Flow-Through Ladder Strategy
A strategy often implemented by Flow Through investors is to keep rolling over their investments to gain a perpetual annual tax credit. I’ll give you an example of an investor who understands the risks and is engaging in this strategy:
Our investor earns $300,000 per year and maximizes his RRSP every year. Since he is in the top marginal tax rate of 46.41% (Ontario) he is basically getting half his contribution amount back in the form of a tax refund. He likes that, but doesn’t like how he is still paying 50 cents on the dollar for most of his earned income - in other words he is always looking for more ways to save on tax.
Now, because Bob is a more aggressive investor he warmed to the idea of investing in Flow Through Limited Partnerships since the savings in tax helped offset the riskiness of the investment. But he also decided to create a strategy around this type of tax advantaged investment product…
Most investors take their money out of a FT-LP (abbreviation for Flow Through Limited Partnership) at the 2 year mark (i.e. as soon as they are permitted) since they can roll that money into another FT-LP and get the tax deductions all over again. Normally I don’t recommend more than 5% of a person’s overall portfolio be exposed to any one FT-LP and no more than 10% exposure to multiple FT-LPs. So in this case our investor (who had a total portfolio of $1 million) put in $50,000 his first year (giving him just under $25,000 back come tax time) and made a second contribution of $50,000 the following year in a different FT-LP.
Now when one FT-LP “matures” after 2 years, he rolls it into another offering so in effect, he has a constant $50,000 deduction from his income every year since you could say he has a 2 year FT-LP ladder. (Same concept as a laddered bond portfolio in that there is a security “maturing” every year available for rollover…).
Let’s look at the annual tax situation before and after implementing an FT-LP 2 year ladder:
Before
Income: $300,000
RRSP Contribution: $20,000
FT-LP Investment: $0
Tax Refund: $10,000
After
Income: $300,000
RRSP Contribution: $20,000
FT-LP Investment: $50,000
Tax Refund: $35,000
Remember, his total portfolio exposure is only 10% to the FT-LP investments starting in year 2 (in year 1 it is only 5%). Also, FT-LPs are very volatile - some lose 30% after two years (or perform even worse!) - in this case Bob is happy knowing that over time some will gain in value and some will lose value and he is comfortable with the volatility - just so long as he is getting his annual hefty tax relief. In his mind, even if the long term performance of the underlying investments in the FT-LP ladder are COMPLETELY FLAT he may still makes 20% per year after factoring tax effects.
A word of caution, do not go out and invest in an FT-LP after reading this information alone - you really need to understand them and hopefully view these investments as you should any other - based on the investment merits first and tax advantages second.
Disclaimer:
ScotiaMcLeod does not actively participate in flow-through shares or make any recommendations towards investing in them. The information contained in this article is general in nature and is not intended to be considered professional tax advice. Investments should not be made for tax considerations alone. Each individual investor’s situation is unique and advice should be received from a qualified tax specialist. The example in this piece is based on a number of assumptions and is illustrative of the application of the relevant income tax provisions to a hypothetical investor. Limited Partnerships are not guaranteed, their values change frequently and past performance may not be repeated. Commissions, trailing commissions, management fees and expenses all may be associated with limited partnership investments. Neither the author nor SCI can make any warranty as to the accuracy or completeness of information, analysis or views contained in this publication or their usefulness or suitability in any particular circumstance SCI and the author accept no liability of whatsoever kind for any damages or losses incurred by you as a result of reliance upon or use of this publication in contravention of this notice. The contents of this information piece are for informational purposes only and are not intended to provide financial, legal, accounting or tax advice and should not be relied upon in that regard. SCI and the author accept no liability of whatsoever kind for any damages or losses incurred by you as a result of reliance upon or use of this publication in contravention of this notice.
