Chess and retirement decumulation

The end game requires a dynamic strategy

Did you catch The Queen’s Gambit series on Netflix? It came out a couple of years ago, and is still playing if you want to take a look. It’s a fictional account of a 1960s prodigy who disrupts the world of chess. Apart from drawing millions of viewers, it’s led to a bonanza in chessboard sales.

There are some interesting parallels between chess and our income choices in retirement. As in chess, a lot of moving parts affect retirement, some we can control and some we must contend with. Both domains require strategy, forethought and flexibility.

Decumulation with tax in mind

Some retirement decisions are one-time, like starting Old Age Security and Canada Pension Plan. Others may be infrequent, like winding-up a business, downsizing a home, whether to engage assisted living support or when to consider a move into long-term care.

In terms of private savings, a critical juncture is when to switch modes from building retirement savings to drawing from them. This is the move from accumulation to decumulation, with three common savings sources to draw from: an RRSP/RRIF (including locked-in versions), a TFSA and non-registered investments. Respectively, the draw from each of these sources is taxable, non-taxable and partially taxable.

Usually, the desire is to maintain a certain lifestyle while minimizing income tax. That’s not as simple a task as it may seem, given our progressive income tax system that charges higher tax rates on higher income levels. Paying tax may not be pleasant, but too much focus on reducing a current year’s tax bill could lead to a disproportionately heftier tax bill in future years, especially if brought into income at death. It depends on personal values how much of tax planning is about the here, the here together (as a couple), and the hereafter.

The key is to determine how best to draw on these savings sources to achieve the desired result.

Planning through the permutations

Effective decumulation is often framed as a search for the optimal order for depleting each savings source before moving on to the next. That’s the way financial planning software algorithms may solve for targets such as maximizing net wealth at life expectancy. In this case, the software might provide a rank order of the six possible permutations among the three savings sources.

But we shouldn’t expect the output to be a set-it-and-forget-it prescription. That would require knowing not only our present circumstances and intentions, but also all future developments.

Consider again the game of chess. The board is an 8 by 8 grid, with each of the two players having 16 playing pieces. So, before the game starts, half of the 64 squares are occupied. White chooses among 20 opening moves, as does Black to follow, leading to 400 possible board layouts when White considers move number two. By round three, there are 197,281 layout possibilities, and over 119 million two moves later.

Amazing as that is as an example of exponential expansion, it pales in comparison to our years in retirement. Life has far more variables, and more actions that may be taken with each. These include the option to draw from multiple sources from time to time to tactically exploit tax opportunities, rather than fully liquidating each source in succession.

Vision, revision and annual reviews

Chess and financial planning share the need to anticipate, act, observe and adapt. That’s what chess masters do, always looking a few moves ahead and then continually adapting as each turn comes around.

Similarly, as life unfolds in retirement, we are not necessarily bound to continue on a path that was suitable when set some years ago, but that may no longer fit current needs. Changes happen to us, and to the world around us:

- Personal circumstances
- Available wealth, in each savings source and as a whole
- The world we live in, with particular attention on any new or modified tax rules

Often, things are fairly fixed over the short term, but become more flexible looking further out in time. With some foresight and forethought, adjustments can be made according to changing conditions – both as required and as desired – in the way we spend our time and how we spend our money.

The important point to emphasize here is that the process is dynamic, ideally anchored by annual reviews with a capable financial advisor. At each turn, advisor and client can plot the best course using the information presently at hand, with full understanding and intention that the plan will revisited as each year unfolds, and revised as necessary according to developments.

Can a trust avoid tax on a deceased person’s RRSP?

A trustee’s tax liability has limits, a court case suggests

In February 2010, a woman learned she had only months to live and took steps to put her financial affairs in order. She executed a codicil naming one of her three daughters as executor of her estate. She named the same daughter the beneficiary of her RRSP, the only significant property she owned.

The woman told her daughter to use the RRSP proceeds to pay for the funeral, related family travel costs, final bills and estate administration expenses, and to distribute any residual funds equally with her two sisters.

When she died, the woman owed more in back taxes than the $76,616 in her RRSP. On receiving the RRSP proceeds, the daughter paid the expenses and distributed the rest as instructed. The Canada Revenue Agency (CRA) later assessed the daughter personally for the RRSP’s full amount.

In February 2021, the Tax Court handed down its ruling of the daughter’s appeal in Goldman vs. the Queen 2021 TCC 13.

How the CRA follows a tax debt

When someone who owes tax gratuitously transfers property to a non-arm’s length person, the CRA may use Section 160 of the Income Tax Act (ITA) to collect the tax debt from the recipient.

Consider a deceased taxpayer with an insolvent estate and an RRSP with named non-arm’s length beneficiaries. An RRSP is included in income in the terminal tax year when someone dies. The CRA will use Section 160 to collect from each beneficiary the proportionate share of tax owed from the RRSP income.

The Goldman case had an additional element: there was an existing tax debt that was larger than the entire RRSP even before the mother’s death. What is the extent of the liability for a named beneficiary in such a situation? And would receiving RRSP proceeds as a trustee make a difference?

Effect of a trust

The judge found that the three certainties for creating a trust had been met: the mother’s intention and identification of her daughters as beneficiaries were both clear, and her death caused the RRSP proceeds to fund the trust. The daughter received those proceeds in her capacity as trustee and was legally bound to carry out the terms of the trust as laid out by her mother.

As to the CRA’s contention that the daughter used her discretion to pay certain expenses instead of paying the CRA, the judge stated that she “received the RRSP proceeds to hold for the benefit of certain beneficiaries. The CRA was not one of those beneficiaries. However, that does not cause the trust to fail for certainty of object. The fact that the [government] dislikes the terms of a trust is not enough to declare it void.”

Even so, the court made it clear that Section 160 isn’t defeated by a trust. Rather, the question is whether the tax liability rests with the trust itself or with the trustee in their personal capacity. The judge said the trustee’s responsibility is to use the trust assets to satisfy tax debts, and that if those assets are insufficient, the tax collector “cannot simply seize the trustee’s personal assets.”

So who bears the tax?

Though the daughter wasn’t liable as trustee for the full RRSP proceeds, she was liable for three amounts:

A total of $8,139 was paid out of an account originally opened jointly for the daughter to care for her mother. Though these payments were in the nature of final expenses contemplated by the trust terms, they weren’t paid out of the RRSP proceeds. While the judge suggested that a reimbursement might have qualified per the trust’s terms, there was no evidence of any such reimbursement to this account from the RRSP proceeds.
The daughter was liable, as she conceded, for her $10,460 distributed portion of the RRSP residue.
Lastly, the daughter claimed $5,000 for legal expenses for the tax appeal. The judge ruled this was the daughter’s personal expense and not an estate expense.

The judge commented that, under a different ITA section that applies to trustees, the daughter could possibly be liable for the residue distributions to her two sister beneficiaries. However, that was not pleaded by counsel for the CRA. The court didn’t assess the two sisters’ liability.

In the end, the daughter was liable for $23,599. If the two $10,460 amounts (the residue to each of the other two sisters) were added, the total would be $44,519. Deduct that from the original $76,616 in the RRSP, and that leaves $32,097. Depending on your perspective, that’s either lost tax revenue or a tax-effective way to pay final expenses.

As this case proceeded under the Tax Court’s general procedure, it could stand as a precedent, so it will not be surprising if the government appeals. Regardless, if you have a client who is the executor for someone with tax debts, it would be prudent for them to clarify their obligations with legal counsel in order to steer clear of potential personal liability.

Budgeting for 2021 CPP changes — and beyond

Will the pandemic lead to higher future premiums?

[Link to original on advisor.ca]

We’re midway through the first phase of Canada Pension Plan (CPP) enhancements announced in 2016. Over the long term, the enhancement is designed to increase the CPP income replacement level from one-quarter to one-third of eligible earnings.

Phase one, which began in 2019, increases employer and employee contribution rates by 1% over five years. Next year marks the halfway point in both time and amount: the cumulative increase will be 0.50% in 2021, taking the contribution rate to 5.45% from the 4.95% starting point.

The rate is applied to the year’s maximum pensionable earnings (YMPE), recently announced as $61,600 for 2021. At the new rate, the 2021 maximum contribution will be $3,166.45 each for employer and employee. Self-employed individuals pay both parts, totalling $6,332.90.

Table: Annual CPP enhancements

Year	Addition	Cumulative addition	Contribution rate
2018	–	–	4.95%
2019	0.15%	0.15%	5.10%
2020	0.15%	0.30%	5.25%
2021	0.20%	0.50%	5.45%
2022	0.25%	0.75%	5.70%
2023	0.25%	1.00%	5.95%

Budgeting for next year

Over the five-year phase-in period, contribution rates will increase by 20%. That will erode an employee’s net paycheque by as much as about $600 once phase one is fully implemented (again, double that for those who are self-employed).

The 20-basis-point addition for next year will probably go unnoticed by most people. Still, it’s a worthwhile discussion to raise in year-end client reviews, as you look toward budgeting adjustments and cash flow planning over the coming few years.

Phase two begins in 2024

Phase two adds a second earnings limit beyond the YMPE, to be called the year’s additional maximum pensionable earnings (YAMPE). The YAMPE will begin as 107% of the YMPE in 2024 and move to 114% in 2025. After that, the two thresholds will be separately indexed using the same standard indexation factor.

Employer and employee contributions up to the YMPE will continue at the 5.95% rate, while the rate between the YMPE and YAMPE will be 4% each. All contributions are deductible for employers.

Employees will continue to claim a tax credit on contributions up to the YMPE, but contributions between the YMPE and YAMPE entitle employees to a deduction. A deduction better aligns to the employee’s cost since it’s set at the marginal tax rate, rather than the lowest bracket rate accorded to the credit.

Will the pandemic prompt more CPP changes?

In its fiscal sustainability report for the third quarter of 2020, the parliamentary budget officer (PBO) raised the spectre that additional funding may be required for the CPP.

The CPP is funded by those employer and employee contributions. Excess cash flow is invested in financial markets to fund anticipated future cash shortfalls as the population ages, which in turn raises the ratio of beneficiaries to contributors.

Analysis from the PBO suggests the CPP is “not sustainable over the long term — albeit to a modest extent.” Though it appears adequate to meet its 25- and 50-year measures, “projected contributions and benefits are not sufficient to ensure that, over the [75-year] long term, the net asset-to-GDP position returns to its pre-pandemic level.” The PBO estimates that increased contributions or reduced benefits amounting to 0.1% of GDP may be required to sustain the plan.

The government is obviously focused on the pandemic for now, but be prepared that we may yet see further CPP adjustments beyond the current enhancement process.