Thanks to a budding tech sector in Waterloo and high priced real estate in Toronto and Vancouver, more people under 50 are striking it rich.

To some, it may seem as though wealthy Canadians need little financial help — many have more money than they know what to do with — but this group still has some complicated financial planning needs.

The biggest issue that young high-net-worth Canadians will have to deal with is tax and, specifically, capital gains tax.

Most of this group will have significant investments outside of an RRSP and they may not tap those funds until they’re well into retirement.

In other words, those gains could be growing for 30 years or more.

It’s an issue Terry Willis is dealing with right now. The vice president at Toronto’s T.E. Wealth has a 40-something client who recently made millions off the sale of a business.

The client is now investing his money and he’s worried about losing a lot of it to the taxman after he sells those stocks or passes away.

“The question we’re asking is, how do we go about mitigating that?” says Willis. “Our solution? Life insurance.”

Cover the bill with life insurance

For wealthy people, life insurance isn’t for leaving money to another generation. Instead, it’s used to take care of the massive capital gains tax that will eventually have to get paid.

While there are a lot of options to choose from, Willis says a whole life policy is typically the best choice, but it can be expensive. The person will fund the policy up front and eventually use dividends to pay the ongoing costs. When the person passes away, that policy will get paid out.

“My client is front-end loading his policy for 10 years, so a significant chunk of capital will go to that at first,” he says. “Because of that expense, it’s really up to the client to determine how much he or she wants to cover.”

Deciding how much to buy depends on how much you think your client will have to pay in three or four decades. While that may seem like a difficult task, Willis says it’s not as hard as it looks.

Just like a retirement projection, you assume a rate of return and assume an inflation rate. You know that the client will be in the highest tax bracket, so about 50% of the person’s money will be subject to a gain, and half of that will be taxed.

Pick a time frame, say 30 years, assume a rate of return of about 6% and then do the math to figure out how compounding returns will impact the portfolio. Once you get the number, you’ll be able to figure out the capital gain.

In some cases, a client may not want to cover all of it.

“There are studies that show that inheritances don’t last beyond three generations, so I tell the client that this is a risk,” he says. “We have the conversation around to what extend they want to transfer this wealth to future generations.”

Make use of trusts

There is another way to mitigate that tax hit: create a family trust.

In that case, money would go into the trust and get paid out to a non-working spouse or child who would be in a much lower tax bracket.

“Distributing income from a trust can be a huge win on an annual basis,” he says. “Compound that for the next 20 or 30 years and the savings can be fairly significant.”

There are some rules around creating trusts explicitly for the tax benefit. If the CRA thinks a client is setting up the trust only to pay less tax then it could attribute all of the income and capital gains made in the trust back to the person who set it up.

With that in mind, it’s critical that the trust is set up properly. Here’s a good primer on how to create a trust and more details on this tax issue.

There are other rules to keep in mind as well, such as the 21-year rule, while some of the recent Federal government changes to trusts may impact your client too.

Clearly, there’s a need for young, wealthy Canadians to seek financial advice. It’s a different process than if they were 65, but the goal remain the same — keep more money in their pockets for them and their families to use.

Bryan Borzykowski is a Toronto-based business journalist. He writes for the New York Times, CNBC, CNNMoney, Canadian Business and the Globe and Mail, among other publications. He’s also written three personal finance books published by John Wiley & Sons. Follow him on Twitter @bborzyko.
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