Every once in a while an opportunity comes up with a client and they say, "I had no idea about that."
Here are three areas that can make a big difference for the right individual.
1) Make a disabled child or a grandchild the beneficiary of your RSP or RIF
In Canada, the biggest tax bill usually comes when the second spouse passes away, if there is still a large balance in a RIF. As an example, in Ontario, if the RIF is worth $300,000 when the second spouse dies, the tax bill might be over $120,000.
This tax bill can be avoided if the person could instead make the beneficiary a disabled child or grandchild. The Canada Revenue Agency (CRA) has made special allowances to let the RSP or RIF to roll to the disabled child or grandchild tax free. The ideal scenario is to have the RSP or RIF roll over to the Registered Disability Plan of the child or grandchild. This will still ensure that they qualify for government disability benefits. This doesn't have to be for the full RSP or RIF, but can be done for a portion.
To learn more about this, and some of the restrictions and rules, check out the CRA's website.
2) Pay insurance costs out of a corporation
If someone has a corporation and can legitimately put expenses through the company, it makes sense to do so. After all, the expenses are paid with 'pre-tax' dollars as opposed to how we pay most of our expenses, with 'after-tax' dollars.
When it comes to personal insurance, you would assume that this would be paid for with after-tax dollars, as the beneficiary might be your spouse or children. This is true, however, in many cases you can instead fund the insurance through your corporation, possibly saving as much as 30 per cent on every dollar if we assume the highest tax rate (in Ontario) minus the small business corporate tax rate.
The way to set it up would be to have the corporation pay for the insurance and be the beneficiary of the insurance.
Because of a unique feature of tax rules, when an insurance policy pays out to a corporation, for every dollar of death benefit that is paid out, it credits a dollar to the Capital Dividend Account or CDA – less the adjusted cost base of the insurance. This CDA allows you to withdraw a dollar from the company tax free for every dollar in the CDA. As a result, if the company receives a $500,000 insurance payout, it will also add up to $500,000 to the CDA. As the owner of the company, you can choose to withdraw the funds almost tax free because of the CDA. The net result is that you have reduced your insurance costs by up to 30 per cent.
3) Make strategic withdrawals from your RSP
I often hear that you shouldn't take money out of your RSP unless you are forced to because you pay tax on withdrawals.
While it is true that withdrawals are taxable, there are years when you should take out money from your RSP even if you don't need it. Here are a couple of examples:
a) A stay-at-home mother has $100,000 in her RSP. She is now at home raising the kids and has no taxable income. She should withdraw anywhere from $10,000 to $20,000 from her RSP. Including the loss of some spousal tax credits, the tax bill will be roughly 21 per cent on the withdrawal. Those same dollars could then be used for her husband's RSP contributions, for RESP contributions, for TFSA contributions, etc.
In the RSP contribution example, if the husband is in the top tax bracket, the family would get a 46-per-cent refund on the contributions. Let's say $20,000 is withdrawn and the tax bill is $4,200. Then the $15,800 is contributed to the husband's RSP. The tax refund is $7,268. If this is then put back into the husband's RSP the next year, the net family RSP balance will have grown by over $3,000, plus the husband will get another $3,300 refund from the $7,268 contribution the following year.
b) A 62-year-old man has retired with no pension. His wife is still working. He has a $600,000 RSP. If the RSP is still large when they both pass away, it will mean that the RSP assets were never enjoyed by the couple and will be taxed at the top tax rate.
The 62-year-old man not only wants to be able to enjoy his retirement, but wants to receive his full Old Age Security.
As a result, he draws $30,000 from his RSP even though he doesn't technically need the cash – but they will also be able to do some extra things with the money while they still have the health to enjoy it. He will pay about 21-per-cent tax on the withdrawal (including lost tax credits). However, if he can do this every year, he will be well under the Old Age Security (OAS) minimum not just at 65, but also likely once he is forced to take the minimum from his RIF at age 71.
If he decided not to take the RSP assets now, he will put off the 21-per-cent tax payment, and benefit from more sheltering, but he will likely lose tens of thousands of dollars of OAS benefits over his lifetime, will have more income in his late 70s and 80s when he might not be in a position to enjoy it, and be more likely to have a large RIF balance at the death of the second spouse.
While you may not be able to take advantage of these ideas, you likely know of someone who could and isn't aware of the opportunity. Be a friend – pass it along.
Ted Rechtshaffen is president and CEO of TriDelta Financial Partners, a firm that provides independent financial planning advice. He has an MBA from the Schulich School of Business and is a certified financial planner. He was vice-president of business strategy at a major Canadian brokerage firm.
Follow Ted on his blog at The Canadian Financial Planner.
Ted Rechtshaffen