Category Personal Finance/ Estate Planning

Put Trust into Your Financial Plans

Regardless of your age, you should be planning financial goals. One of the most efficient ways is through trusts that can help save tax dollars and provide for your heirs.

Here are just some of the ways trusts can be used to maximize your wealth:

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Words of Caution

The CRA has said it launched a special project to audit domestic “inter vivos” trusts to ensure they are set up and managed according to the relevant legislation.

Among the potential targets:

  • Promissory note: Has one been issued to the beneficiaries and it is enforceable?
  • Trustee withdrawals: If trustees have withdrawn money for personal use the CRA could challenge the deduction taken or asses a taxable benefit to the trustees.
  • Twenty-One year rule: The CRA may check to see if the trust has paid the required taxes on accrued capital gains every 21 years..
  • Proper records: The agency may check to see if all the proper accounting records have been kept, minutes taken and that the original settlement property can be produced.

Failure to be in compliance with all the necessary trust and income tax rules might result in tax liabilities, penalties and interest. The worst-case scenario would be for the CRA to determine the trust never existed, in which case all benefit and growth would accrue to the original shareholder.

Support for Your Spouse

You can set up a trust (as provided by your will) to supply a source of income for your spouse and defer taxes. Property transferred to a spousal trust on death does not trigger capital gains taxes until the trust sells the property or the beneficiary spouse dies. Assets transferred to trusts are deemed to be disposed of at their fair market price, which can create tax liabilities.

A spousal trust is a good choice when: a spouse lacks financial expertise; requires long-term care; or you wish to ensure that children are beneficiaries of your estate on the death of your spouse.

Transfer Assets to Children

Assets transferred to a trust for children can still be subject to tax in the hands of the parent transferor, if that parent can control the ultimate disposition of the assets during their life time. This is why inter vivos trusts are usually created by grandparents, with an adult child as trustee and using an asset that is not subject to attribution.

That way, the adult child can continue to control the assets, a strategy often used as part of an estate freeze – a way of freezing the tax liability on assets. You will have to pay capital gains tax on any increase in the assets’ value to the time of transfer (or freeze), but the remaining taxes on any further increase in value are deferred until the trust sells the assets.

Keep in mind that living trusts have a deemed 21-year life span after which accrued gains in the trust are taxed.

Also, remember that depending on how the property is acquired and the nature of the income earned by the children’s trust, income attribution or “kiddie” taxes may apply if minor children or grandchildren are beneficiaries.

Manage Inheritances

If you are concerned that a child or grandchild won’t be able to handle an inheritance wisely until a certain age, a trustee can professionally manage the money until the beneficiary reaches a specified age.

Care for Children

A trust can ensure that minor children are cared for after your death. If you have children with disabilities, a trust can provide the income for their needs. If you have adult children, setting up a trust to take care of their financial needs can cut taxes. The child is responsible for taxes on trust income that is paid out, possibly at a lower rate.

Trusts have many other uses and can be complicated. So contact your accountant to discuss the ways you can effectively maximize your wealth by creating trusts.

Dealing with a Layoff or Forced Retirement

lores_hr_cost_cutting_fired_terminated_envelope_job_employment_words_amIt doesn’t matter whether you’re employed in the private or public sector – companies and government agencies equally struggle to boos the bottom line and stay within tight budget constraints.

Those efforts can sometimes result in downsizing. With little notice in many cases, employees are presented with severance packages or incentives to retire early.

If that unfortunate scenario occurs, you may not be in the state of mind, or have sufficient knowledge, to properly evaluate the offer. Downsizing packages often involve decisions that go beyond severance pay, including benefit replacement and pension considerations. A qualified financial planner can help you assess the package and consider the following issues:

Family finances. Income uncertainty can be a challenge, especially if you’re facing post-secondary education costs for children and other major ongoing expenses, such as a mortgage. The impact on your spouse, especially if he or she is still working, should also be addressed.

Tax planning. Your package may include a significant lump sum, which means you need a strategy to minimize taxes. For example, you might review your RRSP contribution limits and consider using the “retiring allowance” to defer much of the income tax as possible. Or some of the money could be applied to your spouse’s RRSP. In some cases, an employer may agree to make payments over two years. Proper planning in this area is essential, as some of these tax-planning opportunities are only available during the year of severance.

Spending habits. Compile a budget to track monthly expenses. A budget also helps you make changes to your spending patterns. You may decide to impose some restrictions and consolidate debts to reduce interest costs.

Pension choices. This can be one of the most critical financial choices. You should fully understand pension options, because the decision is permanent. If you plan to draw on your pension, determine whether a single or joint life pension is needed, as well as whether you want a guarantee on future income.

If you’re not at pension age yet, you may elect to have a deferred pension or take a “commuted value” out of the plan to rollover to your own locked-in RRSP.

Group benefit replacement. Determine if any employee benefits will continue. You may have to add to your budget premiums for health, dental, life and critical illness insurance to replace lost benefits. An assessment of whether to “self-insure” some of the costs or pay premiums to an insurance company to cover the potential risk needs to be completed. You may be able to apply to become a dependant under your spouse’s group insurance plan. Some coverage, such as disability insurance, will be discontinued because you’re no longer employed.

Income and asset review. By calculating your assets and potential sources of income, you can determine any shortfall in your budget. Income from your spouse or partner may help defray expenses. Consider all assets and sources, such as RRSPs, savings, and Canada Pension and Old Age Security. Review investments. Your risk tolerance has probably changed as a result of your unemployed status.

By using the services of a qualified financial professional, you can get the most out of your severance or early retirement package. Call our firm for help developing a realistic plan that reflects your personal situation and allows you to get on with life.

Don’t Gamble With Your Retirement

The consensus is, as increasing numbers of baby boomers start to retire, nearly 30 per cent of modest-income and middle-income earners are not saving enough to be able to replace the recommended 90 per cent of pre-retirement expenses once they stop working.

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Risks to Consider

While you discuss your plans with your accountant, be certain you take into account these risk factors:

  • Inflation: Price rises over the long term pose a serious threat to your retirement income stream. The gradual gains in the cost of living erode your purchasing power. Structure your investment portfolio to keep pace with inflation.
  • Healthcare: Canadians are living much longer than before because of advances in prescription drugs, awareness of healthy lifestyles and improved healthcare. While it’s great that we can enjoy life longer, for many retirees, this may mean outliving their savings.
  • Rates of return: When you build your investment portfolio, you and your adviser generally use average rates of return. Be certain they are realistic. You may be counting on an eight per cent return but average out to just five per cent.
  • Taxes: It may be difficult to get your head around this concept, but it is possible that you can put too much money into your RRSP. Registered plans and funds, when combined with government or company pensions, life annuities, rental income, and part-time business income, can leave you with a hefty, and unnecessarily high, tax bill. If retirement income sources bump you up into the top tax bracket, each dollar you withdraw from your RRSP may be slashed by as much as 50 per cent after taxes.

In fact, a lot of Canadians simply admit that they are doing a poor job at building savings.

That doesn’t mean that Canadians are going to live in retirement poverty. Not at all. According to the Organization for Economic Cooperation and Development, Canada has the second lowest poverty rate for senior citizens after the Netherlands.

The problem, instead, is that many retirees won’t be able to maintain their current lifestyles after they stop working. They may not be able to spend as much going to restaurants, taking vacations or driving the same class of car.

If you are in your late 40s, early 50s or even older, and feel you are not putting enough aside for a comfortable retirement, you still have time to speed up your savings and build a substantial safety net for the years after you stop working.

First, calculate your total savings and the precise amount you will need for retirement, taking into account the potential risks outlined in the right-hand box. Knowing how short you are from your needs can help motivate you to change your savings behavior. Then consider and discuss with your accountant, these tips and how they might fit into your retirement-planning strategy:

1. Utilize your peak earning years to substantially boost savings. Typically, the final years of employments are peak income years. Rather than enhancing your lifestyle with each pay increase, put pay raises into savings vehicles. Look for ways to downgrade your lifestyle without crimping it, add the savings to your retirement fund. Making this change now also means you are likely to be more satisfied with a lower lifestyle when you stop working.

2. Consider asking your non-working spouse to take a job. If your children are out of the house or don’t require much supervision, it may make sense for your spouse to work and put all the earnings toward retirement. Alternatively, or in addition, you might want to take on a second, part-time job or start a business for additional income.

3. Sell your house. If you can sell your current home and get by in a smaller dwelling, you can reduce living expenses and put the difference in savings.

If you are like many Canadians, the bulk of your retirement income may come from withdrawals from Registered Retirement Savings Plans (RRSPs) or Tax-Free Savings Accounts (TFSAs), or both. Ask your accountant how you can make the most of these plans.

One advantage of the TFSA is that the more you put into one the more money you can live off of tax-free during retirement.

Consider that you may actually be at the same or a higher marginal tax rate after you retire (see right-hand box about risks). If you are likely to bump up into a higher bracket, ask your accountant if it would be reasonable for you to delay RRSP contributions and make the most of a TFSA.

For middle-aged individuals, a combination of the two accounts might benefit you. The current low limit on TFSA contributions won’t let you accumulate enough for retirement, but it does offer more planning flexibility in estate and retirement income planning.

In any event, consider contributing the maximum to both types of tax-advantaged accounts. If your employer offers group plans, take advantage of them and the company’s matching contributions.

The following chart compares the features of TFSAs and RRSPs and can help guide your discussion with your accountant and your ultimate decision:

TFSA RRSP
No need for earned income to build contribution room Earned income is needed to be able to contribute
Annual contribution limit for 2017 is $5,500 Contribution limit is 18 per cent of previous year’s earned income or the limit set by Ottawa, whichever is lower
You need not contribute every year but can accumulate room You need not contribute every year but can accumulate room
Withdrawals, including investment gains or interest, are tax-free Withdrawals, including deposits and investment earnings or interest are taxable
Contributions are not tax-deductible Contributions are deductible and provide a refund at your marginal tax rate
Withdrawals are added to the next year’s contribution limit Early withdrawals are not added to the contribution limit and are taxed heavily
Need not be converted to a Registered Retirement Income Fund (RRIF) Must be converted to an RRIF at age 71, and minimum annual withdrawals are required
Withdrawals are not used to calculate OAS clawback RRSP and RRIF withdrawals are income used in calculating the OAS clawback

Need to Increase Your Retirement Cash Flow?

lores_mortgage_options_types_rates_lengths_terms_mbRetired people sometimes find themselves in a cash bind, but there might be a solution for homeowners in the form of a reverse mortgage. You’ve probably seen ads on television or in magazines about this type of mortgage and wondered if it could work for you. Reverse mortgages can be a useful tool for seniors who have built up equity in their home and are looking to supplement their cash flow in retirement but they are not for everyone.

What Is a Reverse Mortgage?

A reverse mortgage is a loan secured by a home, like any other mortgage. Unlike a regular mortgage, no re-payment of the loan is required until the home is sold, the last surviving spouse dies, or the owner moves out.

Additional Requirements:

  • You must be at least 62 years of age.
  • The home must be your principal residence.
  • Any existing mortgage must be paid off by the proceeds of the reverse mortgage.

Why Is It Called a “Reverse” Mortgage?

A regular mortgage balance decreases over time as payments are made, until finally it is paid off. In a reverse mortgage, the balance increases over time due to interest charges. This is the reverse of a regular mortgage.

How it works: Depending on your age, marital status, and the property, you can unlock as much as 40 per cent of the appraised value of your home. (See right-hand box for additional requirements.)

Let’s say you’ve paid off – or nearly paid off – a conventional mortgage and the home is valued at $300,000. You could wind up with a tax-free $120,000 cash advance. You can take the money in a lump sum or in instalments over the time you remain in the home.

Payments aren’t due until the home is sold or the surviving spouse dies, although you can opt to pay the mortgage earlier. The lender makes its money by recovering the principal and interest when the home is eventually sold.

On the face of it, these mortgages appear to be a good deal for several reasons:

  • The money received is not taxable.
  • The cash advance doesn’t affect government benefits programs such as Old Age Security and the Guaranteed Annual Supplement.
  • Payments are deferred as long as you remain in the house.
  • The mortgage will never exceed the fair market value when the house is eventually sold.
  • You can use the money any way you want (in fact, you can use the money to buy an annuity or purchase life insurance to pay off the reverse mortgage, which means you can still leave the home free of debt to your heirs).
  • You can still sell the house if that becomes necessary, although there may be an early repayment penalty.
  • If you choose to pay the mortgage interest annually, the payment may be tax deductible if the borrowed money is invested.

However, before deciding a reverse mortgage is the tool for you, there are some disadvantages to consider:

  • Interest rates are as much as two percentage points higher than on a conventional mortgage. For example, if conventional mortgage rates are five per cent, a reverse mortgage could cost you seven per cent. The rates are set annually and based on the rate for one-year Government of Canada bonds.
  • Interest continues to accumulate, so in theory the loan, plus interest, could eventually exceed the value of your home. If you sell the house, proceeds will be used to repay the debt and you would have nothing left.
  • Set-up, appraisal and legal fees can run from about $1,800 to as much as $2,300.
  • You cannot move to another home and keep the loan, which means you can’t rent out the place and still keep the reverse mortgage cash advance.

Proceed with Caution: If you think a reverse mortgage might work for you, consult with your accountant first. Generally, a reverse mortgage is a last resort alternative for homeowners.

Life Insurance Policies as Investments

lores_insurance_policy_director_officer_board_mbUniversal life insurance and whole life insurance can be an attractive investment tool in the right circumstances.

Technically, the policies are life insurance policies, not investments, and the returns are generally slightly lower than mutual funds, but they have four significant advantages:

  • Proceeds are life insurance and thus not taxable.
  • The policy can specify a beneficiary and thus avoid probate fees.
  • The value of the investment grows tax free.
  • The policy is “creditor proof” because it isn’t subject to seizure by courts as other investments would be.

By paying more than the minimum premium, policy owners build up a surplus that can be put into various investments the insurance company holds on their behalf. The value of those investments is added to the face value of the policy when the insured person dies. That provides a tax-free payment of life insurance proceeds to the beneficiaries.

Since the life insurance company — not the policyholder — holds the investments the growth is not taxed the way other investments would be. This tax sheltering is similar to an RRSP, with the advantage that when the policy is eventually paid out on the death of the policyholder, there will be no tax on the proceeds.

You may also borrow money from the surplus in the policy at a low interest rate. This would allow you to finance your retirement from that surplus with tax-free money because the funds are in the form of a loan rather than income.

The loan is automatically paid off at death, reducing the insurance proceeds by the amount of the loan.

While the return on investment isn’t generally considered stellar compared to other investments because of the life insurance premiums that must be paid, these policies can be an attractive option if you need life insurance for estate planning purposes.

The actual life insurance cost (called the Cost of Pure Insurance) is very similar to term life insurance, and the policies offer the ability to accumulate a surplus that is invested to your advantage as the face value of the policies increase.

The underlying investments available in a life insurance policy have greatly increased over the past few years. Virtually any mutual fund is available through one carrier or another, along with annuities and GICs.

Talk to your financial advisor regarding these products if you think that you might benefit from universal life or whole life insurance.

Universal vs. Whole Life Plans

When discussing investments in universal or whole life insurance plans with your professional adviser, it’s important to know how the two plans differ.

Both contain four elements:

  • Mortality Cost: The part of the deposit that covers the pure cost of the life insurance death benefit.
  • Administration charge: This is the charge for administering the policy and premium tax.
  • Savings or Investment: The amount remaining after the above two charges are deducted. You will be provided with an illustration of how your savings will grow, often called the Cash Value, Fund Value, or Cash Surrender Value of your policy.
  • Return on the savings: This is the interest rate that is credited annually to the cash value in your account.

In addition, some policies guarantee that the costs will not change and guarantee a minimum return on investments.

Whole Life Insurance

These policies have a level cost that does not increase each year. Your first payment will be the same as your last payment. However, whole life policies disclose neither the mortality nor the administration costs.

Once those two costs are covered, the balance of the premium is the savings or investment portion. The returns depend on excess interest and investment earnings, savings in mortality costs, the operating expenses and the insurer’s board decision on what to pay.

Whole life policies also don’t disclose how they calculate returns on your savings portion and you cannot choose where the money is invested.

Universal Life Insurance

These disclose both the mortality charges and the administration charges, which are often guaranteed not to change for the life of the policy. These policies, in their newer forms, also offer a list of investment options that are similar in some ways to mutual funds. Some are even designed to reflect well-known funds and are even managed by mutual fund managers.