In our most recent post, we told you about a client who had approached us regarding the purchase of a second property. They were wondering whether it would be better to borrow the funds to purchase the property or liquidate some of their investments to cover the costs. We provided them with projections that showed that, over the long-term, their net worth would be greater if they borrowed the funds. While this answered the client's immediate question, the planning process also uncovered a few other items for the client to consider. This post will take a deeper look at one of those items, as well as how the client can address this issue.

Estate Liability

We will start by taking a look at some revised projections for the client that assume a lower annual income requirement going forward. This client has several different account types, including a RRSP (Registered Retirement Savings Plan), TFSA (Tax Free Savings Account) and both personal and corporate non-registered investment accounts. Over time, these accounts will grow, particularly the corporate and RRSP accounts.

While it is always nice to see investment assets growing over the long term, they can represent a significant estate liability when the owner passes away. Assets held in a RRSP or RRIF (Registered Retirement Income Fund) are considered to have been disposed of at the time of death. This means that the full remaining value of the RRSP or RRIF is counted as income on the owner's final tax return. This can result in a large tax bill for the estate while reducing the amount that is available to the estate's beneficiaries.

Managing the Taxes

There are a few options that are available to offset this liability. First, in consultation with an accountant, the holder of a RRSP or RRIF can make the decision to draw down on their account over time. The idea here would be that by adding a small amount to the withdrawals over and above the minimum requirement each year, there would be a significantly lower balance to be counted as income at the time of death. This strategy can work over the long-term, but it does have its drawbacks. If the owner of the account were to pass away sooner than expected, there may still be a significant tax liability. Similarly, by taking larger amounts in any given year, the owner is adding to their taxable income each year. This is why it is advisable to consult with an accountant prior to making any such changes.

Another option is to use insurance to offset the expected liability. Life insurance pays out a tax-free lump sum to the beneficiaries of the policy at the time of the insured's death. This can offset the taxes owing on the registered assets and ensure that the beneficiaries of the estate aren't disadvantaged. This is probably the best way to reduce estate tax liabilities as the amount of insurance can be targeted to a specific outcome. The owner of the policy can decide exactly how much of their expected estate taxes they would like to offset and implement their insurance strategy accordingly.

Registered accounts are just one area where an estate can be impacted by unexpected taxes. Second properties (like cottages or other vacation homes) and capital gains on investments can also add to your final tax bill. If you would be interested in learning more about strategies to offset estate tax liabilities or would like to take a broader look at your financial plan, please do not hesitate to contact any one of us for further discussion. Our next post will examine another interesting aspect of our case study, the client's corporate holdings and their plans to transition these to the next generation.