To save on estate tax, Linda wants to know if she should withdraw more than the annual minimum from her RRIF now even if it means more of her Old Age Security benefit will be clawed back.Laura Proctor/The Globe and Mail
Linda is 81 years old, a recent widow who is well-fixed financially. She has a mortgage-free house in the Greater Toronto Area, two children and four grandchildren. “I have plenty of income to last me until I die,” Linda writes in an e-mail, but she would like to keep the taxes she pays on her estate to a minimum.
In addition to her government benefits of $24,100 a year, Linda has a defined benefit pension that pays $22,520 a year, not indexed to inflation. She draws the minimum from her registered retirement income fund (RRIF) each year, bringing her total income before tax to about $98,000 a year. At that level, a portion of her OAS would be clawed back.
“I want to minimize the income tax that will be deducted from my RRIF, allowing me to leave as much as possible to my heirs,” Linda writes.
Linda lives modestly, spending about $50,000 a year.
Her question: To save on estate tax, should she withdraw more than the annual minimum from her RRIF now even if it means more of her Old Age Security benefit will be clawed back?
We asked Warren MacKenzie, an independent financial planner in Toronto, to look at Linda’s situation. Mr. MacKenzie holds the chartered professional accountant designation.
What the Expert Says
Linda wants to leave as much as possible to her heirs, and is on track to leave an estate of about $4.3-million if she lives to 100, Mr. MacKenzie says. That would be the equivalent of about $2.9-million in today’s purchasing power.
“Why wait until she dies before starting to help her children and grandchildren financially?” the planner asks. If Linda lives to be 100, her heirs may well say, “I don’t need this money now. I wish I could have received some help about 20 years ago.”
As well, Linda might get enjoyment from being involved in her community and financially supporting some cause that is important to her, Mr. MacKenzie says.
In 2025 Linda’s cash inflows will be about $104,000 a year, made up of OAS $9,400, CPP $15,700, DB pension $22,500, RRIF withdrawal of $54,800 and about $1,600 in dividends from her non-registered investment account.
Her outflows will consist of basic lifestyle spending of $49,000 a year, income tax of $24,000 and TFSA contribution of $7,000. The surplus of about $24,000 a year would be added to her non-registered account.
Linda, a do-it-yourself investor, has an asset mix of about 80 per cent in stocks and 20 per cent in cash equivalents. “Given that Linda’s goal is to leave as large an estate as possible, and she could maintain her lifestyle even if her investment portfolios fell to zero, her higher-than-normal risk portfolio makes sense for her,” the planner says.
His forecast shows that if Linda reduced her gifting and charitable outflow, her CPP, OAS and defined benefit pension alone would be more than enough to maintain her lifestyle spending. If she ever needed expensive nursing home care, she could sell her house, now valued at $1.6-million, to cover this cost.
Linda enjoys managing her investments so it makes sense for her to continue, Mr. MacKenzie says. She is planning to simplify her portfolio to reduce the number of stocks that she holds. “But she doesn’t know what rate of return she has earned over the past five years,” he says. The average Canadian equity exchange-traded fund has averaged about 10 per cent per annum over the past five years. “If Linda has not at least matched this return, she should consider moving to ETFs.”
All withdrawals from Linda’s RRIF will be fully taxable, so it would make sense for her to hold all of her interest-bearing investments in her RRIF and her capital gains-producing investments in her non-registered account where she can take advantage of the lower capital-gains tax rate. She should continue to maximize her contribution to her TFSA.
Linda asks if, over the long term, she would pay less tax if she withdrew about $40,000 more than the minimum RRIF withdrawal each year. “She realizes that she would pay tax of about 38 per cent on the additional RRIF withdrawal plus more of her OAS would be clawed back.”
If Linda’s RRIF was as large as it is now when she died, most of it would be taxed at the top marginal tax rate of 53.5 per cent,” Mr. MacKenzie says. That would mean about $375,000 of income tax.
“There are two things Linda should consider,” the planner says. If she lives to be 100, most of her RRIF balance will have been used up by then, so only a small amount will have to be taken into income and taxed at 53.5 per cent. Meanwhile, if she draws more from her RRIF now, she’ll pay more in income tax and have more of her OAS clawed back. So there would be little in the way of cash flow benefit from doing so.
“If Linda could predict when she will die, she could calculate whether it makes sense to have more of her OAS clawed back now in order to end up with less of her RRIF taxed at 53.5 per cent in her estate,” Mr. MacKenzie says. “Given that she is in good health and expects to live for many more years, she should not plan to draw the extra $40,000 a year.”
Linda has four grandchildren, all over the age of 18. “She could give the grandchildren experience in managing money by giving each one $8,000 annually to open a first home savings account,” the planner says. The maximum that can be put into a FHSA is $40,000, deductible in the hands of the person who owns the FHSA. Any interest or gains on the money would grow free of tax.
If the grandchildren are not earning enough to benefit from the tax deduction, they could contribute the money to a tax-free savings account instead. Then later, when they are earning enough, they could withdraw the money from their TFSA and put it in a FHSA to get the tax deduction.
Client Situation
The People: Linda, 81, and her children and grandchildren.
The Problem: How to keep estate taxes to a minimum. Should she withdraw more from her RRIF now even if it means more of her OAS will be clawed back?
The Plan: Consider gifting some money to her heirs now, thus lowering the value of her estate. A smaller estate value will attract less in the way of income tax.
Monthly after-tax cash flow: $6,460.
Assets: Bank account, guaranteed investment certificate $12,650; RRIF stocks $624,000; RRIF cash equivalent $140,000; non-registered stocks $52,000; non-registered cash equivalent $27,000; TFSA $290,000; residence $1,600,000 Total: $2.7-million.
Estimated present value of DB pension: $450,000. That is what someone with no pension would have to save to generate the same income.
Monthly outlays: Property tax $500; home insurance $100; electricity $205; heating $185; garden $80; transportation $230; groceries $225; clothing $100; gifts, charity $350; vacation, travel $500; other discretionary $200; dining, entertainment $300; personal care $225; sports, hobbies $200; subscriptions $75; cleaning person $200; drugstore $30; phones, TV, internet $310; TFSA $585. Total: $4,600.
Liabilities: None.
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