In early December, I probably had the most fun I’ve ever had working with a client. Joan (or so we will call her to protect the innocent) is in her late 50s, recently retired and a chronic saver.
Joan had realized that her chronic savings habits had placed her in a bit of a pickle – between her and her husband, Ted, she had nearly $700,000 tucked away in RRSPs and LIRAs. As Joan and Ted have a very modest lifestyle, they were quite comfortable living on Ted’s pension and a bit of casual work that both of them did in retirement.
When we looked at the tax situation on their estate, it quickly became clear that the government would end up taking nearly 50 per cent of the $700,000 in RRSPs if we did nothing. The tax bill on her estate if she went today would be around $300,000, and based on our projection, likely grow to $500,000 by her mid-70s!
Needless to say, Joan was rather aghast at the situation, especially because she’s currently paying very little in tax. Her income will be quite small (around $25,000 a year) until her OAS and CPP kick in at 65 and then jumps significantly as she will be forced to start taking from her RRSPs at age 72.
Fortunately, Joan is very, very interested in charity.
We realized that Joan can pull money from her RRSP today at a tax rate of about 20 per cent, which is way better than the 53.5 per cent maximum rate she and Ted would be paying on most of their RRSPs and Capital Gains in Ontario via their estate. This is also much lower than her tax rate will be in her 60s and 70s when she starts collecting on other pensions and RRIFs.
Here is our plan:
Step 1: Drain the RRSP, give money to charity.
Joan is going to pull $12,000 a year from her RRSP for 10 years and donate that amount to charity. That donation entitles her to a roughly 40 per cent tax break here in Ontario, which lets her pull out approximately another $10,000 a year from her RRSP – essentially tax-free due to the charitable tax credit – and turn around and re-invest it in her and Ted’s TFSAs. At the end of 10 years that’s going to be about $125,000 in her TFSA, assuming she gets a 4 per cent return on her money.
By the time she’s started collecting CPP and OAS at 65, she’ll have drained her RRSP by $220,000 and have a net $125,000 in her pocket, leaving her virtually in the same financial position after 10 years as leaving the money in the RRSP.
Step 2: Multiply the effect – big time!
The really exciting part of this strategy is how we are going to handle the donation to the charity. Rather than just giving cash, we are setting up an insurance policy which will be owned by the charity, and paid for by Joan’s generous $12,000 annual gift. This policy will pay out $400,000 to the charity on the death of Joan and Ted. We are turning their $120,000 into $400,000 – multiplying their gift by more than 300 per cent by using the insurance.
After 10 years, Joan has the same amount of money in hand to her estate, has reduced her unneeded income in her 70s, and has managed to make a $400,000 gift to her favourite charity.
That’s a $400,000 transformation gift made to charity at basically a net cost to her estate of nothing.
I’m pretty sure that both Joan and I skipped all the way home with big smiles on our faces that day.
The information provided is based on current tax legislation and interpretations for Canadian residents and is accurate to the best of our knowledge as of the date of publication. Future changes to tax legislation and interpretations may affect this information. This information is general in nature, and is not intended to be legal or tax advice. For specific situations, you should consult the appropriate legal, accounting or tax advisor.