Those golden years are coming, and like it or not, the tax man is going to pay your estate one final visit after you die; but there’s no need to stress about your retirement or final tax bill. Just be proactive and prepare in advance. To help you with that, Spencer Bennett, financial advisor, Edwards Jones; and Angie Gurney, CFP, financial planner and insurance specialist, LSM Insurance & PPI Solutions, explain how to prepare today for peace of mind later.
First, Bennett explains that socking money into your registered retirement savings plan (RRSP) is a good thing, but you have to be aware of the all source maximum if you also have RRSP contributions at work. He notes it’s a good idea to max out your RRSP plan from work first to take advantage of any money matching offered by your employer. “We’ll try to grow your money, but we won’t match what you put in,” he chuckles. Often, work RRSPs will match up to a given percentage or dollar amount.
“When you contribute to your company RRSP plan or pension, it decreases how much you can contribute to your personal plan. Work plans are great, but depending on how it is structured and how much you contribute, they may not provide you with enough money to retire comfortably,” counsels Bennett.
Canadians can contribute the lesser of 18 per cent of their earned income from the previous year, or the maximum dollar limit established for the year to their RRSP. Earned income is not just what you make on the job. It includes salary, bonuses, alimony, rental and business income. Therefore, if you have several income streams and set aside a part of the profit from, for example, your rental property and your wages for RRSP contributions, and your employer is also contributing on your behalf, you have to be careful not to exceed your maximum limit. Your limit could also be further reduced by a pension adjustment or spousal contribution.
That being said, there is a little wiggle room. If you did not make the maximum contribution in the previous years, you can carry that contribution room forward. You also get a one-time $2,000 over-contribution limit that is not penalized with extra tax.
An RRSP is not the only long-term savings vehicle. The tax free savings account (TFSA) continues to evolve and help Canadians reach their financial goals.
“The tax free saving account (TFSA) was introduced in 2009. It started with just $5,000 contribution room and has increased since then. If you have never contributed to a TFSA, you may be eligible to contribute up to $46,500,” Bennett points out. “The advantage of a TFSA is the ability for tax-free growth. Any gains on stocks or mutual funds purchased within a TFSA are not taxable, whereas registered saving plan (RSP) contributions can reduce the taxes you pay, but are fully taxable at withdrawal. TFSAs and RRSPs both have advantages and disadvantages. I recommend talking to a financial advisor to see what makes the most sense for you and your retirement plans.”
Bennett notes that each person’s situation is unique, and that means their retirement goals, and how to reach them, should be unique, too. “Business owners and individuals should meet with a professional accountant and a financial advisor to make sure they are making decisions that are in their best interest – one who can get to know your needs and help you come up with a personalized strategy.”
Another way Canadians are long-range planning is by taking advantage of the cash surrender value (CSV) that builds up in permanent insurance policies.
There are two basic types of insurance: term and permanent. Term is used to address risks with a defined timeframe, such as a mortgage. Permanent insurance is used to mitigate risks associated with an unknown time frame, typically the unpredictability of death.
Permanent insurance is further broken down into two categories: whole life and universal life (UL). Both build up cash value that, as you will soon see, can be very beneficial during the policyholder’s life and after they pass away, but both have some very distinct differences.
“The biggest differences are the guarantees that whole life offers over UL,” Gurney explains, noting that “guaranteed cash values, reduced paid-up amounts and level coverage [can help create a] simple, solid plan for individuals needing a permanent solution for estate and tax planning.”
As a retirement tool, “UL is great choice for sophisticated individuals with a large net worth,” she continues; “if you have the ability to take on risk with investments and are looking for additional tax shelter, UL offers choices and allows individuals to choose a plan that works specifically for their individual needs. All types of insurance, from term to permanent plans, from investment portfolios to guaranteed market index funds to mutual funds, are designed to fit UL standards and have maximizers to take full advantage of tax deferred growth within the plan.”
Since CSV in a UL is calculated and available when the policy is surrendered, if the life insured is still alive, it can be used as a collateral for a loan. If the loan is not paid as promised, the policy can be surrendered by the owner to pay down the outstanding loan.
There is another reason to choose permanent insurance – it can help keep the value of an estate intact after death, if the investor has secondary real estate properties.
From a tax perspective, Canada Revenue Agency treats your secondary property (or properties) as though you disposed of them for fair market value in the year of your death. That means, while taxes are not due on your primary residence, they most certainly are due on that vacation home or cottage by the lake.
Capital gains of this nature are taxed at 50 per cent. If you bought a cottage for $250,000, and it is worth $350,000 in the year of your death, your gain is $100,000 and your tax on that is $50,000 (at your personal marginal tax rate). Let’s say you are in a 35 per cent tax bracket: you would need $17,500 to satisfy the tax requirement for the cottage upon your death.
With a whole life policy, CSV can be used to buy extra insurance that will be paid up in full with the guaranteed cash value (it’s called a paid up addition). When it comes to claim time, the death benefit of the UL policy will pay the face value plus what has accumulated in the account, and the whole life policy will pay the face value, which could include paid up additions. Both create the potential for a more generous death benefit that can leave money left over for beneficiaries after capital gains taxes are addressed.
Gurney summarizes the many ways permanent insurance helps individuals and business owners with their long-term financial planning. “Permanent plans are for individuals facing high tax bills at the time of death, philanthropists wanting to plan their donations after their passing, estate planning needs for disabled family members and trusts. Individuals who like to take care of their families, business and estate as well as have control over their wealth after they are gone find permanent life policies to be a great tool for cash-needed solutions without triggering a fire sale of their holdings.
“Whole life is a great option, and if chosen at a younger age, it costs pennies on a dollar.
Business owners, investors and wealthy individuals with a high percentage of non-liquid investments and real estate holdings love this option as they know that their estate will need quick cash at the time of their death. UL is great for utilizing permanent/temporary life insurance needs with tax deferred investment vehicles that can serve as both long and short term solutions and needs for sophisticated and wealthy individuals and business owners; and let’s not forget about using the CSV as collateral for loans, to fund retirement or for business needs without having taking cash out of the business, selling assets or triggering unnecessary taxes.”
Saving for the future, and the tax man’s final visit, is not as straightforward as putting your money under a mattress or in a savings account at the bank; but it is also far less complicated than you may think. The time you spend with a financial and insurance advisor today can make your tomorrow, and your hereafter, much more comfortable for everyone involved. The tools are there. You just need to pick them up and use them.