It's Your Money  

It pays to be segregated

A recent judgment from the Tax Court of Canada reaffirmed the strong case to be made for creditor proofing your investments with segregated funds.

Earlier this year, the Canada Revenue Agency (CRA) attempted to seize the death benefit of a segregated fund account that was paid to the two daughters of an individual who had passed away.

The two daughters were named beneficiaries of their father’s account that was invested entirely in segregated funds.

While this account was used solely for investment purposes, being a segregated fund meant that it falls under the Insurance Act of Canada and not the Bank Act. Therefore, when it comes to taxation and estate matters, it is treated as a life insurance policy for tax purposes.

In its submissions, the CRA relied upon subsection 160 of the Income Tax Act which states, among other things, that when someone transfers property to a non-arm’s length person (such as a child) without proper consideration, the recipient may be on the hook for income taxes owing by the transferor.

When assets pass outside the estate of a deceased person, the CRA will often use section 160 to attempt to pursue the funds to pay taxes otherwise owing.

However, in this case, the investment assets were held in segregated funds and, as mentioned above, they are treated in the same manner as the proceeds from a life insurance policy.

With that in mind, the court found that the money paid out to the two daughters constituted life insurance proceeds payable to named beneficiaries and they did not form part of the father’s estate nor were they subject to pursuit through the section 160 clause.

The decision proved as a great reminder of the benefits of segregated funds and helped reaffirm the legal status of segregated funds and the features that they possess.

In addition to providing creditor protection (whether from the CRA or an outside party), they also bypass the estate as a whole which can greatly reduce estate and probate costs.

For non-registered investments, they can also provide some additional tax savings and reduced accounting costs as well.

Like most other investment options, segregated funds can be purchased in a wide variety of options and properly understanding the type of investments and fees involved is important.

While some segregated funds carry substantially higher fees, others can have the exact same fee structure as comparable mutual funds, which means you get the added benefits of creditor protection and tax savings for free.

Make sure you speak to a qualified financial advisor before investing in something new and don’t be afraid to ask a lot of questions and do your research.          

Choose right adviser

Investment advisers who provide advice to Canadians are typically registered through one of two bodies.

The Mutual Fund Dealers Association (MFDA) and the Investment Industry Regulatory Organization (IIROC) are both self-regulatory organizations that follow the rules set out by the various provincial securities regulators.

There is, however, a third option and it’s not always being used for legitimate reasons.

In addition to insurance, life insurance companies offer investment products often called “segregated funds” that any insurance licensed salesperson can sell to their clients without holding a license with either investment body.

While segregated funds are good niche products that are a great option for some situations, they certainly aren’t meant for everyone.

No doubt there are some who sell only these types of investments who still try to have their client’s best interests in mind, but they are not meant for everyone and many investors should not be using them.

Worse still though, is that some are using this loophole for one of two far more sinister motives.   

The first motive involves a simple unwillingness to adhere to regulations that are put in place to protect consumers. Licensing by the MFDA or IIROC involves significant disclosure and compliance requirements that are strictly enforced.

I have met far too many “advisers” who either used to be investment licensed or chose not to get licensed as they felt that the regulations were simply too challenging or annoying.

They’ve stated that they would rather just sell segregated funds and avoid dealing with all these “rules.” And yes, they know by doing this, they may not be offering the best options to their clients and may be forcing their clients to pay higher fees than necessary.

A couple of years ago, when the Canadian Securities Administrator’s Client Relationship Model (better known as CRM2) rolled out, we saw an even bigger shift of assets into these segregated funds to avoid transparency.

CRM2 requires securities dealers to provide greater fee transparency and disclosure and segregated funds are again exempt from these rules. Some saw this loophole as a way to avoid telling their clients how much they charge in fees.

The second and even more disturbing motive in selling investments solely through the insurance platform is due to being permanently banned from the securities industry.

Yes, you read that right – there are advisers who have been permanently banned from selling securities for wrongdoings that simply move all of their client’s money over to segregated funds and keep on working.

While most regulators (both securities and insurance) realize that this is a problem that needs to be fixed, the framework needed to make this happen is not yet properly established.

There is still limited information sharing about enforcement decisions between many of the provincial and federal regulatory bodies and even if the appropriate insurance authorities are made aware, they still have to conduct their own investigation into the incident(s) in question which all takes time.

Since most bodies don’t have formal information sharing arrangements, the insurance regulators rely on reporting of the disciplinary actions by the licensees themselves, something they may not be willing to disclose.    

What can you do to protect yourself? Take the time to find out what types of licensing and designations your current or prospective advisor holds. The investment advice marketplace is confusing and it’s up to you to ensure that you are receiving advice from someone who’s fully qualified and bound to the highest standards of regulatory oversight.

If your adviser has placed all of your investments with an insurance company, ask if they also hold an MFDA or IIROC licence. If they don’t, it may be time for a second opinion.

Pick out your Ferrari

Do you want to drive a new Ferrari when you retire?

What if I were to tell you that you can afford to and all you have to do is quit smoking.

This week I wanted to demonstrate the power of compounding and I’ve decided to take a slightly different approach to illustrating it to you.

Deciding not to smoke cigarettes has been clearly demonstrated to provide significant health benefits and will likely add many years to your life.

But what about the financial benefits of this decision?

Many smokers start fairly young and for this example, let’s assume that you start smoking at age 16 which happens to be the same age that many people get their driver’s licence. 

Starting smoking at age 16 and burning through (literally) half a pack a day will cost you approximately $2,256 a year. Now let’s instead of putting that $6 a day toward cigarettes, let’s say you decide to invest the money instead. 

Without adjusting for the price of cigarettes going up over time (inflation), you would have $652,743 in your investment account at age 65 when you are ready to retire if you averaged a six per cent per year rate of return.

If, once you turn 18, you invest all of this money inside of a TFSA, the full $652,743 would be tax free money as well.   

I decided to take inflation out of this example for simplicity’s sake.

The price of cigarettes will no doubt rise over time, but so will the price of cars. If we assume that the inflation on both purchase prices are somewhat equal, we can remove this from the example and talk in today’s dollars for both the cigarettes and the car.   

Now comes your reward. Depending on how many options you choose, you can buy a new Ferrari for around $300,000.

If you decide not to take up smoking and put the equivalent money away from the time you get your driver’s licence until the time that you retire, you have enough money on the side for not one but two new Ferraris.

You’ll even have enough money left over to take a trip around the world for two. Not a bad way to kick off your retirement and since you didn’t smoke, you will likely have a longer and healthier retirement as well.   

The above example may seem a little extreme, but it really isn’t. How many people can carve $6 a day out of their expenses?

How much do you spend each day at Starbucks on that fancy coffee?

How much could you save per day if you packed a lunch for work instead of buying your lunch each day? 

The power of compounding is enormous and the above example just goes to show how much you can put away if you start early. 

Of course, the main benefit to not smoking is certainly still your health. For those who don’t think a healthy retirement is enough, maybe the dream of a shiny new Ferrari waiting for you can provide that little bit of extra motivation... 

Parents and grandparents, copy this article (maybe attach a picture of a new Ferrari) and pass it on to any teenagers you have in your lives.

Who knows, this could be the extra motivation they need to make the right decision and never pick up the habit. 

Make your teen money wise

Over the past couple of weeks, I have written about the general lack of financial literacy in our youth and the almost complete absence of teaching these skills in our school systems.

In the final article of this three-part series, I will continue the discussion of ideas you can use to help pass on these important lessons to the teenagers in your lives and look at some strategies that will help older teens.    

By the time your teens turn 16 (and if you’ve followed my advice from the previous two articles), they should know that they will have to save and budget for the things that they want.

While you may find it difficult, now is the time to increase their financial independence. This can be done in many different fashions but here are a few suggestions:

Consider giving your teen enough money to cover things like clothing for the year at the beginning of the school year. Make it very clear that they won’t be getting any more money and it will be up to them to budget appropriately.

Most teens crave more independence and responsibility so use it to provide some valuable financial skills.   

Instead of handing them cash, deposit money directly to their bank accounts and have them manage their funds via online banking and a credit card with a low limit.

At the beginning, make sure to go over month end bank and credit card statements together and use these times to discuss how credit card interest is calculated and illustrate how quickly debt can compound. 

If your teen has a part-time job, encourage them to “pay themselves first” by putting away 10% of each pay cheque into a long term investment account meant only for their retirement.

While the urge to use this money for a car or even school will be high, starting them on the retirement savings path this early can have a profoundly positive impact on their future. 

Bring your teen along to a meeting with your financial adviser who can open an investment account for them and help illustrate how powerful compounding can be over the 45+ years until they retire.

 A simple investment growth calculator, which can be found easily online, can illustrate how immense a small and regular contribution can grow to if given enough time.   

Another very worthwhile exercise is to have your teen create a hypothetical budget for leaving home. They should put together a list of how much they would need for rent, vehicles, utilities, food, entertainment and other expenses.

Once it’s complete, provide them with a sample paycheque for an entry level job, net of taxes, CPP and other deductions of course. 

Now, have your teen start reconciling their expenses by trimming enough out of their budget to balance out. It can be a great benefit for older teens to perform this “dress rehearsal” and you have all the resources at home to put the budget together.

You can use your existing monthly bills to help illustrate what their expenses might look like.         

Attempting to teach financial literacy is an intimidating and often overwhelming project but if you don’t do it, who will?

It is never too early to start and if you don’t feel comfortable or capable, consider enlisting some help from a family member, friend and/or your own financial planner. 

Saving properly and spending wisely are not the dominant cultural values in North America these days.

As a parent, you will be going against the grain when you attempt to pass on some worthwhile lessons and values. But, with some honest discussion and realistic goal setting, hopefully you can help your own teens buck the trend and move in the right direction to achieve their own dreams. 

For more information, a number of excellent resources can be found at: www.moneyandyouth.com

And if you missed part one or two of this three part series, feel free to email me for copies!                        

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About the Author

Brett, designated as a chartered investment manager and certified financial planner, is the regional director (Okanagan) for IG Wealth Management.

In addition to his “day job," Brett was appointed to the board of directors of FP Canada (formerly FPSC) in 2014, named as the board’s vice-chair in 2017 and will take over as board chairman in June. 

Brett has been writing a weekly financial planning column since 2012 and provides his readers with easy to understand explanations for the complex financial challenges that they face in every stage of life.

Enhancing the financial literacy of Canadian consumers is a top priority of Brett’s and his ongoing efforts as a finance writer and on the regulatory side through the FP Canada board focus on this initiative.   

Please let Brett know if you have any topics that you’d like him to cover in future columns by emailing him at [email protected].

The views expressed are strictly those of the author and not necessarily those of Castanet. Castanet does not warrant the contents.

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