Chapter 14 - Impediments to Wealth Flashcards
(14 cards)
What are the three main burdens to Wealth Accumulation?
- Taxes
- Transaction Costs
- Inflation
What are four types of Taxable Income?
- Interest
- Interest is taxed at the highest combines federal and provincial marginal tax rate, interest may be taxed at a rate exceeding 50%. - Canadian source dividends
and foreign source dividends
- A tax credit makes the taxation of dividend income from Canadian corporations more favourable than the taxation of simple interest.
- Foreign source dividends have no gross-up and no similar tax credit, and are taxed in the same way as
interest income. - Capital gains capital
- Capital gains (or losses) arise from the sale or disposition of capital property.
- Capital gains are taxed the most favourably of all earnings types. Only half of any capital gains realized in a given year are included in income for tax purposes. Thus, the effective capital gains tax rate is half that of the ordinary income rate. - Return of
- A return of capital distribution is not taxable in the year the investor receives it. Instead, the original cost of the unitsis reduced by the distribution amount, and a new average cost per unit, known as the adjusted cost base (ACB), is calculated. The ACB is the figure used to calculate the capital gain or loss when the units are eventually sold.
How does inflation affect Wealth Accumulation?
To maintain the purchasing power of wealth in the long term, an investor must seek assets that make positive net returns after inflation and taxes.
For investors, the lesson is that stocks will perform poorly during periods of high inflation, but should compensate for these negative returns during periods of low or moderate inflation.
What are Transaction Costs and how do they affect Wealth Accumulation?
Transaction costs are any fees, explicit or implicit, that an investor pays to complete the acquisition or disposition of a security. These fees can include visible costs, such as mutual fund management fees or trailer fees, or invisible costs, such as wide bid/ask spreads or market illiquidity.
Unfortunately, investors incur transaction costs whether or not they make a return on their investment.
What are some Tax Minimization Strategies?
- Incorporating tax
implications into each trade - Tax-loss harvesting
- Crystallization (managing unrealized gains)
- Selling the most expensive securities first
- Reducing the yield of securities
- Reducing the turnover of securities
- Purchasing a put option
What is Tax Loss Harvesting?
Tax-loss harvesting is the act of voluntarily taking losses in order to create a current tax deduction to offset realized gains.
Typically you would purchased a highly correlated replacement asset.
What are the four considerations when Tax Loss Harvesting?
Four considerations are very important when making tax-loss harvesting trades:
- The CRA imposes certain limitations
- The CRA imposes limits through its superficial loss rule, which stipulates that investors cannot buy the same security within 30 days before or after the loss trade. - Portfolio risk and return profile could change
- Beware of changing that clients asset allocation when using replacement securities for the 30 days. - Transaction costs may be prohibitive
- Ensure that the loss gained from the tax loss harvesting is greater then any transaction costs you may incur to execute it. - Portfolio losses may be too great
- Tax loss harvesting should be delayed if portfolio losses keep accumulating.
What is Crystallization?
Crystallization is the process of realizing losses in a security and allocating the funds to a position with an unrealized gain in an attempt the lower the cost basis.
You get the capital loss from selling the losing position and you can increase the cost basis of a winning position, therefore decreasing the future potential gain.
What is the Tax Benefit to Selling your most Expensive Securities First?
Only really useful when dealing with a security in 2 or more different accounts.
Look at selling the security in the account with the higher costs basis, therefore realizing less capital gains.
What is the Tax Benefit to reducing the Yield and Turnover of securities?
Reducing the yield of securities in a taxable portfolio will minimize the amount of less tax-friendly interest and dividend income. Tax that is paid today decreases a portfolio’s market value and dampens the effect of compounding returns
- This may unintentionally cause the asset allocation of a portfolio to be more growth oriented
Higher turnover increases the chance for capital losses and reduces a portfolio’s after-tax return, especially over long periods. High turnover also increases brokerage fees, further eroding the value of the taxable portfolio.
What is the Tax Benefit of purchasing a Put Option?
Purchasing a put option is beneficial for investors who want to lock in a price for an investment but may not want to realize the gain until a later date.
What are some Tax Efficient Investments?
- Exchange traded Funds (ETFs)
- Index Funds
- Some Active Mutual Funds
- Tax Sheltered Investments
What are Flow-Through Shares?
A type of common equity issued by junior mining companies which provide certain tax credits to investors based on the costs incurred by the company.
Canadian exploration expenses (CEEs), Qualified
CEEs are accumulated in a pool and are 100% available for deduction in the year they are incurred.
Canadian development expenses (CDEs), A company’s CDEs are accumulated in a pool and tax-paying investors can use up to 30% in unclaimed balances in any one year.
Super Flow Through Shares, Flow through that carry an additional 15% federal tax credit that can be carried back three years or forward 20.
What are some inflation Sensitive Assets?
- Real Return Bonds (RRBs)
- Real Estate
- Commodities
- Collectibles
