Have a plan for inheritance

So you have just received an after the death of a loved one.  What happens now?  Although it may be a difficult time, it is also a critical period to get some professional advice.  One positive part of receiving an inheritance is the money is tax-free.  Following are some topics we would discuss when a client receives an inheritance.

Paying off Debt

We like the idea of paying off debt, especially personal mortgages, credit cards, and lines of credit that are not tax deductible.  To begin with, we obtain a summary of all loans, current rates, and repayment penalties, if any.   If only some debt is repaid, then the highest non-deductible interest rate debt should be paid off first.  If fees or penalties apply, it is important to obtain an understanding of these and your advisor should be able to map out the best options.  If you still would like to invest some, or all, of your cash then you’re best to take a new loan out for the specific purpose of investing.  The first step of paying off non-deductible debt first, will ensure that you are able to deduct the interest costs on the new investment loan (if the investments are non-registered).

Increased Income

One of the results of receiving an inheritance is that your annual taxable income is likely to increase.  If you purchase GICs and bonds, you will have to factor in the interest income received.  If you purchase equities, you will have tax efficient dividend income to report and some deferral options.  We provide an estimate of what the income will be once the investments are selected and calculate an estimated income tax liability if the funds are invested in a non-registered account.

Type of Non-Registered Account

If you feel a non-registered account is your best option you should determine the type of account.  If you are single the choice is easy; an individual account.  If you are married or in a common-law relationship, you have a couple of choices.  One is to open an individual account and keep the funds only in your name.  Another is to open a joint-with-right-of-survivorship (JTWROS) account.  This discussion has many components including tax, income splitting, estate wishes, and result of marriage breakdown.

Topping Up RRSPs

One way to defer some of the above income is to deposit funds into a tax sheltered Registered Retirement Savings Plan (RRSP), if contribution room exists.    The greater your income, the better this option is.  If your income is below $40,000 then it is borderline whether this is the best option.  The determining factor is your future income expectations.  As an example.  John received $250,000 as an inheritance.  He is using $150,000 to pay off all debt and would like to invest the remaining $100,000.  John has accumulated a $140,000 RRSP deduction limit, as he has never contributed the maximum each year.    John plans to work for the next five years and earns approximately $80,000 in T4 income.  We recommended that John contribute the $100,000 into his RRSP and claim $20,000 a year as a deduction over the next five years.  One of the main benefits of putting funds in the RRSP (and not claiming the full deduction right away) is that all income is tax sheltered.

Tax Free Savings Account

If you have never set up a Tax Free Savings Account then we would recommend that you take advantage of this type of account and top up to the maximum limit.  If you have opened up a non-registered account and TFSA then we would recommend you transfer the maximum annually (currently $5,000) from the non-registered account into the TFSA to minimize tax.

Structure of Accounts

Many Canadians only have RRSP or TFSA accounts.  Often when significant funds are received (inheritance, sell of a business, life insurance proceeds), people open their first non-registered account.  Unfortunately, one error we see the most is people buying GICs and bonds in a non-registered account while leaving the equity investments within their RRSP.  When this happens, the structure of investments is backwards.   There are many benefits of consolidating investments at one institution, including lower fees and more account options.  It is beneficial to deposit the inheritance cash into a non-registered account at the same institution as the RRSP.  If this is done then the structure can be corrected.  We are able to move cash from the non-registered into your RRSP and move the equivalent value of equity investments out of your RRSP into the non-registered account – this is often referred to as a swap.  A simple swap will ensure that interest income on GICs, term deposits, bonds and other fixed income are tax sheltered within the RRSP.  By holding equities in the non-registered account, you will receive the benefit of the dividend tax credit, and taxation of capital gains and losses.

Updated Documents

Obtain the appropriate forms to update your investment accounts, and update your will, especially if the choice of account  is an individual non-registered account.