Believe it or not I’m an optimist – but sometimes it’s good to look at the dark side to figure out how not to end up in a bad place! This month I’m going to talk about the many ways I see people destroying their wealth.
- Accumulating too much in your RRSP/RRIF
It sounds wrong, but one of the biggest tax traps in Canada lies in wait for those who are too good at saving. Due to quirks of the income tax rules, having too much money in your registered retirement income fund (RRIF) or registered retirement savings plan (RRSP) in your later years can come back to haunt you. Most commonly, chronic savers end up with their estate in the highest tax bracket in Ontario (53.5%) because every dollar in your RRIF or RRSP is counted in your income in your year of death. While you can roll your RRSP or RRIF to your spouse tax-free if they survive you, eventually, the piper comes calling from Ottawa. Ironically, I often see scenarios where the taxes generated in the estate are substantially higher than the taxes saved in the first place.
The second RRSP/RRIF tax trap happens at the time of the first spouse’s death. The surviving spouse often finds themselves thrown into Old Age Security (OAS) clawback status, as their RRIF minimum on the combined total pushes their now individual income over the clawback threshold of $76,910 in income. This can come as a surprise for folks who, when their spouse was alive, were able to income split and stay well below this threshold.
How to avoid:
Consider using excess RRSP funds to make charitable contributions. This helps drain the RRSP over time in a tax-effective way. In December of 2016, I wrote an article on a strategy involving an insurance gift to charity paid for by RRSP holdings, in which we were able to gift $400,000 at a net estate cost of $1300 to one of our clients.
2) Designating the kids as joint owners of assets (like a house) to avoid probate.
Fifteen years ago, I worked with clients whose mom had, after a conversation at her bridge game, decided it was a good idea to jointly register her house (a capital gains exempt asset) with her kids at the bottom of the Toronto housing market. Fifteen years later when mom sold the house, the family found out this resulted in capital gains assessments to her two children who did not live in the house. The net result was $75,000 in income tax between the two kids. All this to save $1800 in probate fees!
Never put someone on the title on your primary residence unless they live there too. For you its tax exempt – for them, it’s a secondary property and subject to capital gains.
Similar issues can arise if you jointly register your non-registered assets like Guaranteed Investment Certificates (GICs) and bank accounts with your children. While this can sometimes work, it can also create issues.
First, changing the ownership can trigger a disposition for tax purposes. Second, a number of Supreme Court rulings over the past 10 years have made this a bit of a legal “grey area” for estate purposes.
How to avoid:
If it’s a house, it’s almost always best if only the people who reside in the house are on the title. Non-registered accounts are often better handled through the use of an insurance-based GIC or segregated fund, where a beneficiary is named. These products, unlike their non-insurance equivalents, will bypass probate, without any of the legal grey areas of joint tenancy.
- Trying to make a fast buck because of a hot stock tip
For whatever reason, human nature is often run by the fear of missing out (FOMO). As you have likely seen, marijuana stocks, and cryptocurrencies have been dominating news headlines for the last few months. Some people have made a pile of quick and “easy” money, and started telling their friends. More recently, many people have been wiped out as the valuations on these “investments” have had huge swings. I have a hard time understanding how a company with no sales can be valued higher than the largest breweries in the world, or how a currency created by computer can be considered more valuable than those backed by governments.
How to avoid:
Don’t go there. Seriously. If you still feel the urge, go buy a copy of Niall Ferguson’s book, The Ascent of Money, which is an engaging read through nearly 1500 years of financial market history, covering other “hot tip” time periods, such as the great tulip bubble of the 1600s. You will learn very quickly the human race has had centuries of hot tips leading to nasty results!
- Waiting too long to implement smart estate strategies
There are many reasons people put off estate planning but it usually comes with a large cost. With a long enough timeframe, you can make significant changes that save you a pile of taxes on your estate.
One key timeframe is age range of 60-65. Many people have significant assets at this point in life, much of which is tied up in RRIFs or RRSPs. As you might recall from Point #1, this is not necessarily ideal. Since OAS (and OAS clawback) kicks in at age 65, and you must start withdrawals at 72, many times we can reduce your RRSP holdings gradually between 60-65 with minimal tax implications. If your RRSP is large by age 72, your marginal tax rate may jump significantly, counteracting the benefits of your years of saving.
Additionally, we use insurance to help offset estate taxation, either directly by naming your heirs as beneficiaries of the tax-free payout, or indirectly by naming a charity, and having the estate use the tax receipt generated at the time of death. Ideally, you should set this up between ages 40-60. While this strategy is still feasible later in life, often the costs and potential health issues make this far more costly than starting while young.
People often view insurance premiums as an expense, not a smart investment in the future. Done right, these strategies can leave your family in a significantly improved financial position once you’re gone.
How to avoid:
Start having planning work done as soon as possible and don’t procrastinate. Every year you wait makes it slightly more difficult.
Alas, the greatest destroyer of wealth we see is divorce. No matter your age, the emotional and financial costs associated with divorce take a heavy toll. Aside from the adage of “choose your spouse well,” the best you can do if you find yourself in a divorce situation is to mitigate the costs.
How to mitigate:
Collaborative divorce is a growing trend, and we have seen it rising in popularity. The collaborative divorce process is designed to lead to more positive financial outcomes than the traditional method, by attempting to bypass the litigation often involved in divorce. This leads to (hopefully) lower legal costs. At the heart of the process is the concept that both parties agree to aim for the best mutually-beneficial outcome, rather than favouring one side over the other. More information can be found at: http://www.oclf.ca/
This information is general in nature, and is intended for informational purposes only. For specific situations you should consult the appropriate legal, accounting or tax advisor.