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tax matters

I think that every male on the planet secretly wants to be a superhero. I'm not talking about one with superhuman powers. That would be unrealistic. But a superhero with such intelligence, resourcefulness and creativity that he could save the world with nothing more than a pair of tweezers and some duct tape – which is entirely doable.

You might recall the 1980s television show MacGyver, the secret agent who had such creativity that he always managed to turn what he had into what he needed – and save the world in the process.

That type of creativity can go a long way when it comes to tax planning too. We have to think outside the box sometimes. Here's an example of one idea that involves your registered retirement savings plan (RRSP) and your will.

The story
Jack and Diane were married many years ago. Jack passed away this year. At the time of his death, Jack owned some investments that had dropped in value. In fact, he had paid $500,000 for the investments, and they were worth just $350,000 at the time of his death this year, so he had an unrealized capital loss of $150,000. Jack also had an RRSP worth $400,000 when he passed away. In addition, Jack didn't have much income this year, prior to his death. He passed away early in the year and hadn't earned much income to that point.

Like many Canadians, Jack had named his spouse as the beneficiary of his RRSP and he left his other assets to Diane as well. And why wouldn't he? This is common advice because leaving assets to your spouse is a good way to defer the ultimate tax bill. But Jack could have improved on his plan. Consider the results experienced by Jack and Diane.

The results
When Jack left his RRSP assets to Diane, those assets transferred to an RRSP for her free of tax. Similarly, the other assets he left Diane were deemed to have been sold at his adjusted cost base (ACB). Diane stepped into the shoes of Jack from a tax perspective. That is, she inherited Jack's ACB on the assets she received.

At the end of the day, Dianne inherited $750,000 of investments from Jack, but $400,000 is inside an RRSP, and any withdrawal of those assets will be taxable in Diane's hands. Diane also owns the $350,000 non-registered investments with an adjusted cost base of $500,000. Diane will have to somehow generate capital gains in the future in order to use up the $150,000 in capital losses she inherited (capital losses can generally be applied only against capital gains). Is there something different that Jack could have done to leave Diane better off financially? Sure.

The idea
If Jack had planned ahead better, he could have left Diane the same $750,000 in assets, but with $325,000 in an RRSP, and $425,000 outside the RRSP with an ACB of $425,000. This would have left Diane better off since there would have been less money trapped in the RRSP subject to high taxes upon withdrawal, and she wouldn't have to worry about using up the capital losses since they'd be fully used up already.

How can this be done? It's not hard. Jack could have named his estate, not Diane, as the beneficiary of his RRSP. You see, if Jack's estate had been named as beneficiary of his RRSP it would have been possible to trigger some income in Jack's hands in the year of his death by causing some of his RRSP to be taxable to him. We could have then offset that income with the capital losses from his non-registered investments. The fact is, our tax law will allow you to apply your capital losses against any type of income in your year of death, not just against capital gains (with some exceptions).

Jack's executor could have elected to transfer just a portion, say $325,000, of his RRSP to an RRSP for Diane on a tax-free basis. The balance of the RRSP, or $75,000, could have been left in the estate to face tax in Jack's hands in his year of death. Jack's executor could have then elected to transfer the non-registered investments to Diane at fair market value rather than cost, triggering the $150,000 in capital losses, resulting in $75,000 (one half of the losses) being available to offset the taxable portion of the RRSP. As an aside: In the case of a registered retirement income fund, the executor cannot elect to transfer less than 100 per cent of the plan to the surviving spouse.

Tim Cestnick is president of WaterStreet Family Offices, and author of several tax and personal finance books.