Part 2 – TFSA Designation at Death… Simple? Nope!

In Part 1 of the articles, I highlighted the importance of choosing a benefactor for your TFSA and the tax outcome with each type. I will continue with the three remaining methods of how to transfer your TFSA upon death.

 

 

Designation of an “Exempt Contribution” by a surviving Spouse/Common-Law Partner who Inherits the Spouse’s TFSA by Bequest.

Another case is where a spouse or common-law partner has not been designated as successor holder or as beneficiary of the spouse’s TFSA, but instead inherits the TFSA from the spouse in a Will. In such a case, the surviving spouse also has the option to contribute and designate all or a portion of the payment as an “exempt contribution” to their own TFSA.

This is true regardless of the holder’s province of residence, but will be especially true in Quebec, in most cases, given that the designation of a successor holder and of a beneficiary is currently only allowed if the TFSA is linked to an annuity contract or insurance policy (segregated funds).

Let us take the case of Julie, who lives in Quebec. Julie is the holder of a TFSA, which she bequeaths in her Will to her husband, Luc. Julie dies at which time the value of her TFSA is $45,000. Income of $1,000 has accrued in the TFSA account since the date of death until the time when the full amount of the TFSA, $46,000, is paid to Luc…

The value of the TFSA of $45,000 at the date of death is not taxable. However, the income of $1,000 earned after the date of death is taxable. This amount of $1,000 is to be included in Julie’s estate but will ultimately be taxed in Luc’s hands under regular trust taxation rules. Luc can contribute the $45,000 to his own TFSA during the rollover period, treat this contribution as an “exempt contribution” by filing form RC240 with the CRA within 30 days following the contribution date. The contribution will have no effect on his unused contribution room. If Luc wanted to contribute all or a portion of the income of $1,000, he received to his own TFSA, this would reduce his contribution room by the same amount.

Designation of an “Exempt Contribution” by surviving Spouse/Common-Law Partner through Intestate Succession.

A spouse may also receive the TFSA following the death of their spouse through the settlement of an intestate succession. In such a case, the surviving spouse also has the option of contributing and designating all or part of the payment received as an “exempt contribution” to their own TFSA, subject to their succession rights and provided that the contribution to their TFSA is made during the rollover period and that form RC240 is filed within the specified time.

Designation of an “exempt contribution” when the transfer of amounts from a deceased spouse’s TFSA is made to satisfy the bequest of a sum of money provided in the Will in favour of a surviving spouse or common-law partner.

It should not be concluded that because a Will does not specifically provide for the bequest of the TFSA in favour of the surviving spouse that the latter may not designate a contribution made to his TFSA as an “exempt contribution” after the death of the spouse. This is in fact what was confirmed in Technical Interpretation 2016-0679751E5 issued by tax authorities on May 11, 2017.

The question asked to the CRA involved determining whether the transfer by the legal representative of the estate (executor/liquidator) of amounts from a deceased TFSA holder to his surviving spouse, to satisfy a specific bequest of a sum of money provided in the Will, meets the definition of “exempt contribution,” if the surviving spouse were to subsequently use the amounts to contribute to her own TFSA.

Such a situation can occur, for instance, when the following facts are found:

Pierre died and was notably the holder of a TFSA in the amount of $45,000. No successor holder was designated for the TFSA and there was no designation of a beneficiary.

Pierre’s Will provided for a specific bequest of $45,000 to his spouse, Christine, and a bequest of the remainder of all his other assets to his daughter, Nicole. Although Pierre’s Will did not provide for a bequest of the TFSA in favour of his spouse, the legal representative of the estate (executor/liquidator), Nicole, agreed to transfer the value of the TFSA in the amount of $45,000 to Christine, the surviving spouse, to satisfy the specific bequest of an amount of $45,000 made by Pierre in favour of Christine under the terms of the Will.

Deceased’s unused contribution room

No contributions may be made to a taxpayer’s TFSA after their death even if contribution room is available. Contrary to an RRSP, where the legal representative of the estate is allowed to contribute to the decease’s RRSP to offset taxes, any unused contribution room when a TFSA holder dies is lost.

However, when death is imminent and a TFSA holder will be leaving a spouse behind, it may be beneficial to take advantage of unused contribution room by contributing the maximum amount to the TFSA before the holder’s death. The surviving spouse will receive a larger [“exempt contribution”] amount which could offset any OAS claw back.

Properly designating the benefactor of your TFSA as a successor annuitant, beneficiary or through a Will is paramount to avoid any unnecessary administrative work for the legal representative of the decease’s estate. Make sure you understand the facts before proceeding.

 

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TFSA Designation at Death…Simple? Nope!

The introduction of the Tax-Free Savings Account (TFSA) from the Conservative government in 2009 provided all Canadians with the opportunity to accumulate monies tax-sheltered and tax-free upon withdrawal. It can be a great source of tax-free retirement income preventing or minimizing the Old Age Security (OAS) claw back. To maintain the inherent tax-free benefits of the TFSA, the annuitant needs to ensure they have properly designated the benefactor of the account.

The methods of transferring one’s TFSA to a benefactor has created complexities. This is Part 1 of 2 in understanding how to protect your legacy.

When the holder of a TFSA dies, the income and gain in value accrued up to the date of death are not taxable. However, the income and gain in value accrued in the TFSA after the date of death are taxable, except if the surviving spouse/common-law partner has been designated as successor holder, not beneficiary.

Designation of Spouse/Common-law Partner as Successor Holder

Only a spouse or common-law partner can be designated as successor holder in a TFSA contract or Will. In this respect, the surviving spouse becomes the new TFSA holder as soon as the initial holder dies. This is an optimal method since it is the only way for the income and gains earned in the TFSA after the date of death to be tax-exempt. In addition, after the death of the initial TFSA holder, such a designation will not affect the surviving spouse’s unused contribution room.

However, for TFSA holders in Quebec, the designation of successor holder is currently only allowed if the TFSA is tied to an insurance policy or annuity contract, such as segregated funds. At present, most TFSAs in Quebec do not allow the designation of a successor holder.

Let us look at the case of Jennifer, who lives in Ontario. Jennifer is the holder of a TFSA and has designated her spouse, Carl, as successor holder. Jennifer dies at which time the value of her TFSA is $45,000. Income of $1,000 has accrued in the TFSA since the date of death.

Carl has become the new holder of Jennifer’s TFSA. Neither the value of the TFSA of $45,000 at the date of death or the income of $1,000 earned after the date of death is taxable. In such a case, Form RC240, “Designation of an Exempt Contribution Tax-Free Savings Account (TFSA),” does not have to be submitted.

Designation of Beneficiary other than Spouse/Common-Law Partner

If, instead, a beneficiary was designated in the TFSA contract or Will, the income and gains accrued up to the date of death are also tax-exempt. However, the income and gains earned after the date of death are taxable for the beneficiary.

Let us take the case of Denise, who lives in Ontario and is the holder of a TFSA. Denise designated her son, Pierre, as the beneficiary for her TFSA. Denise dies at which time the value of her TFSA is $45,000. Income of $1,000 has accrued since the date of death and the full amount of the TFSA, $46,000, is paid to Pierre…

The value of the TFSA of $45,000 at the date of death is not taxable. The income of $1,000 earned after the date of death is taxable for Pierre. The latter may use all or part of the funds he has received to contribute to his own TFSA, provided he has unused contribution room.

Bequest TFSA to Legatee other than the Spouse/Common-Law Partner

The bequest of a TFSA in a Will to a legatee other than the spouse or common-law partner will have the same tax implications as those indicated above, regardless of the TFSA holder’s province of residence at the time of death.

In Quebec, in most cases, given that the designation of a beneficiary is currently only allowed if the TFSA is tied to an annuity contract or insurance policy, the transfer of a TFSA at death will generally be done through a bequest in the Will.

Let us go back to the case of Denise if she lives in Quebec. Denise is the holder of a TFSA, which she bequeathed in her Will to her son, Pierre. Denise dies at which time the value of her TFSA is $45,000. Her estate is settled at which time income of $1,000 has accrued and the full amount of the account, $46,000, is paid to Pierre.

The value of the TFSA of $45,000 at the date of death is not taxable. The income of $1,000 earned after the date of death is taxable. This amount of $1,000 is to be included in Denise’s estate but will ultimately be taxed in Pierre’s hands under regular trust taxation rules. Pierre may use all or part of the funds he has received to contribute to his own TFSA, provided he has unused contribution room.

Designation of an “Exempt Contribution”by Surviving Spouse/Common-Law Partner

A surviving spouse or common-law partner designated as the successor holder of the spouse’s TFSA has the option to contribute and designate all or a portion of the payment as an “exempt contribution” to their own TFSA. Doing so has the advantage of not affecting their unused contribution room. However, the following conditions must be met for a contribution to qualify as an “exempt contribution”:

  • An amount paid out directly or indirectly [through a Will] of an arrangement that ceased to be a TFSA upon the death of its holder must be made to the surviving spouse/common-law partner following the holder’s death.
  • A contribution is made by the surviving spouse to their own TFSA by December 31 of the calendar year that follows the year of death (rollover period).
  • The surviving spouse is not required to fill out form RC240, “Designation of an Exempt Contribution Tax-Free Savings Account (TFSA),” since he/she was classified as successor annuitant. If the designation was classified as beneficiary, then the surviving spouse must complete RC240 and send it to tax authorities within 30 days after the day of the contribution to their own TFSA account and
  • The amount of the “exempt contribution” must not exceed the fair market value of the TFSA at the time of death.

Julie, who lives in Ontario is the holder of a TFSA and has designated her spouse, Luc, as the beneficiary not successor annuitant. Denise dies and the value of her TFSA is $45,000. Income of $1,000 has accrued since the date of death until the time when the full amount of the TFSA, $46,000, is paid to Luc.

The value of the TFSA of $45,000 at the date of death is not taxable. However, the income of $1,000 earned after the date of death is taxable for Luc. Luc contributes $45,000 to his TFSA. Given that Luc has contributed the amount of $45,000 to his own TFSA during the rollover period, he can treat this contribution as an “exempt contribution” by filing form RC240 with the CRA within 30 days following the contribution date. Such an “exempt contribution” will thus have no effect on Luc’s unused contribution room. If Luc wanted to contribute all or a portion of the income of $1,000, he received to his own TFSA, this would reduce his contribution room by the same amount.

Designating the benefactor of an TFSA as a successor annuitant, beneficiary or through a Will has its own set of tax rules. In order to fulfill your estate plans, its important to understand the guidelines and how your designation will be administered by CRA. Make sure you understand the facts before proceeding.

In Part 2, I will discuss the transfer of an TFSA by bequest and intestate succession along with unused contribution room of the deceased.

 

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Minor Beneficiaries

Statistics Canada has forecasted $1 trillion in personal wealth to be transferred to the next generation from 2016 to 2026, with Minors being the benefactors. When assets are left to a minor, either as a beneficiary of a Will or as a named beneficiary of a registered or insurance product, it is essential to ensure proper steps are taken to name a trustee with guidelines to follow.

Issues to be Discussed:

When money is left to a minor without naming a trustee it can create expense and upset because minor children are considered parties under a disability and are not entitled to receive funds directly. Therefore, funds left to a child must be received by a Trustee on behalf of the child and kept invested for his or her benefit until the age of majority or, if desired used to purchase an annuity.

A child’s parent, while automatically the guardian of the child, is not automatically the guardian of the child’s property. When a child inherits assets without a named Trustee, the child’s parent or guardian must apply to the Court to be appointed to manage the child’s property. The provincial agency mandated to protect minors must be served with the Application and will respond to it on behalf of the child. It is not automatic that the Application will succeed. In some cases where a child’s parent or guardian applies, he or she may be considered to have a conflict of interest if he or she wishes to access the funds to help defray his or her own obligation to support the child.

If no Trustee is named, and no guardian appointed by the Court, the funds will be paid into Court to be managed by a provincial government agency. Likely this is not the outcome the deceased would have wanted and does not provide for professional investment advice.

Minors and Will Planning

A minor may be named as either a legatee or as a residual beneficiary. A legatee is a beneficiary who is entitled to a specific asset or sum of money. Where a legacy is left to a minor it is important to review the applicable provincial rules. Some provinces permit a small amount to be paid directly to the minor without the need of a court application. Ontario, for instance allows up to $10,000 to be directly transferred. However, where the legacy is greater than the provincial limit or where the gift is residual to avoid the expense of a court application a trust should be created as part of an estate plan naming a trustee, setting out the power of the trustee to pay income or capital for or to the minor, the age at which the child will become entitled to the capital and the investment powers of the trustee.

Beneficiary Designation on Investment Products

Often a beneficiary designation on an insurance or investment product is not done with the same formality as a Will. Often beneficiary forms are signed as part of the group benefits package offered through work where legal or investment advice is not sought. In these circumstances the appointment of a trustee and their powers are often left to the fine print of the form. Forms are not standard. Most have a place where a trustee can be named, however the forms differ as to the powers the trustee, if any, has.

Where the forms are silent the form creates a bare trust where the trustee may hold the funds and invest them but cannot pay any amount to or for the minor. Another complicating factor is that the forms always limit the funds to be held until the age of majority, after which the child is entitled to the funds.

There are two potential drawbacks to a designation in a Will. Firstly, a beneficiary designation will only apply to those plans in existence at the time the Will is executed, so if other products are purchased after the Will is executed, they will not be included in the terms set out in the Will. Hence, the reason to regularly review your Will. Secondly, there may be an argument made that the funds pass through the Will and thus become part of the estate. To ensure this does not happen some practitioners recommend the terms be repeated as an appendix to the policy or product.

It is possible to direct the Trustee of the registered funds to purchase an annuity for the minor child. Again, this direction or power should be specifically set out. There may be some advantage to purchasing an annuity because RRSP/RRIF proceeds can rollover tax-deferred where the proceeds are used to purchase a fixed-term annuity. The annuity can provide for payments based on a period of not more than 18 years minus the child’s or grandchild’s age at the time the annuity was bought. The payments from the annuity must start no later than one year after the purchase. The annuity payments will be taxable as ordinary income to the child in the years they are received. While an annuity will provide some tax savings it should be weighed against the desirability of holding the funds and investing them over a longer period of time. Keep in mind, since the payout from an annuity is interest rate sensitive you might derive less money than held in equities. This will require a calculation as to the possible return weighed against the tax savings. Should the funds be held in a trust the tax will be deferred to age 18 when there will be a disposition.

Gifting funds to a minor, either in a Will or as a beneficiary of an investment product can be complex. Proper legal and investment advice is always a sound place to start the process.

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Changes to Ontario’s Estate Administration Tax Act

From Jan. 1, 2015 various changes relating to the Estate Administration Tax Act have become effective. While these changes seem administrative in nature, a deeper look reveals they can make estate administration and the probate process more onerous, costly and time-consuming. This makes it critical for Ontario residents to carefully plan their financial affairs to minimize or avoid estate administration tax. This article discusses the changes and their impact for executors/trustees.

The changes

1. Duty to give information

This change requires anyone applying for (i) the grant of probate, administration or testamentary guardianship or (ii) a certificate of appointment of estate trustee, from the Ontario court, to provide such information about the deceased person as may be required by the Minister of Finance. The information must be provided within the time and in the manner as may be prescribed by the Minister. The estate representative is also required to provide all reasonable assistance, and answer all questions, during a subsequent audit. Third parties are also required to provide the required information to the Minister.

2. Assessments and re-assessments

This change gives powers to the Minister of Revenue to assess or reassess the estate in respect of the tax payable. Generally, the Minster may assess or reassess the estate within four years after the day the tax became payable. There is no time limit if the person has failed to provide the information required or made a misrepresentation.

3. Audit and inspection

This change authorizes the Minister of Revenue to appoint inspectors to exercise the powers and perform the duties under the Estate Administration Tax Act.

4. Offences

This change makes failure to provide the information, or providing false or misleading information, an offence punishable by fine, imprisonment or both. The minimum fine is $1,000, and maximum is twice the tax payable. The term of imprisonment may be up to two years.

The impact

While these changes seem simple, the impact can be far reaching.

The “duty to give information” in and of itself doesn’t appear burdensome. However, when it’s read with the increased power of assessment/reassessment and penalties, it’s clear that much more effort and due diligence is required by the person applying for probate or certificate of appointment of estate trustee. The inventory of the estate assets and their values are to be provided to the Minister. It’s now more important than ever the applicant ensures all the assets are reported and proper valuations are done. Depending on the valuation issues and financial affairs of the deceased, it may require significant time before the application is made to the Ontario court for probate or certificate of appointment of estate trustee. In many cases, no distribution of the estate may be possible without probate or the certificate of appointment of the trustee, resulting in delay in administering the estate.

The enhanced audit and verification powers means the Minister may review the asset valuations. What if the valuation is higher – resulting in increased estate administration tax liability, but all the assets of the estate are already distributed? As mentioned, the Minister may assess or reassess within four years, so there is a possibility an auditor may come back on the estate trustee. Does this mean trustees should wait for at least four years before distributing all the assets of the estate? If so, this further adds to delay in estate administration. If not, the trustee may be assuming   the uncertainty and risk.

The solution

A very simple solution is provided in the Estate Administration Tax Act itself – i.e., no tax is payable if the value of the estate does not exceed $1,000.

Obviously, this solution does not apply to most individuals, and highlights the need for estate planning.

Different planning opportunities such as an alter ego trust or joint tenancy for the ownership of property (particularly for spouses or common-law partners) etc. are available to transfer the assets outside of one’s estate, thereby minimizing the estate and resulting estate administration tax.

Each opportunity has its own complexities and may require annual maintenance costs, not to mention potential income tax consequences.

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If you have the choice, what should you choose, Dividends or Salary?

The inspiration for this article came from a friend, an incorporated physician and director of a prominent downtown clinic.

The last time I visited him, the topic of tax efficiency and pensions came up. I asked if he paid into CPP. He confidently claimed that he did not and explained that he drew all his income in the form of dividends paying less tax and avoiding the obligation of having to make both the employer and employee contribution to CPP.

His overly self-assured claim of this strategy’s superiority triggered my curiosity. Is it truly better for a business owner or incorporated professional to draw all their income in the form of dividends?

Dividends with No Salary Avoids CPP Contribution, But at What Cost?

At first glance, the answer seems obvious. Only taking dividends avoids having to make CPP contributions (10.2% of net income for incorporated individuals up to a maximum of $5,497.80 in 2019). This can look attractive, if all the income is spent, since there is more to spend.

Some day, we all will either die at work or retire. The latter is the preferred option for most. The more you save and build wealth, the more comfortable your retirement will be. In an increasingly competitive world where technology is disrupting many business models, business owners and incorporated professionals cannot rely upon the sale of their business to fund their retirement. So, there should be a plan in place to build wealth outside the business.

Established strategies may need to be rethought. Recent changes to the income tax act with the new passive income rules have made it less attractive to transfer money to a holding company via tax free dividend and invest within the holding company.

The Financial Model Illustrates the Potential Opportunity Cost of a Dividend Only Strategy

Two scenarios for a 45-year-old incorporated professional with $250,000 of net business income (before salary or dividends) were examined. Under scenario 1, all income flows out as a dividend. Scenario 2 uses a mix of salary and dividends.

The analysis used one year of income to calculate the impact on disposable income, total funds invested, taxes paid and the future value of the invested funds in 20 years. Both scenarios assume lifestyle expenses of $125,000. All funds in excess of lifestyle expenses are invested with a maximum 1-year RRSP contribution made under the mixed salary dividend option. Growth of 6% before tax and 4% after tax for non-tax-sheltered investments were assumed.

Comparative Analysis of Dividend Only Income VS. Blended Dividend Salary Mix  For 45-Year-Old Incorporated Professional

Dividends Only Salary + Dividends
Business Revenue $250,000 $250,000
Salary $0 ($185,000)
CPP $0 $2,749
Income $250,000 $62,251
Corporate Tax (@13.5%) ($33,750) ($8,404)
Business Net Income $216,250 $53,847
Salary (Before RRSP Contribution) $0 $185,000
CPP Payment ($2,749)
RRSP Contribution ($26,500)
Dividend (Ineligible) $216,250 $53,487
Personal Income Tax ($65,580) ($76,052)
Disposable Income $150,670 $133,546
Spend ($125,000) ($125,000)
Invest – RRSP ( Tax Sheltered Growth) $26,500
Invest – CPP ( Tax Shelter Growth) $5,498
Invest – Opne Acct. ( Taxable) $25,670
$8,546
Total Invested $25,670 $40,544
RRSP Value in 20 yrs. (6.0% growth) $0 $84,989
Open Acct. Value in 20 yrs. (4% growth) $56,246 $18,726
$56,246 $103,715
CPP equivalent asset Value in 20 yrs./20 $0
$10,104
Future Value $56,246 $113,820
Taxes Paid ($99,330) ($84,456)

E&OE

Salary Dividend Mix Provides A Better Outcome

If you are planning for future retirement, a salary dividend mix provides a better outcome. Drawing only dividends does not create the earned income required for you to take advantage of registered retirement savings programs such as RRSPs, DPSPs or IPPs. You also do not get the benefit of the CPP, which while not large, does have real future value with its life-time guaranteed inflation adjusted income. When you combine the impact of more invested dollars with higher rates of compound growth (due to tax sheltering), additional CPP value and less tax, you get a lot more future value to spend in retirement.

As for my friend, he is more focused on purchasing his first home than retirement, so he is still pursuing a dividend only strategy.

This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisers before engaging in any transaction. Neither Brendan Greenwood nor Pelorus Transition Planning Inc. or its affiliates provide tax, legal or accounting advice. This material is based on the perspectives and opinions of the writer only and does not necessarily reflect views of  Pelorus Transition Planning Inc. The opinions or analyses expressed herein are general, and do not take into account an individual’s or entity’s specific circumstances. Investors should always consult an appropriate professional regarding their particular circumstances before acting on any of the information here. Every effort has been made to compile this material from reliable sources; however, no warranty can be made as to its accuracy or completeness. Investments are provided through Worldsource Securities Inc., sponsoring investment dealer and Member of the Canadian Investor Protection Fund and of the Investment Industry Regulatory Organization of Canada.

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Things to Consider Before Withdrawing Funds From Your RRSP

Money withdrawn from an RRSP not only reduces the number of dollars building your retirement fund, but also can create a substantial tax liability.

Source:  Business Matters Volume 24, Issue 3

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Is Your Tax-Free Savings Account a Missed Opportunity?

Tax Free Savings

A Tax-free Savings Account (TFSA) is a missed opportunity for many Canadians who have either not set up a TFSA or are using it to hold low interest GICs. The attraction of a TFSA is tax-free investment growth (interest, dividends and capital gains) without any income reporting for tax purposes when you withdraw funds from your TFSA.

Contribution Room Grows Each Year

Introduced in 2009, Canada Revenue Agency (CRA) currently allows all Canadian residents 18 and older to contribute up to $5,000 per year on a cumulative basis. This means your allowable contribution room grows each year, if not used. (This annual cap is indexed to inflation and will adjust over time in $500 increments). CRA tells you how much room you have to contribute to your TFSA when they confirm your annual income tax payment (Notice of Assessment) or when you make enquires to “My Account” on the CRA website. It is important to make sure you don’t over contribute because there is a 1% penalty per month for over contributions.

Tax Free Withdrawal

Like a RESP or RRSP you can invest in a wide range of investment options. Many Canadians are using their TFSA to achieve short term savings goals and are holding low interest GIC type investments. A TFSA is most interesting as a long term savings vehicle with a goal of getting maximum long term growth. This is because while unlike an RRSP, you do not get a deduction for your contribution; you also do not have to recognize any income when you withdraw funds from your TFSA.  All money withdrawn from your RRSP is considered taxable income.

Benefit From Compound Growth

The power of compounding works magic in a TFSA, the higher your rate of growth and the longer the time held, the greater the benefit to you. At 6% compound growth, the value of your original investment doubles every 12 years rather than every 36 years, if you only get 2% from a GIC. If the 6% investment is left to compound for 25 years your original investment would represents less than ¼ of the value sitting in your TFSA.  That makes the tax free withdrawal look very interesting.

Flexible Savings Vehicle

When you take money out of your TFSA, unlike your RRSP, you can put the money back in to continue your tax free growth. However, you have to wait until January 1st of the following year to put the money in if you do not have any available contribution room.

Preferred Savings Option

For younger and older Canadians, the TFSA may be the preferred savings alternative to an RRSP. If you are young and your income is relatively low, the future tax-free withdrawal from your tax-sheltered TFSA will likely be much more valuable than the small tax deduction available from an RRSP contribution. For older Canadians, the ability to access funds without recognizing income and triggering claw-backs on government benefits such as Old Age Security can be very attractive.

If you are not taking full advantage of your TFSA you are missing a real opportunity to reduce your current and future income tax bill while building wealth and future planning flexibility.

To open a Tax-Free Savings Account, please contact us at Pelorus Wealth Management

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Use the Waterfall Wealth Transfer Concept to Benefit 3 Generations

How would you like to invest money on a tax sheltered basis that you could access if needed and also be able transfer wealth tax-free to your child and your grandchild when you decide? In other words, create something like a trust without having to worry about the rules and tax issues related to Trusts.

If this sounds interesting, then you should explore the benefits of the Cascading or Waterfall Wealth Transfer Concept. It uses permanent Whole Life or Universal Life Insurance to grow tax sheltered value that you could access (if funds are needed), but is intended to be transferred to your child and grandchild. The strategy takes advantage of Section 148(8) of the Canadian Income Tax Act which allows you to transfer ownership of a life insurance policy to any of your children or grandchildren on a tax free basis, provided they are the insured under the policy. A natural or adopted child, grandchild, step child, son-in-law and daughter-in-law all qualify.

To understand how this strategy works and its benefits, let’s look at an example. George’s daughter Susan has recently given birth to a new baby girl, Francine. George and his wife would like to do something special for their new grandchild. They expect her to eventually go to university, get married and have her own family. The family business has been good to them and they are beginning to think about estate planning and transferring some of their wealth to their children and grandchildren.

The Waterfall Wealth Concept was recently presented to George. He originally thought it was foolish to purchase insurance on the life of his new granddaughter. However, as he thought about it, there was merit in the idea of purchasing a universal life policy with a very low cost of insurance (his granddaughter had just turned 1) and building tax sheltered cash value that he could access if needed. Further, the business had been good to them and there would eventually be significant taxes and probate fees to be paid when he and his wife passed away. Here was an opportunity to tax- effectively set aside funds for the benefit of his daughter and new granddaughter that he could control until he decided to transfer ownership.

He thought about the benefits of being able to use the accumulated cash value in the life insurance policy to pay for Francine’s university or as a down payment on a new home. Both future options would be costly, but he felt confident the power of tax-sheltered compound growth within the life insurance policy could be a big help to his daughter when it came time to pay for Francine’s university education or provide a very significant contribution towards the purchase of a new home. Further Francine would have a meaningful amount of life insurance in place at a very affordable cost when she needed protection for her family.

Given his age, George was unsure whether he or his wife would be alive to see either event. He did not want to transfer the life insurance policy until his granddaughter was old enough to understand the value of the gift. To protect against the policy ending up in his estate and being subject to tax and probate fees, he decided he would make his daughter Susan (Francine’s mother), contingent owner of the policy. This would allow the policy to transfer outside the estate and directly to her tax-free. This would protect the policy until his granddaughter is old enough to take ownership.

He also decided he would make Francine’s Mom an irrevocable beneficiary to help ensure the accumulated Cash Value in the life insurance policy was only withdrawn for intended purposes after the life insurance policy is transferred to Francine. An irrevocable beneficiary must consent to any policy withdrawals before the insured can access any of the accumulated value.  This would give Susan the power to act like a trustee to help ensure George’s wishes for the use of the funds are realized. With Susan as irrevocable beneficiary, policy changes could only be made with her (beneficiary) and her daughter’s (owner) signatures.

If you would like to learn more about this or other creative solution to help achieve your personal financial or estate planning goals contact, one of our team members at Pelorus Transition Planning.

 

Michael Greenwood is principal and managing partner at Pelorus Transition Planning (www.thinkpelorus.ca) and has more than 20 years’ experience developing group benefits and wellness solutions for clients across a range of industries.

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