The Professional Advisory June/2013

The

60 Professional

Advisory For Dental Professionals

IN THIS ISSUE In MeMorIaM: Dr. Ian Wexler

DaVe’s Top Ten lIsT for VenDors David Lind

your lease Is a securITy rIsk Ian Toms B.Sc. (Hons)

The Value of TeaMWork In our DenTal offIces Dr. Ron Weintraub

D Is for DeDucTIon David Chong Yen CPA, CA, CFP

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non-DenTIsT oWnershIp of DenTal pracTIces - parT 3 David E. Rosenthal BA., LL.B.

an alTernaTIVe To DoWnsIzIng Mark McNulty BA, CFP ®, CIM

The DreaDeD 10-8 sTraTegy Simon Kay

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The Professional Advisory consists of a group of seven independent professionals who provide services to the dental profession, each of whom specializes in a different field. They have gathered to keep each other informed of the latest developments relating to the profession, and to produce this publication which is designed to provide expert information and advice solely for dentists and their advisors.

In Memoriam: Dr. Ian Wexler

All of the contributors, editors and readers of The Professional Advisory extend our deepest sympathies to Risa Goldenberg Wexler on the passing on March 8 of her beloved husband DR. IAN WEXLER, aged 53, and to their children Callie, Landon and Chase. Ian began his dental career in New Jersey, after graduating in 1985 from the University of Medicine and Dentistry of New Jersey. After marriage, he and his Toronto born wife settled in Ontario. In 1995, a disability meant that Ian had to give up the practice of dentistry. His experience at this time gave him insight into issues related to insurance, especially as they affect self-employed professionals such as dentists. Ian identified a need, and in 1996 founded Protect Insurance Agencies Inc., a company based in Toronto which soon established a national reputation as a leader in the field of disability and other insurance products. Ian was a prolific writer, having written over 65 articles in major journals, and was a co-founder of The Professional Advisory, which now is distributed five times annually to every dentist in Ontario. He was also a frequent and engaging conference speaker at venues across Canada. Ian’s leadership in the insurance services sector, and his commitment to his profession, were well-known within the dental community, and in recognition of his unique role in understanding and addressing insurance issues for dentists and other professionals, he was an eight-time recipient of Great West Life’s prestigious Award of Excellence.

Ian did not build a sales organization. Instead he built an advisory practice based on core, client centric values and selected a team that would continue and uphold that legacy into the future.

Ian was laid to rest on March 10 in Toronto’s Mt Sinai Memorial Park. Ian will be deeply missed by his loving family, by the dental profession to which he was committed, by his colleagues at Protect Insurance, by us here at The Professional Advisory, and by everyone who was touched by his energy, commitment and love of life.

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Your Lease Is A Security Risk IAN D. TOMS B.Sc. (Hons) www. iantoms.com

Please send comments to iantoms@pipcom.com.

Do you think your landlord is going to call you up and tell you that you are over-paying rent?

Your lease can quietly drain away thousands of your dollars each year. It’s up to you to actively manage your lease affairs. At least 40 per cent of tenants following the steps indicated in this article will find a rent “leak”.

The area of your premises determines how much rent you pay in two ways. First, you pay rent on a per square foot basis. Secondly, the calculation determining your share of additional rent is based on your premises area measurement. Therefore premises area has to be accurately measured, measured according to reasonable criterion, and the certified area applied to how payments are calculated. A 10 per cent error costs a 1,500 sf tenant, who is paying a gross rent of $40 per square foot, about $180,000 during a 30 year tenancy.

Defining what rent is payable on the certified area is equally important. Base or net rent is simple to manage, but the components and share calculation of additional rent is often vague and subject to landlord’s discretion, which a prudent tenant needs to manage. a. During the offer to lease negotiation, the premises area measurement criterion must be clearly defined, reasonable and the final measurement capped.

The share of additional rent must be reasonable, defined and fixed. Additional rent component inclusions and exclusions, and a mechanism to audit additional rent must be established. b. On premises possession, the premises area needs to be certified by measurement on-site by a qualified professional. c. At the beginning of the tenancy, all rental payments need to be adjusted according to this certified measurement. It amazes me to see long

standing tenants pay rent on the original premises area estimate even though the premises area was certified as agreed! d. During the new lease negotiation, the proposed lease must be reviewed to ensure that the terms and conditions describing rent components and area measurement - so carefully negotiated in the offer to lease - are transferred to the new lease.

Otherwise what was the point of all of the effort during the offer negotiation? e. Under an existing lease for an established tenancy: i. With respect to premises area measurement: 1. Check your lease documents to determine: a. how much space does your lease indicate you actuall have as leased space? b. how is the premises area supposed to be measured? c. was the indicated area ever certified?

Clue number one is that if the premises area figure indicated in your lease ends in one or two zeros, that figure is very unlikely to be accurate.

2. Check your area measurement by hiring a qualified space measurement consultant to certify your premises area.

3. Check your area measurement against what you are actually paying for by comparing your rent payment calculations against your annual additional rent statement or rent cheque.

4. Always be on the lookout for the landlord trying to increase the rent by increasing the premises area measurement. a. At any time a landlord may try to quietly “sneak one past the goalie” by not saying anything and simply billing you for rent calculated on a larger area. b. Landlords attempt to introduce new premises area measurement at lease term renewal. ii. With respect to additional rent: a. Check your lease to determine exactly which costs you agreed to pay for, which costs did you not agree to pay for, how your share of each cost is to be calculated, and whether administration or management fees apply 4 2

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Base or net rent is simple to manage, but the components and share calculation of additional rent is often vague and subject to landlord’s discretion, which a prudent tenant needs to manage.

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category may be legitimate, the total cost may to some or all costs. be away out of line. b. Review your annual additional rent statement, d. If you suspect an incorrect calculation, or comparing both costs and calculations that a cost ought not to be included, you need claimed by the landlord, to those indicated to refer the matter to a qualified professional under your lease. rather than to go directly to your landlord. c. Compare the additional rent costs indicated by your additional rent statement to determine Bottom line is, never assume your landlord is “out to if each cost is reasonable, and whether any get you”. Always assume that you need to actively look costs are duplicated. Even though a cost out for yourself. PA

Mr. Toms has been creating and preserving realty leasehold value since 1986 and can be reached at (705) 743-1220, by e-mail at iantoms@pipcom.com, or through his web site at: www.iantoms.com.

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The Value of Teamwork in Our Dental Offices DR. RON WEINTRAUB www.innovativepracticesolutions.ca

Please send comments to drronips@rogers.com.

Successful practices require expertise beyond providing high level clinical skills. A well-run dental practice requires a group of competent professionals who create a positive atmosphere, embrace a common philosophy, and contribute to the effectiveness of the operation of the office. This group of people constitutes the TEAM. Identifying Team Members The TEAM is divided into two groups that perform specific duties and play an indispensable role in the ultimate success of dental practices. Examining the TEAM’s interactions with a view to enhancing outcomes of their roles’ contribution within the practice is prudent. The numbers of TEAM members range from a single practitioner’s receptionist who is sometimes combined with clinical responsibilities to larger practices’ Human Resource allocations that could be as complex as the following: 1. Administrative Group a. Greeter/Dismisser b. Receptionist/appointment provider c. Re-care coordinators d. Treatment coordinator e. Office manager 2. Clinical Providers a. Dentists b. Hygienists c. Chairside assistants d. Treatment facilitators e. Denture therapists f. Lab technicians

Solo and multi-provider practices In solo practices, many support functions are, of necessity, assigned to two or three staff members. It is, therefore, crucial that they be adequately cross-trained to cover the variety of tasks smaller practices need to be discharged satisfactorily in much the same way as their larger counterparts. An even more daunting task than training is finding people with the proper skill set to be proficient in all the roles they may be asked to fulfill. When we are fortunate enough to attract individuals with this potential, we need to provide sufficient training for them to be able to multitask successfully on behalf of the practice.

In contrast, large multi-provider practices have the luxury of departmentalizing the different office and clinical functions allowing team members to focus on specific roles. Having a large team, however, creates the necessity for a serious focus on internal TEAM management; the success of which has a huge effect on the professional and financial outcomes of the office. The challenge is to incorporate the various possibilities to maximize positive interactions of the TEAM with patients and their teammates.

Recruitment practices Recruiting staff needs careful attention. Currently, advertising on Kijiji and other such sites add another dimension to recruiting in addition to advertising on conventional print publications. Such advertisements should yield a good variety of applicants. Careful screening of applicants’ experience, acquired skills through work, and interpersonal skills is followed by a face-to-face interview to determine the personality profile and, most importantly, how the candidate would mesh with the existing office culture and personalities.

Another crucial step in the process of recruiting is having a panel of interviewers that include the dentist or designated office manager and, if it is an administrative slot to be filled, a representative of the existing team. For example, someone who has front desk exposure would have insight as to the qualities needed for the position in addition to being 4 4

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helpful to smooth the integration process of the new hire.

In the case of clinical staff, an arranged paid working interview should be agreed upon to assure that the applicant and practitioner are both comfortable. For all new hires, hours and salary parameters presented in written form avoid any misunderstanding. Once a candidate has been cleared, a definite confirmation needs to be offered immediately without any procrastination to prevent losing someone who is acknowledged as a “fine fit.”

Importance of retaining effective team members A well trained, talented, patient-connected team member is a significant asset in a practice. Today, when asked where they receive their oral care, many patients answer “dentistry on ________St.” or “___________ dental group,” thus confirming that although dentists are the primary TEAM member, they are not the sole attraction for the patient. In fact, the entire clinical and administrative team play an important role in patient retention and new patient acquisition.

The importance of a TEAM member is noted particularly when we are invited to enhance a practice; we frequently attempt to retain and augment the skill set that already exists rather than suggest new hires. Often the existing staff has pre-existing significant relationships with the patient base that takes years to develop.

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Strategies to maintain and maximize excellent current team membership Among some of the effective strategies to help retain, maintain, and maximize an excellent team are the following: 1. Project support and appreciation of the importance of staff members’ role for the office as motivation for them to be even more invested in the success of the office.

2. Provide clear job descriptions and offer help to expand their roles through continuing education internally and via seminars. A series of metrics can be set up to be able to quantify the improvement that team members have brought to their role.

This allows for goal setting for the employer.

3. Recognize achievement to maintain the momentum. Many people are not necessarily motivated only by increased compensation but are more motivated by job improvement and recognition.

4. Schedule regular team meetings with an agenda that are chaired by rotating staff members.

A well-integrated, highly motivated team respectful of patients and the roles of other teammates is an outstanding precursor of excellent practice success. It is beneficial to provide the framework for the TEAM for this to be the norm in our offices. PA

Ron Weintraub is a founding partner with the Bayview Village & Downtown Dental Associates and brings over thirty-five years of knowledge and experience in the practice of general dentistry to the Professional Advisory. Large companies such as Patterson Dental, Ash Temple Ltd, Henry Schein Arcona, & the former Canadian Dental Co. have benefited from his insight. As owner of Innovative Practice Solutions, Ron advises dentists on practice enhancement, practice purchases, sales, location evaluations, associate buy-ins, and business mergers. Dr.Weintraub can be contacted at (905) 470-6222 Ext. 221 or drronips@rogers.com.

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D is for Deduction DAVID CHONG YEN CPA, CA, CFP www. dcy.ca

Please send comments to dcy@dcy.ca.

Dentists running a business may deduct all reasonable business costs. However, this is often harder to decide than it appears. Some common issues are: • Is an outlay an “expense” or “capital”?

• Is the expense really a “business expense” at all?

• What are some common deductions you might be missing?

• Which expenses are most likely to attract Canada Revenue Agency (CRA) attention?

If you buy something with continuing value beyond one year, it is usually considered “capital”. For example, a $50,000 piece of equipment cannot be expensed in the year of purchase because you expect to get many years’ service from it. The tax system allocates the cost to each of these future years rather than give a big deduction in year one; this annual “depreciation” is a deductible expense. So it matters how you characterize the asset involved, since the various asset-types have different depreciation rates, determining how fast you can write it off. For example, software can be written off over two years, but dental equipment has a much slower write-off, so if you can separate out the software value in a large equipment purchase, you get a faster write-off, and thus save taxes faster. It’s worth money to you by speeding up your return on the equipment investment.

Often, you will face difficult decisions such as whether an outlay is a repair (needed just to keep the item at the same level of quality) or an improvement.

For example, patching the carpet in your office is fully deductible if you are keeping the same quality flooring and just ensuring its serviceability is not degraded. But if you replace your carpet with ceramic tiles, you have upgraded the value of the building, so that improvement is usually capitalized as an additional

building asset (only eligible for a slow write-off ).

These decisions are often in the ‘grey’ area, so only make such outlays after asking your advisors how you can be as tax-effective as possible. Large equipment purchases such as a CEREC or E4D are always capital, but small items are often written off the same year, since they will be used up in only a year or so, and the amounts are too small to warrant separate tracking.

CRA permits dental instruments below $500 to be written off as expenses.

There are many ‘grey’ area decisions as to whether an expense is really a ‘business’ expense at all. For example, the CRA can decide that salaries paid to related persons are not needed to earn business income. So while the related person still pays personal tax on their salary, the dentist or the Dentistry Professional Corporation (DPC) does not get a deduction, since the relative’s services were not actually needed for it to earn income. Therefore, be careful not to deduct salaries to related persons which are higher than what you pay non-related persons for similar work.

Another difficult area is travel. Deductible travel for continuing education includes hotel costs and meals incurred during your stay, and travel to/from the site.

Be careful not to include costs for non-professional family members.

Many continuing education promoters claim that travel costs for educationthemed tropical cruises are deductible, but CRA only allows a deduction for reasonable costs of attending a comparable course in North America, so you should try in such cases to remove excess costs which are really just vacation expense. Flagrant abuse of these rules is a popular CRA audit target. 4 6

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Deciding which items to deduct is often difficult, since excess caution may mean paying too much tax, but being too aggressive can result in CRA scrutiny, and a bill for taxes plus interest, and sometimes, penalties.

Many dentists do not realize that they can expense travel done for true business purposes. For example, if you use your personal car for business (such as to visit your banker or lawyer, or to buy supplies) you can expense each kilometre to the business. At present, you can recover 54 cents tax-free (for the first 5,000 km driven in the year) and 48 cents tax-free (for each additional km driven in the year) from your DPC for each business-related kilometre driven, and that cost is tax-deductible inside the DPC. Be sure to keep a careful record in a log book of the date, length and purpose of each business trip. Also, normally, if you spend $100 on meals and entertainment for clients, the tax rules only allow you to deduct $50. However, if the payment was for a meal intended for your staff, it is 100 per cent deductible (to a yearly maximum of six). So staff parties, dinners and other outings are

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still 100 per cent deductible up to the maximum of six per year, where all staff have been invited.

The CRA is always looking for deductions taken as practice expenses which they consider to be personal.

Some expenses often scrutinized by CRA include: unreasonable salaries for family members; unreasonable travel expenses for continuing education and conferences, especially for family members; and personal meals and entertainment expenses.

Deciding which items to deduct is often difficult, since excess caution may mean paying too much tax, but being too aggressive can result in CRA scrutiny, and a bill for taxes plus interest, and sometimes, penalties. Therefore, this area requires careful thought, and often, checking out your ideas with professional advisors first. PA

David Chong Yen, CPA, CA, CFP of DCY Professional Corporation Chartered Accountants is a tax specialist and has been advising dentists for decades. Additional information can be obtained by phone (416) 510-8888, fax (416) 510-2699, or e-mail david@dcy.ca. Visit our website at www.dcy.ca. This article is intended to present tax saving and planning ideas, and is not intended to replace professional advice.

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Dave’s Top Ten List for Vendors DAVID LIND www. ppsales.com

Please send comments to david.lind@ppsales.com.

As a dental practice appraiser and broker I am fortunate to be in a position where my daily activity is a window into what works and what does not work in terms of value creation in a dental practice.

As practice values continue to soar, buyers are being very careful (as they should be); therefore it is more important now than ever that you and your practice are ready when the time comes to sell. This article will take a page from Late Show Host David Letterman’s monologue and enlighten you about my “Top Ten List” for Dental Practice Vendor’s.

10. Location/Premises - Dental offices are located in a multitude of different kinds of locations. Buyers want visibility and new patient flow. This means that the walk-up over a bank will be a tough sell.

It also means a practice in a professional building with strong new patient flow due to excellent internal marketing is appealing. The inside should be attractive and well maintained but does not have to have all the latest hi-tech gadgets. There is no one size fits all.

9. Be Educated - Most often, selling a dental practice will be a once in a lifetime experience. Take the time to understand the market and where your practice fits into it. Learn how to make it appealing to buyers. Be realistic in your expectations and have a plan for how the transition will go and what you’re going to do after you sell.

8. Have balanced financial metrics - Many dentists only look at their financial performance once a year at tax time when they see their accountant. As you prepare to sell be aware of how the revenue

comes in and where the expenses go out. Look at hygiene revenue - is it over 30 per cent? Is the rent expense 6.5 per cent or less? Are staff costs around 26 per cent of gross? All of these factors are very important as are many other financial metrics.

7. Surround yourself with experts - Selling a dental practice is a complex undertaking. You will likely have shares of a Dentistry Professional Corporation (DPC) to sell, capital gains to consider, staff and a landlord to deal with, diligence to comply with. It is extremely important to consult with professionals that know what they are doing. Your accountant, lawyer, financial advisor and broker all play an integral role in a successful outcome.

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The sale of your practice, while a complex undertaking, can and should be a very rewarding process. It will allow you to receive value for what you have created and leave a legacy that has benefits for your staff, your patients, and the buyer.

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6. Time it Right - I do not mean to say that you should try and pick the top of the market. I mean you should be mentally prepared for the life change that selling a dental practice means and you should not wait until it is too late. Once your practice starts to decline, the new patient flow starts to dry up, and you start feeling tired, it is a slippery slope that is hard to reverse. 4 8

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5. Staff Considerations - Once you are gone, your staff becomes a very important link to the patients for the buyer. Have good people and deal with any bad apples before you sell. It is important that you have the right number of staff for your practice size (no “floaters”) and that they are paid market rates. If they are overpaid, you will have to deal with that before a sale is concluded.

4. Have Contracts - The days of handshake deals with people are sadly over. It is imperative that if you have an associate, you have a good contract drafted by a dental lawyer. If you do not, the value that your associate brings to your practice will not only evaporate, it may actually be an impediment to you concluding a sale. Deal with this right away.

Additionally, your practice value will be enhanced if you have written employment contracts with your hygienists and your other staff members.

3. Focus on Hygiene - The hygiene revenue produced in your practice is a key value driver and a real focus for buyers. You should strive to keep it at 30 per cent of your gross or more. Hygienists should be paid at the market rate for your area

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and should be able to produce three times what they are paid per hour.

2. Have a good Premises Lease - Landlords have become increasingly difficult to deal with during transition periods. Your lease should have a term, including renewal options of 10 years or more, should not have a demolition or relocation clause, and should be assignable with the landlord’s consent which should not be unreasonably withheld for a fixed fee.

1. Plan Ahead - As the previous nine bullets indicate, there is a lot to do in order to be prepared to sell your practice. Your goal should be to obtain a fair price and provide the buyer with an excellent opportunity for a successful transition. This will take time to orchestrate so I recommend you begin discussions with the experts about five years prior to your ideal sale date.

The sale of your practice, while a complex undertaking, can and should be a very rewarding process. It will allow you to receive value for what you have created and leave a legacy that has benefits for your staff, your patients, and the buyer. PA

David Lind is a Principal and Broker of Record in Professional Practice Sales Ltd. (www.ppsales.com), which specializes in the valuation and sale of dental practices. He can be reached at (905) 472-6000 or 1-888-777-8825 or e-mail at: david.lind@ppsales.com

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Non-Dental Ownership of Dental Practices - Part 3 DAVID ROSENTHAL BA., LL.B.

certain specified family members of a dentist can be non-voting shareholders of the dentist’s PC. Those family members are restricted to a dentist’s spouse, children and parents. Having such family members as non-voting shareholders of your PC is now a common and excellent structure for dentists.

Please send comments to david@drlaw.ca.

In volume 58 and 59 of The Professional Advisory I wrote about non-dentist ownership of dental practices.

The primary questions are: What can non-dentists purchase or own? Aside from actually working at a dental practice, how can non-dentists profit from a dental practice? This is Part 3 of the article and will continue to explore answers to these questions.

From a legal perspective the starting point is to understand what only a dentist or a dentistry professional corporation (PC) can own; and that is the professional dental goodwill of a dental practice.

That goodwill includes custody and control of all patient records and files (including patient billing records and treatment plans), patient charts, x-rays and models, patient lists, and use of any dental practice names. A dentist or PC are the only ones who can own the goodwill.

The other fundamentals to understand are: 1. a dentist can not engage in any form of fee or income sharing except with other dentists at the practice and with dental hygienists who practice dental hygiene in and at the dentist’s practice; 2. a dentist can only practice dentistry with other dentists. A dentist can not work for non-dentists whether as an associate, employee, partner or otherwise when engaging in the practice of dentistry; and 3. only a dentist can prescribe dental radiographs and only a dentist can be a radiation protection officer.

In volume 59, we explored the use of a technical services corporation. Volume 58 described how

Creating the proper share structure for your PC is a critical step and your tax and legal advisors will assist you in that process. In particular, careful thought needs to be given to the attributes of your family member’s non-voting shares: • do the shares participate in the profits only (dividends) and/or in the PC’s residual value and growth (equity) • what priority do the shares have against other classes of PC shares for dividends or distribution when winding up or selling the PC shares • do the shares have a fixed value • are there redemption or retraction rights • how many different classes of non-voting shares should be issued Generally speaking, for maximum flexibility each family member should have a different class of nonvoting shares.

If family members receive shares that are not redeemable by the PC, it is essential to have a shareholders agreement. Your dental practice is your livelihood. It is critical that you, the dentist, and not your family members have absolute control of the PC and practice at all times. 4 10

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If family members receive shares that are not redeemable by the PC, it is essential to have a shareholders agreement. Your dental practice is your livelihood. It is critical that you, the dentist, and not your family members have absolute control of the PC and practice at all times.

A properly draft shareholders agreement will ensure you have such control.

Non-voting shares have voting rights under the Business Corporations Act (Ontario) in certain cases.

In some circumstances shareholders of each class are entitled to vote separately as a class, whether or not that class of shares carry the right to vote. If, for example, you need to reorganize your PC share structure but your rebellious family member will not agree, then this is serious problem. This can be dealt with in the shareholders agreement by family members giving a power of attorney to the dentist relating specifically to the PC shares.

At some point in your career you will sell your practice by asset sale or a sale of all the PC shares. The dentist must be assured that all the PC shares or assets will be sold, whether or not the other shareholders (your family members) wish to sell or agree on the sale price or sale structure. The shareholders agreement should provide that the dentist has the right to ‘drag along’ the other shareholders on the sale of the practice.

Consider other events such as death of a family

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member or divorce or separation from your spouse.

Those events are stressful enough. The shareholders agreement should specify what happens to the family member’s shares. For example, the shares might be redeemed by the PC or purchased by the dentist.

The shareholders agreement should deal with how those shares are going to be valued and the terms of payment. It may be appropriate for your family members to obtain independent legal advice before signing a shareholders agreement.

The dentist must remain in control of the PC regardless of changing circumstances. A properly drafted shareholders agreement will ensure this. The ideal time to complete the shareholders agreement is at the beginning of the process when the non-voting shares are being issued to family members.

The rules permitting family members to own shares of your PC present significant tax planning opportunities and potentially substantial tax savings for you and your family. However, the laws are complex. Proceed carefully and with the benefit of professional advisors who are very familiar with such structures and who regularly advise dentists on such matters. PA

David Rosenthal is a senior lawyer with Spiegel Rosenthal Professional Corporation whose practice is devoted to corporate, commercial and business law, with special emphasis on advising dentists. He can be reached at (416) 865-0736 or e-mail to david@drlaw.ca.

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An Alternative to Downsizing MARK McNULTY BA, CFP, CIM www.yournumber.ca

Please send comments to mark@mcnultygroup.ca.

Case Study One: The retired dentist Dr. John and his spouse, Mary, are 70 years old.

They spend $9,000 per month after-tax including government benefits. They have $1.4 million in RRSPs. They have exhausted their “tax-paid” savings.

John and Mary are considering downsizing their home to free up some more cash. It is worth $800,000. The problem, of course, is they are not satisfied with any of the alternatives to where they can downsize.

Therefore, a $400,000 line of credit is set up (to give us room if markets decline). Next, $150,000 is actually borrowed and invested in the banks listed above. This means the interest payments are $4,500 and the dividends earned are $6,450. After tax, this translates into a net profit for John and Mary of $2,434 per year just on the dividends, for a net after-tax yield of 1.6 per cent.

The trading strategy will be to take money off the table any time the shares are up to a certain level. Therefore, if we bought $150,000 and the stocks are now worth $160,000, then $10,000 of shares are sold and these funds are used to pay down the loan.

Case Study Two: The dentist who is mortgage free Another dental family we work with live in Toronto, they are both 53 years old, and have a mortgage free home worth $2,000,000. If $500,000 was borrowed using the same numbers as case study one, they would add $8,000 to the tax-paid savings every year. Again, this is just on dividends and assumes no growth in the stock prices of the banks over the next decade.

With real estate prices hovering at record highs in Canada, have you ever considered downsizing? If so, here’s the problem - downsize to what? All too often, by the time you pay all costs and buy again into a smaller property and fix it up to be something you love - the amount of money you end up banking is insignificant.

Here is another alternative - borrow against your home to invest. Now before you stop reading, hear me out.

Interest rates are at all-time lows and the consensus is they will not be going up anytime soon. I just checked with a contact at a major bank and we can get a line of credit (with the home as collateral) at three per cent. The loan would be interest only and the interest would be tax-deductible. Therefore, on an after-tax basis the loan against the home would probably cost between 1.5 and 2.0 per cent.

We are not recommending the stocks below, but here is an example of what the big banks are paying via The reason we consider this as an option is because dividends: they have very little savings built up personally.

They have a portfolio of $2.4 million but it is all in ROYAL BANK OF CANADA 4.1% corporations and RRSPs. For future tax planning, it BANK OF MONTREAL 4.7% will be good to build up tax-paid money in order to CANADIAN IMPERIAL BK OF COMM 4.8% allow us to draw on the tax-deferred money at a slower TORONTO DOMINION BANK 4.0% pace, thereby lowering their tax bill in the future.

NATIONAL BANK OF CANADA 4.5% BANK OF NOVA SCOTIA

4.2%

The Downside This is an average yield of 4.4 per cent, which is more Of course, we all know borrowing to invest increases than enough after-tax to pay the interest on your debt. our exposure to the ups and downs of the stock market.

There would still be cash flow left over, and you would Therefore, if you ever consider this as an option it is also still have the prospect of capital growth in the important to first understand the difference between shares of the banks. risk and volatility. Risk is the possibility that you 4 12

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All too often, by the time you pay all costs and buy again into a smaller property and fix it up to be something you love - the amount of money you end up banking is insignificant.

might lose the money you invest. For example, if you speculated on Nortel and didn’t sell, your money is gone. Another risk is if you sold out after the 2008 stock market crash, you missed out on making all the money back.

Volatility, on the other hand, just means the ups and downs your investments undergo. Not many Canadians or investment professionals believe that if

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you buy the big banks, you risk losing all your money.

The prices of the stocks go up and down, but that is volatility - not risk.

For these two families, we have ample assets outside of this strategy and the improved cash flow is worth the volatility they will encounter. However, this plan is not for everyone and must be considered carefully before implementing. PA

Mark McNulty BA, CFP®, CIM is the Director, Private Client Group of the McNulty Group of DWM Securities Inc., member of Canadian Investor Protection Fund. This article is for information only. Its opinions are those of the author, not necessarily those of DWM Securities Inc. He may be contacted at 905-470-6222 ext 209 or mark@mcnultygroup.ca

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The Professional Advisory

Vo l.60 : June 2013

The Dreaded 10-8 Strategy SIMON KAY www.protect-ins.com

Please send comments to simon.kay@protect-ins.com.

So right off the bat, I need to disclose that while I am very well versed on the 10-8 insurance strategy, I have never, in my 25 years in the insurance industry, executed one. In light of recent proposed changes in the Federal budget, I suppose you can understand why. For those dentists that are engaged in this structure, you will need to have an advisor review the components of the contract and make changes if necessary.

In terms of straight talk about 10-8’s, let’s just call this what it is; it’s a maneuver to reduce the cost of permanent insurance. Essentially you pay the cost of insurance and make a large additional deposit into the policy. The insurer guarantees the interest rate you receive on the deposit (typically 8 per cent) so long as you borrow that deposit back at a fixed borrowing rate (typically 10 per cent). The intention is to use the borrowed funds for something investment or business related so that you can not only write off the pure cost of insurance but also the 10 per cent lending rate. The issue that Canada Revenue Agency (CRA) has is that the credit and loan rates are linked.

So do you have an issue? A few simple questions will answer that. First, do you have a Universal Life insurance contract? Second, are you borrowing against the policy to use the borrowed money for investment purposes or injecting back into your business? If you answered yes to both questions, is there a guaranteed link that the insurer is providing between the credit and the borrowing rate?

If any of the answers are no, you’re all good. If not, you will need to have the structure reviewed by an advisor that understands not only how 10-8’s were implemented but also your options to be compliant with the changes in this year’s federal budget.

Let me explain why many advisors including myself have been fundamentally against this strategy or any similar structure. Insurance is the no/low risk portion of your portfolio, so why would you add risk to a no/low risk product? Insurance is so elegant in its simplicity. It’s pretty much the only remaining tax shelter left in our financial tool box. Policy growth is accumulates tax free, can flow out to your beneficiaries tax free, can be funded corporately and can even flow out of a corporation tax free. This recent change is not really about insurance at all. All of the tax efficiencies are well intact and unaffected. The changes only affect the linking of credit and borrowing rates of the insurance product. CRA’s intention was not to allow for this outside manipulation of the contract. So in my estimation, trying to squeeze a few extra points out of a simple, risk free product is just too aggressive for my tolerance and client advice. It was just a matter of time before CRA challenged the abuse of the spirit of the treatment of insurance.

For those who participated in 10-8’s, the question now is, what do I do? First and foremost, have it reviewed.

Understand your options. There may be loans to be settled, the cost of insurance structure will need to be reviewed because it was likely designed with yearly renewable term that is cheap in the early years and increases every year becoming cost prohibitive as you get older. 4 14

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The Professional Advisory

Vo l. 60 : June 201 3

For those who participated in 10-8’s, the question now is, what do I do? First and foremost, have it reviewed.

Understand your options. There may be loans to be settled, the cost of insurance structure will need to be reviewed because it was likely designed with yearly renewable term that is cheap in the early years and increases every year becoming cost prohibitive as you get older.

One option may very well be to completely unwind the structure. If that is the case but you still want to carry permanent insurance, you may have another issue. You are now older and as such, your base cost of insurance has gone up with your age. The other issue is that you may have changes to your health history that will create underwriting issues and either affects your rate or your ability to get approved for coverage at all.

For those that have met me, you know that underwriting is near and dear to my heart. Rates have increased and underwriting has tightened significantly in the last four to five years in an effort to increase profitability in the low interest environment. That said, there is more of sensitivity to relatively simple medical histories, scheduled doctor’s appointments, family history, foreign travel, assets abroad, etc.

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My advice is to absolutely make sure you seek underwriting expertise before going any further.

Completing an application and then leaving the due diligence solely to the insurer is too much of a gamble in terms of what they find out and how they evaluate that evidence. See Dr. Wexler’s article on the underwriting process in The Professional Advisory Volume 57 for more commentary on this topic.

So my final words of wisdom are the following. Don’t wait. You may not be compliant with changes in the budget to the 10-8 strategy so being proactive when it comes to taxes is paramount. Next, reach out to your advisor or someone you trust that is competent when it comes to not only the original strategy but also CRA’s position and options going forward. Understand your options so you can make good choices going forward. PA

Simon Kay is a Life, Estate and Private Underwriting Specialist who has written articles and been interviewed extensively on insurance and underwriting issues. He is a partner with Protect Insurance Agencies Inc. who is a leading authority on insurance issues for dentists and provides specialized expertise in life, disability, critical illness, long term care and other insurance products and services to over 900 dentists across Ontario for the past 17 years. Simon can be reached for questions or other enquiries at (416) 391-3764 or simon. kay@protect-ins.com.

The views expressed in any article are those of the author alone. They should not be acted upon without the advice of your “professional advisors”.