#132 Budget Lessons

I don’t normally like to piggyback on mainstream financial news. Mostly because I like to keep a focus on long-term thinking, and I find mainstream financial news very often self-purporting. But today I’m reeling back my long-term stance to talk about impactful changes in the Alberta and Federal budget announcements. Yeah, just when you thought you were done with tax stuff for the year, here I go bringing it up again. Too bad. This is important.


Irrespective of individual political views (I read through a lot of sour commentary over the last few days), the new budgets will have significant financial planning implications that are worth paying attention to.


Balancing the Budget

A big theme this year is the focus on producing a balanced budget. In Alberta we’ve only been out of surplus for a couple years, but the Federal government has been in deficit since the 2008 recession.


With oil revenues down the Alberta Government has found significant budget-balancing challenges. To help offset this they intend to introduce the first personal income tax increases since 1987.


Unlike federal tax brackets which are progressive (different levels like a staircase), Alberta has maintained a level 10% income tax bracket since the time of King Ralph. The new income tax increases will affect the highest income earners in Alberta and include a disappearing tax bracket at the top end.


There will be two new tax brackets phased in over three years at $100,000 and $250,000. At $100,000 income tax will increase from 10% to 11.5%. At $250,000 tax will climb up to 12% for 2018 and then drop down to 11.5% in 2019. After 2019 only two tax brackets will remain in AB - less than $100K and greater than $100K. At the peak in 2018, an individual earning $250,000 will pay $2,250 more in provincial taxes than they do at current rates which theoretically should not be uncomfortable. The new tax brackets are expected to mitigate 10% of the deficit.


More important than the actual balancing of the budget is the idea that it represents. Governments striving to maintain a balanced budget shows residents that it’s important to live within your means. Leadership comes from the top, and it would be wonderful for all of Canada to embrace this new culture.


Lesson we can learn:


Cash flow planning is important. The Alberta government has set the long term goal of using 50% of oil revenues for operations (down from the current 100%), and the other 50% will be split equally between debt repayment and savings. Everyone could benefit from setting a cash flow plan and sticking to it. Did you get a tax refund back this year? How does 50% for spending, 25% for debt repayment and 25% for savings sound?


Encouraging Personal Savings

Investors in Canada have two reasons to celebrate the new federal budget. The first is the reduction in RRIF minimums, and the second is an immediate retroactive increase to TFSA contribution room.


RRIFs are the decumulation version of RRSPs (you accumulate in an RRSP, and you decumulate in a RRIF), with legislated minimum amounts that must be withdrawn every year. In theory, withdrawing only the minimum produces a consistent and sustainable indexed income for life. Previously, the minimum withdrawal formula was based on a 7% rate of return and a 1% annual increase, which was causing some investors to withdrawal (and pay tax on) income too soon. The investors impacted the hardest were the ones with the least flexibility - anyone who was still working due to circumstance (rather than choice) after age 72 was fighting against a significant tax headwind.


The new budget updates the formula to a 5% rate of return and a 2% index, which reduces the minimum income requirement between age 72 and 94 by about a third.


The second widely anticipated change is the increase in TFSA contribution room from $5,500 to $10,000 for 2015. The CRA has confirmed that, even though the budget has yet to be ratified, investors can act immediately on the increase.


Lesson we can learn:


The government recognizes that individual savings are necessary for the long term economic growth and stability of our country, and will also be needed to fund the majority of personal long term income needs (CPP & OAS should be less than a third). They want you to save. You should want you to save too.


An Entrepreneurial Nation

There are three major changes impacting small business owners. First, phased in over the next three years, the tax rate on small business will be reduced by 2%. The dividend income gross-up will also increase to maintain integration, so the tax-savings will only be meaningful if income is retained at a corporate level. For small business owners, the saving within your holdco vs RRSPs conversation is about to get a lot more interesting.


In addition, the lifetime capital gains exemption on the sale of small businesses, farms, and fishing property is currently $813,600. An additional item in the budget looks at increasing the exemption on farms and fishing property (not small business though) to an even million. This is really good news for our local farmers, potentially creating $37,000 to $41,000 of tax savings on the sale of land (assumes 50% inclusion rate and 39%[AB] to 44%[SK] marginal tax rates).


And finally, a potentially huge announcement is the ability for a private business owner to donate the proceeds of the sale of their company to a charitable organization (sale has to be arms-length and proceeds donated within 30 days) and receive a full waiver of capital gains.


In addition to the elimination of capital gains, potentially saving major tax, the small business owner would receive a total combined charitable tax credit of 50% in Alberta or 44% in Saskatchewan, which is equal to or greater than the highest marginal tax bracket. This means pay no tax on the sale of the business, and getting a significant tax credit that can be applied against other income in the current year (or for the next 5 years). While the sale of the business has to be arms-length, the seller can double up their legacy by creating a registered private foundation for the business proceeds.


Normally with this type of strategy we look at transfers on death using a buy-sell agreement, and we fund the private foundation with a life insurance policy. Now, we can significantly increasing the foundation’s assets by using the business proceeds to fund it rather than the insurance. Without capital gains to worry about, the life insurance can replace the business proceeds in the estate so that it remains fully funded and the CRA is just about completely removed from the equation.


Lessons we can learn:


Tax savings for small business owners can have an economic impact that percolates through to the rest of society. If you are a small business owner, make sure you are maximizing your impact by taking advantage of tax planning strategies.


If you have questions on changes to the federal or provincial budgets, or for more information on taking advantage of some of the advanced tax planning strategies available to you, speak with a CERTIFIED FINANCIAL PLANNER® today.




Written by Meagan S. Balaneski, CFP, R.F.P CERTIFIED FINANCIAL PLANNER®
Advantage Insurance & Investment Advisors

Investment Funds Representative
Manulife Securities Investment Services Inc.

The opinions expressed are those of Meagan S. Balaneski and may not necessarily reflect the views of Manulife Securities Investment Services Inc.

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