Seniors get off easier from trust shakeup

If you're a senior, don't judge Ottawa's move against income trusts by the savaging of the trust market yesterday.

Everyone else, feel free to lick your wounds and plot your strategy in the next federal election. The Conservatives have offered significant tax breaks for seniors to blunt the effect of the coming new tax on income trusts, but they left pretty much everyone else with their neck exposed to the kind of vicious market forces we saw in evidence yesterday.

There are actually two tax breaks for seniors, a $1,000 increase in the age credit (a tax credit for lower- to middle-income people) starting in 2006 and a much more significant move to allow pension-income splitting in 2007.

Income splitting is a concept based on the idea that two people making, say, $25,000 a year, pay less tax than one person making $50,000. Practically speaking, income splitting allows a spouse with a big income from a registered pension plan, a registered retirement savings plan or a registered retirement income plan to shift some of the money into the hands of a lower-income spouse and thus pay less in taxes.

Garth Turner, the maverick Conservative MP and an advocate of pension-income splitting, has said that two million Canadians could benefit from the use of this strategy. To David Phipps, a senior investment adviser with Assante Capital Management Ltd. in Ottawa, pension-income splitting is more significant than the news that income trusts face a life-altering tax hit starting in 2011. "For a lot of Canadians, pension-income splitting is going to have a really huge impact."

To show what he means, Mr. Phipps created a rough guide based on a couple where the husband has $50,000 in pension income and the wife has no income. With the new income-splitting rules in place, both the husband and the wife would be able to report income of $25,000.

Previously, the husband would have paid about $10,200 in tax based on an average tax rate for Ontario residents of 20.4 per cent. With income splitting, both spouses would pay taxes at a rate of 13.9 per cent, and their total income tax owing would be $6,950. Total tax savings: $3,250 per year.

It's worth noting that income splitting has long been possible through the use of spousal RRSPs, where a higher-income spouse puts money in an RRSP in the name of a lower-income spouse. But you have to set up a spousal RRSP well before retirement, whereas the new pension-income splitting system will simply be a matter of filling out your tax return in the right way each year after you turn 65.

"The new rules probably will provide a lot more flexibility," said David Shymko, a financial adviser and partner with Macdonald, Shymko in Vancouver. "In the past, you had to plan years advance. You had to stack things up in the lower-income spouse's hands."

Financial advisers say they see a lot of client couples where one spouse has a higher pension income than the other. But many of these people are already using income splitting through spousal RRSPs. For them, the new rules may not have much impact.

Seniors who expect to benefit from pension-income splitting will have to compare their projected tax savings with the swath of wealth destruction caused by the plunge in income trust prices.

Several widely held trusts like Yellow Pages Income Fund and CI Financial Income Fund fell by about 20 per cent yesterday. The S&P/TSX capped income trust index fell 12.4 per cent. You'll feel these declines not only when you look at the individual trusts or trust-focused mutual funds you own, but also mainstream Canadian equity, balanced and income funds. Many of the funds in this category have included trusts in their portfolios, sometimes in significant quantities.

If you're not a senior and you have exposure to income trusts in your portfolio, then the news on trusts is all bad. You've got the status quo on taxes, and your trusts have plunged in value with no realistic hope of full recovery.

The situation is especially painful for people aged 55 to 65 who are trying to build up their assets in the home stretch before retirement. Pension-income splitting won't help this crowd for years to come.

Seniors will certainly save a lot on taxes with pension-income splitting -- $1-billion a year if you add in the benefits of the higher age credit. In fact, Canada's Association for the 50 Plus, the foremost voice for seniors in this country, yesterday commended Finance Minister Jim Flaherty for balancing the new trust tax with pension-income splitting.

Non-seniors won't see the same balance because there isn't any.

rcarrick@globeandmail.com