The Ins & Outs of Estate Preservation

Country Routes - November, 1997

This is the second of a two part series by an associate of mine, Brian Quinlan, who is an accountant specializing in estate matters. He has written some articles for various publications including one for the Financial Post magazine in January of this year titled, "Ten Ways to Beat The Taxman". He has given me permission to reprint them here in my monthly column along with the Canadian Moneysaver Magazine where they appeared earlier in the 1990's. I plan to be working with him more closely in the future in matters primarily concerned with Estate Planning. He is well versed in all matters pertaining to this area and I feel confident that his expertise is what I was looking for to help me deal in areas beyond my own expertise. His firm, Quinlan Quinlan, is located at 8 King Street in Toronto. Quinlan merged with Lawless in October 1996 under the Campbell Lawless banner.

RRSP/RRIF Meltdown - This idea comes from Ian Jarvis of Investors Group in Scarborough. Ian comments that a prime candidate is an individual with a large RRSP or RRIF who is concerned with a significant tax liability to be faced on death. Ian is quick to comment that the plan is not for everyone as there is investment risk involved.

Say the individual has a $200,000 RRSP/RRIF and a ten-year time horizon. For simplicity let's assume a constant interest rate of 10%. Ian recommends the following: Borrow $200,000 and invest it. As the purpose of the loan was investment, the interest on the loan is tax deductible. Withdraw $20,000 from your RRSP each year. (Some tax will be withheld on the withdrawal. This will be refunded when your return is filed.) Use the $20,000 from the RRSP withdrawal to pay the interest cost on the loan. The result: the yearly RRSP/RRIF withdrawals are tax free as they are offset by the interest expense deduction. It may appear that at the end of the ten years the RRSP/RRIF has been removed completely tax free.

However, this assumes no growth in the RRSP/RRIF during the meltdown period -- quite unrealistic. To counter this, the RRSP withdrawals are increased, which means your loan interest must be higher to offset the increased RRSP/RRIF withdrawal. In a recent situation Ian was involved in, the loan was 2 1/2 times the RRSP. Investing outside an RRSP removes the constraints to investing inside your RRSP. Full international investing is available. As well, you can take advantage of capital gains being taxed on only 75% of the gain and as well, when applicable, the dividend tax credit. In the end, you have a $200,000 (or greater) loan outstanding that can be paid off by liquidating the portfolio built up on the borrowed funds. What you have left is the after-tax growth of the portfolio from the original $200,000 (or greater) invested.

Ian points out the risk -- the portfolio funded by the loan must "really work for you". The return must be great enough to ensure the after-tax return on the portfolio is greater than the tax that would have been paid on the RRSP/RRIF on death.

Estate "freeze"

As your estate grows so does the tax liability. An estate plan must encompass a way to stop this growth accruing in your hands. This is accomplished by exchanging a "growth asset" for a "non-growth" asset. This will "freeze" the growth in your hands and the tax liability. The growth after the time of the freeze accrues to someone else -- your heir(s). As the growth is frozen so is the tax liability. This liability can then be estimated and steps taken to plan for it. Often life insurance will be purchased. On death the insurance proceeds are used to pay the tax liability -- the estate remains intact.

A portfolio of growth investments can be transferred to a corporation on a tax-free basis. In return you receive preferred shares of the corporation. The preferred shares are non-growth and can provide you with the flexibility to receive periodic dividends, to have the shares redeemed and for you to continue to control the investment decisions. Your heirs, perhaps your children, would subscribe for the common shares (or the "growth shares") for a nominal amount, say $100. The future growth of the investment portfolio will accrue to the common shares and will be taxed in your heir's hands when they sell or are deemed to sell the shares on their death.

U.S. Assets

In designing an estate plan, U.S. assets cannot be forgotten. Many are under the impression that recent changes to the U.S./Canada Tax Treaty have made U.S. estate taxes a moot point. While the changes to U.S. estate taxes are welcome to all Canadians, the taxes cannot be ignored. The changes are favourable and will never result in a tax-payer being in a worse tax position than previously. The new rules have different impacts on different taxpayers. For example, U.S. estates of less than US$1,200,000 will not have a U.S. estate tax if the estate is made up of U.S. securities. However, ownership of U.S. real estate remains subject to tax. Taxpayers with U.S. non-real estate greater than US$1,200,000 and owners of U.S. real estate must still consider the alternatives to reduce their U.S. estate tax exposure.

Your Will

This is one of the last steps in an estate plan. After you have decided on your estate's objectives and design and have begun to enact a plan, your will needs to be prepared (or amended). Like all financial planning, estate planning is continuous and needs periodic revisions and changes, as does your will.

If you have any questions, please call Reg Borrow at (519) 855-6639. He is an Independent Financial Consultant with Regal Capital Planners Ltd.

Money Matters Index                                 Home Page

Created: Mon Sep 23 10:30:50 1996
Web Page designed and created by Champ Consulting Services, Georgetown, Ontario