Debt swaps entail replacing non-deductible debt with deductible debt. Let's look at an example to see how it works:

Jason has non-registered investments worth $50,000. He also has a house worth $400,000 and a $200,000 mortgage. He has an unused home equity line of credit (HELOC) secured by the house with available credit of $100,000. A debt swap consists of selling the non-registered investments, using the proceeds to pay down the non-deductible mortgage, and then borrowing the same amount using the line of credit and making new (or even the same) investments in a non-registered account. The line of credit interest is tax deductible because the loan proceeds are used to make an investment. The order of events is very important here – the loan proceeds must be used to make the investment. This strategy has been supported by court cases including the famous "Singleton Shuffle" and even more recently the Lipson case (the taxpayer lost but the judgement pretty much supported a straight forward debt swap). Please note however, that each person's circumstances are different and the above noted cases and situations may not apply to you. And if CRA disputes your tax deductions, you may incur legal costs and may have to present your case to the courts, and of course, you might lose. Poor execution of any tax reduction strategy always bears the risk of disallowance.

I have seen some blogs where the blogger stated that the loan interest would not be deductible if used to buy an investment where the return would be in the form of capital gains (because capital gains are not considered income). This would be true if the only potential return would be capital gains, but that is rarely the case. Let’s say for example that someone used borrowed money to buy a certain large well known software company's stock 10 years ago. At the time, the company was not paying a dividend, so at that point the only kind of return you could get was in the form of capital gains. But because there was still the potential to earn dividend income at some point in the future, the courts have ruled that the loan interest is still deductible. And as it happens, the company eventually started paying dividends, which just proves the point. The CRA recently issued a tax bulletin confirming this interpretation (IT-Bulletin 533).

Although a debt swap does not increase your overall risk (and one could argue that it decreases it slightly because your interest becomes tax deductible therefore your cash flow is improved), a more conservative option would be to simply liquidate the investment and pay down the debt. but be sure to see risk section below

Imagine you have the ability to save $200 per month. After 12 months, if you earn a return of 6%, you will accumulate $2,467. Now, if instead, you borrow $60,000 at 4%, you will pay the same amount in interest as you were previously saving ($200 per month) but at the end of the year, assuming the same return, your investment return will be $60,000 times 6% = $3,600. And on top of this return, your interest is tax deductible, so your actual out of pocket cost is less than $200 per month, depending on what your marginal tax rate is (or MTR, which is the tax rate on the last dollar earned or first dollar deducted – Click here for tax calculator . If you want to play with various scenarios, check out Talbot Stevens' website at www.talbotstevens.com where you can download software that illustrates various leverage scenarios.

The risks of pursuing this strategy are the same as in the Smith Manoeuvre below except you would not have distribution risk.

RRSPs I think pretty much everybody in Canada knows how RRSPs work so I’ll confine myself to describing what I like and dislike about them. I like that they encourage people to save long term for their retirement. I like that they can grow tax deferred for a long time. The advantage to tax deferral is that you can have growth on the growth (as Einstein said "The most powerful force in the universe is compound interest"). So even if your marginal tax rate is the same as when you were accumulating the RRSP assets, you can end up with more capital than if you paid the tax on the growth each year. And for many people, their marginal tax rate when they retire is actually lower than when they were accumulating.

Here's what I don’t like about them. First of all, tax changes over the last couple of years means that for non-registered investments (RRSPs, RRIFs, and RESPs are all registered investments), capital gains are taxed at 50% and dividend income is taxed at roughly 50% depending on what province you live in. These are absolute tax savings, not just deferral. And with capital gains we also have deferral – we don't pay tax until we actually sell the investment. Together these measures make RRSPs less attractive in comparison, because the absolute tax savings on capital gains and dividend income are lost when the investment is held within an RRSP.

Let me tell you a little story. I have clients who have almost all their assets in RRIFs (RRIFs are simply RRSPs that have been converted after retirement to an income producing vehicle). She has a good pension. With their normal RRIF payments and pension income, they both have taxable income at around $80,000 each. For anything they earn over $80,000 their OAS starts to get clawed back. At about $129,000 it is totally clawed back. This makes their effective marginal tax rate in this range about 52%. Now what happens when they want to go on their Florida vacation (about $15,000), European cruise ($10,000) or pay for their boat at the marina ($12,000)? As soon as they withdraw from their registered assets, they have to pay 52 cents on the dollar. Not good!

So for anybody with a good pension (teachers, government employees, employees of any large corporation etc.) accumulating RRSPs doesn't make sense to me. If the couple above had accumulated non-registered assets, they would have had a fair bit of tax deferral and they would have had absolute tax savings on capital gains and dividends. They would only pay a little capital gains on their capital when they withdraw it.

Planning point: keep you conservative interest bearing investments in an RRSP and your equity investments that generate capital gains and dividends in your non-registered plans (including TFSAs).

There are lots of people out there who have pension incomes or will have them in the future at around $65,000 so they potentially face a very high tax rate (higher than Hal Jackman, or Paul Desmarais). Keep in mind that when the last spouse dies, the entire RRSP or RRIF is added to their income for the year, so if it is a sizable amount, a large chunk of it will be taxed at the top marginal rate i.e. up to 52%.

How about spousal RRSPs? I don’t much see the point of this added complexity now that we can split pension income (more on that elsewhere) so I wouldn't even bother with these now. Bottom line here is that I think you should reach retirement with a combination of registered or pension funds and non-registered capital.

RRIFs RRSPs are an accumulation of contributions that create a tax deduction in the year of the contribution or 60 days in the year following. RRIFs are converted from RRSP plans and in work in reverse fashion, that is, they allow you, the planholder, to continue to defer tax but you must withdraw a prescribed amount each year and pay tax on this withdrawal. You must convert your RRSP to a RRIF by the end of the year you turn 71. RRIF income received after you turn 65 is eligible for both the $2,000 pension income credit and income splitting (more on that elsewhere). One small planning point is that if you don’t need the full RRIF payment, and you have a younger spouse, you can have the payments based on your spouse's age.

TFSAs These are a great way to save non-registered capital for your retirement. Although you don’t get a deduction at the time of contribution, you don’t have to pay tax on your later withdrawals, so it avoids the problems I described under the RRSP section. I think these are particularly useful for those with good pensions, limited RRSP contribution room (usually the same folks), or uncertain income (because they can be accessed with no penalty in case of emergencies). If you have an investment that you think will go to the moon, put it into a TFSA. Or alternatively, if you have a special fund for emergencies, or a savings account, move the funds over to a TFSA. In other words, a TFSA is good for both conservative and aggressive investments.

In Canada, individuals file tax returns, not couples. Because of our progressive tax system, tax rates go up as your income goes up. So if one member of a couple makes a lot, and the other very little, they pay far more tax than if the income were evenly split between the two individuals. A simple example will highlight the difference.

• John and Mary Oldfashion. John has a taxable income of $120,000 per year and Mary has no taxable income. Their total family tax bill is $36,719.
• Bill and Jane Evensteven. Both Bill and Jane each have a taxable income of $60,000 so there total family income is the same as John and Mary. But their total family tax bill is $25,224 which is $11,495 less than John and Mary’s total tax bill. That's a huge difference.

There are many ways to split family income, but CRA also has many rules that limit income splitting. There are basically three kinds of income splitting: 1) income splitting before retirement 2) income splitting after retirement and 3) income splitting after death.

Here are some ways to split income before retirement:

• Hiring Spouses and Children – If the higher income spouse is running a business they can hire their spouse or children and pay them a wage. The spouse or children actually have to do work, and the value you ascribe to it must be reasonable and supportable  
• Prescribed Rate Loan - The Income Tax Act (ITA) has attribution rules to prevent a higher income spouse from transferring assets to a lower income spouse but the higher income spouse can lend money to the lower income spouse at a prescribed rate, currently at an all time low of 1%. Once established, the loan rate does not need to be reset.  
• Spousal RRSPs – As described under the RRSP section, this strategy is less attractive because of the pension income splitting option. Having spousal RRSPs adds unnecessary complexity to a portfolio, so I generally wouldn’t bother with them anymore.  
• Savings by lower income spouse - The higher income spouse can pay all the household expenses and the lower income spouse can save all their income to build-up non-registered savings. This can help even out the capital positions of both spouses and thus even out their post-retirement income.

Before age 65, only company pension and superannuation annuities qualify for income splitting or annuities arising from the death of your spouse. If you don't have a company pension, it’s kind of hard to split income. After attaining age 65, RRIF income qualifies, so if you haven't converted your RRSP to a RRIF or annuity, that’s the time to do it. Income splitting is only going to work if you and your spouse are in different income brackets. When I'm doing a couple’s tax return and they have qualified pension income, I run a pension splitting optimizer to determine how much to move over. It’s not always obvious what the right amount is, so this routine is very important and sometimes I can save my clients thousands of dollars in tax.

Testamentary Trust - There used to be an excellent way to split income after death by creating a testamentary trust in your will. Formerly, a testamentary trust was taxed separately and like an individual taxpayer, there were graduated rates (but no personal exemption). This was such a nice way to reduce taxes that the government changed the rules such that testamentary trusts are now taxed at the top marginal rate. Therefore, do not use a testamentary trust for this purpose (there may be other valid reasons to have a testamentary trust). However, if we don’t have a testamentary trust, we can still take advantage of the graduated rates for an estate, which are available for 3 years after the death of the taxpayer. We do this by holding the estate open, and not distributing the capital until the 3 years has expired.

Let's look at an example:
Laura is 80 years old and has 3 grown children, all of whom have high taxable incomes (over $120K). Laura’s total capital is $3 million. If she leaves 1/3 to each child, each of them will be paying tax at the top rate on the additional income from their inherited capital. If we assume that this capital would generate a taxable income of 4% or $40,000 each, the children will pay an additional tax of $17,900 each per year. But if Laura's estate is held open for 3 years, then the estate would pay tax at the graduated rate. The estate would pay tax of $35,000 per year and thus the family would save $18,700 ($17,900 times 3 = $53,700 - $35,000) over the 3 years when the estate is left open. If one of the beneficiaries needs all or a portion of their capital, that’s not a problem, because the executors can always distribute a portion of the estate whenever they decide.
Keep in mind that the estate will have to file a tax return every year while open, which will probably cost $250 to $400 per year, but the tax savings make this expense well worth it.

Capital gains are a wonderful way to make money because they are taxed at 50% less than interest and employment income but the best part is that they are only taxed when you sell the investment, so potentially you can defer them almost forever (when you die, you can pass to your spouse tax free, but if there is no spouse, the tax is then payable). Combining absolute tax savings with tax deferral is a beautiful concept and it makes sense too. You should be rewarded for taking a risk – capital gains are sometimes hard to get. The only bad part of capital gains is when they aren't gains but are losses. You can only offset these against capital gains. Capital losses can be applied back 3 years to offset previously declared capital gains or can be carried forward forever to be used against future capital gains.

To show the power of tax deferred growth, let's look at an example:

Bob has a stock his grandfather left him (his cost base would be equal to the value on the day his grandfather died) and it was worth $30,000 on the day he inherited it. It pays him no dividends but grows steadily in value year after year at 5% per year. Bob's wife Mary has a GIC that her mother left her on the same day that Bob’s grandfather left him his inheritance (an amazing coincidence) that is also equal to $30,000 and it also grows on average 5% a year. Mary pays the tax on the GIC, but does not take out the interest and she reinvest this at 5% every year too. Both are in a 40% tax bracket. So now let's see how they’ve done 20 years later.

Bob's $30,000 has grown to $79,598.93 and Mary’s has grown to $54,183.34. To be fair, Mary has paid the tax each year and Bob has not, so let's assume that Bob now sells the stock. If he didn’t have the capital gains 50% exclusion, Bob would pay $19,839.57 in tax, leaving him $59,759.36 which is $5,576.02 more than Mary has, even though they started with the same money at the same time and had the same rate of return, all because of the power of compounding (see Power of Compounding for another example of the power of compound interest). And if we then take into account the 50% inclusion rate, that means Bob's actual tax would only be 50% of $19,839.57, leaving him with $69,679.14 versus Mary’s $54,183.34.

Dividends are distributions of after-tax profit to registered owners of common or preferred shares. These are usually paid quarterly. There are many kinds of dividends but I will confine this discussion to the most common, which are eligible dividends. Dividends from large corporations like banks, manufacturers, oil and gas companies etc. are usually going to be eligible. Eligible dividends are subject to gross-up (making them bigger) offset by a dividend tax credit. We don't need to get into the mechanics of this. The important thing is that eligible dividends are taxed much less than interest income. The exact amount of tax depends on which province you live in. As a percentage of the full tax rate on interest income, they vary from 37.3% in Alberta to 61.6% in Quebec www.walterharder.ca/MarginalTaxRateCalculator.html for tax calculator for Canada). The rate for Ontario is 49.7%, so dividend income is taxed slightly less than capital gains income in Ontario. However, there is no tax deferral – the tax on dividend income is due in the year the dividends are received.