Tax Managed Strategy 10
Not only can charitable donations provide individuals with the satisfaction of giving back to their communities, Canadian tax laws ensure that there has never been a more tax advantaged time to give.
Donating to charities is a strong tradition in Canada and is something many of us find very appealing. Not only are we giving back to those less fortunate but the government rewards us with a tax credit. If you currently donate or are thinking of donating in the future you may be interested in this strategy.
By borrowing to invest you can significantly increase the amount of your donation and your tax savings
The charitable leverage strategy involves taking discretionary cash flow that you might otherwise use to fund an annual charitable donation and instead use those proceeds to pay the interest on money you have borrowed to invest.
The interest payments on the loan are generally tax deductible, and you can use these tax savings to pay the tax on any investment income earned in the year. Remaining amounts can then be donated to the charity. At the same time, you now have a large lump sum amount invested that takes advantage of the benefits of compounding so that you can make a significant donation in the future.
Another alternative is to continue to make your annual charitable donations but use the resulting tax savings to fund an investment loan. The investment loan is used to purchase non-registered investments. The loan interest is generally tax deductible and is paid with the tax savings from your charitable donations. The result being that you now have the potential to significantly increase the value of your non-registered investment portfolio over the long term by having a large lump sum invested that benefits from the effects of compounding, which can also be used to make an additional sizeable future donation if you so choose.
An in-depth look at the issues and opportunities
Normally when transferring the ownership of publicly traded securities like stocks, bonds, mutual funds and segregated fund contracts to charity, the donor would have to pay tax on 50 per cent of the capital gains realized from the assets’ appreciation in value.
However, under a special government incentive program the donation of publicly traded securities benefits from a capital gains inclusion rate that is reduced to zero per cent. In other words, the tax on any capital gains arising from the disposition of publicly traded securities donated directly to a charity has been eliminated – a significant tax savings¹.
With the charitable leverage strategy the cash flow requirements are the same as if you were making an annual contribution. However, in addition to increasing the amount of the donations and the tax savings, this strategy allows you the flexibility to:
- Wind-up the program at any time
- Continue the program for as long as you like to maximize your donations and tax savings
- Hold back the annual donations if you need the money
How borrowing to invest can work – case study
Joe would like to start making annual charitable donations. He has $3,000 of annual discretionary income eligible for contribution. Joe would like to maximize the amount of his charitable contribution and would like to accomplish this as tax efficiently as possible.
Here’s how Joe’s situation looks, using this leverage strategy²:
Determining the amount of the loan
Joe’s annual donation amount will carry an interest-only loan of $60,000, calculated as follows:
How Joe’s situation stacks up
The $3,000 amount that Joe can afford to donate each year is now used to cover all borrowing expenses. The annual interest expense deduction provides Joe with tax savings, which less any tax on the investment income, is donated to charity.
For illustration purposes only. This is a fictional scenario.
What it looks like at year 10³
At the end of year 10, the value of the $60,000 invested is $47,451 (with the loan repaid) which, when combined with the donation of the annual tax savings, results in a total donation of $56,533.
As you can see by utilizing this charitable leverage strategy, Joe’s cash flow requirements have not changed but he has nearly doubled the amount of his donations over 10 years from $30,000 to $56,533. This not only benefits the charity but it also has increased his tax savings by $6,085 – a win-win situation.
Here’s how it works step-by-step
Apply for an investment loan and use the funds to purchase non-registered assets.
Loan interest is paid with the annual discretionary cash flow that you were otherwise going to donate.
Loan interest that is paid becomes a deduction on your tax return.
Tax savings from the interest deduction less any tax on the investment income is donated to a charity each year.
At the end, use the investment to repay the loan and donate the residual to charity.
As outlined above, it’s a simple strategy – and it can make a big difference to your bottom line.
- Individuals currently donating to charity or planning to
- Individuals interested in giving back to their community
- Experienced investors with a long-term horizon and not averse to increased risk
It’s important to remember that this strategy may not be appropriate for someone with a low risk tolerance.
- Use the annual contribution amount to fund a leverage loan to maximize the donation amount and tax savings
Investment options with Manulife Investment Management
Mutual Funds can help meet your specific financial needs, throughout your life. Whether you are just starting out, accumulating wealth or are nearing/in retirement, mutual funds offered by Manulife is committed to providing quality investment products and services so you can enjoy life and worry less.
Manulife Segregated Fund Contracts combine the growth potential offered by a broad range of investment funds, with the unique wealth protection features of an insurance contract. Through Manulife segregated fund contracts, investors can help minimize their exposure to risk through income, death and maturity guarantees, potential creditor protection features, and estate planning benefits – all from a single product or insurance contract.
Manulife Bank Investment Loans allow investors to make a large initial investment contribution and benefit from the potential for compound growth and interest deductibility. These loans are available for a variety of Manulife Mutual Fund accounts and Segregated Fund contracts, and offer attractive options such as 100 per cent financing, no margin-calls on market fluctuations⁶ , interest-only payments and a one-step application process.
1 This applies to direct donations to a charity (or donations in kind) while alive. If a direct donation occurs at death a zero capital gains inclusion rate will only apply if the donation is a gift to which subsection 118.1(5.1) of the Income Tax Act applies and that is made by the taxpayer’s estate. 2 Investment returns, interest rates and tax rates are for illustration purposes only. 3 This illustration assumes that a specific percentage of loan interest is tax deductible. However, actual tax deductibility of loan interest depends upon a number of factors, with the Income Tax Act (Canada) providing the framework for determining deductibility. Tax laws are subject to change and, therefore, tax treatment of illustrated figures cannot be guaranteed. Results for Quebec residents may differ as the deductibility of investment expenses incurred by an individual or trust are limited to the amount of investment income earned during the year. Readers should consult their own tax and legal advisors with respect to their particular circumstances. 6 No margin-calls on 100% Loans and Multiplier Loans, however if Loan to Value (LTV) exceeds 125%, then interest only loans may be converted to a principal plus interest loan at the discretion of Manulife Bank. The no margin-call feature is not available on Custom Loans.
Borrowing to invest may be appropriate only for investors with a higher risk tolerance. You should be fully aware of the risks and benefits associated with investment loans since losses as well as gains may be magnified. Preferred candidates are those willing to invest for the long term and not averse to increased risk. The value of your investment will vary and is not guaranteed, however you must meet the loan and income tax obligations and repay the loan in full. Please ensure you read the terms of the loan agreement and the investment details for important information. Manulife Bank of Canada solely acts in the capacity of lender and loan administrator and does not provide investment advice of any nature to individuals or advisors. The dealer and advisor are responsible for determining the appropriateness of investments for their clients and informing them of the risks associated with borrowing to invest.
The commentary in this publication is for general information only and should not be considered investment or tax advice to any party. Individuals should seek the advice of professionals to ensure that any action taken with respect to this information is appropriate to their specific situation. Manulife Funds and Manulife Corporate Classes are managed by Manulife Investment Management Limited (formerly named Manulife Asset Management Limited). Manulife Investment Management is a trade name of Manulife Investment Management Limited. The dealer and advisor are responsible for determining the appropriateness of investments for their clients and informing them of the risks associated with borrowing to invest. The Manufacturers Life Insurance Company (Manulife) is the issuer of insurance contracts containing Manulife segregated funds and the guarantor of any guarantee provisions therein. Manulife Investment Management is a trade name of Manulife. Any amount that is allocated to a segregated fund is invested at the risk of the contractholder and may increase or decrease in value. Quick loans, Multiplier and Custom loans are offered by Manulife Bank of Canada. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the fund facts as well as the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. Manulife, Manulife Investment Management, the Stylized M Design, and Manulife Investment Management & Stylized M Design are trademarks of The Manufacturers Life Insurance Company and are used by it, and by its affiliates under license.