My son, Winston, is now five, and like many young boys he loves nothing more than to wrestle, tackle, body check, and use other forms of bodily contact on all manner of victims. His sister, my daughter, Sarah, is usually the target of choice.
Now, Winston has been taking tai kwon do. The other day, he came home from his lesson, still full of energy, and started punching his favourite target -- Sarah. I immediately stepped in: "Winston, you can't practice your tai kwon do punches on Sarah. If you do it again, you won't be going to your next lesson."
"But dad," Winston justified, "that wasn't my tai kwon do punch. It was a regular punch."
Good answer, I thought to myself. He's thinking outside the box. That type of thinking could take him far. When it comes to your registered retirement savings plan, are you thinking outside the box? This type of thinking could save you thousands in tax dollars.
Don and Denise were a married couple, and Denise died this past summer. At the time of her death, she owned an RRSP worth $350,000, and some investments outside her registered plan worth $250,000, for assets totalling $600,000. By the way, the $250,000 portfolio had an adjusted cost base of $400,000, so there were unrealized capital losses of $150,000 in her portfolio -- a common problem today. Finally, Denise had very little income in her year of death.
Denise did what many Canadians have done: She named her spouse as the beneficiary of her RRSP, and also left the non-registered investments to him upon her death. Let's take a look at the results of this.
Since Don is the beneficiary of Denise's RRSP, those assets transfer to an RRSP or registered retirement income fund for Don, with no tax to Denise in her year of death. Likewise, the non-registered investments were left to Don, so Denise is deemed to have sold those investments at her cost. Don effectively inherits Denise's adjusted cost base.
After all is said and done, Don has simply stepped into Denise's shoes from a tax perspective. Don owns the $600,000 of assets inherited from Denise, but $350,000 of it is stuck in an RRSP where any withdrawal will be fully taxable. Further, he now owns the $250,000 non-registered portfolio with an adjusted cost base of $400,000, so he'll have to somehow generate capital gains in the future in order to use up the $150,000 in losses he inherited. (Capital losses can generally be applied only against capital gains.)
Is there something different that Denise could have done to leave Don better off after her death? Sure there is.
The better plan
With a little advance planning, Denise could have left Don with the same $600,000 in assets, but with $200,000 in an RRSP, and $400,000 in non-registered investments with an adjusted cost base of $400,000. He would've been better off since there would've been less money trapped in the RRSP subject to high taxes upon withdrawal, and he wouldn't have to worry about using up the capital losses since they'd be fully used up already.
How could this have been done? Simple. Denise could have named her estate, not Don, as the beneficiary of her RRSP. That's it.
Here's how it works: If Denise's estate were named beneficiary of her RRSP, it would've been possible to trigger some income in her hands in the year of death by causing some of her RRSP to be taxable to her, which we could have then offset with the capital losses from her non-registered investments. You see, Canadian tax law will allow you to apply your capital losses against any type of income in your year of death, not just against capital gains, with some exceptions.
In this case, Denise's executor could have elected to transfer just a portion, say $200,000, of her RRSP to an RRSP for Don tax-free, leaving the $150,000 balance of the RRSP in the estate to face tax in her hands in her year of death. The executor could have then elected to transfer the non-registered investments to Don at fair market value rather than cost, triggering the $150,000 in capital losses to offset the taxable portion of the RRSP. (Note: In the case of a RRIF, your executor cannot elect to transfer just a portion of the plan to your surviving spouse; it's all or nothing.)
The result? Don inherits $200,000 of RRSP assets with the rest, or $400,000, outside an RRSP with a cost base of $400,000.
Naming your estate as beneficiary of your RRSP can make sense where you have capital losses and expect to have insufficient income in your year of death to use up those losses.
Tim Cestnick, FCA, CFP, TEP is author of The Tax Freedom Zone and Winning the Tax Game 2003. He is managing director, National Tax Services, at AIC Ltd.
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