Financial Planning, Investment Counselling, Tax and Accounting

Contents

Market update
How to pay tax on half your income
TFSA update

Market update

As you read this newsletter, it’s just past the end of the third quarter in what continues to be a most eventful year for stock markets and the economy.

It’s also one year since the weekend that shook the foundations of Wall Street and of the global financial system—when Lehman Brothers collapsed, Merrill Lynch vanished as an independent entity, and AIG was taken over by the U.S. government.

In light of that, we thought it might be worthwhile to briefly summarize where we’ve been over the last year, where we are today, the prospects for the period ahead, and any lessons learned.

Where we’ve been

In June of 2008, the market was characterized by rampant optimism. Canadian markets had hit new highs and any concerns were set aside as minor annoyances. Four months later we were in the midst of a global financial crisis and it truly did feel like the world might be coming to an end. Talk of a return to a Great Depression-like economy dominated radio, television, and newspaper reports. From October 2008 to March 2009, fear was rampant and stocks responded to the many nightmarish scenarios by hitting the lowest levels in years, with financials especially hard hit.

Although no one knew it at the time, March 9, 2009 turned out to be the bottom. Since then, we’ve seen the economy move back from the precipice, and there is a growing consensus that we will see updated statistics that could report economic growth in the second half of this year. The Economist recently ran a cover story discussing the extent to which the economic recovery was led by Asia.

As a result, we’ve had a strong recovery in markets—up 50% from their bottom in the beginning of March and retracing a good portion of the losses since last fall. The second quarter of this year, from March to June, was especially strong. Since 1956 the Canadian market has only had three quarters when the market has risen more than this one.

What important lessons have we learned in the last 12 months?

1. We were reminded of just how volatile stocks can be.
2. And of the importance of true diversification.
3. Many investors discovered that they’re less comfortable with risk and volatility in their portfolio than they had believed.
4. Investors were also reminded of the need to focus on what they can control, understand cash needs, and think through how much risk they can tolerate to fund those needs.
5. In some cases, investors began rethinking retirement plans.
6. Finally, we were reminded that, in today’s world, we should expect the unexpected.

Where we are today

Today, the market is somewhere between absolute pessimism and euphoria, and many investors can be characterized as extremely nervous.

As a general rule, a certain level of nervousness is positive. What gets investors in trouble is an excess of either optimism or pessimism. While today’s mood may be erring on the side of being a bit too pessimistic, we think that being cautious in the current market makes sense, provided that prudent caution doesn’t cross the line into panic.

The good news is that there are still excellent opportunities for investors who are prepared for short term volatility. We spend a lot of time listening to the best market minds and to money managers who have lived through multiple cycles. We are reassured that most say that they are still finding very good value—not to the extent that they did earlier this year — but still well ahead of that they would have seen a year ago.

The outlook going forward

In August, Business Week ran a cover story called “The Case for Optimism.” The premise was simple: Beyond the issues facing the global economy, there are many underlying positives that give cause for optimism if we look out two to three years and beyond.

There are things happening under the surface that will drive economic growth, and with that economic growth will come growth in stock prices. Examples include the positive impact of technology, the recovering U.S. housing market, the revitalization of economies, and the incredible energy from the developing world’s educated youth and emerging middle class.

Volatility

Let us close by talking about market volatility. In 1907, U.S. financier J. Pierpont Morgan singlehandedly averted a banking panic among U.S. investors. Later in life, someone asked him his best guess on the direction of markets. He answered, “They will go up and they will go down.”

One hundred years later, that’s still the best answer for someone looking for a short term market forecast. No one can predict market movements in the immediate period ahead. All we can do is understand clearly how much short term volatility we can live with, adjust our portfolios accordingly, and stay focused on the horizon as we deal with the rough waters.

No one likes volatility but, for most of us, it’s the necessary price to arrive at our ultimate destination.

Thank you for the continued opportunity to work together. Remember, we are always here should you have any questions or wish to talk about anything related to your portfolio or your finances.

Today’s tip: How to pay tax on only half your income?!

Although various types of income receive preferential tax treatment, such as capital gains (50% taxable) and dividend income (tax reduction via the dividend tax credit), employment or consulting income is normally 100% taxable.

However, according to recent high-profile press reports, there is now a new tax planning strategy that may allow you to pay tax on only 50% of your consulting income. This strategy works as follows:

1. Claim to perform consulting work and insist on getting paid in envelopes stuffed with cash. Let’s assume the amount is $225,000.
2. Rather than declare this cash as income, store it in safes and a safety deposit box for a few years.
3. Once it appears that CRA may become aware of the payments, have your tax counsel approach them on an anonymous basis under their Voluntary Disclosure Program.
4. As part of the full and complete disclosure, negotiate with CRA to pay tax on only 50% of the income disclosed ($112,500).
5. Don’t forget to mention your former employment as Prime Minister of Canada.

TFSA update - CRA has recently clarified the beneficiary rules for Tax Free Savings Accounts (TFSA)

What happens when the planholder of a TFSA dies?

The deceased planholder is considered to have received, immediately before death, an amount equal to the fair market value of all the property held in the TFSA at the time of death. All earnings that accrue after the planholder’s death will be taxable to the beneficiaries and must be reported by the plan holder’s beneficiaries in their income for the year it is received.

What if the spouse or common-law partner is the sole beneficiary of the TFSA?

If the TFSA at death is left solely to a spouse or common-law partner of the planholder, the TFSA continues in the name of the spouse or common-law partner as successor holder under the plan.

What if the spouse or common-law partner is not the sole beneficiary of the TFSA?

If the TFSA at death is left to the deceased planholder’s spouse or common-law partner and other beneficiaries, CRA does not consider the other beneficiaries as successor planholders.

What if the spouse or common-law partner is not named as beneficiary in the TFSA contract but in the will?

Then the deceased holder’s estate is the beneficiary. If the will states that the spouse or common-law partner is the sole beneficiary of the estate, the spouse or common-law partner becomes the successor planholder.