Soaring stock markets are accentuating a complication associated with a lifetime’s successful investing.
When your stocks in a non-registered portfolio go up in value, so does the tax bill when you die. This may help explain a recent increase in the number of readers asking about how to protect their investments from taxes on death. One reader referred to a “tax bomb” and asked for thoughts on how to defuse it.
To start with, let’s look at taxes that apply to your investments when you die. Christine Van Cauwenberghe, a Winnipeg-based certified financial planner (CFP) with IG Wealth Management, says Canadian residents are deemed to have disposed of all their assets as of the date of death.
If you die with $400,000 worth of stocks in a non-registered investment account and your cost was $200,000, then you have a $200,000 capital gain. Current rules require that you pay tax on 50 per cent of a gain, which means $100,000 is subject to tax in this example.
Ms. Van Cauwenberghe suggests using a marginal tax rate for estate planning of 50 per cent, which is in range of the top marginal rates in all provinces. This means an estimated tax bill of $50,000 on that $400,000 portfolio.
“In many cases, at the date of death, you’re going to have more taxable income than at any other time of your life,” she said. “Even though you weren’t in the highest marginal tax bracket during your lifetime, you will be at the time of death.”
Registered retirement savings plans and registered retirement income funds are effectively deregistered at date of death, Ms. Van Cauwenberghe said. “If you have $400,000 in an RRSP or a RRIF, that’s $400,000 of taxable income in the year of death. That’s the real kicker with RRSPs and RRIFs.”
Finally, the ever-popular tax-free savings account. As advertised, they are tax-free. Ms. Van Cauwenberghe said that if you have $100,000 in a TFSA at the time of death, there is no tax to your estate.
Here’s something to ease the mind of people who have investment assets and worry about a tax hit at death. Through what’s called a spousal rollover, both non-registered and RRSP/RRIF assets are transferred to a spouse or common-law partner with no tax triggered. “The tax bomb, so to speak, is not going to go off until the second spouse dies,” Ms. Van Cauwenberghe said.
A surviving spouse does not need contribution room in their own registered account for a spousal rollover of an RRSP or RRIF, Ms. Van Cauwenberghe said.
While TFSAs are not taxed upon the death of the account holder, there is still a tax detail of some importance for couples. If you name a beneficiary for the account, this partner can put the assets in their own TFSA, regardless of whether there is contribution room. If there’s growth in the TFSA after death but before the assets are paid out to the spouse, it’s taxable in the hands of the beneficiary spouse.
By using the successor holder designation instead of beneficiary, the surviving spouse can take over the TFSA, including any asset growth after death, with no tax consequences.
Looking ahead to a tax bill for their estate, some readers have asked whether it makes sense to sell some of their unregistered stocks before they die. Ms. Van Cauwenberghe said this could make sense for someone who is in a low tax bracket and is in no danger of triggering a clawback of Old Age Security benefits.
It’s not just rising stock markets that have people thinking about the tax hit on their investments on death. With the federal government facing a big deficit as a result of pandemic spending, there’s continuing speculation about an increase in the inclusion rate for capital gains to 75 per cent from the current 50 per cent.
Even a 75-per-cent inclusion rate beats the full tax hit on RRSPs and RRIFs, said Daryl Diamond, a certified financial planner and author of a new book called Retirement for the Record: Planning Reliable Income for Your Lifetime … to the Soundtrack of Your Life.
It’s a point he makes in coaching clients to recognize that taxes on investment gains at death are a sign of success as an investor. “Not to sound flippant, but I say to people that if we can create a great tax explosion in your estate at the time you pass on, we’ve done a great job.”
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