Planning & Advice

How to protect your money from the tax man when you die

March 29, 2019


How to protect your money from the tax man when you die

Planning & Advice

Canada doesn’t have a “death tax” (estate tax). Still, there are taxes that can be triggered upon your death. The Canada Revenue Agency will want their cut of your nest egg.

When you die, you are taxed as if you sold everything you own (possibly triggering large capital gains). Also, all money in registered plans (like RRIFs) becomes de-registered and included as income upon death. The result: the deceased’s marginal tax rate can move into very high rates on their last tax return. That adds a bit of an insult to injury, if you ask us. You saved all those years for yourself and your family — not to give it away to the government!

How do you keep the tax man at bay? Here are some tips and strategies for reducing taxes while you’re alive, and beyond.

We’ll also talk here about strategies to improve tax efficiency in preparation for leaving a legacy (that the tax man mostly can’t touch). OK, let’s get to it.

Strategies reducing your taxes (when you’re still alive)

1. The easiest way to save money on taxes? Reduce your taxable income by adding money to an RRSP.

An RRSP lets you contribute a certain amount each year depending on your income (see your Notice of Assessment from the CRA). When tax season comes around, the money you contributed to your RRSP will be deducted from your total taxable income. 

Example: if you earned $40,000 and contributed $5,000 to your RRSP, your total taxable income would be $35,000.

2. Withdraw from your retirement savings more gradually over a longer period of time. Eventually, your RRSP will have to be converted to a RRIF and you will start making payments.

This conversion is required by the end of the year you turn 71, with mandatory payments starting the next year. You don’t have to wait until your hand is forced. Instead, convert a small amount and start receiving smaller payments earlier on. This can help you avoid the tax trap of climbing into higher tax brackets later in retirement when the forced withdrawals get larger and larger.

Even better: you can use these small early RRIF withdrawals to top up your TFSA each year if you don’t need to spend the money for your living expenses.

3. Use a TFSA. It allows you to contribute up to $6,000 per year, no matter your growth and investment income. The tax man can’t touch the interest earned on your money when you take it out. The growth and investment income is tax-sheltered.

4. Use non-registered accounts, which aren’t tax-deferred or tax-sheltered. The good news is that not all of the earnings will be taxed at your top rate: some may be eligible for reduced tax rates.

What happens to your investments when you die?

How you plan for retirement and eventual death – sorry, but you’re not immortal – will determine how your life savings will be passed on to those left behind.

When you die, the money in your RRSP can be passed on to a beneficiary, if you’ve named one on the account or in your will. If you haven’t named a beneficiary, then the money goes to your estate.

When the money is transferred from your RRSP to your beneficiary (or estate), it is considered income and taxed like income – unless you named your spouse, in which case they can take advantage of a rollover to move the money into their own RRSP, deferring that tax bill until they die.

Here’s the big problem if there is a lot of money left in your RRSP when you die: that full amount in your RRSP will be taxed according to the income bracket — leaving a lot less for your loved ones.

Remember, you were able to take advantage of tax deductions when you put money in. You also had tax deferrals on growth and investment income, to pay less tax while you were alive. But now your whole nest egg is going to be taxed, all at once.

This can leave a major dent in the nest egg you planned to pass on to your loved ones.

What about your TFSA? Well, a TFSA can be passed on to your spouse or paid out to a beneficiary without being taxed. What can be taxed is any growth or investment income accrued after death. 

  • Example: there is $50,000 in your TFSA. It took a while for the account to actually get transferred and in the meantime, the TFSA earned $3,000 in interest. Now, that $3,000 is subject to being taxed.

A non-registered investment account functions after death much like a TFSA. A non-registered investment account becomes part of your Estate when you die. You can’t name a beneficiary on the account like you can with RRSPs and TFSAs.

You are taxed on your terminal (final) tax return just as if you sold all the investments on the day you died. The money is transferred to your Estate. From there, any additional growth and investment income is taxed to your Estate until your Estate is settled (i.e. everything has been paid out) according to the instructions in your will.

Here’s a bonus tip for couples: non-registered accounts can be rolled over to a surviving spouse without immediate tax consequences (similar to the RRSP spousal rollover). That way, at the very least, the capital gains can be deferred until the last spouse dies.

Ways to protect your financial legacy for your family (and from the tax man)

First, a caveat. We’re not legal professionals. We’re not tax specialists, either. But as a financial adviser, we can tell you that these are some common ways Canadians reduce the tax they pay, so they can leave more for their loved ones.

Naming beneficiaries on your registered accounts

If you’re married, you could name your spouse as a beneficiary. Then the plan is rolled over to the spouse on a tax-deferred basis. 

Have a will

That probably means setting up a meeting with a lawyer. This is too important to DIY. Without a will, the courts gets to decide who gets what according to the laws in your Province. And that court may not make the choices you would. Also, dying intestate (without a will) can draw out the process of settling your estate. It could leave your loved ones with the burden of making court filings and appearances, just to get control of the Estate back in their hands.

Roll over your non-registered investments smartly

If you have a surviving spouse and a lot of unrealized gains in non-registered investments (because you’ve been saving and investing for a long time, like a boss!), don’t let the CRA tax all the gains when you die. 

Instead, roll over your investments on an adjusted-cost basis to your surviving spouse. This will help to avoid capital gains upon your death. Your financial adviser and tax professional can help you with this.

Use a family trust, alter-ego trust, or testamentary trust in your will

By using different types of trusts, you can take advantage of more specialized tax strategies like an estate freeze. Doing this, you might exert more control over how your money is used by your beneficiaries both before and after your death. When it comes to trusts, you should work with your financial adviser, as well as tax and legal professionals, to learn if they are a fit for you.

We are financial advisers who often help clients that need help with estate planning. But for the tips we’ve given above, you may also want to consult with a lawyer or accountant. They have other valuable kinds of expertise and can help develop a strategy in line with your financial plan.

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    Thank you for the infos. Short but very explicit. ??

  2. Yvonne

    On death tax consequences for RSPS or RIFS really depend on who is listed as the beneficiary of the RRSP. The general rule for an RRSP or RRIF is that the value of the RRSP or RRIF at the date of death is included in the income of the deceased for the tax return for the year of death There are three exceptions to this rule where the tax can be deferred if the beneficiary of the RRSP, RRIF, or estate is one of three parties: the spouse (includes common-law partner) financially dependent child or grandchild under 18 years of age, or financially dependent mentally or physically infirm child or grandchild of any age. Your spouse as the beneficiary The spousal rollover provision allows a spouse that is listed as the beneficiary to rollover the amount of the deceased’s RRSP into their RRSP without any tax consequences. Obviously for planning purposes, it is wise in most cases to list a spouse as a beneficiary.

  3. bill maclellan

    I followed the link for the lunch and learn sessions but it seems they are just for multiple employees. How do you register as an individual? Thanks

  4. John

    Great advice. Q: To roll over non-registered investments to a surviving spouse on death, do they need to be the named-beneficiary for the account (similar to registered accounts like RRSP)?

  5. Bernard Fried

    In Ontario it was not mentioned that the Ontario Government will take a Probate Fee to settle the Estate. One great Tax avoidance is to make the accounts joint with a living Relative that will outlive you. In this Fashion, the Relative gets your money when you die without Income Taxes or Probate. Lastly, Gift away as much as possible so that there is nothing left for the Government to Tax!

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