Inheritance enhances retirement and estate plan

Over the years we have helped new clients and existing clients deal with inheritances. In the majority of cases the inheritances are coming from parents. These can be done upon the parent’s passing away but are also done while they are alive in more and more cases. In other cases we have clients receiving inheritances from uncles/aunts, siblings, friends, and other individuals.

The greater the inheritance the more critical it is to get some professional advice. One positive part of receiving an inheritance in Canada is the money is not taxed. 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 wealth adviser 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 interest expense incurred from the money borrowed is generally tax deductible if the purpose of the use of the borrowed funds is to earn income in non-registered accounts.

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 may consider to open an individual account and keep the funds only in your name. Alternatively, you may open a joint-with-right-of-survivorship (JTWROS) account with your spouse or common-law partner.

The person who received the inheritance would be primary on the account. If a non-registered account is already opened then we have a discussion regarding the risk of commingling funds in the event of a marriage breakdown.

This discussion has many other components to talk about including tax, income splitting, and estate wishes. Consulting a family law attorney may be required in cases of marital breakdowns.

Topping up RRSPs

One way to defer some of the above income is to deposit funds into a tax sheltered Registered Retirement Savings Plan, if contribution room exists.

The greater your income, the better this option is. If your income is at or below the lowest tax bracket then there may be other options you would want to consider.

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.

One option we may suggest to John is to contribute the $100,000 into his RRSP and claim $20,000 a year as a deduction over the next five years assuming that there is no extra cash flow for additional contributions. 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

Any income earned within the TFSA is tax free, if you have never set up a TFSA, the cumulated TFSA contribution limit for 2019 is $63,500. It may be worthwhile to understand the advantage of this type of account and top up to the maximum limit. Starting in 2019, the annual limit is $6,000, indexed to inflation thereafter.

If you have both non-registered account and TFSA, then we would recommend you to transfer your assets (up to the maximum limit) from the non-registered account into the TFSA, to take advantage of the tax-free feature.

Skipping a generation

Sometimes the people receiving the inheritance do not need the funds themselves. In these situations we often map out a strategy that will skip to the next generation. Sometimes this will help younger generations pay off mortgages, purchase a home, or build up retirement savings

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.

One thing that we see is people buying GICs and bonds where the interest income is fully taxable in a non-registered account while leaving the equity investments which have tax-efficient dividend income 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 do a series of trades that will correct the overall structure will ensure that interest income on fixed income is tax sheltered within the RRSP. By holding Canadian 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, Powers of Attorney, beneficiaries and ownership. We always encourage people to update their Will and other legal documents (if necessary).

Kevin Greenard CPA CA FMA CFP CIM is a Portfolio Manager and Director, Wealth Management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week in the Times Colonist. Call 250-389-2138.