In its original form, initiative was an email periodical which had about a 200 word count base text, complemented with a graphic to show connections, flows or other dynamics, including labels and other supplementary text. Those graphics were not compatible with later technology, so only the original base text has been preserved for the present archiving purpose. The material was current to the year and month of issue (Vol#,No#) but is not a legal opinion.
Vol.1. Vol.2. Vol.3. Vol.4. Vol.5. Vol.6. Vol.7.
Volume 6
It is possible for a registered funds qualified beneficiary to absorb the taxation of those funds away from a deceased annuitant’s estate.
To make the transaction even more financially attractive, such a beneficiary may elect to defer the taxation on the received funds by placing them into his/her own tax deferral vehicle.
Refund of premiums paid to Can be transferred to:
RRSP (1) RRIF Annuity
Annuitant’s spouse or common-law partner Yes Yes Yes
Financially dependent child or grandchild No No Yes (2)
Infirm financially dependent child or grandchild Yes Yes Yes
(1) Must be 69 or younger at the end of the year the transfer is made.
(2) Annuity payments must commence no later than one year after the purchase and all payments must be received by age 18.
The transfer or purchase must occur in the year the funds are received, or within 60 days of the year-end.
Next month’s initiative will look at situations where the annuitant may exercise greater control over the funds.
In certain situations (see past three issues of initiative) registered money may rollover tax deferred to a financially dependent disabled beneficiary.
But what if the beneficiary lacks mental capacity to purchase an annuity or to make a joint election with the executor of an estate?
As well, even if the mental infirmity does not amount to mental incapacity, the initial receipt of the funds (prior to purchasing the annuity) may disentitle the beneficiary to provincial government support which is subject to asset and income means tests.
Recent proposed amendments to the Income Tax Act attempt to address some of these concerns, by allowing RRSP or RRIF funds at death to be transferred tax deferred to a ‘lifetime benefits trust’, which in turn would purchase a ‘qualifying trust annuity’.
Still there are remaining challenges that will hopefully be addressed before the proposed amendments are passed:
This tax deferral is available for mental infirmity, but not for physical infirmity
It is not clear whether the trust definition gives sufficient discretion to trustees to indeed adequately preserve provincial government support
A requirement that income of the annuity be recognized as income of the beneficiary could again imperil provincial government support
There is a standing myth about Wills that a person lists off all of his/her assets for the world to see. Perhaps this is one reason that some people delay in executing a Will due to the perceived daunting task of doing that big inventory.
Quite to the contrary, it is usually only where items of substantial commercial value are involved that a testator will list such items in the Will. Otherwise, the list would be outdated in no time, and it would indeed be a costly, time-consuming and burdensome exercise to keep the Will up-to-date.
Still, items of lesser but worthwhile value and items of sentimental value are often earmarked for particular persons. In such situations, a precatory memorandum or ‘memorandum of wishes’ may be prepared to list off such items and the intended recipients.
The Will would suggest that the executor consult the memorandum as a moral guide, but the memorandum would not be incorporated into the Will as a legal direction to the executor.
Ultimately the legal rights to such items would remain with the beneficiaries under the Will, so if it is anticipated that relationships after death will be contentious then the items may need to be fully listed in the Will after all.
Client and spouse have just bought their first house. They are now in the process of arranging mortgage insurance with their local lending institution, and have been offered mortgage life insurance protection. Should they take it?
As a first consideration, life insurance protection is indeed a prudent step to protect the family’s home should the breadwinner be no longer around to pay the mortgage. The decision is more as to whether the Clients should take the bank’s mortgage protection or obtain their own insurance.
Some considerations:
Bank mortgage insurance
Can appear less expensive early on, but it is generally a level annual premium cost for a declining amount of coverage
Insures the bank to pay off its money at-risk; it can’t be used for ongoing family support or to pay off other debts
Is specific to the institution, and will have to be re-applied at a new institution (assuming it is even available), which will be subject to insurability
Your own life insurance
Will generally be a level premium for a level coverage (though you may yourself choose to reduce the coverage over time)
Is paid to a spouse or other beneficiary who decides whether retiring the mortgage is necessary, or if there is a more pressing need
Remains in-force regardless of the location of the mortgage; you can decide whether to move your mortgage entirely on financial/ business considerations
There are very few situations in which insurance premiums may be a tax-deductible expense. Generally in order to qualify, the economic substance to which the insurance coverage relates must be a business purpose and/or income-generating activity.
In the case of supporting bank indebtedness, there are strict qualification criteria and documentation requirements that must be adhered to in order to obtain the deduction:
The lender must be a restricted financial institution (“RFI”), which definition includes banks, trust companies, credit unions and insurance companies
The interest payable on the borrowing is itself a deductible expense in the normal course of business
The RFI requires the insurance as collateral as a lending requirement (ie., it cannot merely be an accommodation to the borrower in order to facilitate premium deductibility)
The amount then eligible for deduction is the lesser of:
The annual premiums paid on the policy, and
The annual net cost of pure insurance
This deduction is further reduced proportionately by the actual dollars at risk. For example, if a borrower drew down a $1M line of credit an average of $400K during the year, the deductible amount would be 40% of the figure calculated using the above formula.
Client corporation is taking out a line of credit to support its business operations. As part of the discussions, the lender has offered what is apparently inexpensive debt-elimination life insurance coverage.
Apart from the general considerations of bank insurance vs. own insurance and deductibility of premiums (see the last two issues of initiative), the owner of the corporation is wondering what estate planning implications there may be to the choice between accepting the bank’s coverage or the corporation obtaining its own key person life insurance.
Essentially, where bank insurance is used, proceeds from the policy go directly to the bank to retire the indebtedness, and that’s pretty much the end of it.
By stark contrast, had the corporation obtained its own coverage and collaterally assigned the policy to the bank to support the indebtedness:
The corporation is able to retire the indebtedness
Any excess insurance proceeds are tax-free to the corporation
The corporation will get its normal credit to the capital dividend account (insurance proceeds less adjusted cost basis), even if all of the funds had to be used to retire the indebtedness
The CDA credit is now available for the tax-free distribution of retained earnings post-mortem, whether by CDA election on a deemed dividend upon share redemption, or as a cash-purge of the ongoing corporation
Note: This article reflects present CRA practice, but case law may interpret otherwise.
Client has been bombarded with innumerable investment choices through the media over the years. He has asked Advisor to provide him with some kind of framework for understanding investment income taxation.
Despite this being a tall order, the building blocks are the three principal types of investment income:
Property income – such as interest, rent and royalties – is fully taxable at an individual’s marginal tax rate.
Dividend income –
Dividends from foreign corporations are fully taxable at an individual’s marginal tax rate.
Canadian dividend income is subject to a gross-up and tax credit procedure, with the effective tax rate ranging from zero up to 2/3 of the top marginal tax rate.
Capital gains – which can arise when underlying assets within the investment are traded or when the investment itself is disposed – are effectively subject to taxation at one-half of an individual’s marginal tax rate.
Of course many investment structures can give rise to two or even all three types of income. Ultimately, Advisor will work with Client to ascertain goals, assess risk tolerance and dovetail investment choices for an optimal portfolio mix.
Client is confused with all the recent media talk about the changes to dividend taxation, and has asked Advisor what it is all about.
The procedure is designed to treat the investor as having received certain qualifying Canadian corporations’ income as their own income directly:
The dividend is grossed-up to estimate the original income to the corporation
Investor’s tax liability is calculated based on this higher amount
Investor gets a tax credit estimating the tax the corporation has already paid
Both the gross-up and the tax credit are based on the assumption that the combined federal-provincial corporate tax rate is 20%. In fact, only small business rates are in this range; otherwise actual corporate rates (depending on province) are in the mid 30-40% range.
As a result, some corporations have been reorganized recently as ‘income trusts’ in order to bypass the corporate tax and have gross income taxed direct to shareholders.
In response, federal rates are to be reduced leading up to 2010 (and the provinces are expected to follow suit), but the prevailing rates will still apply for income entitled to the small business rate reduction.
In Ontario, for example:
Gross-up Tax credit At top MTR
Prevailing rates 25% 18% 31%
Eligible dividends 45% 27% 22%
There are two key tax benefits related to capital gains:
Inherent growth of assets is not taxed annually. Rather, the growth in value of capital properties is delayed until sale or transfer of the property.
Capital gains are more favourably taxed compared to regular income. Presently, only one-half of the gain is taxable, but as recently as the late 1990s, the taxable amount has been as high as 75% of the gain – and it will likely always be a political target to keep an eye on.
Despite these benefits, even the best planners among us will not be able to escape the inevitability of death. At that juncture, even though assets are not ‘actually’ disposed, they are ‘deemed’ disposed from a person to his/her estate at fair market value, with tax then inconveniently due.
With that in mind, it is common for spouses to structure their estates in such a way as to minimize and defer taxes. In the case of a spousal rollover at cost base, the tax will be payable on the growth over two (or more if there is a remarriage) persons’ time of ownership, but the cash payment for those taxes will be delayed until the latest death of the spouses.
The formula is:
FMV
minus ACB
equals capital gain times (50%)
times terminal marginal tax rate
equals due to CRA
Client-couple have been model citizens for Advisor’s investment practice. They have budgeted wisely, saved conscientiously, and adhered vigilantly to a long-term investment focus that has enabled them to share a comfortable retirement.
Now that they are in their 70s, it is clear that a substantial inheritance will be passing on to their children – or will it?
On the recent death of a good friend they saw a hefty chunk of the investment assets go out the door to pay taxes on capital gains, and they have asked Advisor for a cost-effective suggestion as to how they may avoid the same unfortunate fate.
Assuming that they are in reasonable health, this is an ideal situation for joint-last-to-die life insurance coverage:
As its name suggests, joint-last life insurance coverage pays on the later of two or more lives insured on the contract
Since capital assets such as investments can roll over between spouses, no tax will actually be due until a second death
For ‘pennies’ in premium cost, comparative ‘dollars’ in death benefit will be guaranteed to provide liquidity to pay the taxes
Further more, joint-last insurance premium cost is less than the cost to obtain coverage on either one of them separately
Client has always been a cautious investor, and she is even more so now that her husband has passed away and she is managing the finances on her own.
She will have a reduced pension as surviving beneficiary of his company pension plan, and is now wondering what she might do with the non-registered GIC portfolio.
Advisor has analyzed Client’s situation and has suggested that a portion of her non-registered investments be used to purchase a non-registered prescribed life annuity contract:
Client must understand that once the capital is committed, the timing and amount of payments are fixed for life.
As the payments will continue for life, her capital will never run out. Still, it would be prudent for her to include a guaranteed minimum number of payment years to assure a reasonable return of the committed capital.
Unlike a registered annuity (coming out of an RRSP for example) that is fully taxable, non-registered annuity payments are a blend of taxable interest and non-taxable capital.
Finally, the plan can be structured as a prescribed annuity contract (PAC) so that the interest amount is the same on each payment received. The alternative (a non-prescribed annuity) would front-load the interest component (somewhat like a mortgage payment) and give rise to higher tax in the early years.
Client has run his incorporated business for well over a decade and has made regular RRSP contributions. Even though his investment performance has been reasonable (for which he appreciates Advisor’s guidance), he is a bit concerned that the cap on RRSP contributions make it difficult for him to sock away as much as he would really wish to have working for him for his retirement.
Advisor has suggested that he consider replacing some or all of his RRSP program with an individual pension plan, or IPP. As compared to the RRSP which prescribes the maximum amount that can be put into it, IPP contributions are actuarially determined by the expected/required income to be drawn from the pool of money during retirement.
Above all, Client must understand that an IPP is a formal ongoing legal obligation that has both benefits and drawbacks. Among the features and benefits:
Larger contributions, particularly for those in their mid-40s and onward
Generally is most appropriate for 6 figure+ income (for cost reasons)
Based on an indexed retirement income (preserving real dollar value)
Enhanced creditor protection relative to RRSPs
Ability/requirement to take a contribution holiday if investments over-perform
Ability/requirement to make a tax-deductible top-up if investments under-perform