How Can Paul And His Wife Save Tax On Their $2-million Portfolio?

Q. My wife and I are recently retired and have a portfolio of about $2 million in dividend paying stocks, pipelines, utilities and some exchange-traded funds (ETFs) tracking Canadian and U.S. high dividends stocks as well as S&P 500 and world equity shares. We also have $900,000 in guaranteed investment certificates (GICs) and high-interest savings accounts (HISAs). We are also fortunate to have defined benefit pension plans and annuities producing about $100,000 in income per year. My question is, what should I be doing with our investments at this point? We won’t likely ever spend all this money. We have two very successful sons and five grandchildren. We’d like to pay less tax but who wouldn’t? Any thoughts would be helpful. —Thanks, Paul

FP Answers: If your goal is reducing your annual tax bill, Paul, you may benefit from a strategy that uses asset location to guide asset allocation. Asset location refers to holding investments in different types of accounts based on how they are taxed to shelter certain types of income.

In your case, however, you did not mention holding registered retirement savings plan (RRSP) assets, which is not uncommon for retirees with large defined benefit pension plans. Without registered accounts, traditional asset location strategies become somewhat less relevant if most of your investments are in taxable accounts. Generally speaking, asset location tends to favour the following structure:

• High-interest savings accounts and GICs are the least tax-efficient investments in non-registered accounts because interest income is taxed at full marginal tax rates.
• Canadian dividend-paying stocks are typically more tax efficient in non-registered accounts due to the dividend tax credit, leading to a reduced tax rate on Canadian dividends versus other income.
• U.S. dividend-paying stocks generate foreign income, which is also taxed at full marginal tax rates like interest.
• Non-registered accounts benefit from the preferential taxation of capital gains, along with the ability to offset gains with capital losses.
• U.S. stocks held in a tax-free savings account (TFSA) are subject to a 15 per cent withholding tax on dividends, which is not recoverable.

Based on these dynamics, your GIC holdings are likely the least tax-efficient part of your portfolio. That said, this is somewhat by design. Generally speaking, the more certainty an investment provides, in terms of income or capital, the more likely its income will be fully taxable. Pension income is a good example. While pension income is less tax efficient than Canadian dividend income, the trade-off is the security and predictability that comes from decades of contributions and deferred tax savings during your working years.

With approximately $2 million invested in global stocks and $900,000 in cash equivalents, your overall portfolio allocation is roughly 70 per cent stocks and 30 per cent cash or cash equivalents. Portfolios in this range are typically considered balanced growth or growth-oriented portfolios.

Because we should not let the tax tail wag the dog, it may not make sense to shift GICs into stocks solely for tax advantages if taking on additional risk is unnecessary. In fact, holding a meaningful cash allocation has become increasingly popular in recent years. Many investors have preferred cash over traditional bonds, particularly after global bond markets experienced double-digit declines in 2022. HISAs and GICs also have interest rates that are comparable to bond yields currently.

Reviewing your annual spending needs should help determine whether portfolio adjustments are necessary for practical cash flow purposes or simply to improve tax efficiency. But your reference to “dividend paying stocks” deserves some attention. If you are biased toward stocks that pay dividends, you are earning more of your return from income taxable annually as opposed to capital growth. Holding a stock that pays a lower dividend that may earn more of its return from stock price appreciation over time may be more tax efficient. Especially if you are a buy-and-hold investor living mostly off your pensions.

Tax planning for retirees often involves balancing the benefits of realizing taxable income today against leaving deferred taxes to the estate later on. Rebalancing a non-registered portfolio frequently involves triggering capital gains or losses, so improving portfolio efficiency may also mean gradually addressing unrealized gains over time.

One approach is a partial “meltdown” strategy, where capital gains are intentionally triggered each year to reduce the future tax burden on the estate. If your unrealized gains are substantial, it may take several years to reposition the portfolio without materially increasing annual taxes.

Additional tax efficiency may also be possible depending on how investment income is split between you and your wife. If your investments are jointly owned and income is already being reported evenly, particularly if your pension incomes are also similar or eligible for pension income splitting, you are likely already operating fairly efficiently from an income-splitting perspective.

If one spouse has materially lower income, however, it may make sense for that spouse to reinvest their after-tax income into accounts held beneficially in their own name, while the higher-income spouse assumes a greater share of household expenses with withdrawals from their accounts.

Since you mentioned that you are unlikely to spend all of your assets, another option is to intentionally increase spending during retirement. Doing so naturally reduces future estate value while allowing you to enjoy more of your wealth during your lifetime.

You could also consider gifting funds to your adult children, which generally does not trigger any tax issues in Canada other than tax on capital gains. A gift itself is not taxable, however. Assisting with registered education savings plans (RESPs) or in-trust accounts for your grandchildren may also help support future education or financial goals if that has not already been explored.

Lastly, charitable giving remains one of the most effective ways to reduce taxes in retirement. Donations generate valuable tax credits and donating appreciated securities directly can be especially tax efficient. By transferring securities in kind you can avoid triggering capital gains tax while still receiving a charitable receipt for the full market value of the donation.

Overall, your situation appears less about maximizing returns and more about balancing tax efficiency, estate planning, family goals and personal comfort with risk — which is a fortunate position to be in, Paul.

Andrew Dobson is a fee-only, advice-only certified financial planner (CFP) and chartered investment manager (CIM) at Objective Financial Partners Inc. in London, Ont. He does not sell any financial products whatsoever. He can be reached at adobson@objectivecfp.com.

Do you have a question for FP Answers? Email wealth@postmedia.com.

• How can I start saving in an RRSP and TFSA when every time I try, debt payments or unexpected expenses derail me?
• My three sons are all co-executors of my will and two live in the U.S. Will this cause problems?