Today’s tip: “Life-long dollar-cost averaging can increase your long-term retirement investing profits”

Dollar-cost averaging involves investing equal amounts of money over a specific period ($200 a month, say). It’s a little like systematic saving, except that you put your money into stocks (or mutual funds) instead of a bank account.

Advantages of dollar-cost averaging:

• Dollar-cost averaging helps build consistent long-term retirement investing returns: Long-term studies show that the stock market as a whole generally produces total pre-tax annual returns of 8% to 10%, or around 6% after inflation. Over periods of a few years or less, the return is far more variable and always uncertain.

  The surest way around this uncertainty is to start practicing dollar-cost averaging as early as possible, and invest regularly over the course of your working years. Then you can sell gradually in retirement.

>Dollar-cost averaging largely frees your retirement investing from stock market trends: In fact, if you invest a fixed sum at regular intervals throughout your working years, perhaps increasing that sum from time to time as your income rises, you can largely forget about market trends. That’s because you’ll automatically buy more shares when prices are low and fewer when they are high, and your retirement investing will benefit from the long-term rising trend in the market.

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Lets look at an example: Let’s go back a little over 9 years, to January 2, 2001. Say your employer pays you an annual bonus of $1,000. As part of your retirement investing, you create a dollar-cost averaging program that involves investing this money every year in shares of Scotiabank (symbol BNS on Toronto), one of the stocks we cover in our Successful Investor newsletter.

On January 2, 2001, Scotiabank shares closed at $20.58 (all share prices adjusted for a 2-for-1 split on April 1, 2004.)

Over the following years, Scotiabank shares rose as high as $54 (in 2007), fell as low as $24 (in the market downturn of 2009), and rebounded to $48.93 on January 4, 2010, when you would have made your latest purchase.

However, thanks to dollar-cost averaging, you would’ve bought more Scotiabank shares when they were low and fewer when they were high. So, if you bought Scotiabank shares on the first trading day of every year from January 2001 through January 2010, your average cost would have only been $37.66 a share.

Right now, Scotiabank is trading at around $51 a share. That means you would be ahead by $13.34 a share, or 35%.

It’s worth noting that this gain doesn’t include Scotiabank’s dividend payments, which have risen significantly over the past 10 years. In 2001, the bank paid an annual rate of $1.24 a share, for a 2.8% yield. By 2010, that payout had risen to an annual rate of $1.96, for a 3.8% yield.

Next Wednesday, August 4, 2010, Investor Toolkit will show you nine key factors you can use to judge a stock’s investment quality.

If you have investment-related questions, or if you’d like to ask me about stocks you’re considering buying (or selling), you should join my Inner Circle service. Click here to learn more.

When you do, you’ll have three main retirement investing options:

1. You can cash in your RRSP and withdraw the funds in a lump sum. In most cases, this is a poor retirement investing option, since you’ll be taxed on the entire amount in that year as ordinary income.

2. You can purchase an annuity (we recently examined the pros and cons of annuities on TSI Network. Click here to read that article.)

3. You can convert your RRSP into a RRIF (registered retirement income fund).

RRIFs are the best retirement investing option for most investors

Converting to a RRIF is the best retirement investing option for most investors. That’s because RRIFs offer more flexibility and tax savings than annuities or a lump-sum withdrawal.

Like an RRSP, a RRIF can hold a range of investments. You don’t need to sell your RRSP holdings when you convert — you just transfer them to your RRIF.

When you hold a RRIF, you must withdraw a minimum each year and report that amount for tax purposes. (You may withdraw amounts above the minimum at any time.) Revenue Canada sets your minimum withdrawal for each year according to a schedule that starts at 7.38% of the RRIF’s year-end value at age 71, reaches 8.75% at age 80, and levels off at 20% at age 94.

Here are four retirement investing tactics for making the most of your tax savings when you convert your RRSP to a RRIF:

1. Use a younger spouse’s age to set a lower minimum withdrawal: For example, if your spouse is 65 when you turn 71, then the minimum withdrawal set by Revenue Canada is 4.00%, rather than 7.38%. The rate increases yearly until it reaches 7.38% when your spouse turns 71. It then follows the normal schedule, reaching 8.75% when your spouse reaches 80, and levelling off at 20% at age 94.

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2. Stick with late-in-the-year payments: You start making withdrawals from your RRIF in the year following the year in which the RRIF is established. For example, if you open a RRIF in 2010, you have to make your first withdrawal by December 31, 2011.

You can receive RRIF payments on any schedule, though most investors receive them either monthly or yearly. Unless you need monthly payments to live on, it’s best to request only one payment per year, near year-end, to prolong your tax deferral. For practical purposes, however, set a date such as December 15 to allow for delays. Just contact the broker or institution that holds your RRIF to set up your yearly payment.

3. Withdraw shares instead of cash: Keep in mind that you don’t need to make your minimum withdrawal in cash. Instead, you may make an “in-kind” withdrawal of shares instead of cash.

4. Name a RRIF beneficiary: Assets in a RRIF automatically pass on to your beneficiaries in the event of your death. If you name your spouse or a financially dependent child under 18 as beneficiary, assets are passed on tax-free to their RRIF or RRSP.

Account for withholding tax when withdrawing more than the minimum requirement

Note that when you make a RRIF withdrawal above the minimum requirement, Revenue Canada requires your financial institution to withhold tax at the time of withdrawal. Tax is withheld at the rate of 10% for amounts up to $5,000, 20% up to $15,000 and 30% on $15,001 and up.

The tax on your RRIF withdrawal may be more or less than the amount withheld. You’ll have to report the full withdrawal as income and pay tax at ordinary rates. But you’ll get a credit against taxes owing for the tax that is withheld.

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When you’re doing this kind of retirement planning, it’s always good to have clear arrangements in place and keep them up to date as your circumstances inevitably change. Here are three tips you can use to avoid placing undue stress on your loved ones and maximize the investments you leave to your heirs:

1. Have a financial contingency plan: This will allow someone you trust to take charge of your finances and investments if you can’t handle them yourself. However, it’s best to focus on finding someone you trust thoroughly, and giving that person as much latitude as possible.

The alternative — leaving fixed instructions — introduces a random element that can only hurt you. After all, fixed instructions (such as “If I get sick, convert all my holdings into T-bills”) won’t add to your wealth. But they may turn out to be wholly inappropriate, and whoever you put in charge won’t be able to do anything different.

2. Invest based on your heirs’ timelines: If you have substantially more money than you’ll need for the rest of your life, and you plan to leave the excess to your heirs as part of your retirement planning, it makes sense to invest at least part of your legacy on their behalf. That is, invest based on their time horizon, not yours.

For instance, if your heirs are in their 40s, your retirement planning should involve holding at least part of your portfolio in a selection of investments that would suit investors in their 40s. Of course, you’d still want to invest conservatively. But you’d want to take advantage of the many years that 40-somethings have till they reach retirement age.

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If your retirement planning involves holding your money in T-bills for the last few years of your life, it will generate a minimal return after taxes — you may actually lose money after accounting for taxes and inflation.

After your death, it may take months or longer to settle your estate. After that, your 40-something heirs may need time to put your legacy to work, especially if they are inexperienced as investors. They may have passed 50 by the time they get around to investing in an age-appropriate fashion. Missing out on, say, three years of even moderate returns can take a big bite out of the funds they’ll have a few decades later, in retirement.

3. Keep a close eye on your life-insurance forms: As part of your retirement planning, you should periodically check the form that names or changes the beneficiaries of your life-insurance policies. Often, you’ll name a primary beneficiary (generally your spouse), and a secondary beneficiary (often your children) if the primary is incapacitated or dies at the same time as you.

We once came across a case where the insurance agent mixed up the primary and secondary beneficiaries. As a result, instead of going to the bereaved spouse, the form said the eldest child was to receive the proceeds of the policy.

Happily, the eldest child recognized the mistake and immediately agreed to sign the cheque over to the surviving parent, for whom it was obviously intended. But if the child had refused to sign the cheque over, the surviving parent would have had no recourse. The insurance company would have had to follow the instructions on the form.

Of course, most children will do the right thing in a case like that. But you have nothing to gain by putting them to the test. Many families have been torn apart irrevocably for smaller amounts than the payout on the average Canadian life-insurance policy. That’s why you’ll always want to take a moment and be sure the form is correctly filled out before you sign.

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How the RRSP meltdown works

When you take money out of your RRSP, you have to pay tax on your withdrawal at the same rate as ordinary income in the year you make the withdrawal. However, under an RRSP meltdown strategy, you would offset the additional tax by taking out an investment loan and making the interest payments from funds you withdraw from your RRSP (the withdrawals must be equal to the interest payment).

Since the interest on the loan is tax deductible, the tax on the RRSP withdrawal is cancelled out. This, in theory, results in zero tax owing on your withdrawal.

You can then use the investment loan to buy dividend-paying stocks, which you would use to provide income during retirement. Dividend-paying stocks also have the advantage of being very tax efficient.

RRSP meltdown by the numbers

The idea of withdrawing funds from an RRSP tax free has obvious appeal. However, we’ve looked at a number of different RRSP meltdown strategies over the years, and have found that they mainly serve the interests of the brokerage industry more than those of investors. Here’s why:

Say you make a $5,000 withdrawal from your RRSP and want to offset your tax payable using the interest from an investment loan. Supposing a 5% annual interest rate on the investment loan, you would have to borrow $100,000 to invest in dividend-paying stocks to generate a large enough interest deduction to offset the withdrawal.

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The fees and commissions that the investor generates when he or she invests the money are an obvious benefit to the investor’s broker. The investor, meanwhile, significantly increases his or her leverage. Moreover, many investors attempt the RRSP meltdown when they’re at or near retirement. In other words, the worst time to take on additional debt.

Some RRSP meltdowns involve extreme risk

Some financial advisors take this to a ridiculous extreme by offering arrangements that involve making RRSP withdrawals and placing the money in business or real-estate deals that generate large tax deductions. These then offset the taxable income from the withdrawals.

The investor who has participated in this type of RRSP meltdown is then left holding an illiquid, and often quite risky, investment. To generate the tax deductions, you may also have to take out or guarantee a large debt.

Sometimes the deal “guarantees” the investor a steady income. But the guarantee is sure to be full of holes. The only things that are reliably guaranteed in these deals are the huge fees and commissions they generate for the salespeople and financial institutions involved. This type of meltdown strategy is never a good idea — no matter where you are in your investing career.

Borrowing to invest can be a good strategy — but there’s no benefit to connecting it to RRSP withdrawals

Of course, borrowing to invest can go wrong if you buy at the top of the market and sell at a low. However, taking out an investment loan can be a good investment strategy for certain investors.

For example, you may consider borrowing to invest if you are in the top income tax bracket and expect to stay there for a number of years, you have 10 or more years until retirement, and you have the kind of temperament to sit through the inevitable market setbacks without losing confidence at a market bottom and selling out to repay your loan.

Either way, we see no benefit in complicating matters by tying your investment loans to RRSP withdrawals.

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The main benefit of annuities is that they offer stable, predictable income. That may make them suitable for part of your assets, depending on your age, investment experience, the time you want to devote to your investments, your desire to leave an estate to your heirs and other aspects of your retirement investing.

The main drawback is that annuity payments stop when you die. But that’s not always the case. Read on for more details on the different kinds of annuities.

How annuities work

There are basically three types of annuities:

Term-certain annuities are payable to you, or your estate, for a fixed number of years. Your estate will receive the payments even if you die. You could outlive this type of annuity.

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Single-life annuities are payable to you for as long as you are alive. These annuities may come with a minimum number of years of payments. If you die while the minimum payment period is still underway, future payments would go to your estate.

Joint and last survivor life annuities are payable as long as you, or your spouse, are alive.

3 ways annuities can hurt your retirement investing

Stable, predictable income is a plus for any retirement plan. However, annuities do have certain disadvantages that can lower your retirement investing income.

Here are 3 drawbacks you should keep in mind when deciding whether annuities are right for you:

1. Annuities are linked to interest rates: The rate of return you receive on an annuity is linked to interest rates at the time you buy it. That makes periods of unusually low interest rates, like today, an especially poor time for buying annuities.

However, if you want to buy annuities, you could buy one annuity a year for the next five years. That way, your returns will increase if interest rates rise as we expect.

2. Poor liquidity: Unlike stocks, it can be difficult or impossible to sell an annuity if you decide it no longer meets your needs. Moreover, you will likely get a low price for your annuity because the date of your death is uncertain.

3. Tax disadvantages: When you own an annuity, the income payments you receive are made up of interest and a return of your principal. The return of your principal is tax free, but the interest portion of the payment is taxed as ordinary income.

Ordinary income is taxed at a higher rate than returns on a stock portfolio. If you build your retirement investing portfolio as we recommend, part of your return would come in the form of dividends from Canadian stocks, which qualify for the dividend tax credit. The remainder would come in the form of capital gains, which are taxed at half the rate of ordinary income, and are only taxed in the year you sell.

A safety-conscious investment portfolio is often a better option than annuities

In the end, we think most investors would be better off building a retirement investing portfolio that contains the kind of high-quality, safety-conscious investments we recommend our Canadian Wealth Advisor newsletter, well balanced across the five main sectors of the economy (Manufacturing & Industry, Resources & Commodities, the Consumer sector, Finance and Utilities).

At the moment, we advise against buying annuities or long-term bonds. However, our view may change along with interest rates and inflation.

You can get our latest buy/sell/hold advice on dozens of safety-conscious investments suitable for retirement investing, as well as strategies you can use to increase your profits with lower risk in our Canadian Wealth Advisor newsletter. Click here to learn how you can get one month free when you subscribe today.

Some investors in this situation look for what brokers sometimes refer to as a “rescue stock” — a can’t miss trading idea that can make up for the shortfall in their retirement planning. This, of course, is unrealistic. If such a low-risk, high-potential stock existed, why would you buy anything else?

In fact, if you’re heading into retirement and are short of money, you should move your retirement planning in the opposite direction: aim for safer investments, rather than one last gamble.

(Our Successful Investor Wealth Management clients’ retirement planning goals are always one of our top considerations when we manage their portfolios. Click here to learn more about how you can profit from our portfolio management services.)

Here are two practical solutions to a pre-retirement money shortage. In addition to improving your finances, both can improve your quality of life in retirement:

1. Work longer: Put off retiring from your current position, or continue to work part-time. Or, find full- or part-time work in another field. To start, this can solve a common problem that many retirees fail to foresee: how hard it can be, and how much it can cost, to fill up all the free time that comes with retirement.

Many retirees admit that they fill this time by giving free rein to Parkinson’s Law (“work expands to fill the time allotted for its completion.”) Some find that minor tasks take over their lives, so they never get to tackle the more fulfilling projects that they’ve put off till retirement, such as learning another language, taking courses, organizing a stamp collection or whatever. A part-time job, paid or volunteer, gets you out of the house and provides contact with other people. Many studies suggest these two fringe benefits can prolong your life and keep you healthy.

Members of Pat McKeough's Inner Circle get answers to their individual investment questions, including specific recommendations, plus all our publications and full access to the extensive Inner Circle membership section of our TSI Network website. Now you can join them. Click here to learn how you can benefit from membership in Pat McKeough's Inner Circle.

2. Analyze your spending: Start by doing a detailed study of how you spend your money now. Then, you analyze your findings to see what expenses you can cut or eliminate. This too can have fringe benefits, especially if it helps you break unhealthy habits.

For instance, cutting out fast food can save the average Canadian anywhere from hundreds to thousands of dollars a year. In retirement, you’ll have time for a cooking class or two, and soon you’ll be able to cook better-tasting and healthier food than you can buy at any fast-food chain. The cost difference between home cooking and fast food can be substantial, and it’s like tax-free income.

Smart retirement planning starts with a healthy attitude

These two retirement planning tactics may come hard or easy to you, depending, in part, on your upbringing. People who come from humble circumstances often develop a degree of both frugality and industriousness early in life. Finding part-time work while in school, and making every penny count, becomes a game for them.

It’s easy to let frugality evaporate in mid-life, when money becomes more plentiful. But some find that if they return to frugality later in life, it’s more fun than ever. It’s a little like taking pleasure from a game that you haven’t played since you were young.

Your enjoyment of, or distaste for, frugality is partly a matter of attitude. But that’s under your control. Don’t think of it as penny-pinching. Think of it as taking charge of a part of your life, so that more of your money goes to things you choose.

If you’d like me to personally apply my time-tested approach to your investments, you should consider becoming a client of my Successful Investor Wealth Management service. Click here to learn more.

RRSPs are a form of tax-deferred savings plan. RRSP contributions are tax deductible, and the investments grow tax-free. (Note that you can contribute up to 18% of your earned income from the previous year, to a maximum of $21,000, rising to $22,000 in 2010). March 1, 2010, is the last day you can contribute to an RRSP and deduct your contribution from your 2009 income.

When you later begin withdrawing the funds from your RRSP, they are taxed as ordinary income.

Here are 3 retirement investing strategies you can use to make the most of your RRSPs, both now and in the future:

1. Hold mutual funds in your RRSP: At year end, mutual funds distribute any capital gains they have made during the year, after deducting any capital losses, to their unitholders. So, you may have to pay capital gains taxes on your mutual-fund holdings, even though you haven’t sold.

If you hold mutual funds outside of your RRSP, you’ll have to pay capital gains tax on half of those realized capital gains. So, as part of your retirement investing plan, we recommend that you hold mutual funds in an RRSP.

Members of Pat McKeough's Inner Circle get answers to their individual investment questions, including specific recommendations, plus all our publications and full access to the extensive Inner Circle membership section of our TSI Network website. Now you can join them. Click here to learn how you can benefit from membership in Pat McKeough's Inner Circle.

2. Keep higher risk investments outside of your RRSP: We continue to believe that holding higher-risk stocks in your RRSP is a poor retirement investing strategy. That’s because if you hold them in an RRSP and they drop, you not only lose money, but you also lose the tax-deduction value of a loss in your RRSP. Outside your RRSP, you can use capital losses to offset taxable capital gains in the current year, the three previous years, or any future year.

You also lose the opportunity for tax-free compounding that the money would have enjoyed within your RRSP. This is a crucial part of successful retirement investing. That’s because, after about 7 years in an RRSP, the ability of an RRSP contribution to grow and compound free of tax is usually worth more than the initial contribution itself. That’s why RRSPs are a bad place for aggressive investments of any kind. The potential losses that these investments could suffer are just too costly.

3. Consider RRSP withdrawals only in years of little or no income: Making early withdrawals from your RRSP only makes sense when you’re in a low income-tax bracket, and you have exhausted all other means of income. That includes periods when you are ill, say, or unemployed.

If you still have funds left over after you’ve made a withdrawal, a good place to put them is in a tax-free savings account (TFSA). Like an RRSP, TFSAs shelter future gains from tax. But unlike RRSPs, withdrawals from your TFSA are not taxable.

We always keep our Successful Investor Wealth Management clients’ retirement investing goals in mind when we manage their portfolios. If you’d like me to personally apply my time-tested approach to your investments, you should consider becoming a client of Successful Investor Wealth Management. Click here to learn more.

That’s because, if one spouse earns more than the other, the higher-income spouse would, of course, be in a higher tax bracket. That means that any extra money the higher-income spouse earns on investments, such as through capital gains, interest or dividends, would be taxed at a higher rate. So, you can lower your family’s overall tax bill by aiming to have both spouses in the same tax bracket.

The Canada Revenue Agency won’t let you lower your income tax by simply giving invested funds to a lower-income spouse. “Attribution” rules apply if you do that. That means the higher-income spouse must pay tax on any gains or investment income from those funds.

In a recent issue of Canadian Wealth Advisor, our newsletter for more conservative investors, we looked at a number of ways you and your spouse can even out your incomes in retirement. Below are three simple strategies. They’ll save you taxes both now and on future retirement income.

1. Have the higher income spouse pay the household bills: The easiest way to even out income between two spouses is to have the higher-income spouse pay the mortgage, grocery bills, medical costs, insurance and other non-deductible costs of family life.

Remember that you have to keep separate bank accounts and accurate records. The higher-income spouse can also pay the lower-income spouse’s tax bill each spring, and any instalments that are due during the year.

All of these measures will let the lower-income spouse build a larger investment base. They’ll also cut the amount of tax the lower-income spouse pays on retirement income and investment income earned now.

Members of Pat McKeough's Inner Circle get answers to their individual investment questions, including specific recommendations, plus all our publications and full access to the extensive Inner Circle membership section of our TSI Network website. Now you can join them. Click here to learn how you can benefit from membership in Pat McKeough's Inner Circle.

2. Set up a spousal RRSP: Registered retirement savings plans, or RRSPs, are a form of tax-deferred savings plan designed to help investors save for retirement. RRSP contributions are tax deductible, and the investments grow tax-free. (Note that you can contribute up to 18% of your earned income from the previous year to a maximum of $21,000, rising to $22,000 in 2010).

When you later convert your RRSP to a registered retirement income fund (RRIF) and begin withdrawing the funds, they are taxed as ordinary income.

A spousal RRSP is one way to achieve equal retirement income. Suppose you are the higher-income spouse. You can make contributions to a spousal RRSP, and claim the tax deduction. Your contributions to the spousal RRSP will count toward your annual RRSP deduction limits.

Your spouse can still contribute their full deduction to their own separate RRSP. When the money is withdrawn from the spousal RRSP years later, it is taxed in the hands of your spouse. That’s an advantage if he or she is still in a lower tax bracket.

A spousal RRSP is also a way to defer taxes if you are no longer able to contribute to a personal RRSP because of your age. As long as your spouse is 71 or younger, you can contribute to his or her spousal RRSP and still claim the tax deduction.

Note that withdrawals from a spousal RRSP are generally subject to a “three-year rule.” If a spouse withdraws funds from an RRSP within three calendar years after the higher-income spouse’s last contribution, the higher-income spouse must declare the withdrawal as income on his or her tax return. The exceptions include spouses living apart due a marriage breakdown and the death of the contributor in the year a withdrawal is made.

3. Pay interest on your spouse’s investment loans: If the lower-income spouse takes out an investment loan from a third party, such as a bank, the higher-income spouse can pay the interest on that loan.

For example, say you’re the higher-income spouse and you make an interest payment on your spouse’s investment loan. As long as you don’t repay any of the loan principal, you do not have to claim any of the investment return on your income taxes. You should, however, make sure to pay the interest with a personal cheque bearing your name, so it’s directly tied to you.

The lower-income spouse would then deduct the interest payments on the loan on his or her tax return, even though the higher-income spouse paid them. This strategy lets the lower-income spouse build up a larger investment base.

If you’re looking for safety-conscious investment strategies like this, you should subscribe to Canadian Wealth Advisor. Click here to learn how you can get one month free when you subscribe today.

There are lots of ways to shift investment capital and income to the lower-income spouse. This lets you lower your overall tax bill right now. It also ensures that each spouse gets roughly the same amount of income in retirement. That will cut taxes later, as well.

In the last issue, we discussed the income-splitting techniques of paying your spouse’s bills, setting up a spousal RRSP and swapping assets for cash or shares. Here are more ideas:

Reinvesting attributed income

Revenue Canada won’t let a higher-income spouse simply give money to a lower-income spouse. “Attribution” rules apply if you do that. The original, higher-income spouse must pay tax on any gains or investment income from those funds. However, gains from reinvesting that initial earned income are only taxable in the hands of the lower-income spouse.

For example, if the higher-income spouse gives the lower-income spouse $10,000 to invest at 10%, the $1,000 in interest income is taxable to the higher-income spouse. But if the lower-income spouse then invests the $11,000, the gain on the $1,000, or $100, is taxable to the lower-income spouse.

Over time, this “secondary” income could grow to be a significant investment asset for the lower-income spouse.

Lending money to a spouse

Attribution rules also apply if you lend money to a spouse for investment, unless you charge interest.

The interest rate must be either a commercial rate of interest, or equal to Revenue Canada’s prescribed interest rate, which is set every three months. The Revenue Canada rate is calculated based on the average yield of 90-day treasury bills sold during the first month of the previous quarter. The rate used is the one for calculating taxable benefits from low-interest and interest-free loans to employees and shareholders.

This rate currently stands at 1%. That’s much lower than most commercial borrowing rates. The lower-income spouse can then invest the borrowed funds at a higher rate. This can include a combination of interest, dividends or capital gains

That means the difference between the Revenue Canada rate and the returns on the invested funds is taxed in the hands of the lower-income spouse. The lower-income spouse can also deduct the interest payments on his or her tax return. When the loan is set up, the rate can be permanently set, whether the loan is for one year, 20 years or indefinitely. That’s an added advantage, especially now, with the prescribed rate at an all-time low.

To meet Revenue Canada’s requirements, the interest must actually be paid from the lower-income spouse to the higher-income spouse. It must be paid in each year, or by the following January 30. The higher-income spouse must report the interest as interest income.

It’s a good idea to draw up a formal promissory loan agreement or note between the spouses. It should detail the term of the loan, and include the prescribed rate during the current calendar quarter.

Pay interest on investment loans

If the lower-income spouse takes out an investment loan from a third party, such as a bank, the higher-income spouse can pay the interest on that loan. No attribution accrues to the higher-income spouse, providing they don’t pay any of the loan principal. The higher-income spouse should make sure to pay the interest with a personal cheque bearing his or her name, so it’s directly tied to them.

The interest payments on the loan are deductible on the lower-income spouse’s tax return, even though the higher-income spouse pays them. This technique lets the lower-income spouse build up a larger investment base.

In fact, long-term studies show that six out of 10 family fortunes get dissipated by the end of a second generation. And nine out of 10 are gone by the end of the third generation.

Canwest Global Communications Corp.’s recent filing for bankruptcy protection provides an example. The company was founded by Izzy Asper some 35 years ago. As part of CanWest’s settlement with its creditors, the Asper family could see its controlling interest in the company drop below 10%.

Making sure your heirs don’t grow complacent should be part of your retirement planning

One reason why so many family fortunes are lost over the long term is that the prospect of an inheritance can undermine the ambition of heirs. Many young people find it difficult to put their best efforts into low-paid, low-status entry-level jobs. If they expect to inherit money, it may undermine their motivation all the more.

Members of Pat McKeough's Inner Circle get answers to their individual investment questions, including specific recommendations, plus all our publications and full access to the extensive Inner Circle membership section of our TSI Network website. Now you can join them. Click here to learn how you can benefit from membership in Pat McKeough's Inner Circle.

However, a dose of modern reality can counter this tendency. You may even consider having such a discussion with your heirs as part of your retirement planning.

Retirement entails costs that are likely to lower the size of many inheritances

To begin, there’s a good chance that at least one member of a couple in their 70s will live to age 90 or beyond. So the typical heir could be, say, age 60 before he or she gets a dime.

Moreover, medical expenses soar in later years. That’s especially so now, with today’s faster pace of medical advances, many of which are hugely expensive. It may help to inform your heirs that your retirement planning doesn’t include cutting corners when it comes to keeping yourself alive, mobile and pain-free.

For that matter, you may want to get hold of a copy of one of the Die Broke books. The philosophy of these books is that you should spend all of your money while you’re alive. But you don’t need to agree with that retirement planning philosophy, or even read the book.

If your heirs lack ambition, it may be worthwhile to get hold of a dog-eared, used copy, ideally with crucial passages highlighted, and leave it around the house where they are sure to see it.

Retirement planning is something we always keep in mind when we manage the portfolios of clients of our Successful Investor Wealth Management service. Click here to learn more about how Pat can personally apply his time-tested value-investing approach to your investments.