Advisor’s Edge / advisor.ca – Page 27

Safeguarding RRSPs against creditors

Is my RRSP protected from creditors? Clients are keen to know how bankruptcy affects this key savings vehicle.

Whether it’s nervous clients reviewing their depleted nest eggs, or troubled clients readjusting to a job loss, this is one question financial advisors have probably been asked fairly often in recent times.
The easiest answer is: Indeed—in the case of bankruptcy—except for deposits made within the 12 months leading up to the bankruptcy.

And isn’t it rather fortuitous that the federal bankruptcy amendments, exempting RRSP/RRIF assets from seizure in a bankruptcy, came into force just about a year ago, July 7, 2008, right around the time financial markets began to show us quite forcefully what had been brewing within the economy.

Short of bankruptcy, creditor protection would depend on the type of plan being held, whether it is lifetime or estate protection at issue, and what province or territory the client currently resides in.

Insurance-based plans

For insurance-based plans, protection is available against lifetime creditors if one or a combination of certain family members—spouse, child, grandchild or parent—is named a beneficiary. In the common-law jurisdictions, it’’s determined by the relationship of the beneficiary to the annuitant; whereas in Quebec it is the relationship to the owner. The distinction is irrelevant in the case of RRSP/RRIFs since the annuitant and owner are one and the same.

Insurance-based plans also allow protection against estate creditors if any beneficiary is named, family or otherwise. In either case, insurance-based plans are not automatically protected, but rather obtain protection if the owner has taken the active step of naming appropriate beneficiaries.

Lifetime protection, generally

British Columbia, Alberta, Saskatchewan, Manitoba and Newfoundland allow for lifetime creditor protection through their respective judgment enforcements legislation. No beneficiary designation is required; however, in B.C. deposits within 12 months of a claim remain exposed.

The Prince Edward Island law protects only where a family beneficiary—spouse, child, grandchild or parent—is named.
There’s no legislation enabling lifetime protection for residents of Ontario, Quebec, New Brunswick, Nova Scotia, Yukon, Northwest Territories or Nunavut.

Estate creditor protection

In B.C. and PEI, legislation is in place to assure RRSP/RRIF assets bypass estate creditors, so long as any beneficiary is designated (other than the estate of course).

Case law informs the protection in the remaining jurisdictions. In the 2004 Perring case (Amherst Crane Rentals Limited v. Perring), the Ontario Court of Appeal confirmed that non-insurance RRSP/RRIFs flow directly to a named beneficiary, out of the reach of estate creditors. The relevant phrasing in the Ontario law is the same or similar to legislation elsewhere. While not a certainty, this case would therefore likely have strong influence in those other jurisdictions — Alberta, Saskatchewan, New Brunswick, Nova Scotia, Newfoundland and Labrador, Yukon, Northwest Territories and Nunavut.

The 1997 Clark decision (Clark Estate v. Clark) from the Manitoba Court of Appeal held that RRSP proceeds had to be paid back by a named beneficiary to an insolvent estate, until creditor claims were satisfied. While this has not been directly overruled, it has also not been followed on occasion, so that leaves some uncertainty in Manitoba.

The Supreme Court of Canada ruled in the Thibault decision in 2004 (Bank of Nova Scotia v. Thibault) that a particular RRSP did not constitute an annuity for Quebec purposes, and therefore was available to estate creditors. While Quebec intended to remedy the legislation, the consensus from the legal community is that it falls short, and therefore it remains that RRSPs likely are exposed to creditors.

TFSA creditor protection

Insurance-based TFSAs are likely to be treated the same way as insurance-based RRSPs.
For non-insurance plans, provincial or territorial laws have been amended (or will be in the near future) to allow beneficiary designations. Once in place (some have had to be re-drafted), protection against estate creditors will likely be the same as with RRSPs. Even so, the local law should be confirmed before relying on financial institution forms.

One thing is certain though, no province or territory has granted lifetime protection to TFSAs.

Certain conditions and classes of creditors may override technical compliance with the rules, even for insurance-based plans.
If a creditor is able to show a fraudulent conveyance or preference, impugned transactions may be reversible. It depends on the province or territory whether intent is a necessary component of the action, or if prejudice to the claimant is sufficient.

It’s possible that matrimonial property, support orders and dependants’ relief claims could impress a trust upon RRSP/RRIF assets. In addition, CRA has been successful in actions taken against registered plans.

Where any of these complications are present, legal advice should be sought out before making any moves.

TABLE: Expected creditor exposure

The chart below summarizes expected treatment.

What is estate planning anyway?

Estate planning is a nebulous phrase. Appropriated by all manner of professionals and institutions, it has long since become a buzz phrase often catered as much to the services being made available as to the person to whom they are being offered.

This can be confusing not only to the general public, but just as much to those operating within the field. As an estate planning lawyer, I’ve found myself frequently revisiting my own definition of estate planning, trying to dovetail it within the geography of other kinds of planning, particularly services offered by the financial professions.

A hundred years ago estate planning was arguably the sole preserve of lawyers, bundled up – at least from a lay perspective – in a few key documents: A Will, perhaps a trust, possibly a power of attorney, and some supporting material. To boot, structured planning would have been skewed toward the wealthy.

By the 1920’s, the advent of personal income taxation gave accountants a much more active role in personal finance. And in the half century or so following, investment and insurance professionals similarly evolved, and their entrepreneurial efforts further expanded the availability of wealth management expertise out to the mass market.

Today there is a very good argument to be made that the majority of estate planning is now done as an accessory to financial decision-making. Case-in-point, many Canadians’ principal wealth is in one or more registered savings plans, the remaining value of which will pass to a named beneficiary at death – and you don’t need a lawyer or a Will for that.

Of course that’s a fairly narrow view of estate planning as strictly centering on death. In truth, it is about understanding one’s roots, relationships and responsibilities, and using that knowledge to make plans to care for oneself and for others, now and in future.

Nonetheless the question begs an answer: Has estate planning really just become the death footnote to a more glamorous successor, financial planning? Certainly not.

While a classic legal-centric view of estate planning may be past its time, the legal element – the expectation and confidence that a person’s intentions will be upheld – remains its defining characteristic. In other words, legality equals certainty.

From that perspective, attention is drawn away from the strategies engaged and documents produced (necessary though they will be in the end), and focuses more appropriately on the analysis and advice of allied professionals engaged in open communication. Just as the person’s relationships are the foundation for the plan, the advisors’ relationships are central to the effectiveness of its implementation.

Ultimately, it is really not relevant which professional leads this process, but it is critical that all available expertise is brought to bear

Relation-Slips – Tax matters on becoming a spouse

The cake’s been cut, the closets assigned, and your life of living together is in full swing. Whether you’ve gone the formal route or simply shacked-up, come tax filing time the warm and fuzzy will give way (ever so briefly) to the cold reality that it’s time to sort and report your economic union. So here’s an overview of the key tax implications of being a spouse … from married to buried.

Individual taxation: A blurred principle

In principle, the Canadian income tax system treats each individual as a separate economic unit. In reality, the personal and economic dependence in relationships can blur the distinction from one individual to the next. .

As a result, our system recognizes select relationships – in particular, spouses – as being sufficiently closely connected that each individual’s tax liabilities and tax benefits should also be connected.

So, who is a spouse?

If your client is legally married, he or she is a spouse.

Short of that it is not so obvious, in large part because the term ‘common-law’ is defined differently from province to province for family property rights and parenting matters.. For income tax purposes, your client is a spouse if they live with another person in a conjugal relationship, whether that person is of the same or opposite sex, and

that relationship has lasted at least 12 continuous months;
the two of you are legal parents of a child; or
one of you has custody and control of the other’s child, and the child is wholly dependent on that custodial person for support.

Opportunities through credit transfers

Every Canadian is entitled to claim a basic personal amount to reduce their federal and provincial taxes. For 2008 the federal basic amount is $9,600; some provinces use that number, others have different figures.

The system understands, however, that some residents will leave the workforce after they get married. Therefore, the government has instituted a spousal credit that in effect stands in for the basic amount that the “supported spouse” will not be claiming personally. If the stay-at-home spouse makes money, but stays under the basic personal amount, that credit claim is reduced pro rata for each dollar the supported spouse earns.

The federal basic personal amount and the spousal credit were brought in line with one another for the 2007 tax year, but in many provinces the disparity between the provincial basic personal amount and the spousal amount remains.

Where the supported spouse has taxable dividend income, the supporting spouse may elect to report those dividends as his or her own. In addition to increasing the spousal credit, the supporting spouse will be able to claim the related dividend tax credit. As all \ of the dividends must be included in the election, it will be necessary for the spouses to compare the results with and without the election to see whether it is worth proceeding.

There are a number of other tax credits that can be transferred to a working spouse so that they will not be left unused:

Age amount for individuals 65 and over
Amount for children born in 1990 or later
Pension income amount
Disability amount, and
Tuition, education, and textbook amounts (to a maximum of $5,000).

Strategically combining credits

Some credits based on receipted payments may be combined by spouses in order to maximize their tax credit value.

A tax credit is available for medical expenses above a minimum threshold which is the lesser of a set dollar figure ($1,963 in 2008) and 3% of an individual’s net income. By combining the expenses for oneself, a spouse and eligible dependants, the threshold may be reached sooner. Furthermore, the claim period is any 12 months ending in the tax year and therefore the decision to combine must be considered in conjunction with that date choice.

Qualifying charitable donations entitle an individual to a tax credit from the very first dollar, but the value of the credit is greater once donations exceed $200. The 2008 federal credit rates are 15% below that threshold and 29% above it, and provincial credits are similarly applied in two stages. Spouses are allowed to combine their donations made in the tax year to break through that threshold and access the higher credit rates sooner.

Sharing the burden

Of course it’s not all good news.

Many tax credits have a policy purpose of assisting individuals and families of modest income, with those credits lost or clawed back if net income exceeds stipulated levels. Though such credits are applied for and paid on an individual basis, that individual must disclose the combined net family income of the two spouses to determine whether the income threshold has been reached. Key credits that can be reduced include:

Refundable medical expense supplement
GST/HST credit, and
Canada child tax benefit (CCTB), which includes the national child benefit supplement and the child disability benefit

It is important to know that your client has an obligation to notify the CRA if there is a change in circumstance, such as the start of a spousal relationship that may affect entitlement to these types of benefits, particularly the CCTB.

In the investments arena, the source of funds is critical to the determination of who gets the tax bill. If a spouse transfers assets to the other spouse, the tax on any income from those assets (including capital gains) is attributed back to the original investor. However, it may be possible to get around these attribution rules if the receiver spouse gives a fair market value asset in exchange, pays prescribed interest, invests in a business, or reinvests the income to earn second-generation income. This method, though, is quite complex and advisors should talk to a tax expert for further details.

On the home front, each individual is entitled to make use of the principle residence exemption to protect the capital gains on one’s home from being taxed. Once you become a spouse, the exemption must be shared between the two individuals such that only one property can be protected for any given year, even if each owns a separate property. In fact if spouses each carry a property out of a marriage (ie., on separation), a subsequent exemption claim by a husband on his property extinguishes the wife’s ability to claim an exemption on her property for the years the properties were concurrently owned within the marriage.

Later years and into the beyond

A more recent, and useful, development in spousal-related tax law, is the ability to split pension income. Spouses may now annually elect to split as much as 50% of eligible pension income. The optimal split will drive income into lower tax brackets, reduce old age security clawbacks, preserve age credit entitlement and possibly double-up access to the pension credit.

Couples can also make contributions into a spouse’s RRSP in a forward-thinking plan for facilitating later income splitting in retirement. There are even rules that allow a post-mortem contribution to be made from a deceased spouse into a surviving spouse’s RRSP. This is in addition to the ability to rollover RRSP and RRIF plans to a spouse at death to keep growth and income in a tax sheltered zone. As well, when the new tax-free savings accounts (TFSAs) become available in 2009, the proposed rules will also allow rollovers to spouses at death.

During their lives and at death spouses can generally transfer capital property to one another directly or via a trust without triggering inherent capital gains. For optimal benefit, a deceased spouse’s will might create a testamentary trust that enjoys both the rollover and reduced future taxes through graduated bracket treatment for as long as the surviving spouse may live.

So, ‘til death may you part … and maybe longer still.