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Changing income trust rules could crack retirees' nest eggs

My grandfather always had words of wisdom to share. He would say, "Tim, before you criticize someone, you should walk a mile in their shoes. That way, when you criticize them, you're a mile away and you have their shoes." That advice has served me well over the years. The point he was making was that it's tough to tell someone face to face that you're unhappy with what they've done.

Today, Finance Minister Ralph Goodale is in the unenviable position of having to tell thousands of Canadian retirees, who have turned to income trusts to provide the much needed cash flow they require to sustain themselves, that he's not happy about their investments.

Maybe he should walk in their shoes for a while.

The issue

On Sept. 8, the Department of Finance issued a consultation paper on the issue of publicly traded flow-through entities -- specifically, income trusts and limited partnerships. The government says it's concerned about the impact of these investments on tax revenue and economic efficiency. But let's be truthful -- the real concern is tax revenue.

Apparently, the government lost $300-million in tax revenue in 2004 as the result of Canadians investing in these things. And, if income trusts grow in popularity, even more tax revenue could be lost.

The reason? A publicly traded business structured as a corporation pays tax at the corporate level, with additional taxes paid by you and me when we receive dividends.

An income trust eliminates the tax at the corporate level, with the end investor paying the only level of tax.

And so the consultations begin. The Department of Finance wants the input of Canadians before deciding what to do about this "tax problem."

The impact

The fact is, income trusts have been important to the self-sufficiency of many retirees over the past five years. Two forces have been working against retirees: (1) Interest rates have been very low, providing little income to those who need it, and (2) retirees are being forced to withdraw, and pay tax on, assets in their registered retirement income funds (RRIFs) at an excessive rate.

Today, a five-year guaranteed investment certificate offers about 3 per cent annually, a 10-year Government of Canada bond offers 3.85 per cent, and the last issue of Canada Savings Bonds offered 1.55 per cent. Subtract from these figures inflation at 2.6 per cent and the real return is close to zero. Then, consider that a 70-year-old with a RRIF is required to make a withdrawal of 5 per cent of the RRIF balance in the year, increasing to 8.75 per cent by age 80.

The bottom line? Many seniors are experiencing a quick de-capitalization of their retirement savings. This could leave many without enough to survive in their later years. Income trusts have been a saving grace for many.

Any decision to change the tax rules around income trusts had better consider the impact on these retirees. Perhaps Mr. Goodale has another solution for them?

The overreaction

Let's put this whole concern in perspective. In 2004, $300-million in tax revenue was "lost," according to the Department of Finance. Actually, not true. This claim ignores the fact that many of those dollars will be collected in the future. Income trusts typically result in a tax deferral rather than an elimination of tax. But let's not argue over such trivial details. It's also important to realize that $300-million represents just 15/100ths of 1 per cent of Canada's $195.8-billion in revenue in 2004-05. That's the equivalent of a $50,000-a-year income earner giving up $75. Heck, the income trust market has plenty of room to grow before deferred tax revenue should be a concern. A word to Mr. Goodale: Take a Valium.

Tim Cestnick, FCA, CPA, CFP, TEP, is a tax specialist and author of Winning the Tax Game 2005 and The Tax Freedom Zone.

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