Since the announcement of this year’s Federal Budget on Tuesday there has been significant discussion of the proposed tax changes presented, with many Canadians justifiably concerned about the impact the increase to the capital gains inclusion rate will have on their wealth planning. I recommend reading my most recent note – A Commentary on Capital Gains in Canada – in which I provide insight on how the proposed change will impact your wealth planning, especially when it comes to your estate planning. The proposed changes will have a real impact on Canadians’ ability to pass on their wealth to the next generation, whether that’s a non-registered investment portfolio or a family cottage, or a portfolio of investment properties (either held in personal name or in a corporation or trust).

 

In summary, the proposed changes are as follows:

For Corporations and Trusts

Increase the capital gains inclusion rate from 1/2 (50%) to 2/3 (66.67%)

For Individuals

Increase the capital gains inclusion rate from 1/2 to 2/3 on the portion of capital gains realized in the year that exceed $250,000, either directly or indirectly via a partnership or trust, net of any:

• Current-year capital losses.
• Capital losses of other years applied to reduce current-year capital gains; and
• Capital gains in respect of which the lifetime capital gains exemption, and other measures proposed in this Federal Budget which we will not discuss here.

 

In the example I provide in the commentary article I’ve linked above, the deemed disposition of a vacation home valued at $1.75M (with a cost base of $300,000) to heirs who are not your common-law partner or spouse under this new tax schedule will result in your estate having to pay an additional $64,185.50 at a marginal tax rate of 53.53%.

 

From a wealth planning perspective, one key strategy to mitigating the impact of taxes on your estate is using tax-exempt whole or universal life insurance. Though there are multiple strategies you can utilize with this type of insurance policy, I want to mention two:

 

1. Funding Your Estimated Estate Tax Liability

You can put in place a policy that covers your anticipated taxes payable upon your death. This requires a review of your financial plan and determining the maximum amount of tax you are anticipated to pay during your lifetime should you pass.

2. Funding Using Anticipated Excess Assets

Through your financial plan you can anticipate your cash flow needs as best as possible, which could identify non-registered assets (money outside an RRSP or TFSA) that you will never utilize for your own personal lifestyle or leisure needs and will be passed on to your heirs. Alternatively, you may have allocated these funds for your heirs already. Either way, capital gains will be paid on this amount when passed through your estate to your heirs – a gain that will only grow over time. Instead, you may want to consider transferring these assets into a tax-exempt whole or universal life policy.

You would trigger the capital gain on the assets used to fund this policy in the current year, however the payout of death benefit and any cash-surrender value of a tax-exempt life insurance policy is paid directly to your beneficiaries tax-free. Moreover, you are avoiding accruing future capital gains that will erode the value of your estate.

 

If you have any questions, as always feel free to reach me at matthew.valeriati@rbc.com or call me at 416-699-0183. Now onto your regularly scheduled Your Morning Java Update.

 

There was additional news of note here at home this week as Canada’s CPI results for March came in at 2.9% - higher than February but below market expectations. Of note was the month over month increase in energy costs, increasing 2.1% from February. Looking on the bright side, food inflation declined month over month by -0.2% and on an annualized basis from March of 2023, food costs have increased 3.0% - which was down from 3.3% in February. Other core measures were also down, so it would appear there is a broadening trend here in Canada on price deflation. Given this week’s results, Canadian bond yields declined as the odds appear to tip in favour of that the Bank of Canada cutting rates by June at the earliest. (RBC Canadian Inflation Watch)

 

The U.S. consumer continued to surprise to the upside, with March retail sales increasing 0.7% from February on the back of increased online activity. A strong labour market in the U.S., combined with steady wage growth, appears to be lessening the impact of above target inflation on consumers. Even lower-income households are spending at reasonable levels. With inflation still well above target, the fact the economy continues to remain strong in the U.S. means the Federal Reserve can afford to keep rates higher for a little longer. (This is discussed in the attached Global Insight Weekly article) Combining this news with recent geopolitical risks in the middle east, equity markets were down this week. Should interest costs continue to remain high, market valuations will need to adjust downward as profit margins for U.S. companies will remain tight. The saving grace for U.S. securities will be a relatively strong Q1 earnings season that is presently underway. (Yahoo Finance)

 

In Europe, the inflation story has improved dramatically in the last six months both on the mainland and in Britain. In comments made earlier this week, ECB council member Mario Centeno stated that the Bank will not be taking cues from the U.S. Federal Reserve with regards to its decision on when to cut rates. (BNN Bloomberg) ECB President Christine Lagarde has been less forthcoming about the degree in which the Bank will cut rates this year, but markets in Europe are currently pricing in anywhere from 2-3 rate cuts which is a substantial divergence from where we thought the ECB would be relative to the U.S. last September.