Retirement – Page 4 – Doug Carroll

Who pays the tax on mom’s RRIF at death?

Sibling stressors, legal rules, moral dilemmas

Some of the largest dollar value estate planning decisions we make are the naming of beneficiaries on registered plans.

By doing so, the plan proceeds go directly to the named beneficiary/ies, rather than falling into the estate of the deceased. This bypasses exposure to estate creditors and probate tax, as well as the potential delay of having to pass through the estate.

But while making a beneficiary designation streamlines both time and cost of distribution, the tax result could present an unexpected dilemma for the recipients.

Why is there tax on registered plans at death?

A registered retirement income fund (RRIF) is the payout form of what originated as a registered retirement savings plan (RRSP). Together they are legally-authorized income deferral arrangements. When a person dies, there is no more future deferral time, so the arrangement is generally terminated.

The main exception is a tax-deferred rollover to a spouse (or possibly to a dependent child), but otherwise the account value is brought into the deceased’s income in the terminal year.

Who is responsible for paying the tax?

Absent a rollover, and assuming for the moment no named beneficiary, a deceased’s RRIF will be paid to the estate.

It is the executor’s job to deal with the deceased’s debts, with tax liabilities being top of the list. The RRIF proceeds can be used to pay the tax associated with its terminal income inclusion, and the net remaining funds are then available to be distributed to estate beneficiaries along with other estate assets.

Does a beneficiary designation avoid income tax?

If the deceased had named a beneficiary on the plan, the gross proceeds would be paid in accordance with that designation. However, despite that no money flowed into the estate, the RRIF would still have been included in the terminal year income, the tax on which remains the estate’s responsibility.

But who actually bears the tax?

If the estate has insufficient assets, the CRA can follow that RRIF into the named beneficiary’s hands and require payment of the deceased’s tax on that amount. Otherwise with a solvent estate, if the RRIF beneficiary/ies and the residual estate beneficiary/ies are different, then the latter effectively bear the tax on the former’s RRIF receipt.

What did mom know, and what did she want? – Jeffrey’s dilemma

That last situation was the subject of a recent conversation with Jeffrey. He and his brother were named as beneficiaries of their mom’s RRIF, while they and their sister were the three estate beneficiaries. It was openly known that mom intended the brothers to get the RRIF, but it was unclear if she was aware of the tax rules.

While everyone got along fine, the sister could potentially have questioned mom’s knowledge and intention at the time of making the beneficiary designation. Whether that would be successful before a judge would depend on the facts and available evidence, but it would be certain to hurt family relations and cost money.

The brothers, who were also the executors, looked into whether there was an accepted practice in such cases. Ultimately, it came down to a moral decision, and they decided that they two would bear the tax.

In all, it’s a reminder that even apparently simple decisions could have unexpected effects. While it’s impractical for you to have each RRSP or RRIF designation legally reviewed as made, the topic should be on the agenda next time you’re with your estate planning lawyer, to be sure they properly reflect your intentions and expectations.

Magic Number – What are some advisor assumptions on how much to save?

How much do I need to save for retirement? It’s the most common question asked of financial planners.

Of course, the response depends on how much you’ve already set aside, how much you need to live on now, and how much you want to (or must) spend in those later years. That’s the core of financial planning, and there’s a lot of information to be gathered, decisions and assumptions to be made, and calculations to be applied to come up with viable options and sound recommendations — and even then, there is still some degree of uncertainty.

This doesn’t mean that you don’t go to the effort, particularly if you are the financial planner tasked to make those recommendations. The critical step of any plan though, is putting it in motion.

Heuristics – The appeal of simplicity

In the face of what may feel like a laborious and elusive task, people often prefer to use a heuristic, for example “save 10 per cent of your income.” This is also known as the 10 per cent rule. Because it is so simple, it may very well get things moving, which in fairness, is a victory in itself.

Once good saving habits are established and experience gained, adjustments can be made that cater to changing circumstances.

Even so, 10 per cent is just a nice, round, but otherwise arbitrary figure. The aura that surrounds it should not be confused with the principled due diligence that informs good financial planning.

Do you apply it before or after…?

If we’re not careful, the apparent simplicity can be misleading. How you apply it is equally and arguably more important than the rate you choose in the first place. Too little and there’s not enough when you need it. Too much and the budget stress could be overwhelming, perhaps leading you to abandon the initiative you have taken. Consider these key tax issues:

Is the 10 per cent set before or after income tax?

In other words, are you applying it to gross income or net income? As a rough example (which varies by province), the average tax rate at $100,000 is about 25 per cent.

So, do you target $10,000 based on the gross, or about $7,500 based on the net? That could hinge on the mechanics of how you save.

If you pre-calculated $10,000 then you could pre-authorize a proportionate dollar amount from each paycheque/auto-deposit.

If instead you took 10 per cent off each deposit after it is in your account, it would come out to $7,500.

Are you saving with before-tax or after-tax dollars?

As compared to the first question, which was about the amount to save, this is about deductibility. Put in more familiar terms, you could make a deductible RRSP contribution, or a non-deductible TFSA deposit.

While you can get more into the RRSP to begin, eventually that is taxed on withdrawal before you can spend. TFSAs face no further tax. You’ll need to look at tax rates now (known) and in retirement (assumed) to properly compare. If you’re doing some of each, the arithmetic is more challenging.

Pre- or post-payroll?

If you contribute to a workplace group RRSP, your employer will generally reduce its withholding tax, as it knows of this deduction. When you contribute to your own RRSP, the annual withholding will likely exceed your actual tax due, resulting in you receiving a tax refund. While you don’t have to, reinvesting the refund effectively boosts your savings rate.

Canada Pension Plan?

The CPP is a savings program, with a base premium of 4.95 per cent. It is withheld by your employer, so most people wouldn’t notice or think of it as saving, per se. But depending on your response on the preceding questions, it could be quietly baked into your savings rate. And with premiums increasing to 5.95 per cent over the next few years, and an additional four per cent premium on higher income levels after that, it warrants a closer look to make sure it dovetails with your intentions.

Housing and mortgage?

What does housing have to do with it? Well, equity in a house is a type of saving, usually by first saving a down payment then servicing a mortgage. As an owner, you defray some of your future shelter costs, whereas otherwise you would need more savings to pay future rent. Whether this is before, after, or part of your 10 per cent depends on your circumstances, which is why a holistic financial plan should underlie your efforts.

A sea change for the CPP

More benefits and premiums on the horizon

It may seem to some people that the Canada Pension Plan (CPP) is constantly changing, as it has regularly been in the headlines since the 2008–09 economic downturn. The truth is the CPP goes through incremental indexing every year, while wholesale revisions are uncommon.

But with the recent change in political leadership in a number of provinces and at the federal level, the most significant changes to the CPP since the 1990s have gone from talk to action.

On June 20, 2016, Ottawa and the provinces reached agreement in principle to enhance the CPP. First reading of Bill C-26, which contains the proposed CPP enhancements, was on October 26. At the time of writing, the bill continues to work its way through Parliament, having passed second reading on November 17 and been reported back without amendment from the Finance Committee on November 24.

Here’s what to expect as we transition into this new normal.

Why increase the CPP?

Research commissioned and analyzed by the Federal Department of Finance points to a concern about both current and projected future under-saving for retirement.

Based on Statistics Canada’s Survey of Financial Security 2012, it is estimated that 24% of families nearing retirement age are at risk of not having adequate income in retirement to maintain their standards of living.

At the other end of the age spectrum, young workers face longer life expectancy, which in turn requires more conscientious long-term savings. With workplace pensions becoming rarer and those already established shifting away from defined benefits, the pressure on individual savings is accentuated. Add to that the current (and potentially prolonged) low-interest-rate environment, and a perfect storm may lie ahead for many working Canadians seeking the safe harbour of a comfortable retirement.

The components of change

The CPP is structured as an insurance arrangement where premiums during working years fund pensions in retirement.

The retirement pension is calculated as a replacement percentage of a target income level. Accordingly, there are two large levers that can be used to increase pensions: adjust the replacement percentage or the target income level. These changes will effectively do both:

The income replacement level will increase from 1/4 to 1/3 of eligible earnings
The upper earnings limit will be increased by 14%

Of course, hikes to employer and employee premiums will be required to pay for those increases.

Timelines, and projecting the dollars and sense of it

The plan is to have all changes in place by 2025, with the seven-year transition to begin in 2019. It will occur in two phases.

For the five-year period from 2019 to 2023, the rate of contributions based on the existing year’s maximum pensionable earnings (YMPE) will be raised each year. Currently, employers and employees each contribute 4.95% of the YMPE. By 2023, that will be 5.95% each, based on the following implementation schedule:

Table: Upcoming CPP premium increases

Year / Cumulative addition

2019 0.15%
2020 0.30%
2021 0.50%
2022 0.75%
2023 1.00%

The second phase of the transition will be the augmentation to the earnings limit. The YMPE will continue as a concept, and a new concept will be introduced to track the upper earnings limit: the year’s additional maximum pensionable earnings (YAMPE). The YAMPE will begin as 107% of the YMPE in 2024 and move to 114% of it in 2025, after which the two thresholds will be separately indexed, though using the same standard indexation factor.

The Office of the Chief Actuary projects the YMPE (currently $55,300 for 2017) will rise to $72,500 by 2025, putting the YAMPE at $82,700 (in round terms). On the enhanced portion between the YMPE and YAMPE, the premiums are expected to be 4% each for employers and employees.

Some offsetting relief

To recognize the difficulty low-income individuals may have in budgeting for higher premiums, the working income tax benefit (WITB) is being raised. The WITB is a refundable tax credit that is reduced to zero at an income of $18,292 for unattached individuals and $28,209 for couples with children, in current-dollar values. The value of the WITB will be increased to roughly offset the incremental CPP premiums.

At the upper income end, those employees required to pay premiums on the enhanced portion of the CPP (the range between the YMPE and YAMPE) will be entitled to claim a tax deduction for this amount. The prevailing tax-credit structure will continue to apply to existing employee premiums based on the YMPE. As the tax credit is at the lowest-bracket rate, a tax deduction is more valuable as an employee’s income increases. This has the added effect that, should an employee reduce registered retirement savings plan or pension contributions (both being deductible amounts) in response to the increased premium on the CPP enhancements, there would be no increase in that person’s current taxes.