Fatal attraction: Can you love an asset too much?
Financial Post August 8, 2009
The client: A 59-year-old man and high-income earner before retiring from a major energy company. He earned $150,000 to $225,000 a year, including bonuses. His retirement income is $130,000 a year, his pension is $65,000. His net worth is $3-million.
The portfolio: Approximately 80% of net worth is in shares of a foreign energy company that trades in U. S. dollars; 15% is fixed income.
The problem He is extremely overweighted in a single asset, which is rather risky. The fact that the company trades in a foreign currency further complicates his portfolio. “If you own U. S. situs property, which includes shares, that is worth more than US$3-million, you are taxed in both countries and receive a pretty onerous tax hit,” says David Salloum, a certified financial planner with RBC Dominion Securities Inc.
The fix: The first step Mr. Salloum took was to recommend an accountant that is licensed in both Canada and the United States to get the client’s tax issues in order, as well as a lawyer that is aware of all the estate-planning issues involved in owning a large portion of U. S. property.
He opened an investment account for the client’s wife and arranged a spousal loan. “Because she never worked, she has virtually no tax rate,” he says. “So, if the client lends her money at X– and right now spousal loan rates are low– we can turn around and buy preferred shares in dividend-paying stocks that have an interest rate two to three times X. That way, we get more money into her hands as well as reducing his taxable income.”
He also set up a joint last-to-die universal life insurance policy. “The client has three kids. If something were to happen to him and his wife, there would be a substantial tax liability based on how many shares he has in the company. It pays when the last one of them falls off the perch.” Once the policy is paid off, the client can borrow against it and help fund his retirement.
His next step was to tackle the behemoth in the client’s portfolio. “It’s still a good company,” he says, “but does the word diversification mean anything to him?” To avoid a major tax hit, Mr. Salloum used covered calls, an options strategy, to spread the sale of shares over several years. For example, if the stock is trading at $70 today, the client can sell a call option for $75 in December (with an additional $2-per-option fee.) “Instead of waiting for it to get to the price we’re willing to sell it at, why not sell an option at that price?”
The outcome He brought the fixed-income portion up to 40% and put most into an RRSP for tax purposes. The proceeds from the sale of shares were used to buy high-quality, dividend-paying Canadian stocks — banks, utilities, pipelines, giant retailers — most of which are option-eligible. By chipping away at the 80% single-asset shares, Mr. Salloum brought it down to a more palatable 25%. The client is familiar with the company and is comfortable with this level of risk, although Mr. Salloum would like to see the level drop even further. “Our company policy is that no one equity holding should be more than 10% of the total. I want the portfolio to pass the SWAN test for both of us: Sleep Well at Night.”
THE NEW PORTFOLIO
-40% fixed income
-25% shares in foreign energy giant
-25% high-quality dividend-paying Canadian stocks