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A financial advisor’s responsibilities often extend beyond rates of return to include tax, retirement and estate planning. To understand these aspects of a financial plan, advisors should take the opportunity to learn more about a client’s family, values and priorities in order to effectively manage the client’s assets in life and at death.

New advisors, in particular, might benefit from reviewing common planning issues for clients at different life stages.

Young professionals: debt costs and registered accounts

Young professionals often spend their time and resources paying off post-secondary debt or planning for significant purchases such as a car or house, rather than planning for retirement. This creates an opportunity to talk about debt and savings.

The tax implications of debt — specifically, the deductibility of interest costs — can be a significant factor in prioritizing which debt to pay off first. The general rule, under Section 20(1)(c) of the federal Income Tax Act, is that interest on a loan is tax-deductible if the loan is used to earn income. Where two loans are identical in all respects other than the deductibility of related interest, the loan with non-deductible interest is more expensive and should be paid off first.

Consider a fictional client, Jessica, who has two outstanding loans of $15,000 each: one to purchase a car for personal use, the other to purchase dividend-paying stocks in a non-registered investment account. Annual interest on each loan is 8%. Interest on the car loan, however, is non-deductible, while interest on the stock loan is tax-deductible as the stocks have the potential to pay dividend income. Jessica wants to know the cost of each loan for the current year. Her marginal tax rate (MTR) is 35%. Table 1 shows the results.

Table 1: Cost comparison of loans (non-deductible versus tax-deductible interest)
$15,000 car loan$15,000 stock loan
Interest cost (8% annually)$1,200$1,200
Tax savings from deductible interest (35% MTR)$0$420
Cost of loan (current year)$1,200$780

Another important decision for young professionals is whether to invest available cash in an RRSP or TFSA. For a client who expects to withdraw money in the future when subject to a higher marginal tax rate, the TFSA is normally a better vehicle.

Consider Thomas, a fictional 22-year-old business graduate in a junior role at a marketing firm. His marginal tax rate is 20%, and he expects his employment income to increase. His bucket list includes a round-the-world trip 20 years from now, and he expects to withdraw his money at a 45% tax bracket to pay for the trip. With $6,000 from employment income to contribute to either an RRSP or TFSA, Table 2 shows the latter makes the most sense.

Table 2: RRSP versus TFSA when withdrawals are made at a higher tax bracket relative to contributions
RRSPTFSA
Pre-tax investible income from employment$6,000$6,000
Tax (20%)$0$1,200
Net contribution$6,000$4,800
Total amount after 20 years (6% annual growth)$19,243$15,394
Tax on withdrawal (45%)$8,659$0
Net cash at withdrawal$10,584$15,394

In contrast, if Thomas expected his tax rate to go from high (45%) to low (20%), investing through an RRSP would be preferable. In such a scenario, using the same growth assumptions over 20 years, his net cash at withdrawal in an RRSP would be $15,394, compared to $10,584 in a TFSA.

Note that there are often exceptions. For those saving for their first home, the RRSP can provide tax-deductible contributions while allowing up to $35,000 to be withdrawn tax-free for a home purchase.

Squeezed in the middle at mid-life

Middle-aged clients commonly experience cash-flow pressures due to children, household expenses like mortgage payments and renovations, and sometimes caring for aging parents. Still, it’s important for these clients to understand the importance of retirement planning. This is especially true given the declining availability of defined benefit pension plans.

Advisors can also communicate the importance of creating a will. While this is important for clients of all ages, middle-aged couples can face unique challenges at death if their intentions aren’t appropriately communicated. When someone dies intestate, government legislation defines how the deceased’s assets are distributed. In many cases, the spouse is entitled to a defined share of the estate, often referred to as the preferential share. Amounts in excess of the preferential share are normally divided between the spouse and children. While this distribution might be suitable for some couples, the following challenges can arise:

  • A common-law partner might not inherit at all, or may be required to pursue other processes to win a share.
  • Children might inherit directly, which can present problems in the case of minor, disabled or spendthrift children.
  • A surviving spouse may require the consent of the Public Trustee to deal with assets for minor children.
  • Taxation is accelerated as transfers
    to children don’t normally occur on a tax-deferred basis.
  • If no guardian for minor children is named, the courts will appoint one.

In addition, middle-aged couples often face changes in their family structures, whether resulting from a new child, new properties or a relationship breakdown. Whenever significant shifts occur, advisors should work with clients to create or update their estate planning documents where necessary.

Estate planning concerns for retirees

Retirees must decide the best way to transfer certain registered assets (RRSPs, RRIFs and TFSAs) and life insurance proceeds to beneficiaries. With the exception of Quebec, provincial and territorial legislation allows for named beneficiaries on RRSP, RRIF and TFSA contracts, enabling assets to bypass the deceased’s estate and avoid estate administration fees and complex estate settlements. The same is also possible for insurance contracts in all provinces and territories.

The alternative is not to name a beneficiary on plan contracts and to flow the assets through the deceased’s estate to be governed by the deceased’s will (or intestacy rules in the case of no will). Both options have advantages and disadvantages (see “Pros and cons”).

It can often be more useful to flow assets through the deceased’s estate by leaving the contract designation blank or naming “estate” as the beneficiary. Doing so allows for greater control after death, potentially through the creation of a testamentary trust. Subject to the deceased’s will, an estate designation can also provide for children or grandchildren of a beneficiary if the beneficiary predeceases the testator, and permit the designation to be automatically revoked upon the testator’s marriage.

Retirees should also know that, when they pass away, their tax bills for the year of death can spike dramatically. Given Canada’s graduated tax rate system, it’s not uncommon for Canadians to be taxed at lower tax brackets and rates while living, only to be subject to tax at the top rate in the year of death because of the deemed sale of assets at death. Where assets aren’t transferred to a spouse or common-law partner at death, appreciations in capital (non-registered assets) and the full value of RRSPs and RRIFs can create a large taxable income for the year of death.

To avoid this, clients can consider a tax-deferred rollover to a spouse or common-law partner. Or, during retirement, clients can withdraw more than needed from RRSPs and RRIFs and be taxed at lower tax rates, with excess money reinvested in tax-efficient TFSAs or non-registered accounts. Clients employing this strategy should be mindful of income-sensitive benefits like Old Age Security to avoid clawback.

Successful advisors plan ahead for their clients. Whether your clients are young professionals, middle-aged couples or retirees, discussions about tax, retirement and estate planning can deliver value, uncover opportunities and deepen relationships.

Pros and cons of named beneficiaries on RRSP, RRIF, TFSA and insurance contracts

Pros

  • Avoids estate administration fees (a.k.a. probate, which is as high as 1.7% in Nova Scotia)
  • Avoids complex estate settlements and related delays
  • Amending designation when required is simpler than updating a will
  • Avoids creditors of the deceased’s estate1

Cons

  • Can create inequitable distributions if RRSP/RRIF taxation at death is charged to and paid by the estate2
  • If the beneficiary is a minor or incompetent, proceeds may be paid to the Public Trustee on the beneficiary’s behalf
  • If the beneficiary predeceases the plan owner, a contract designation doesn’t provide for the proceeds to pass to the beneficiary’s children on the owner’s death
  • Designation is not automatically revoked on marriage or divorce

1 Subject to exceptions

2 Which is normally the case in the absence of a designation in favour of a spouse or financially dependent child

Wilmot George , CFP, TEP, CLU, CHS, is vice-president, Tax, Retirement and Estate Planning at CI Investments. Wilmot can be contacted at wgeorge@ci.com. Liam Bushell was a summer student at CI Investments.