as of late. Below, we address what has driven this new bout of angst.
Interest rates may remain elevated longer-term.
One catalyst for the rise in volatility has been a growing appreciation that interest rates may stay higher for longer than originally expected. Central banks in Canada, the U.S, and England kept their policy rates unchanged at their most recent meetings. Still, their language clearly emphasized a message they have been trying to deliver for some time: the need to tread cautiously with future policy decisions and to avoid cutting rates too early. Most central banks have acknowledged that inflation has come down but are awaiting more definitive proof that inflation is under control. Moreover, an uptick in North American inflation, an increase in U.S. job openings, and some improvement in the U.S. manufacturing sector, all suggest underlying resilience in the economy, which bolsters the case for sustained higher rates.
Bond yields have increased as of late.
The swift move higher in government bond yields (and the corresponding price decline) has been particularly noteworthy. For example, the 10-year U.S. government bond yield rose from nearly 4.25% at the start of September to close to 4.75% recently, marking a 16-year high. The move in Canada has been similar, with the 10-year yield rising from roughly 3.55% to 4.15% over the past month. This shift isn’t attributable to a single factor. A combination of economic resilience, anticipation of an extended period of higher rates, lingering inflation concerns, and lower demand from traditionally big investors like foreign governments, central banks, and commercial banks may have contributed. Moreover, there has been a growing supply of bonds as governments increase their issuance to fund their budget deficits. In other words, lower demand and rising supply have both played a role.
Impact of bond yields on other investments
The rise in government bond yields is having a broader impact on markets than one might assume. Most people appreciate that higher rates raise interest costs for borrowers. However, these rates also influence the prices investors are willing to pay for various investments. That’s because government bonds, widely regarded as being nearly “risk-free”, often set the minimum return investors demand from other asset classes. If held to maturity, investors can count on the government returning their full principal, in addition to making promised interest payments along the way. If you’re an investor and you see that these bonds are now yielding 4% versus 1% a few years ago, it may change how you evaluate the prospect of investing in riskier assets like stocks or real estate. This reassessment can result in a valuation adjustment, with prices that fall as bond yields rise, and vice versa. Some investments naturally have more sensitivity to this phenomenon than others.
Summary
While the recent uptick in volatility and market declines have been orderly so far, we are mindful that bond yields may continue to move higher in the near-term. However, we believe that current yields, which are near decade highs, present some of the more attractive opportunities in fixed income in some time. We also believe that sustained high interest rates will eventually take their toll on the economy, which, in turn, should help re-establish the diversification benefits of fixed income in portfolios as bond yields begin to settle down.
Financial planning considerations for U.S. persons living in Canada
Over the years, there appears to be a growing number of US persons working and living in Canada either for career purposes or through marriage - and as a result there are extra considerations to keep in mind from a financial planning perspective. We will take a brief look at these issues and how they may impact you.
If you are a U.S. person for U.S. Income tax or transfer tax purposes (which is a topic in and of itself), your U.S. status will define your tax obligations and filing requirements under U.S. tax law. The United States is one of the few countries in the world that levies tax on your worldwide income or worldwide estate based upon citizenship and residency status. This can have implications for U.S. persons living in Canada. This week, we’re taking a very high-level view at what you need to know if you’re a U.S. person with registered savings plans in Canada.
There are a number of registered savings plans available to Canadian residents that provide tax and other benefits (such as tax deferral, exemption of income from tax and certain government incentives as well as just promoting savings). These plans include registered retirement savings plans (RRSPs), registered retirement income funds (RRIFs), tax-free savings accounts (TFSAs), and registered education savings plans (RESPs) & even registered disability savings plans (RDSPs).
U.S. persons who have an interest or involvement in these plans may be subject to punitive U.S. tax, additional U.S. filing requirements, or even double taxation - making some of these plans undesirable from a U.S. tax perspective.
Which plans may be impacted?
A Canadian registered plan that is set up in Canada as a trust may potentially qualify as a foreign trust (both grantor and non-grantor trusts) for U.S. income tax purposes which can impact the tax consequences of holding these plans. In simple terms a foreign grantor trust is a trust in which the grantor or owner retains the power to control the assets and income within the trust whereas a foreign non-grantor trust is a trust that does not meet the definition of a grantor trust.
TFSAs
A TFSA that qualifies as a foreign trust may not be a good option for U.S. persons living in Canada due to the adverse tax treatment of income and capital gains earned in the plan. There is also additional filing requirements under the foreign trust rules.
Additionally, a U.S. beneficiary of a TFSA may be exposed to the U.S. foreign trust rules after the death of the holder until the plan is wound up.
RESPs
Generally, a U.S. person should avoid being the subscriber of an RESP or a contributor to an RESP where the RESP will qualify as a foreign grantor trust. Doing so would expose that individual to the risk of double taxation of the income earned in the RESP and the government grant and bond paid into the plan. There is no relief under the Canadian – US Tax treaty to defer US Income tax within these plans.
RDSPs
Similarly, a U.S. person should not be the holder of or a contributor to an RDSP due to the foreign trust rules and the risk of double taxation. The tax treatment will depend on whether the RDSP qualifies as foreign grantor or non-grantor trust.
Which plans may not be impacted?
RRSPs and RRIFs
If you are the annuitant of an RRSP or RRIF, or named as a beneficiary or successor holder of one of these plans, you are generally not subject to adverse tax treatment. This could make an RRSP or RRIF an appropriate option for you.
Get qualified advice.
It’s incredibly important to seek advice from a qualified cross-border tax advisor about whether you should invest in a specific Canadian registered savings plan or not. Specifically, consider the after-tax return of investing in each plan including taking into consideration both the Canadian and U.S. tax implications of doing so. You should also be aware of any additional U.S. tax preparation fees & filing requirements you may incur as a result of investing in a specific registered savings plan.
We’d be happy to speak with you about any questions you might have!
As always, we are available to connect with you personally. Please don’t hesitate to contact us at 519-822-2024 or elineskyschuett@rbc.com.
