How investment income can be taxed at a lower rate or not at all .
By Michael Landry For years, one of the simplest forms of tax planning has been to buy secur¬ ities that, until they mature, allow in¬ terest to accumulate tax-free. Before 1974, for instance, people who owned Canada Savings Bonds could defer pay¬ ing taxes on the interest as long as they let the interest accumulate and did not collect the cash. Although this is no longer true of new issues of Can¬ ada Savings Bonds, many banks and trust companies offer savings certificates that work in much the same way. Taking advantage of these can often save money for the taxpayer. Suppose a physician with a taxable income of $25 000 invests $10 000 in a 5-year trust certificate at 10%. If taxes are paid yearly on the interest and the remaining interest is reinvested, the transaction is worth a net $13 114 after 5 years. On the other hand, if that same doctor invests that amount in a savings certificate for which taxes are deferred, the net after 5 years is $13215 the extra coming from having the use of the deferred tax money. If the physician is olose enough to retirement when he purchases the cer¬ tificate that it matures after his retire¬ ment, when he is in a lower tax bracket, his savings will be even better. But what about the physician who is not within 5 years of retirement? For him, there is a plan known as the single premium deferred annuity (SPDA), which allows interest accumulation taxfree for a much longer period. As its name indicates, the SPDA re¬ quires its purchaser to pay a lump sum, or premium, which will be paid back with interest sometime in the future. At present, the government unofficially allows taxpayers to set maturity dates for SPDAs up to age 75 and, thus, to defer income tax on the interest for an extended period. At any age, a taxpayer may purchase an SPDA contract and set the date at which repayment begins, 10, 15 or more years later. Meantime, the initial deposit collects interest without any current tax liability for the tax¬ payer.
Options
ment purposes is
Michael Landry,
vice-president
of MD
Management Ltd., the CMA's membership service subsidiary. types of annuity, such as one which
provides that the purchaser will be paid a certain sum monthly for life. (In this particular contract, if the investor dies before it matures, all the accumulated interest is paid tax-free to the beneficiary). If the purchaser chooses to be repaid by an annuity, he will pay tax only on the interest portion of each annuity payment that is, the capital will not be taxed. Let us imagine an example. Dr. Jones earns a constant $28 000 net. He and his wife already have the $1000
investment income that is allowed to each investor tax-free. Now he invests $10 000 at 9% in an SPDA for 20 years, during which period it grows to $56 000. If he takes the whole in one lump sum and is still working, he will pay tax on it of $24 900, leaving an accumulation of $31 100. Had he in¬ vested the original $10 000 at 9% and paid tax each year, reinvesting the re¬ maining income, his accumulation would have been only $25 000. However, if Dr. Jones takes the ac¬ cumulation after his retirement (when his income tax bracket would be lower) he could purchase an annuity to spread the income over a number of years. Obviously, the lower the tax bracket, the higher the after-tax yield. The SPDA becomes even more at¬ tractive when it is used to benefit per¬ sons other than the taxpayer for in¬ stance, his children. Funding for a child's college expenses should be anti¬ cipated well in advance. Money given to children for invest¬
Most contracts offer several options one of which allows the purchaser to surrender the contract at any time and pay income tax on the accumulated interest. Other options are different 564 CMA JOURNAL/MARCH 20, 1976/VOL. 114
normally taxed as if the parent earned it. However, this income attribution rule does not apply where the property is transferred to a trust for the benefit of a person under 18 if the property does not become his or hers until age 18 or later. Many taxpayers have combined the benefits of an SPDA with those of such a trust; the result is a monthly stipend for their children who are travelling, attending university, ete. To do this, the taxpayer sets up a trust, and then the trust purchases single premium de¬ ferred annuities the regular annuity payments to commence sometime after the child's 18th birthday. When the child reaches maturity, he may sur¬ render the SPDA contract and collect the premium and accumulated interest, or he may choose to spread repayments over a number of years. He pays in¬ come tax on the money as he receives it, and, if he is in college, he has per¬ sonal exemptions and tuition fees to offset the income. Suppose Dr. Jones were to set up a trust for his daughter, Eve, and con¬ tribute $5000 or her 10th, 11th and 12th birthdays. After each contribu¬ tion the trust purchases a single pre¬ mium defeTred annuity, to mature on Eve's 18th birthday. The accumulated value in the trust, at 9% interest, would be $27 500. At that time, let us sup¬ pose, Eve realizes she will spend the next 5 years in university; thus she chooses to have the accumulated value paid back over those 5 years. This an¬ nuity provided an income of $6500 in each of the 5 years, and only $3600 of it is taxable. The balance is considered a return of capital. Because Eve has no other income and her tuition fees are $900, she actually pays no tax at all on the annuity. How much tax would be saved? If the three single premium deferred an¬ nuities had been set up in Dr. Jones's name and the accumulated value paid to him over the 5 years that Eve atattended universiy, his taxable income would have been higher by $3600 a year, less the dependent deduction he would have had for Eve. At a constant taxable income of $28 000 during that 5-year period, he would have paid $1832 a year in taxes on the annuity. Extrapolating these figures over the 5 years reveals the Joneses saved approx¬ imately $7500 in taxes by combining an SPDA and a trust arrangement. ¦
By Michael Landry For years, one of the simplest forms of tax planning has been to buy secur¬ ities that, until they mature, allow in¬ terest to accumulate tax-free. Before 1974, for instance, people who owned Canada Savings Bonds could defer pay¬ ing taxes on the interest as long as they let the interest accumulate and did not collect the cash. Although this is no longer true of new issues of Can¬ ada Savings Bonds, many banks and trust companies offer savings certificates that work in much the same way. Taking advantage of these can often save money for the taxpayer. Suppose a physician with a taxable income of $25 000 invests $10 000 in a 5-year trust certificate at 10%. If taxes are paid yearly on the interest and the remaining interest is reinvested, the transaction is worth a net $13 114 after 5 years. On the other hand, if that same doctor invests that amount in a savings certificate for which taxes are deferred, the net after 5 years is $13215 the extra coming from having the use of the deferred tax money. If the physician is olose enough to retirement when he purchases the cer¬ tificate that it matures after his retire¬ ment, when he is in a lower tax bracket, his savings will be even better. But what about the physician who is not within 5 years of retirement? For him, there is a plan known as the single premium deferred annuity (SPDA), which allows interest accumulation taxfree for a much longer period. As its name indicates, the SPDA re¬ quires its purchaser to pay a lump sum, or premium, which will be paid back with interest sometime in the future. At present, the government unofficially allows taxpayers to set maturity dates for SPDAs up to age 75 and, thus, to defer income tax on the interest for an extended period. At any age, a taxpayer may purchase an SPDA contract and set the date at which repayment begins, 10, 15 or more years later. Meantime, the initial deposit collects interest without any current tax liability for the tax¬ payer.
Options
ment purposes is
Michael Landry,
vice-president
of MD
Management Ltd., the CMA's membership service subsidiary. types of annuity, such as one which
provides that the purchaser will be paid a certain sum monthly for life. (In this particular contract, if the investor dies before it matures, all the accumulated interest is paid tax-free to the beneficiary). If the purchaser chooses to be repaid by an annuity, he will pay tax only on the interest portion of each annuity payment that is, the capital will not be taxed. Let us imagine an example. Dr. Jones earns a constant $28 000 net. He and his wife already have the $1000
investment income that is allowed to each investor tax-free. Now he invests $10 000 at 9% in an SPDA for 20 years, during which period it grows to $56 000. If he takes the whole in one lump sum and is still working, he will pay tax on it of $24 900, leaving an accumulation of $31 100. Had he in¬ vested the original $10 000 at 9% and paid tax each year, reinvesting the re¬ maining income, his accumulation would have been only $25 000. However, if Dr. Jones takes the ac¬ cumulation after his retirement (when his income tax bracket would be lower) he could purchase an annuity to spread the income over a number of years. Obviously, the lower the tax bracket, the higher the after-tax yield. The SPDA becomes even more at¬ tractive when it is used to benefit per¬ sons other than the taxpayer for in¬ stance, his children. Funding for a child's college expenses should be anti¬ cipated well in advance. Money given to children for invest¬
Most contracts offer several options one of which allows the purchaser to surrender the contract at any time and pay income tax on the accumulated interest. Other options are different 564 CMA JOURNAL/MARCH 20, 1976/VOL. 114
normally taxed as if the parent earned it. However, this income attribution rule does not apply where the property is transferred to a trust for the benefit of a person under 18 if the property does not become his or hers until age 18 or later. Many taxpayers have combined the benefits of an SPDA with those of such a trust; the result is a monthly stipend for their children who are travelling, attending university, ete. To do this, the taxpayer sets up a trust, and then the trust purchases single premium de¬ ferred annuities the regular annuity payments to commence sometime after the child's 18th birthday. When the child reaches maturity, he may sur¬ render the SPDA contract and collect the premium and accumulated interest, or he may choose to spread repayments over a number of years. He pays in¬ come tax on the money as he receives it, and, if he is in college, he has per¬ sonal exemptions and tuition fees to offset the income. Suppose Dr. Jones were to set up a trust for his daughter, Eve, and con¬ tribute $5000 or her 10th, 11th and 12th birthdays. After each contribu¬ tion the trust purchases a single pre¬ mium defeTred annuity, to mature on Eve's 18th birthday. The accumulated value in the trust, at 9% interest, would be $27 500. At that time, let us sup¬ pose, Eve realizes she will spend the next 5 years in university; thus she chooses to have the accumulated value paid back over those 5 years. This an¬ nuity provided an income of $6500 in each of the 5 years, and only $3600 of it is taxable. The balance is considered a return of capital. Because Eve has no other income and her tuition fees are $900, she actually pays no tax at all on the annuity. How much tax would be saved? If the three single premium deferred an¬ nuities had been set up in Dr. Jones's name and the accumulated value paid to him over the 5 years that Eve atattended universiy, his taxable income would have been higher by $3600 a year, less the dependent deduction he would have had for Eve. At a constant taxable income of $28 000 during that 5-year period, he would have paid $1832 a year in taxes on the annuity. Extrapolating these figures over the 5 years reveals the Joneses saved approx¬ imately $7500 in taxes by combining an SPDA and a trust arrangement. ¦
