Rolling Assets Into Trust – Hull on Estate and Sucession Planning Podcast #84
Listen to Episode 84 – Rolling Assets Into Trust
This week on Hull on Estate and Succession Planning, Ian and Suzana further last week’s discussion on trusts and tax planning wills by illustrating the benefits of rolling over assets and being conscious of tainted trusts.
Rolling Assets Into Trust – Hull on Estate and Succession Planning Podcast #84
Suzana Popovic-Montag: Hi, and welcome to Hull on Estate and Succession Planning. You’re listening to Episode #84 of our podcast on Tuesday, October 30th, 2007.
Welcome to Hull on Estate and Succession Planning, a series of podcasts hosted by
Ian Hull and Suzana Popovic-Montag, that will provide information and insights into estate planning in Canada, from the offices of Hull Estate Mediation in Toronto, Ontario, Canada. Here are Ian and Suzana.
Ian Hull: Hi Suzana.
Suzana Popovic-Montag: Hi there Ian. How are you?
Ian Hull: Just terrific thanks.
Suzana Popovic-Montag: That’s good. Already for Halloween?
Ian Hull: Almost.
Suzana Popovic-Montag: That’s good.
Ian Hull: Nothing like leaving it till the last minute.
Suzana Popovic-Montag: That’s what we do these days.
Ian Hull: Well, we were in the last podcast, we were sort of rounding up on our issues relating to inter vivos trusts but we also talked a lot about designations of beneficiaries. So why don’t we talk a little bit about RRSPs and some tax issues surrounding them.
Suzana Popovic-Montag: That’s a great idea, Ian, because we know basically that RRSPs and RRIFs, the Registered Retirement Income Funds, are deemed at law to be disposed of on death at fair market value. And it’s the Income Tax Act that provides for that, that says, you know, on death, there’s a disposition.
Ian Hull: So to be clear then, the value at death is the fully taxable income of the year in the year of death itself. So it can be a big hit in terms of the tax burden and from that standpoint, the tax burden is typically paid out of the residue of the estate.
Suzana Popovic-Montag: That’s right. There is, though, an exception that arises in circumstances where the proceeds from the RRSP can qualify as a refund of premiums.
Ian Hull: Well that’s right, and that’s a good point. That doesn’t always arise in these situations but something we should also consider.
Alright, so now just talking about this deferring tax with RRSPs. The proceeds themselves qualify as refunds of premiums only though if they’ve been paid to a surviving spouse or common-law spouse or a financially dependent child or grandchild. So that’s how we get into this area of exceptions where we don’t have to pay this, what can be an enormous deemed disposition tax.
Suzana Popovic-Montag: And if there is a beneficiary designation that’s actually in favour of one of those eligible persons that you talked about, Ian, the surviving spouse, the common-law partner, or some financially dependent child or grandchild, then the proceeds are actually going to be paid directly to that beneficiary as this refund of premiums.
Ian Hull: Well that’s interesting. And that’s a really important, almost akin to the rollover idea. They call it as income tax can only do something different but it’s the same in terms of its effect. So if the RRSP proceeds paid to the estate qualify as a refund in premiums and if they’re allocated to and are distributed by the executor to the eligible person, then we aren’t looking at that draconian and quite painful deemed disposition payment.
Suzana Popovic-Montag: And what will happen in those circumstances is that the refund of the premiums is going to actually be included in the income of the recipient in the year that it’s received, as opposed to being included in the estate.
Ian Hull: Okay. Now you were talking about the spouse or common-law partners and I mentioned this whole rollover idea. How does that work again?
Suzana Popovic-Montag: Well the spouse or common-law partner can put that refund of premiums into their own RRSP if they are under the age of 69, or into an RRIF or other annuity contract and then defer the tax, pursuant to the provisions of the Income Tax Act.
Ian Hull: And one thing that is not always considered and a bit little known, so to speak, is that dependent children or grandchildren may also use this refund of premiums to purchase a fixed term annuity to the age of 18 or something of that nature in terms of a financial instrument product and again, hopefully deferring this tax.
Suzana Popovic-Montag: And Ian, when we talk about children or grandchildren who are dependent on the deceased, what are we talking about?
Ian Hull: Well, it’s a good question because there’s a lot of to and fro on this issue and there’s certainly a lot of cases out there. But in terms of looking at it from Revenue Canada’s standpoint and CRA’s standpoint, a child or a grandchild who is dependent because of a physical or mental infirmity is one that has to qualify in that sense.
Suzana Popovic-Montag: I see.
Ian Hull: So that kind of a situation, of course, and, you know, we can identify physical or mental infirmity fairly broadly, then that child can transfer the refund of premiums into this RRSP or the RRIF or the life or term annuity. And all of this allows us to give some good tax deferral for someone who clearly would greatly benefit.
Suzana Popovic-Montag: And thinking in turning to the next, we have sort of a deferring tax, there’s also a tax that arises on capital gains, and I thought maybe we could just talk about that a little bit.
Ian Hull: For sure, because this is the thing we talked about trusts and those other instruments that we were using before. But this is an important consideration because the deemed realization of capital property at fair market value is done immediately prior to death in terms of the calculation.
Suzana Popovic-Montag: So you’re saying, Ian, then that when someone passes away, there’s this deemed, you know, realization of a capital property. So everything they own suddenly is deemed to have been disposed of, and if it was disposed of at a value greater than what it was purchased for, then that’s that capital gain we’re talking about taxing?
Ian Hull: That’s right. And it’s, I mean, it really is, it’s a bit of an artificial moment in time because obviously when you die, you haven’t got a fair market value, you haven’t got an instant value there but, you know, say you own a cottage property or a chalet in addition to your house because the house is a principal residence and treated slightly differently. But say you’ve got a second property, the deemed disposition occurs on the date of your death. Well, this cottage may not be sold for another three generations, who knows. So you have to go back and work up what that is, as you say, in terms of the growth and the capital tax payable.
Suzana Popovic-Montag: And in these circumstances, the deferral of the tax or a rollover of the property could be done. And I think in that case then, it’s adjusted cost base, which is available to people so that on these transfers to a spouse or to a qualifying spousal trust, there is this deferral essentially of tax.
Ian Hull: Right. And we talked about in earlier podcasts why we would set up trusts. Well this is one of those situations where you are essentially rolling the asset into or assets, say there’s an investment account or a bank account, and then a cottage. You’re rolling it into this spousal or qualifying spousal trust, therefore, and as you say, it’s at the cost base, the adjusted cost base. So you’re really allowing for an important deferral and one that can be very important because spouses and certainly when you want to do some estate planning, maybe one spouse has more assets than the other or the like. And you want to make sure that that surviving spouse isn’t hit with a heavy burden of tax or too heavy of a burden of tax. And this rollover goes a long way to avoiding that.
Suzana Popovic-Montag: And so the idea then, just so I understand it, really is that on the date of a spouse’s death, there’s a deemed realization of all property. So capital property in this case, which will generate either a capital gain or a capital loss. And instead of paying tax on it at that moment of time, provided that the deceased has planned his or her affairs properly, then that gets transferred over to the surviving spouse, or to that surviving spouse’s trust?
Ian Hull: That’s right.
Suzana Popovic-Montag: Oh, that’s great.
Ian Hull: So now, let’s sort of talk a little bit about what that is. I mean, we’ve talked about the concept generally but let’s talk about what it is to be, how do you qualify as a spousal trust?
Suzana Popovic-Montag: Well in that situation, the surviving spouse has to be entitled to all of the income during his or her lifetime. So we talked about previously that a trust usually has a breakdown between the income beneficiaries and the capital beneficiaries and to be a qualifying spousal trust, there is that requirement that all the income specifically goes to the spouse and no one else.
Ian Hull: And that is so crucial. I mean what CRA says is that if you’re going to do this and you’re going to take advantage of it, we’re only going to give it to certain situations and that is to a surviving spouse. So if you allow for anyone else to get at the income from this trust, you’re going to create problems. We’ll talk about those problems in a few minutes but the idea is, is that you restrict who gets the benefit.
Suzana Popovic-Montag: And I’m presuming that’s what they refer to as “tainting” the spousal trust.
Ian Hull: That’s right. And because as the rules are clear in the Income Tax Act, only the surviving spouse can have use of the income or the capital, to be fair. You can also, the surviving spouse if the trust is set up properly, you can also use the income and then maybe you need another $10,000 or something to buy a new car or something, you’re allowed to pull capital out as well. But the key is, is that it’s only the person…the question is, is that whose benefit is the money going to? And like you say, this whole idea of tainted and it will be tainted or it will not be an effective, proper spousal trust if you have anyone else able to access that money.
Suzana Popovic-Montag: So either the income or the capital during the spouse’s life?
Ian Hull: Right. Now, it’s interesting, like for example, what a lot of trusts will have is a contingent interest which is that there’s a possibility of someone else getting access to it. And say you say, well the income and capital can go to my surviving spouse or my daughter, Betty. And if you have that kind of language in the trust, you’ve changed it. It is no longer a truly spousal trust in the mind of CRA.
Suzana Popovic-Montag: And so the idea really is to be careful when those trusts are being drafted so that, as you say, a contingent interest doesn’t somehow taint the trust. And I imagine the same would be the situation if there’s a direction in the trust to pay the income until death or remarriage, which is kind of language that we see typically in situations where a spouse survives another spouse. And that kind of direction would also taint the trust, I imagine.
Ian Hull: That’s right because you’re allowing other events to transpire. Alright, well I know this is sort of a bit heavy in terms of the tax side, but it’s such an important part of the planning that we, you know, when we were sitting back and trying to plan our next 50 podcasts, we thought one of the things that we maybe have glossed over which is fine, but we may have glossed over a little bit was some of the detail on these tax issues. And because we keep talking about the fact that it is so tax-driven, most estate planning. Well, in fact, it is for a good reason and so we are going to continue to spend a little bit more time on some of these basic tax concepts so that we understand what is, you know, probably 75% of the planning that goes behind estate planning is tax-driven and why.
Suzana Popovic-Montag: Well, that’s great Ian. Thanks very much. I look forward to our next podcast.
Ian Hull: Thanks Suzana.
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