You can already see it, it happens every year: February starts, the snow still covers the ground, and spring keeps teasing with the possibility of an early return. What other annual event coincides with Spring’s gentle flirtations? RSP season, courtesy of your local financial institutions! With RSP deadlines looming come the great rush to place money to get your tax deduction.
RSPs have their place, but are grossly overused in my opinion. The deduction is great and the tax-sheltered growth inside the RSP is even better; however, every dollar taken out of the RSP is fully taxed at whatever rate you are at when you access the money. Some advisors might argue that you may be in a lower tax bracket when you access the money, and while this may be true, why would you want to plan to be in an extremely low tax bracket in retirement? Doesn’t that contradict the purpose of planning? Plus, government benefits like CPP and OAS are taxable benefits as well, and your RSP’s adding to your income in retirement can decrease your OAS payment through a claw back.
Another limiting factor to RSPs is that they are limited to how much you can contribute each year. For 2018, the limits are 18% of last year’s total income, to a maximum of approximately $26,000.
So, what other options exist?
Roughly 60 years ago, the Income Tax Act added a tax-deductible option for Canadians that is often overlooked, mainly because the banks don’t offer it despite the fact that it is still available today. It’s called a Flow-through Share. What is a Flow-through Share?
Flow-through Shares (FTS) were put in place to offer a dollar-to-dollar deduction to invest into Canada’s energy sector. Some industries within the energy sector may offer additional incentives to invest, such as the mining industry, which offers an additional 15% tax credit in addition to the dollar-to-dollar deduction. These tax credits come in the form of Canadian Exploration Credits (CEC's), which can make FTS's an enticing option for investors looking to maximize their tax deductions.
While there is no maximum contribution to a flow through share, 2 important aspects you should be consider are The Minimum Tax Threshold, and investment suitability. The Minimum Tax Threshold is applicable if you use government sponsored programs, such as an FTS, and have reduced your tax liability to zero in any given year. You will still be required to pay some tax, but FTS’s can allow you to drop multiple tax brackets to reduce your tax liability in that given year. The second aspect to consider is whether the investment is suitable for you and your current situation. This needs to be determined on a case-by-case basis and is dependent on many factors. It would make sense to spend some time with an advisor who will help you assess the risks and benefits of a flow through option.
The underlying assets of FTS’s are energy sector stocks that are publicly traded. These stocks are purchased at a “premium” because of the benefit of a flow-through, and these stocks can also come with “warrants”. Warrants are added incentives that are given when the stock is purchased, which allow for the stock to be purchased at a future date for a pre-determined price, independently of the trading-value. For example, a stock might be listed for a dollar. A warrant allows you to purchase that stock at any point over the next year or two (depending on the terms of the warrant) at a set price. If the warrant was given for $1.15/share, and the stock rises to $1.50/share, the warrant could be triggered and an immediate benefit would take place. This would increase the value of the shares purchased with the warrant by $0.35/share in this particular scenario.
Some flow through companies want this warrant, which will increase the cost of the premium you pay, but could extend the time that a liquidity event would take place. Others want to keep the fund more “lean” and will opt out of the warrants, which can shorten the time period a FTS will hold the funds and therefore negotiate a lower premium to pay, which will keep the fund leaner for the investors. Either strategy can be successful; however, one gives you more downside risk to the market than others. The energy sector in the past has been very cyclical, and it seems like we are just coming out of a few not so great years, which could mean there is upside potential taking place, and there have been signs of that in the past year.
If you are in the highest tax bracket in Alberta, and you invested in a mining flow through, your capital at risk would be less than 50%. This means if the investment itself lost 50% in value, you would still break even. The money received is now a capital gain, as opposed to RSPs, which are treated as income when they are accessed.
Flow through may or may not be a viable option for you, but it should be something you are aware of to determine if/how it could fit into your portfolio. If you have sold a business or a property (that isn’t your personal residence) or have high income in 2017, FTS’s might be worth considering. Planning for FTS’s should be done within the calendar year, as opposed to RSPs, whose deadline occurs at the end of February of the following calendar year.
If you would like more information on FTS's or even would like me to sit with your accountant to discuss if these are a suitable investment for you, I would be happy to have that conversation.
For questions on this, and any other topics related to financial options, please reach out to me directly at chris@oaktreews.ca
Chris Boyle
780 966 5084