Author: Doug

Vol.04 No.1 – Non-traditional RRSP & RRIF maturity options: The Tax Melt

Perhaps the greatest drawback to investing in RRSPs (and in turn RRIFs) is that the accumulated funds are fully taxable at the time of withdrawal from the respective tax sheltered plan.

In extreme circumstances, the plan holder may realize less than 60% of the funds on an after-tax basis.  The default tax-reduction strategy some people undertake is to delay withdrawals from such plans for years or even decades.

A tax melt strategy may enable a person to accelerate rather than delay the conversion into after-tax money.  What’s more, implemented effectively the strategy can result in the bypass of some or all of the tax on such registered money withdrawals.

The key is to create qualifying tax deductions to offset the taxable income, usually through a leveraged investment program.

RRSP/RRIF withdrawal

LESS tax payable

PLUS tax deduction

The combination of systematic RRSP/RRIF withdrawals in parallel with a controlled series of mirrored deductions can free up trapped registered funds and potentially lead to an earlier retirement.

Vol.04 No.2 – CCRA curtails ”Buy-low, Donate-high” Charitable Giving schemes

Advisor has been solicited for referrals (for commission) to a charitable giving program.  Included in the glossy promotional kit are sample marketing letters, charts of projected financial results, and  tax and legal opinions from leading accounting and law firms.

The thrust of the program is that a person can purchase certain items at ‘wholesale’ (medical supplies, glasses, comic books, etc.) and donate them to charity at a significantly higher appraised ‘retail’ value.

Such plans have come to be known in the tax community as “”buy-low, donate-high” arrangements because they provide a tax benefit greater than the cost of the property.

Effective December 5, 2003, draft Income Tax Act amendments were introduced to curtail the majority of such arrangements, exempting publicly traded securities, certified cultural property, ecological gifts, or real property situated in Canada.

The value of a gift of property for charitable donation purposes will be limited to a donor’s cost of the property, where it is donated within three years of acquisition by the donor or is otherwise acquired through a gifting arrangement or in contemplation of donation.

Vol.04 No.3 – Planned Charitable Giving with Insurance

Advisor is on the planned giving committee of his local church.   As with many small charities, the church seems to be in a constant state of soliciting donations, and would like to establish a long-term funding solution.

Advisor has engaged the STEPUP team to assist in putting together a proposal that would enable donors to allocate a small proportion of their existing donations into strategically structured  life insurance policies.

Among the benefits of a life insurance based solution:

Certainty for donor & charity

Relatively small premiums

Significantly larger bequests

Virtual incontestability

Potential creditor protection

Can avoid probate

No transfer costs

Immediate payout at death

May self-complete if disabled

Here are the tax results of common ownership structures:

Policy      Named             Tax benefit             Tax benefit

Owner      Beneficiary      Lifetime                 at Death

Donor       Charity             None                     Death benefit

Donor       Estate*             None                     Death benefit

Charity     Charity**         Annual premium   None

*   (Charity is a beneficiary in Will)

** (Whether paid to Charity or insurer)

Vol.04 No.4 – Multiple Wills for Private Corporation Succession

Client has worked hard to build her business, taking it from a basement office to a $10 million dollar corporation.  She has now engaged Advisor to provide suggestions on how to  structure the succession to her adult children with:

Minimal cost,

Maximum privacy, &

Complete ongoing control in her hands

Part of the solution may be to engage in a multiple Will strategy.  Under this type of arrangement, the Client’s lawyer prepares two Ontario Wills that reference one another.  The corporation shares and other assets not requiring probate will be listed in the “non-probate” Will.  All other assets not listed will be governed by the main Will, which will eventually be submitted to probate (for reasons outside the testator’s control).

Some of the benefits of this simple plan

Bypass probate taxes on selected assets – In this case, this could be as much as $150,000 in Ontario

No disposition taxes (as might occur in an immediate transfer) – Note that such taxes will  however likely be incurred at death

Maintain confidentiality of succession plans now and after death – The non-probate Will is not filed with the court

Maintain complete control of the selected assets for life – Unlike an estate freeze, she still has full testamentary control of the business should she decide to change either Will

Vol.04 No.5 – Dangers of Do-it-yourself Will kits

Advisor is thinking of giving do-it-yourself Will kits to his Clients.  As advertised:

You will avoid the cost of a lawyer in drafting the Will, &

The document will be valid and enforceable

Even if this holds true – and despite that the blank forms may be “lawyer-approved” – there is no assurance that Clients will be adequately informed of their  tax, estate, family & property rights and obligations beyond the Will.

One of my own Clients originally executed such a document to distribute her house, cottage and RRIF to her three adult children respectively.  The potential result:

Estate would have paid  the maximum amount of probate tax

Cottage would likely have to be sold to pay capital gains tax

It was unclear who was to pay the tax liability out of  the RRIF

A grandchild under Client’s care had a potential support claim

There were no provisions for a son’s pending marital breakdown

The chosen phrasing disproportionately favoured grandchildren

There was a potential intestacy of undistributed assets

Apart from the potential dire impact on a Client, Advisor may wish to consider his own exposure: Such a recommendation from a professional advisor could be construed as legal advice – and most, if not all E&O policy coverage for financial advisors excludes legal advice.

Vol.04 No.6 – Wills, Powers of Attorney and Extra-Provincial Real Estate

Advisor always recommends that her Clients execute Wills and powers of attorney generally, but is wondering whether those with foreign real estate should be doing something more.

An Ontario Will purports to deal with all personalty, as well as real estate located in the province.  The law of a foreign jurisdiction (even another province) will determine whether an Ontario Will or power of attorney for property can be ‘re-sealed’ to deal with real estate there, or if a local document/ procedure may be required.

Some caveats before rushing into this enterprise:

All documents must be carefully coordinated so as not to conflict with one another

Potential application of forced heirship laws

Alternative ownership structures/transfers

Potential conflicting laws of deemed revocation

On marriage, separation & divorce

At insolvency or bankruptcy

Upon mental incapacity

Vol.04 No.7 – Business use of Life Insurance: Purpose and Amount

Advisor asked me for a rough summary to characterize the main business-related insurance needs of a potential Client in a small business or professional corporation.

THIS ISSUE: “Purpose” and “Amount”

NEXT ISSUE: “Duration” and “Structure”

PURPOSE:

Buy-sell – Facilitates buy-out of deceased’s interest by surviving owner/shareholder(s) &/or redemption by corporation

Key person – Contributes emergency capital and maintains the ongoing value of the business in the absence of a key contributor

Estate liability needs – Deemed disposition/realization taxes and other liabilities imposed on estate

Income replacement – Replaces lost income-earning capacity of principal breadwinner to spouse and family

AMOUNT:

Buy-sell – Respective needs are proportionate to shares held; increases as business grows; tax effects may cause adjustments

Key person – Includes out-of-pocket costs, lost person’s unique value and replacement cost; often subsumed under buy-sell if closely-held

Estate liability needs – Increases as business grows; tax on excess over cost base; reduced by LCGE; rollover deferrals

Income replacement – Declines over time as number of income-earning years reduce; generally a commuted present value

Vol.04 No.8 – Business use of Life Insurance: Duration and Structure

Advisor asked me for a rough summary to characterize the main business-related insurance needs of a potential Client in a small business or professional corporation.

LAST ISSUE: “Purpose” and “Amount”

THIS ISSUE: “Duration” and “Structure”

DURATION:

Buy-sell – Temporary need until owners dispose of respective interests; may become permanent to support lifetime buy-out

Key person – Temporary for corporation to hold for as long as the person can effectively contribute; truncated if interest is disposed

Estate liability needs – Permanent need up to death; may recoup tax from life sale; deferral opportunity by spousal rollover

Income replacement – Temporary need to retirement; calculated as person’s intended retirement age less current age

STRUCTURE:

Buy-sell – Common options may be: Corporation owner on all; Personally owned on each other; Personal – others as beneficiaries

Key person – Corporation as owner, payor and beneficiary; any other structure will likely have negative tax consequences

Estate liability needs – Respective personal- or spouse-owned, with spouse/family beneficiary/ies directly or via estate or trust

Income replacement – Respective personal-owned with spouse/family beneficiary/ies, preferably via trust

Vol.04 No.9 – The un-funded (unfounded?) gratuitous tenancy

Client’s 83 yr-old father died recently; for the last 10 years, an old family friend (female) had been living in his house.

Father’s Will allowed the ‘friend’ to remain in the house for up to ten years, but otherwise gave little guidance on expenses or situations that would allow or require the house to be sold.  The estate beneficiaries are grandchildren and great-children of the deceased.

As it turns out, the house is effectively the entire estate, and there are no financial assets to maintain it.  It obviously needs to be sold but the friend is threatening litigation, including claiming support entitlement as common law spouse.

After much hand-wringing, Client (as executor) has agreed to pay resettlement costs and a share of rent for the friend to enter a local seniors’ residence.

With 20/20 hindsight, it would have been nice if one or more of the following had been executed/prepared :

Statutory declarations confirming the non-conjugal status

Formal tenancy agreement (whether or not rent was being paid)

Domestic contract clearly defining the relationship & obligations

More clearly drafted Will terms addressing contingencies, & explicitly giving power to sell despite the gratuitous tenancy

Vol.04 No.10 – A discretionary trust to preserve government disability support

Client’s 62 year old son is visually impaired and mentally challenged; he has never left home.  Client is becoming increasingly concerned what will happen to him when she dies — her 86th birthday is just around the corner.

Son receives support payments through the Ontario Disability Support Program (ODSP), but Client is concerned that once he receives her estate he will be disqualified under ODSP income and asset tests.

Ever since the 1989 case     of Audrey Henson, it has     been considered a     planning key to place     such funds in a fully     discretionary trust for     such beneficiaries, as had     been done for Audrey     under her father’s Will.

Subsequent to this case, the Ontario government has taken the administrative position that trust funds that are subject to a trustee’s full discretion will not be included in the financial tests; other provinces may still include such trust funds in determining a beneficiary’s eligibility for respective provincial disability support benefits.

While it took some legwork for Client to identify an appropriate trustee, she is now comforted that her son will continue to receive his government support, and still be able to enjoy the fruits of her estate.

Vol.04 No.11 – Estate creditors and non-insurance RRSP proceeds

Client’s wife recently passed away; the couple was resident in Ontario.  Wife had no assets to speak of, except some RRSP funds (in the form of bank GICs) naming him as beneficiary.

Creditors of his wife’s estate have been putting pressure on Client to repay the registered funds to his wife’s estate in order for their claims to be satisfied.

Client wants to roll over the RRSP funds to his own plan and has asked Advisor what he should do.

Fortunately for Client, in June 2004 the Ontario Court of Appeal in Perring held that RRSP proceeds flowing to a named beneficiary are completely out of the reach of estate creditors.  Prior to this decision, the Ontario courts had followed the Manitoba case of Clarke which allowed estate creditors to ‘call-in’ such funds if an estate was insolvent.

Of course, insurance-based RRSP proceeds were already accorded this protection against estate creditors, in addition to enjoying greater potential creditor protection against lifetime creditors.

Still, creditor exposure of investments remains an area of law that varies by province and certainly warrants an annual review by Advisor of Client’s RRSP/RRIF accounts and non-registered holdings.

Vol.04 No.12 – Year-end spousal RRSP contributions and withdrawals

It is December and Client has had a great sales year, which in turn has pushed him well into the highest tax bracket.  He has $80,000 unused RRSP contribution room, and he expects that making such a contribution will negate (in practical terms) his high bracket tax portion.

Client has left a voicemail message for Advisor to call back in the new year for an appointment to arrange for the contribution ‘in the first 60 days’ so that it will be credited against the current year just ending.

Advisor knows that Client is 2-3 years from retirement and that his wife is a stay-at-home mom with virtually no earned income.  Accordingly, it may be beneficial to make the contribution to a spousal RRSP for the purposes of future retirement income splitting … but here’s a benefit Advisor can offer for a potential sooner tax advantage:

Generally withdrawals by a spouse will be taxed in the hands of the contributor spouse, up to the amount of deposits in the year of withdrawal and the two preceding taxation years

While contributions made in the first 60 days are credited to the contributor’s previous calendar year’s return, for the purposes of spousal withdrawals they occur in the calendar year of contribution

If Advisor can get Client into the office before the end of the December, he will give Client’s spouse the opportunity to withdraw those funds almost a year earlier, perhaps even accelerating Client’s own retirement date.

Vol.03 No.1 – Executor Compensation

Advisor has a Client who is concerned that his estate may be eaten away by executor’s fees, and is considering placing a term in his Will to deny compensation.

The difficulty with such a term is that it may dissuade anyone from taking on the time-consuming role with its related liabilities, ultimately harming the estate.

Client had heard that executors take 5% of the estate.  In truth, the benchmark is a little more complicated:

2.5% of income called-in

2.5% of income paid out

2.5% of capital called-in

2.5% of capital paid out

0.4% of annual assets

and may be less than this benchmark or occasionally more, depending on a number of factors:

Time spent

Estate size

Care required

Skill applied

Success/results

Also to be considered, a spouse or family-member executor/ beneficiary is less likely to take such taxable compensation, preferring to simply distribute the tax-free estate assets.

Finally, while an executor can and should employ professionals to assist in specialized tasks, to the extent that the executor has employed and paid (out of the estate) others to carry out executor responsibilities, the executor’s own compensation should be reduced accordingly.

Vol.03 No.2 – Insurable Interest: The Manitoba Reprieve

Client’s life was insured under a criss-cross buy-sell funding scheme for a long-since-abandoned business venture.

Client has recently discovered that his former partner (now his competitor) continues to hold the policy on his life, and he has asked Advisor if the policy can be cancelled.

There are three initial questions that Advisor should ask Client to determine how to proceed:

Is there a validly executed buy-sell agreement governing the insurance?

If so, is there a provision that obligated each of the parties to cancel all policies or assign them to the respective life insured?

If not, did the Client live in and operate that previous venture in the province of Manitoba?

The last question is critical as Manitoba allows a life insured to apply to a court to terminate the policy where insurable interest no longer exists.  Presently,  no other province has such a statutory provision.

Despite the apparent unseemly result, the Ontario Court of Appeal affirmed in 1998 that no such provision will be inferred from or read into the Ontario Insurance Act.

Vol.03 No.3 – Maximizing the Annual Charitable Tax Credit

The Income Tax Act provides incentives for each of us to make contributions to charitable organizations.  In fact, it provides a strategic advantage for both the charity and the donor by making it advantageous to make larger contributions than might otherwise be considered.

For a person’s annual tax return, contributions up to $200 entitle the donor to a credit at the lowest federal tax rate, while donations in excess of $200 entitle the donor to a tax credit at the highest rate.

Some simple strategies to help you maximize the credit:

Do not claim the credit in a chosen year, then use the carryforward provisions to accumulate multiple years’ donations on one year’s tax return

Aggregate charitable donations on one spouse’s tax return

Double the donation dollar value, but contribute every other year

Contribute at year-end rather than at the beginning of the year

Consider non-cash donations – particularly property with accumulated capital gains such as publicly listed securities – to obtain additional tax relief while continuing to provide valuable funding to worthwhile causes

Use insurance and annuity strategies for leveraged value

Vol.03 No.4 – A Nightmare in Key Person Insurance

“Key person” insurance is intended to provide funding to a business to allow it to weather the loss of an important contributor to the operation.

While gathering information from a small business Client to prepare her Will, I inquired about the “comprehensive key person” insurance she said she had in place …

Coverage: There was $200K insurance for a business with inherent capital gains of $4M, and a market value of $5M.  The true need?

As previously  calculated, $200K “key person” reserve for the business

About $1M capital gains coverage for the estate/spouse

Up to $5M buyout funding for the son

Ownership: Client owned the policy, the corporation was paying the premiums and Client’s spouse (second marriage) was beneficiary.

For key person, the corporation should be owner, payor and beneficiary.

This Client’s structure will likely result in a shareholder benefit (taxable) when premiums are paid annually.

Purpose: Client’s desire was to provide cash to her adult son for him to buy the business.

Unfortunately, son came from the 1st marriage, didn’t get along with 2nd spouse, and knew nothing of the business.

Apart from determining how son might obtain the proceeds to perform the buyout, clearly there are  more complicated issues yet to be resolved.

Vol.03 No.5 – Simultaneous death and jointly owned insurance

Where one spouse owns capital property, it is common to have jointly owned last-to-die reciprocal-beneficiary life insurance for capital gains tax liability at the second death.

However, when simultaneous deaths occur (unlikely as that may be), the beneficiary is deemed to predecease the insured and proceeds revert to the estate of the insured.

Where the spouses’ ultimate estate beneficiaries (their families) are identical, funds can likely be shuffled so that financially this will not matter.  However, in situations where the spouses’ respective estate beneficiaries are different (such as a second marriage), a significant – and likely unintended – tax result can arise,  whereby the asset and related tax liability fall into one spouse’s estate, but the insurance proceeds are split between the two estates.

Depending on the preferred result desired, here are some ways – alone or in combination – to address this dilemma:

Property-owning spouse owns the insurance solely

Detailed Will drafting, a spousal trust and/or an insurance trust

Transfer the capital property itself into joint ownership

Use insurance contingent ownership rather than joint ownership

Execute a domestic contract addressing these contingencies

Vol.03 No.6 – Income attribution rules and the family’s total tax bill

Client is looking for ways to reduce her family’s total tax bill.  While many direct and indirect (generally by trust) transfers to a spouse or minor children will result in earnings being taxed in the hands of the transferor, there remain a number of legitimate strategies.  Among them:

Generally

Loans at the prescribed interest rate

Second-generation ‘earnings-on-earnings’

Sales at fair market value

Paying small business wage & salary income to family

Spouses

Contributing to a spousal RRSP

High income spouse to pay household expenses

CPP splitting

Minors

Contributing to a minor child’s RESP

Positioning investments of minors to achieve capital gains

Transferring the child tax benefit to the minor

Waiting until a minor reaches the age of majority

Investing in an insurance policy on the life of a minor child and then transferring the policy to the child after age of majority

Vol.03 No.7 – Split-dollar Life Insurance Strategies

Client has read in the general media about ‘split insurance’ and has inquired whether Advisor can sell such a product.

As a starting point, Advisor will want to make sure that Client understands that ‘split-dollar’ is not a type of insurance but rather a mode of sharing the contractual rights and obligations of an insurance policy.

It is generally intended to allow one party to control the insurance death benefit and the other party to use the tax-sheltering features of an exempt life insurance policy.

Common uses of split-dollar funding include:

Family intergenerational wealth building/protection strategies

Tax-effective corporate investment income sheltering

Perquisite – and golden handcuff – for valuable key executives

Assisted funding of a supplemental executive retirement plan

A formal written agreement should be executed in order to create as much certainty as possible, particularly for:

Allocating premium payment obligations

Protecting against inadvertent taxable benefit assessments

Preparing the parties regarding potential exposure to creditors

Pre-determining ‘break-up’ and dispute resolution recourse

Vol.03 No.8 – Insurance Incidents of Ownership for U.S. Estate Tax Purposes

Advisor is in the midst of arranging for insurance coverage for Client who is an American citizen resident in Canada.  Client is wondering whether this will be caught under the U.S. 45-50% estate and gift tax regime.

While Client should obtain an opinion from a qualified U.S. tax professional, in principle Client could be caught if one or more of the incidents of ownership are present:

The right to change the beneficiaries or their shares

The right to surrender the policy for cash or cancel it

The right to borrow against the policy reserve

The right to assign the policy or revoke an assignment

A reversionary interest by which the insured or his or her estate may regain one or more of the above rights in the event of a beneficiary predeceasing the insured or certain other contingencies

(Source: CCH Estate Planning Guide)

The good news for Client is that this U.S. federal tax is scheduled  to be phased out by 2010.

The bad news is that many of the states (which until now piggybacked to participate in this tax) have enacted or will enact legislation to replace this revenue source, making for a potentially much more confusing tax regime.

Vol.03 No.9 – Uncertainty under the Rules of Intestacy

A Will provides certainty as to who will receive what of a deceased person’s property, when property transfer will occur, and how (and by whom) it will be carried out.  In the absence of a Will – called an intestacy – unnecessary emotional and financial strain can wreak havoc.

Intestacy rules vary by province of residence and death.  In Ontario, an intestate estate is distributed to survivors as follows:

Spouse alone: All to spouse

Spouse & 1 child: Preferential share*: $200K to spouse; Distributive share: 1/2 spouse; 1/2 child

Spouse and 2+ children: Preferential share*: $200K to spouse; Distributive share: 1/3 spouse; 2/3 children

Children alone: Children equally  (Children of a predeceased child share as a class)

No spouse or children: Next of kin share by defined formulae

* The preferential share is much less or not available at all in some provinces

Particularly troublesome for families with young children, there is limited access to inherited funds on behalf of a minor beneficiary, and virtually no restriction on that beneficiary’s access to those funds at age of majority (18).

Vol.03 No.10 – Do common law spouses need Wills?

Advisor referred Client to me to assist in what was thought to be a relatively simple estate administration.

As it turned out, Client owned her house as 75/25 tenant-in-common with her recently deceased common law husband; they had been together for over 30 years.  They had always intended to change to joint ownership, and likewise kept meaning to execute Wills.  At husband’s death neither of these steps had been taken, resulting in his interest in the house falling into his intestate estate.

Here is where the odyssey began:

Upon intestacy, a spouse – legal or common law – has the first right to be named as executor

Ironically though, a common law spouse is not a listed person entitled to share in an intestacy

We considered a property division under family law, but that only applies to legally married spouses

We tracked down three great aunts – none of whom husband had ever even met – in three separate rural Atlantic provinces’ nursing homes

Thankfully, all three women released their estate interests (which they did not have to do)

Several months (and some legal fees and disbursements later), Client had her home free and clear

So, do common law spouses need wills? – Definitely!

Vol.03 No.11 – RRSP Fundamentals: Earned Income

The RRSP – meaning “registered retirement savings plan” – might be viewed as the cornerstone of individual investment planning for one’s retirement years.

The main tax advantages of using an RRSP are:

Dollar-for-dollar tax deduction in year of contribution

Tax-deferred accumulation of funds remaining in the plan

While the amount one may contribute in a given year is limited to a percentage of ‘earned income’ (up to a dollar cap), carry-forward provisions enable a person to catch up on forgone contributions in future years. ‘Earned income’ has a fairly broad definition, including:

Income from office or employment

Royalties from authorship or invention

Net rental income from real estate

Proprietor/partner active business income

Qualifying support payments received

Amounts received under a supplementary unemployment benefit plan

Net research grants

CPP/QPP disability pensions

Vol.03 No.12 – Traditional RRSP Maturity Options

Client turned 69 this year.  Apart from another candle on the cake, this is a very significant year in Client’s retirement planning.  By December 31, Client’s RRSP must be matured in one of three ways, or in a combination.

While a lump sum cash-out is possible, it is likely to produce a large immediate tax bill.  Accordingly, the decision is whether to convert to a RRIF or to purchase a qualified annuity.

RRIF

Basics – Like an RRSP, it allows tax sheltered accumulation – No further contributions – Mandatory withdrawals

Advantages – Ongoing investment control – Can respond to changing needs by adjusting amount and timing of income – Lump sum withdrawals

Drawbacks –  Capital may diminish – Client may outlive the RRIF income – Requires ongoing investment decisions

Annuity

Basics – In essence, it works like the reverse of a mortgage – Lump sum paid to institution – Annual/monthly payments

Advantages – Cannot outlive “life” annuity – In certain market conditions, income can exceed RRIFs – No investment decisions – Income is guaranteed

Drawbacks – Capital is fully committed – Most annuities cannot be cashed or altered – Payments cannot be adjusted to reflect changing needs