Preserving Capital in Inflationary Times

Evelyn Jacks

Preserving capital in the current environment includes three goals: managing the financial triggers caused by the current environment, understanding the tax-efficient "wealth horizon", and preserving income-producing capital in advance of transition events: retirement and death of a taxpayer. 

Have you discussed these with your clients?  Here are some tips for starting new fall planning conversations:

Manage the Current Environment. Today’s investors, particularly retirees or business owners who are short of cash, may be tapping into inflation-eroded capital to shore up consumption needs. That’s not ideal. Understanding and managing the triggers that cause your clients to make financial decisions is critical.  Proactivity is important – a chat about increased interest costs, a tax audit you may not know about, or a new illness in the family - can all provide opportunities for you to build on relationships while helping clients make sound financial decisions that will follow a pre-determined financial plan.

Down the road, the potential of a mild recession provides additional challenges.  That’s because, in a recession, the economy slows down, and wages, prices, profits, business valuations and government revenues all can all fall.  What coping strategies are available for your worried clients?  Are there opportunities here?

From a tax viewpoint, yes, especially for business owners. Consider whether this is a good time to:

• Value taxable assets and review retirement and estate plans?
• Crystalize the value in the company?
• Pay out any available tax-free capital dividends in the Capital Dividend Account (CDA)?
• Realize capital losses in the corporate investment portfolio?
• Carry back losses to prior years to recover tax refunds?
• Reduce corporate or personal instalment payments?
• Tax into TFSA deposits to shore up cash flow needs, with a view to redepositing early in the new year?

Retirement Assets - Manage the Wealth Horizon:  Melting down taxable registered assets over the longest possible retirement period is critical to avoid paying tax at top marginal rates in the hands of the last survivor. Consider the tax-efficient wealth horizon:  the number of years left to the end of life of the youngest family member:

• If that’s 20 years, calculate how much must be added to income each year of the wealth horizon to generate tax at the lowest possible  -  a worthwhile exercise which may surprising:  even at the age of 55, taxpayers are often already behind in maximizing their after-tax retirement returns.    
• What investment strategies can be put into place to create more tax-efficient income sooner?
• Are there opportunities to reduce income with tax-deferral vehicles, like the new ALDA (Advanced Life Deferred Annuity)?
• Can taxable income be split with spouse or family, or, if single, with the community through a strategic philanthropic plan?

Win on Estate Planning: Manage Capital Preservation.   The timing of asset dispositions can affect tax costs. This can be controlled while the taxpayer is alive, but generally not at death, at which time a deemed disposition occurs. Consider the following strategies:

• Should a spousal loan be created before the end of the current quarter, take advantage of lower prescribed interest rates, and transfer assets to equalize income withdrawals from a non-registered portfolio in retirement?  
• Should a disposition or transfer of assets occur this year, when valuations may be lower? 
• Should the sale of a piece of property be structured over several years to take advantage of capital gains reserving provisions?  
• Should principal residence holders use home equity to take on a loan for investment purposes and generate tax-deductible interest, and in doing so, diversify investments? Or should they do the opposite – pay off loans in anticipation of higher interest rates?

The Next Steps:  It is unclear whether inflation has peaked or if the threat of a recession has been averted.  However, what investors can be sure of is, that proactive planning that includes the integration of a sound tax strategy with a stellar investment portfolio, and after-tax income can be maximized and the value of capital preserved.

These proactive conversations and tactics can also calm investor behavior, thereby helping everyone stick to longer-term wealth management goals.

Additional Educational Resources: For more information, join us at the September 21 Virtual CE Summit on Audit Defence for Small Business Owners or live at DAC Acuity 2022 in Niagara Falls. This year’s theme: Velocity – How to Gain Momentum in the New Economy.