Category: Empire Life Initiative

Vol.07 No.2 – RRSP vs. open account: Part 2 of 2 – Key questions

Recall that last month Advisor had discussed with Client  some comparative features of registered and open investment accounts.  Client is now asking what Advisor needs to know to advise how Client might proceed. Some questions that Advisor will want answered:

Employment matters

Has Client’s employer been withholding tax at source?

Is it a group RRSP (with source deduction), or personal RRSP?

Is Client a member of a registered pension plan?

Tax characteristics

What is Client’s marginal tax rate presently? in retirement?

What will Client do with any tax refund received?

Timelines

How many years until Client will begin drawing down funds?

How much and how long will/must Client draw upon the funds?

Investment/financial profile

Does Client have a contingency fund for emergency needs?

What is client’s risk tolerance and rate of return expectation?

What other wealth and savings does Client have presently?

Will Client receive an inheritance from parents or grandparents?

Does Client have investments that may suffer capital losses?

Spouse and family issues

Is Client contributing to a spousal RRSP?

What is spouse’s income and expected retirement income?

Does Client have children who will require support in future?

Last month: Part 1 – Comparative features

Vol.07 No.3 – How much to contribute to RESPs

Client just opened a Registered Education Savings Plan for her child, and has asked Advisor how much she should be contributing to the program.

While the absolute amount being saved for education will depend on one’s current financial situation and future education expense expectations, there are some tax considerations that may affect how one chooses to save.

Some key benefits of RESPs include:

The earnings in the RESP will be taxed to the child (presumably at a lower rate) when the funds are applied to education in future.

The 20% Canada Education Savings Grant matches contributions up to $2,000 (proposed to go to $2,500 in the March ‘07 budget).

Further financial incentives may also be available for lower-income families.

Beyond the level at which the incentives are available, it may be worth considering other education savings options:

She may simply choose to invest in capital gains directed investments, only half of the growth of which is taxable to her.

She could set up an in-trust account, though according to CRA’s practice any interest and dividends will be taxed to her from year to year, while the capital gains may be taxed to the child.

If a very substantial future need is anticipated, this may warrant the formality and cost of establishing a formal trust so that all of the earnings can be designed to be eventually taxed to the child.

Vol.07 No.4 – RRSP vs. Paying down the mortgage

Client is mulling over what to many in the financial advice field is the age-old conundrum: Whether to use his forthcoming tax return to increase the investment in his RRSP or to apply it to reduce the mortgage on his home.

RRSP

The general advantage is the  tax-deferred investment growth of the money in the RRSP.

As well, the deposit will reduce his annual reportable earnings, which may in turn result in another tax refund next year.

In the future though, the money withdrawn from the  RRSP (or from a follow-up RRIF) will be fully taxable.

Mortgage

An unfortunate drawback of a principle residence is that mortgage interest is not tax-deductible.

By corollary, the effect of the early principal payment is that it reduces the cost of future interest that would otherwise compound against him.

As a final point, due to the principal residence exemption, his expected return is tax-free.

Ultimately, Client would be well served by seeking advice of both his tax advisor and his investment advisor in order to decide which route makes the best sense in his situation.

Vol.07 No.5 – The principal residence exemption

Client-couple are wondering whether they can declare the cottage as their principal residence in order to capture the galloping growth in the hot recreational real estate market.

While an important consideration in their tax planning, the election to eliminate capital gains using the principal residence exemption really only happens when one disposes of a property.  Specifically, one does not choose particular years, but rather decides how many of the ownership years to elect the exemption upon.  In fact, one can elect one less year than otherwise required as the calculation is designed to pick up gaps that might result from mid-year transfers.

The reportable capital gain is calculated as (1 + Years elected) / (Years owned)

The exemption is available on traditional houses, condominiums, mobile homes, houseboats, co-op interests and life leases.

Bear in mind that when more than one property is owned in a given tax year, the election to treat a disposed property as a principle residence will limit or preclude such an election on a later disposed property.

If/when Clients sell the house to move to the cottage, they will want to balance the current savings of electing the exemption on the house against potentially larger gains on the eventual sale of the cottage if strong growth continues.

Vol.07 No.6 – Existing homeowner title insurance to fight real estate fraud

On your recent annual financial check-up with retired Client-spouses, they advised that a major bank recently called asking for payment on a mortgage they knew nothing about.  They have lived in their home for over 50 years (having retired their mortgage decades ago) and are therefore wondering … How could this happen?:

A fraudulently executed document transfers the property into the fraud artist’s name

The fraudster then purports to discharge any existing mortgages in order to apply for a mortgage with a new financial institution

The new mortgage is registered on the property

The new financial institution advances the negotiated funds to the fraudster who immediately skips town

Clients now have to engage a lawyer to help clean up a potentially costly problem

While the provincial governments have initiated legislative steps to address some of these problems, an existing homeowner title insurance policy will assure that the costs of such corrective actions are covered:

Such policies are generally retroactive to the original purchase date

Protection can often extend to heirs of the owner

The premium is a one-time cost

Usually there is no deductible if a claim is made

The policy actually covers a large number of potential title problems beyond the fraud concern

Vol.07 No.7 – Failing the spousal rollover: Avoiding the sole annuitant trap

Advisor and Client are discussing investment succession issues.  Client has a general familiarity with the key rules in the Income Tax Act allowing for spousal rollovers:

Registered (RRSP & RRIF) money can roll to a spouse at death, generally by designating the spouse as beneficiary of the plan

Non-registered capital assets can roll to a spouse during lifetime or at death, though income from the rolled assets is attributed to the transferor (with some exceptions – see initiative Vol.3, No.6)

For insurance-based non-registered money, however, Advisor should pay close attention to the annuitant provisions of the contract.  If it does not allow for a successor annuitant, or if a successor is allowed but not elected, the original contract will likely be at a legal end on the death of the original annuitant.

Even if a successor owner is named (even a spouse), tax will be due on any realized capital gain for the original contract, and the successor will own a new contract.  Rather than being a rollover of an asset at its cost base, this is essentially passing ownership after an actual capital gain is realized.

Insurance-based investments in registered plans for a spouse beneficiary do not have the same concerns as tax is not payable until money comes out of the RRSP/RRIF.

Vol.07 No.8 – Accessing the newly increased lifetime capital gains exemption

Client has always been an entrepreneur, having built and sold her first company many years ago to seed her second venture. She was able to escape most of the tax on the sale of her shares in the first transaction by claiming her full $500K lifetime capital gains exemption.

Being an astute (and attentive) business manager, Client’s ears perked up when she heard that that the 2007 federal budget intended to increase the lifetime capital gains exemption from $500K to $750K.  She has inquired with Advisor whether she will be able to take advantage of it, perhaps as part of an estate freeze for her current company which has at least another $1M of inherent growth.

While there are some transitional rules for dispositions before and after the March 18, 2007 announcement date, the exemption indeed continues to be available to:

Qualifying small business corporation shares

Qualifying farming property

Qualifying fishing property

As client has used the original $500K, she will have the difference of $250K to employ in the proposed estate freeze – and she will likely be looking for  Advisor’s assistance to obtain life insurance coverage to protect against the frozen tax liability in excess of the exempt portion!

Vol.06 No.1 – “Qualified beneficiaries” deferring tax on received RRSP/RRIF money

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.

Vol.06 No.2 – Proposed ‘lifetime benefits trust’ for infirm RRSP/RRIF beneficiaries

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

Vol.06 No.3 – The precatory memorandum: Non-binding moral Will instructions

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.

Vol.06 No.4 – Bank mortgage insurance or your own insurance

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

Vol.06 No.5 – Life insurance premiums deductibility on bank indebtedness

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.

Vol.06 No.6 – Corporation using own-insurance or bank debt-coverage insurance

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.

Vol.06 No.7 – The three principle types of investment income for tax purposes

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.

Vol.06 No.8 – Taxing dividends from Canadian corporations

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%

Vol.06 No.9 – Deferring terminal tax on capital gains using spousal rollovers

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

Vol.06 No.10 – Using joint-last-to-die life insurance to preserve an estate

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

Vol.06 No.11 – Prescribed life annuities

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.

Vol.06 No.12 – Individual pension plans

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

Vol.05 No.1 – Using a tax-deductible retiring allowance for RRSP surplus-funding

Last year Client purchased the 30 yr-old business of her mentor; he offered to stay on to assist his successor.

Unfortunately, the arrangement is not working out as planned and Client is seeking a way to diplomatically break ties with her mentor – professionally and financially.

This may be an ideal situation for a retiring allowance.

From the Client-employer standpoint, as long as the amount of the allowance can be justified in the context of the employment relationship, the amount is tax-deductible.

On the receiving end, some or all of the amount may qualify for mentor to make a bonus RRSP contribution, as follows:

Base maximum is $2,000 for each pre-1996 service year

For each pre-1989 service year during which the employer did not contribute to an RPP or DPSP, an additional $1,500

Direct deposit to the RRSP by the employer will bypass the need for withholding tax

Unused sick credits may qualify, though that is unlikely in this situation

Transfer to recipient’s RRSP or RPP must occur within 60 days after the end of the year of receipt

Vol.05 No.2 – Tax-splitting CPP retirement benefits

Client-couple have had a ‘traditional’ family home with husband working full-time and wife mostly ‘stay-at-home’.  Husband is retiring next year and the couple is looking for ways to reduce their household tax bill.

One simple option may be for the couple to share their Canada Pension Plan retirement benefits.  Both pensions must be shared and therefore this is only effective where there is a disparity in the entitlements.

Some keys to this type of legally-sanctioned income splitting:

It is available to both common-law partners and legally married spouses

If only one spouse-partner is entitled to a pension, sharing can still occur if the other spouse-partner is at least age 60

The sharing scheme can integrate with provincial pension plans if the province permits it

The shareable portion is calculated is a ratio of cohabitation period to CPP contributory period.

Sharing commences once an application is approved — Past receipts cannot be retroactively taxed to a spouse-partner

Sharing may terminate upon written request (reinstateable on further mutual written request) or upon certain life events such as death, separation, divorce, and change in contributor status

Vol.05 No.3 – Private corporation RDTOH and life insurance

While a private corporation enjoys tax advantages that allow it to earn and grow business income, that same corporation is an imperfect vehicle for the storage of that wealth, and can often penalize the shareholder/owners.

Client’s small business corporation has indeed generated excess cash, and he has now engaged Advisor to suggest investment alternatives for the company.

A significant concern is the imposition of the 26.67% refundable tax on non-active income (essentially investment income) that must be deposited with CRA.

The CRA deposit is tracked in the corporation’s refundable dividend tax on hand (“RDTOH”) account. To retrieve the RDTOH, the corporation must declare and pay taxable dividends to its shareholders: $1 returned for each $3 paid.

A key benefit that tax-exempt life insurance can offer to a small business corporation is insulation against RDTOH leakage.  Money invested in an exempt policy not only escapes annual taxation, but also bypasses the associated mandatory deposit to CRA’s refundable tax account — meaning that more of that excess cash remains invested.

Vol.05 No.4 – Life insurance and a private corporation’s capital dividend account

Client understands that insurance premiums may be less costly if the insurance is owned and paid corporately rather than using net after-tax funds to pay at the personal level.

Still, he is concerned that this may result in a tax hit when the proceeds are paid, and he has asked Advisor to clarify.

Indeed, certain tax-free corporate receipts such as life insurance may be flowed through tax-free to shareholders via the corporation’s capital dividend account (“CDA”).

A private corporation receives life insurance proceeds as a tax-free receipt to the corporation.

Its CDA credit is equal to the gross insurance proceeds less the corporation’s adjusted cost basis (“ACB”) of the policy.

Where the originating policy is not owned by the corporation itself, the ACB reduction will not apply, meaning that the CDA credit will be equal to the gross insurance proceeds.

A common strategy used to distance the corporation from the policy is to have an associated corporation own the policy, though one must be careful that this is not the sole purpose of the latter corporation, else CRA deem this an avoidance transaction using GAAR.

Vol.05 No.5 – Hotchpot: The rule against double estate portions

Client’s elderly mother prepared a Will some years ago, leaving the residual estate property – presently about $600,000 – to be shared equally between Client and her brother.  Just this last year, mother gave brother $200,000 for the down payment on the purchase of a house.

Client has inquired with Advisor whether this may affect the Will distribution.

While there is no definitive answer, the likelihood is that the down payment falls within the rule against double portions, or “hotchpot”.

Under this equitable rule, it is presumed that when a child receives a substantial payment (relative to the size of the estate), it is an advance of a Will inheritance.  The rationale is that a parent is presumed to wish to treat children equally, though this presumption is rebuttable based on the facts of the case.

If the issue threatens to cause some family angst (now or after mom dies), Client may wish to suggest that mother speak to her lawyer about incorporating a ‘hotchpot clause’ in a revised Will.  That way mother will be able to explicitly state how any such gifts are to be treated.

Vol.05 No.6 – Corporate ‘net-valuing’ as a probate tax reduction mechanism

Client has a $2.5M stock portfolio, a substantial portion of which is leveraged through bank loans.

She has a mentally disabled adult son who will be her sole heir.  His inheritance is to be held in trust as directed in her Will, with her nephew as trustee managing son’s affairs.

Client’s problem is that, for the probate tax calculation, the only allowable deduction against gross assets is indebtedness against real estate.  In her case the debt is against personal property, and therefore the portfolio will give rise to $35,000+ probate tax.

One option for Client is to create a corporation to house some of the portfolio and related debt.  In that way, probate tax would be levied on the net value of her shares (ie., corporation value equals portfolio minus debt), rather than the gross value of the portfolio alone.

Of course, there are costs involved in establishing and maintaining a corporation, not to mention the legal and tax issues of holding an incorporated portfolio.

Still, it is worth Client’s time to meet with her investment advisor, accountant and lawyer to come up with a solution that fits her unique requirements.

Vol.05 No.7 – Personal insured annuity: lifetime returns, guaranteed inheritance

Client-couple are retired in their late-60’s, with reasonable pension and other assets to sustain their lifestyle.

They have a GIC portfolio for play money to buy gifts for their grandchildren, and intend to pass on that portfolio to those grandchildren after the second of them dies.

They have approached Advisor with a challenge to achieve two apparently conflicting goals:

Produce higher returns without increasing risk, &

Guarantee the principal for the grandchildren’s inheritance

While Advisor will want to be certain through a financial planning review that indeed the targeted money is surplus to these Clients, this appears to be an ideal situation to employ an insured annuity strategy:

Re-allocate a portion of an interest-earning portfolio into a ‘prescribed annuity’.

The annuity pays a higher annual dollar-figure relative to a comparable interest-based investment, and is taxed more favourable in comparison to interest income.

Part of the excess income is used to fund a life insurance policy to replenish to the estate the funds committed to the annuity

The anticipated net income yields a higher return, with guaranteed annual income and guaranteed inheritance value

The strategy is flexible enough that it can be done individually, or on a joint-last death basis.

Vol.05 No.8 – Corporate insured annuity: increased income and distributions

Client is the shareholder of a small business corporation that has become a cash cow in his winding-down years.

Client is aware of the high tax rate on passive (investment) income, and the related RDTOH (see Vol.5, No.3), and has asked Advisor to devise a strategy for more effective management and withdrawal of that corporate cash.

In consultation with Client’s legal, tax and accounting counsel, Advisor may wish to suggest the use of a corporate insured annuity strategy.

For a qualified corporation – The non-prescribed annuity income will be sufficient on an after-tax basis to pay insurance premiums that will replace the capital committed to the annuity, and still enable larger annual dividends

For a shareholder – The greater corporate income in turn means that larger dividends will be distributable annually, without increasing investment risk

For a shareholder’s beneficiaries (particularly the spouse) – Rather than having to pay full tax on a wind-up distribution, the corporation receives life insurance proceeds tax-free, and may in turn distribute some or all of those proceeds tax-free

Vol.05 No.9 – Education planning trust

An elderly grandmother wishes to provide that an inheritance to a young grandchild be used for post-secondary education.  She has asked Advisor how she can be sure that the money is not instead frittered away.

While she will simply pay the costs herself if she is living at the time, she can use her Will to settle a testamentary trust to assure her wishes will be fulfilled in her absence.

As long as the terms of the trust are not illegal or immoral — and we are talking about education here — then she has great latitude in how the trust will be managed:

Distribution could be delayed until one or more dates after the age of majority

Prior to those dates, the trustee can be empowered to encroach on capital if it would be in the child’s best interests

The trustee could pay costs directly to the institution, just to make sure it doesn’t get diverted into a less education-related purpose — like a sports car — on the way to the registrar

Grandmother could even use a reward system to accelerate the inheritance based on achievement

If the grandchild does not enter or continue in school, Grandmother could have an alternate beneficiary altogether.  More likely, the distribution will simply be delayed until one or more later dates — and this alone may be an incentive for grandchild to enter & complete school.

Vol.05 No.10 – Creditor protection by severing jointly owned segregated funds

Client-couple, both professionals, equally  contribute to a jointly-owned $500,000 investment portfolio.

While the joint ownership structure assists in avoiding probate and simplifies estate transfer at a first death, they are aware that the portfolio is exposed to either of their potential creditors.

They have asked Advisor if there is a way to achieve a variety of goals — probate avoidance, creditor protection, and tax-effective spousal transfer & estate succession.

Here is a simple alternative Advisor may wish to suggest:

Sever the joint ownership and maintain two distinct portfolios

Hold the new portfolios in segregated funds

Name one another respectively as beneficiaries, thus

Avoiding probate and estate creditors on first death

Obtaining lifetime creditor protection pursuant to the Insurance Act

Enabling capital cost rollover on a first death

If the couple has children, they may wish to modify this structure so that the children are contingent beneficiaries, thus extending creditor protection and probate avoidance on past the second death.  If the children are minors, insurance trusts may be used within the structure to maintain the mentioned benefits, while extending control and tax-effectiveness of the estate well into the future.

Vol.05 No.11 – Taxation of RRSP/RRIF funds at death

The central tax feature of RRSPs/RRIFs (and their locked-in variations) is that they provide tax-sheltering during the life of the plan holder, with any withdrawals being taxed annually as regular income.

At death,

There is a deemed disposition of the entire plan

The plan value is added to the deceased’s income that year

The estate and the plan beneficiary are jointly liable for the tax

Apart from the obvious emotional loss, this deemed disposition at death visits upon a family a tax hit at an otherwise very financially vulnerable time:

A principal financial provider has been lost

A key tax-sheltered savings/income source has been disposed

The forced lump sum receipt often causes the deceased to be taxed at a higher marginal rate, resulting in a lower realization of the plan’s spendable value compared to a controlled disposition

Fortunately, the income and associated tax bill can be recognized in other hands and/or deferred where certain family members are named as beneficiary of the plan:

A spouse

A minor child or grandchild

A disabled dependent child or grandchild

The next three issues of initiative will look at the options that may be available in each of these circumstances, and where it might be preferable not to exercise such options.

Vol.05 No.12 – Allocating terminal RRSP/RRIF funds to “qualified beneficiaries”

When a “qualified beneficiary” is named to receive registered funds (either directly, or possibly via the deceased’s estate), some or all of the income recognition (and related tax imposition) can be in the hands of a lower-tax beneficiary rather than in a high-tax terminal return.

A “qualified beneficiary” is a:

Spouse, being either a legally married person or a common law partner.  A common law partner is a person with whom the annuitant lives in a conjugal relationship, and such person:

Has been so living for at least 12 continuous months

Is the parent of the annuitant’s child by birth or adoption, or

Has custody and control of the annuitant’s child, and the child is wholly dependent on that person for support

Financially dependent child or grandchild, being a person whose income is less than the basic personal amount for income tax filing purposes ($8,012 for 2004)*

Physically or mentally infirm child or grandchild, who is financially dependent, being a person whose income is less than the prescribed annually indexed amount ($14,035 in 2004).  It may also be possible to establish financial dependence in a fact-specific appeal to CRA where income exceeds these amounts

The Canada Revenue Agency specifically intends that this scheme be used to enable people in such situations to pay the least amount of tax the law allows.

Next month’s initiative will look at how the qualified beneficiary may further defer tax on the received funds.