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How you can give a boost to your spouse's inheritance

There are so many important issues that I could write about from a tax perspective. Take for example the fact that the Canada Revenue Agency has now confirmed that the breeding and raising of earthworms is considered to be a farming activity. And for those who live in Manitoba, there is the Odour Control tax credit worth looking at. Both of these facts offer some interesting tax planning opportunities – particularly for those who live in Manitoba, have an odour problem and spend a lot of time fishing. If you're in this boat (pardon the pun), I'll address this unique planning opportunity another time.

Today, however, I want to talk about an often overlooked tax planning opportunity that could help your heirs save a lot of tax after you're gone. It may involve changing the beneficiary of your RRSP.

The scenario

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Picture this. You own a portfolio of securities (non-registered investments held outside of an RRSP or RRIF) that has dropped in value. Let's suppose that the portfolio is worth $500,000 today, but that your cost amount was $700,000, so you have an unrealized capital loss of $200,000. Let's also suppose that you have RRSP assets worth, say, $400,000.

Suppose also that you plan to leave your spouse with all of these assets at the time of your death, and you've accomplished this by naming your spouse as the beneficiary of your RRSP in the plan documentation, and your spouse is due to inherit the non-registered assets as well. By doing these things, you'll avoid all tax on these assets at the time of your death. Sounds good, doesn't it?

The problem

If you were to die today, your spouse would inherit $900,000 of investments from you, but $400,000 would be stuck in an RRSP where any withdrawal by your spouse later will be fully taxable to him or her. In addition, your spouse will own the $500,000 non-registered portfolio with an ACB of $700,000, so your spouse will have to somehow generate capital gains in the future in order to use up the $200,000 of capital losses he or she inherits from you (capital losses can generally be applied only against capital gains). Is there something that you could do differently so that your spouse is better off from a tax perspective after your death? Sure.

The strategy

It's possible in this example to leave your spouse with the same $900,000 in assets, but with $200,000 in an RRSP, and $700,000 in non-registered investments with an adjusted cost base of $700,000. The beauty of this is that the $700,000 of non-registered investments can then be accessed on a tax-free basis by your spouse due to the high ACB. In addition, there are fewer dollars stuck in an RRSP that will be taxable when withdrawn by your spouse. Finally, your spouse won't have to worry about using up those unrealized capital losses after you're gone because they will already have been used up.

How can you accomplish these things? First, consider naming your estate, rather than your spouse, as the beneficiary of your RRSP. By doing this, it's possible for your executor to trigger some income in your hands in your year of death by causing some of the RRSP to be taxable to you. It would then be possible to use your unrealized capital losses to offset that RRSP income in your year of death. You see, our tax law will allow you to apply your capital losses against any type of income, not just capital gains, in your year of death (with some exceptions).

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In this example, your executor could elect to transfer just a portion, say $200,000, of your RRSP to an RRSP for your spouse tax-free, leaving the $200,000 balance of the RRSP to face tax in your hands in your year of death. Your executor could then elect to transfer the non-registered investments to your spouse at fair market value, rather than at cost, triggering the $200,000 capital loss to offset the RRSP income. (Note: In the case of a RRIF, your executor cannot elect to transfer just a portion of the plan to your surviving spouse; it's all or nothing.)

The result? Your spouse will inherit $200,000 of RRSP assets with the rest of the assets, or $700,000, outside an RRSP with a cost amount, or ACB, of $700,000. Naming your estate as beneficiary of your RRSP can make sense when you have significant unrealized capital losses to use up, particularly when you expect to have insufficient other income in your year of death to use up those losses.

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About the Author
Author and founder of WaterStreet Family Offices

Tim Cestnick, FCPA, FCA, CPA(IL), CFP, TEP, is an author and founder of WaterStreet Family Offices. More

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