SAMPLE PLAN FOR ILLUSTRATIVE PURPOSES ONLY

Transcription

1 RBC Wealth Management Prepared exclusively for Bob and Mary Smith Halifax, Nova Scotia January 2017 Prepared by: The Wealth Management Services Team and John Bell RBC Wealth Management

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3 Table of Contents INTRODUCTION... 1 FINANCIAL ASSUMPTIONS... 2 YOUR CURRENT FINANCIAL SITUATION... 7 A LOOK INTO THE FUTURE... 9 YOUR FINANCIAL PROJECTIONS ALTERNATE SCENARIOS WEALTH ENHANCEMENT STRATEGIES BUSINESS PLANNING YOUR INVESTMENTS EDUCATION FUNDING RISK MANAGEMENT YOUR ESTATE PLAN FINAL WORD SUMMARY OF RECOMMENDED ACTIONS PLEASE REMEMBER

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5 Introduction Your Compass Financial Plan is intended to provide an analysis of your current financial situation, and to determine your ability to meet your goals and objectives with your existing and expected future resources. Having a clear picture of your financial situation makes it possible for us to provide you with highly customized advice and recommendations around strategies that are expected to help you meet your goals and objectives, and enhance your financial situation wherever possible. It is important to remember that your plan is intended to be an illustration at a point in time that provides a framework to help you make informed financial decisions. John Bell will review your goals and circumstances with you on a regular basis. An updated financial plan will be prepared upon your request if there are any material changes to your circumstances or goals that have the potential to significantly impact your financial plan. It is also important to remember that your financial plan is dependent on the information that you have provided to us and a significant number of assumptions such as investment returns, tax rates, future cash flows and others. Therefore, the financial projections should be viewed as an illustration of how your financial situation will evolve over time. Your Goals and Objectives Your goals and objectives provide the basic framework for the development of your financial plan. Based on our discussions with you to date, our understanding of your main financial goals and objectives are as follows: 1) You wish to ensure that you have sufficient financial resources to retire in 2020, and to maintain your current lifestyle throughout your lifetimes. 2) In the event of either of your deaths or disability, you wish to ensure the family can maintain its current standard of living. 3) You wish to ensure you are converting your wealth to income in a tax efficient manner. 4) You wish to ensure there is a plan in place to provide for the post-secondary education of your grandchildren and that the residue of your estate is transferred to your children in a tax efficient manner. Key Findings The following is a summary of our key findings: Our financial projections indicate that you will have sufficient financial resources to fund your stated goals and that you will have surplus wealth available to transfer to your beneficiaries. In the event of either spouse s premature death or permanent disability, your resources and existing insurance coverage appear to be sufficient to meet your family s needs. There are tax and estate planning opportunities available for you to further strengthen your financial position. These are highlighted through the advice and recommended actions throughout this report. Compass Financial Plan for Bob and Mary Smith 1

6 Financial Assumptions Your financial plan is based on the information you have provided to us as well as financial assumptions made regarding the future including projected investment rates of return, inflation and income tax rates. Please keep in mind that these assumptions are subject to change over time. Basic Planning Assumptions: Bob Mary Description: Date of Birth (Current Age) March 12 th, 1964 (52) January 30 th, 1964 (53) Retirement Date (Age) January 1 st, 2020 (55) January 1 st, 2020 (55) Life Expectancy Government Benefits: CPP Start Age Estimated Benefit 100% 100% OAS Start Age Estimated Benefit 1 100% 100% Indexation Assumption 2.00% 2.00% Income Assumptions: Employment Income $125,000 / year $125,000 / year Indexation Assumption 0% 0% Other Income (Tax-Free): Inheritance in 2025 $300,000 - Indexation Assumption 0% - Lifestyle Expenses: Current and Throughout Retirement $100,000 / year % Allocated 50% 50% If Sole Survivor 80% 80% Indexation Assumption 2.00% 2.00% Other Expenses: Charitable Donations $10,000 / year Indexation Assumption 0% 1 The maximum amount in 2017 is approximately $579 per month. For 2017, part or all of this amount may have to be repaid (clawed back) if your annual net income is above $74,788 and the full OAS pension is eliminated when your net income is $121,071 or above. Compass Financial Plan for Bob and Mary Smith 2

7 Financial Assumptions Assumed Rate of Return on Your Investment Assets: Based on discussions with John Bell, we have assumed that your investment assets will earn a rate of return associated with that of a Balanced investor profile. While this can vary over time, our current Balanced investor profile would have a benchmark asset mix as follows: Asset Type Cash Fixed Equities Income Cdn U.S. Foreign Minimum 0% 25% 13% 13% 10% Benchmark* 5% 40% 20% 20% 15% Maximum 20% 55% 27% 27% 20% * For the purposes of preparing our financial projections, the assumed rate of return for the above portfolio is 6.00%, before income taxes, and a management fee has not been deducted to arrive at this rate of return. We have assumed that the above rate of return will apply to all investment assets including those held by your private corporation. RRSP Contributions: We have assumed that you will both maximize your RRSP contributions annually. Tax Free Savings Account (TFSA): We have assumed that you will both contribute $5,500 (not indexed) to a TFSA annually. Surplus Savings Strategy: When you are expected to have cash flow surpluses or capital receipts, we have assumed that they will be saved to your respective non-registered portfolios when applicable. Retirement Pension Splitting: We have assumed that you will both elect to split your eligible pension incomes for tax purposes, to the extent that you would benefit from doing so. Compass Financial Plan for Bob and Mary Smith 3

8 Financial Assumptions Lifestyle Assets: The table below presents a summary of your lifestyle assets. Description of Asset Home Cottage Ownership Joint Joint Fair Market Value (FMV) $850,000 $200,000 Adjusted Cost Base (ACB) N/A $150,000 Growth Rate 2.00% 2.00% Sale Date Never Never Life Insurance: The table below presents a summary of your life insurance coverage. Type of Insurance Insured Owner Beneficiary Term Life Bob Bob Mary Death Benefit $500,000 Coverage Expires Age 65 (2029) Annual Premium Included in your lifestyle expenses Asset Redemption: When necessary, investment assets are liquidated in order of the lowest tax cost to the highest tax cost. As a result, if necessary, we have assumed that you will draw taxable dividends from your private corporation prior to voluntary payments from your registered plans. RRSP funds are assumed to be converted to a Registered Retirement Income Fund (RRIF) when needed to meet expenses, but no later than the year you turn age 71. Compass Financial Plan for Bob and Mary Smith 4

9 Financial Assumptions Private Shares: The following is a summary of your private share holdings: Bob Mary 50% 50% ABC Inc. ABC Inc.: You each own 50% of the common shares of the company. We have considered the following: Share structure: Common % Number Paid Up ACB Shares Ownership of Shares Capital (PUC) Bob 50% 50 $50 $50 Mary 50% 50 $50 $50 Assets: Asset FMV ACB Growth Sale Rate Date Investment Portfolio $1,580,000 $1,430, % As Needed Operating Company $500,000 $500, % At Retirement Transactions: Investment Deposits From To Amount Indexation (Net of Income Tax) (Date) (Date) Net Earnings $100,000 / year 2017 Retirement 0% Our projections indicate that you will not need to draw taxable dividends from your private corporation to fund your stated goals. Tax Balances: Opening RDTOH Balance Opening CDA Balance $0 $0 Compass Financial Plan for Bob and Mary Smith 5

10 Financial Assumptions Taxes: In preparing the projections, we assume that current tax rates and calculations will not change, and that tax brackets and tax credits will increase by the assumed inflation rate. Annual Asset Yield Assumptions: In the following table, we provide the rates of return used in projecting the income derived from your investment assets. Note that investment income is taxed differently depending on whether it is interest, dividends, realized capital gains, or deferred growth (which triggers a capital gain only when the investment is sold). Although no one can accurately predict how often you and /or your advisor might sell securities and realize capital gains over an extended period, we assume that a portion of your equity portfolio is disposed (and reinvested in the same asset class) each year. This is represented by the Capital Gain rate, whereas the Deferred Capital Gain represents the unrealized capital gains in your portfolio. Asset Type Interest Dividend Capital Deferred Net Total Return Gain Capital Gain Returns* Cash 2.50% 2.50% 0.50% Fixed Income 4.25% 4.25% 2.25% Equities Canadian 2.40% 2.90% 2.20% 7.50% 5.50% U.S. 2.10%** 2.60% 2.80% 7.50% 5.50% Non-North American 2.00%** 2.70% 2.80% 7.50% 5.50% Home 2.00% 2.00% 0.00% *Net of Inflation Assumption of 2.00%. **Dividends paid from foreign holdings do not qualify for the dividend tax credit and are taxed at the same rate as interest income. The rates of return used in our Financial Plans are based on RBC Investment Strategy Committee's long term expectations of the markets and do not take into account exchange rate fluctuations. The following table provides an illustration of historical rates of return for the various asset classes and a comparison with the rates of return used within your financial plan. Please keep in mind that past performance is not indicative of future performance and that the rates used do not necessarily correspond to current market returns. Historical Percentage Returns (as of December 31st, 2015) * 10 years 20 years 30 years Compass Plan Rates Inflation (CPI) 1.63% 1.84% 2.29% 2.00% Cash (FTSE CDN 30 Day T-Bill) 1.57% 2.59% 4.53% 2.75% Fixed Income (FTSE Universe) 5.03% 6.34% 7.96% 4.25% CDN Equities (S&P / TSX Composite) 4.38% 7.63% 7.85% 7.50% U.S. Equities (S&P 500) 9.20% 8.26% 10.33% 7.50% Foreign Equities (MSCI EAFE) 4.83% 4.52% 7.38% 7.50% * Rates of return above are calculated using an applicable index s historical rate of return. All rates of returns are expressed in Canadian dollars. Projected Amounts: Please note that all schedules, tables and graphs in your plan beyond the current year reflect projected amounts in future dollars. For example, the purchasing power of $100,000 in 2030 will not equal $100,000 today, due to inflation. Compass Financial Plan for Bob and Mary Smith 6

11 Your Current Financial Situation Current Net Worth Statement Your net worth statement summarizes your assets as we have understood from our discovery process with you. It serves as a reference point for future comparisons and will provide a means of tracking your progress towards your objectives. Investment Assets (such as non-registered and registered plans) are income producing assets that will fund your current and future objectives. Lifestyle Assets (such as your home) generally do not produce income and are used in your day to day living. The value of your interest in private shares is included separately under the heading Private Shares. Assets (Excluding Private Shares) Bob Mary Joint Total Non-Registered Assets Non-Registered Portfolio 550, ,000 1,200,000 Registered Assets RRSP 325, , ,000 TFSA 50,000 50, ,000 Total Registered Assets 375, , ,000 Lifestyle Assets Home 850, ,000 Cottage 200, ,000 Total Lifestyle Assets 1,050,000 1,050,000 Sub Total 925,000 1,100,000 1,050,000 3,075,000 Private Shares Bob Mary Joint Total Common Shares ABC Inc. 1,040,000 1,040,000 2,080,000 Sub-Total 1,040,000 1,040, ,080,000 Total Net Worth 1,965,000 2,140,000 1,050,000 5,155,000 Compass Financial Plan for Bob and Mary Smith 7

12 Your Current Financial Situation Projected Family Cash Flow Statement (For the Next 5 Years) Your cash flow statement is fundamental in identifying your ability to save, or whether you have any cash flow deficiencies. The amounts below should match the information that you have provided, with the exception of amounts resulting from the assumptions that we have outlined in this report (such as investment income and income taxes). Cash Inflows Employment Income 250, , , Investment Income 54,480 57,875 61,340 70,405 65,470 Capital Redeemed ,716 65,498 Total Cash Inflows 304, , , , ,968 Cash Outflows Lifestyle Expenses 100, , , , ,243 Estimated Taxes 75,543 76,338 77, ,228 Charitable Donations 10,000 10,000 10,000 10,000 10,000 Reinvestment of Investment Income and Surplus Savings Reinvestments of Investment Income 54,480 57,875 58, Surplus Savings 3, Total 57,740 58,229 58, Registered Contributions RRSP Contributions 45,000 45,000 45,000 45,000 0 TFSA Contributions 11,000 11,000 11,000 11,000 11,000 CPP Contributions 5,197 5,308 5, Total 61,197 61,308 61,421 56,000 11,000 Total Cash Outflows 304, , , , ,968 Investment Income includes projected interest, dividends and realized capital gains from non-registered investments and capital gains resulting from the redemption of capital required to fund cash flow needs. Capital Redeemed represents the non-taxable portion of non-registered assets redeemed to fund cash flow needs. Compass Financial Plan for Bob and Mary Smith 8

13 A Look into the Future We will now provide you with an illustration of how your wealth will evolve over time based on the assumptions that we have outlined. The top graph illustrates your cash inflows (total funds received) and cash outflows (which include expenses, income taxes, and any savings) over your lifetimes. The bottom graph provides an illustration of how your net worth (excluding your private shares) is expected to change over your lifetimes. The projected value of your private shares is reflected separately on the following page. Bob Pre-Retired Retired D MaryPre-Retired Retired D 400K Expenses (Except Taxes) 350K Total Tax 300K 250K 200K 150K 100K 50K 0K 8M 7M 6M 5M 4M 3M 2M 1M Total Funds Received Total Net Worth Lifestyle Assets Total Net Worth Year 2053 Amount 7,877,978 0M The fluctuations in the top graph are a result of the following future events: 2020: Reduction in income representing the beginning of your retirements. 2025: Receipt of an inheritance by Bob. Beginning in 2029 (for Bob and Mary): An increase in income from CPP & OAS benefits beginning at age 65. Beginning in 2036 (for Bob and Mary): An increase in income from minimum RRIF payments beginning at age 72. Compass Financial Plan for Bob and Mary Smith 9

14 A Look into the Future The graph below illustrates the projected change in value of your private shares over time. As mentioned in the Financial Assumptions, our projections indicate that you will not need to draw taxable dividends from your private corporation to fund your stated goals. Your Current Financial Situation Projected Net Worth in 2053 Excluding Private Shares Projected Value of Private Shares in 2053 Total Projected Net Worth in 2053 $7,877,978 $8,864,604 $16,742,582 Your total projected net worth in 2053 of $16,742,582 represents $8,207,601 in today s dollars (assuming 2.00% inflation). In comparison, your current net worth is $5,155,000. Finding: Our financial projections indicate that you will have sufficient financial resources to fund all of your stated goals, and that you will have surplus wealth available to transfer to your beneficiaries. Compass Financial Plan for Bob and Mary Smith 10

15 Your Financial Projections Your Projected Income The following table provides you with a breakdown of your projected income by source. Employment Investment CPP/OAS RRIF Total Capital Year Ages Income Income Income Income Inheritance Income Redeemed /53 250,000 54, , /54 250,000 57, , /55 250,000 61, , / , , , / , ,470 65, / , ,461 68, / , ,351 72, / , ,133 76, / , , , / , ,556 75, / , ,296 79, / , ,786 82, / ,829 43, ,043 55, / ,045 52, ,939 51, / ,300 53, ,251 54, / ,212 55, ,243 55, / ,255 56, ,386 57, / ,211 57, ,465 60, / ,071 58, ,470 62, / ,575 59, , , / ,369 60, , , / ,216 61, , , / ,119 63, , , / ,081 64, , , / ,105 65, , , / ,192 67, , , / ,356 68, , , / ,590 69, , , / ,905 71, , , / ,304 72, , , / ,788 74, , , / ,368 75, , , / ,035 77, , , / ,792 78, , , / ,646 80, , , / ,598 81, , , / ,653 83, , ,199 0 Investment Income includes projected interest, dividends and realized capital gains from non-registered investments, and capital gains resulting from the redemption of capital required to fund cash flow needs. Capital Redeemed represents the non-taxable portion of non-registered assets redeemed to fund your cash flow needs. Compass Financial Plan for Bob and Mary Smith 11

16 Your Financial Projections Your Projected Net Worth The following table provides a summary of the expected variation in the different types of assets throughout your lifetimes at the end of each calendar year. Lifestyle Investment TFSA RRSP RRIF Value of Private Total Year Ages Assets Assets Assets Assets Assets Shares Net Worth /53 1,071,000 1,274, , , ,243,374 5,519, /54 1,092,420 1,351, , , ,412,356 5,898, /55 1,114,268 1,429, ,059 1,005, ,587,594 6,292, /56 1,136,554 1,342, ,016 1,110, ,684,397 6,450, /57 1,159,285 1,291, ,222 1,176, ,784,676 6,611, /58 1,182,471 1,235, ,751 1,246, ,888,561 6,776, /59 1,206,120 1,174, ,682 1,321, ,996,184 6,945, /60 1,230,242 1,107, ,100 1,400, ,107,683 7,119, /61 1,254,847 1,334, ,092 1,483, ,223,199 7,597, /62 1,279,944 1,271, ,752 1,571, ,342,880 7,797, /63 1,305,543 1,201, ,180 1,665, ,466,878 8,002, /64 1,331,654 1,125, ,481 1,764, ,595,351 8,214, /65 1,358,287 1,079, ,767 1,870, ,728,463 8,467, /66 1,385,453 1,034, ,156 1,981, ,866,384 8,737, /67 1,413, , ,773 2,099, ,009,289 9,017, /68 1,441, , ,752 2,224, ,157,361 9,306, /69 1,470, , ,232 2,357, ,310,788 9,606, /70 1,499, , ,363 2,497, ,469,766 9,918, /71 1,529, , ,304 2,646, ,634,497 10,242, /72 1,560, , , ,660,244 4,805,192 10,527, /73 1,591, , , ,670,538 4,982,068 10,821, /74 1,623, , , ,677,289 5,165,351 11,122, /75 1,655, , , ,680,189 5,355,274 11,431, /76 1,688, , , ,678,942 5,552,080 11,749, /77 1,722, ,254 1,061, ,673,273 5,756,019 12,076, /78 1,757, ,890 1,135, ,662,373 5,967,353 12,411, /79 1,792, ,072 1,215, ,646,298 6,186,350 12,756, /80 1,828, ,037 1,299, ,624,311 6,413,289 13,110, /81 1,864, ,852 1,388, ,596,006 6,648,461 13,473, /82 1,901,930 1,008,541 1,482, ,561,041 6,892,166 13,846, /83 1,939,968 1,043,342 1,582, ,518,618 7,144,714 14,229, /84 1,978,768 1,080,073 1,688, ,468,319 7,406,427 14,622, /85 2,018,343 1,118,758 1,801, ,409,600 7,677,641 15,025, /86 2,058,710 1,159,608 1,920, ,341,584 7,958,700 15,438, /87 2,099,884 1,202,589 2,046, ,263,888 8,249,963 15,862, /88 2,141,882 1,247,861 2,179, ,175,686 8,551,803 16,297, /89 2,184,719 1,295,605 2,321, ,076,101 8,864,604 16,742, *89/89 1,071, ,136 1,138, ,017,753 4,345,634 8,207,601 *In the final year, we have provided you with both the actual projected dollar values, and the equivalent values in today's dollars, based on an assumed inflation rate of 2.00%. Compass Financial Plan for Bob and Mary Smith 12

17 Alternate Scenarios We will now provide illustrations of how a change in certain key variables could potentially affect your financial projections. Maximum Annual Expenses This analysis illustrates the maximum level of annual expenses (in today s dollars) that your financial resources could support throughout your lifetimes, without drawing on the value of your lifestyle assets. This illustration is intended to provide you with an indication of the strength of your financial position and the amount of flexibility that you may have to incur expenses above the level of your stated goals. BobPre-Retired Retired D MaryPre-Retired Retired D 5.0M Total Net Worth 4.5M Lifestyle Assets 4.0M 3.5M 3.0M 2.5M 2.0M 1.5M 1.0M 0.5M Total Net Worth Year 2053 Amount 2,218, M Under this scenario, we have assumed that all of the current and future liquid assets of your private corporation would be depleted through a stream of annual taxable dividends of $125,000 (not indexed) from 2017 to Your Current Financial Situation Annual Lifestyle Expenses * Projected Net Worth in 2053 Excluding Private Shares Projected Value of Private Shares in 2053 Total Projected Net Worth in 2053 $100,000 $7,877,978 $8,864,604 $16,742,582 Alternate Scenario $198,000 $2,218,634 Depleted $2,218,634 * In today s dollars Your total projected net worth in 2053 of $2,218,634 represents $1,087,626 in today s dollars (assuming 2.00% inflation). Findings: You have significant flexibility to incur expenses above the level of your stated goals. This flexibility may enable you to follow through on other objectives that may be important to you. For example, gifting funds to your children, grandchildren or charitable organizations early, insuring your estate liability (to be reflected shortly), or increasing your spending. Compass Financial Plan for Bob and Mary Smith 13

18 Alternate Scenarios Impact of Lower Returns This analysis is intended to provide you with an indication of the impact a 2.00% reduction in the expected annual investment rate of return could have on your ability to meet your financial goals. As stated in your Financial Assumptions, the expected annual return based on the Balanced investment asset mix is 6.00%. Under this analysis, we have assumed a 4.00% expected annual rate of return. BobPre-Retired Retired D MaryPre-Retired Retired D 5.0M Total Net Worth 4.5M Lifestyle Assets 4.0M Total Net Worth Year M Amount 4,616, M 2.5M 2.0M 1.5M 1.0M 0.5M 0.0M Under this scenario, we have assumed that you would draw dividends from your private corporation at the start of retirement until age 71, as follows: Year Bob Mary 2020 to 2035 (not indexed) $15,000 / year $15,000 / year Your Current Financial Situation Portfolio Return Projected Net Worth in 2053 Excluding Private Shares Projected Value of Private Shares in 2053 Total Projected Net Worth in % $7,877,978 $8,864,604 $16,742,582 Alternate Scenario 4.00% $4,616,579 $5,042,730 $9,659,309 Your projected net worth in 2053 of $9,659,309 represents $4,735,217 in today s dollars (assuming 2.00% inflation). Finding: When considering an expected annual investment return of 4.00%, your financial resources would still be sufficient to fund your stated goals. Compass Financial Plan for Bob and Mary Smith 14

19 Wealth Enhancement Strategies We will now focus on tax and retirement planning strategies that would be expected to enhance the strength of your financial position relative to your goals. Projected Marginal Tax Rate and Repayment of Social Benefits As a framework for certain tax planning strategies, the following table illustrates your projected marginal tax rates: Year Ages Marginal Tax Rate for Bob Marginal Tax Rate for Mary / / / / / / / / / / / / / / / / As mentioned in the Financial Assumptions section, part or all of your OAS pension may have to be repaid (clawed back) if your annual net income is above $72,809 and the full OAS pension is eliminated when your net income is $117,909 or above. In your situation, our projections indicate that you will be subjected to the OAS claw back. The above table reflects the impact of this amount in the calculation of your total tax. Finding: The above projections indicate that your tax burden is lower starting in retirement until you start to receive your pension incomes and minimum RRIF payments. In this section, we have identified tax planning opportunities that may enhance the strength of your financial position. Compass Financial Plan for Bob and Mary Smith 15

20 Wealth Enhancement Strategies Tax Planning Advice and Strategies to Consider: Using Your Financial Assets to Meet Your Income Needs In order to ensure you are using your financial resources wisely, it is important to determine how to best combine your various sources of income to provide the cash required to fund your lifestyle expenses. Choosing which sources of income and which assets to use to cover your expenses and in which order is important as the tax implications resulting from these may vary significantly. Each year, your personal and corporate tax rates may vary considerably, therefore, it is important to consult with qualified tax advisor annually to make the best decision possible regarding which investments to draw on to maximize your after-tax income. Determining which investment assets to draw on: Step 1 The first step is to determine how much after-tax cash flow you will have from various sources of income. Some examples include: Government income sources such as CPP and OAS retirement benefits. Mandatory payments from a RRIF for persons who are over 71 years of age. Investment income which is often variable rather than fixed. Step 2 In any given year when your lifestyle expenses are expected to be greater than the total of the above sources of income, you will need to withdraw from your assets to cover the difference. Generally, it is best to first redeem from assets that attract the least amount of tax such as: Capital dividends from your private corporation (tax free). Withdrawals from a Tax Free Savings Account (tax free). Non-registered assets, beginning with investments that have the lowest accrued capital gains (often little or no tax payable). Taxable dividends from your private corporation (taxable at a preferred rate). Step 3 Once most of the above assets have been depleted you will need to withdraw from assets that may be less tax efficient or fully taxable including: Lump sum RRSP withdrawals (fully taxable) payments above the mandatory minimum. Determining the optimal strategy for redeeming assets to cover an income shortfall in any given year can be a complicated process. While the above is intended to provide you with some guidance, you should always rely on the advice of a qualified tax advisor, to confirm the best strategy for you, particularly where you are considering extracting funds from your private corporation. Please refer to Your Financial Projections for a detailed breakdown of how we have assumed that you will use your financial assets to fund your cash flow needs over time. Recommended Action: We recommend that you consult with a qualified tax advisor annually to ensure that you draw upon your financial assets in the most efficient way possible to meet your needs, based on your personal tax rates and the tax situation of your private corporation each year. Compass Financial Plan for Bob and Mary Smith 16

21 Wealth Enhancement Strategies Individual Pension Plan (IPP) As shareholders and employees of your business, you have the option of considering an IPP as a method of investing for retirement. An IPP is a registered defined benefit pension plan, similar to many large company sponsored plans, except it is established and sponsored by your company and designed for you as the only members. IPPs generally have only one plan member except certain family members may also participate if they are employees of the company. In order to establish a plan you must receive employment income from your company which is reported on a T4 by the company as a salary and/or annual bonus. An IPP is most suitable for those who have significant T4 income and are at least forty years of age. Once you retire, you have options as to how you receive the funds. You could receive a pension from the plan or transfer part or all of the balance to another tax-deferred plan. These options vary by province and are subject to income tax rules. Key benefits of an IPP include: Creditor protection for the pension funds, whereas in many provinces RRSPs offer creditor protection only in the case of bankruptcy. Your company will most likely make larger contributions to the IPP than you could otherwise contribute to your RRSP and depending on your corporate and personal tax rates, an IPP may help you achieve a greater after-tax retirement income as compared to the most likely alternative of maximizing your RRSP and leaving the difference in the company to grow (and paying it out to yourself as a stream of dividends during retirement). If the IPP becomes underfunded due to poor investment performance, then it may be possible for additional funds to be contributed to the IPP to top-up the plan which is not possible with an RRSP. In certain cases using an IPP may provide you with an enhanced ability to split income with your spouse prior to age 65. There are also certain considerations specific to IPPs that you should be aware of which include the fact that: As with other pension plans, the funds are considered locked-in and are subject to certain restrictions which vary by province. The company has the ongoing obligation to fund the plan. Pension plans require additional reporting and actuarial valuations which involve professional fees. An IPP may not offer the same degree of income splitting to which spousal RRSPs can (such as contributing exclusively to a spousal RRSP) since only up to a maximum of 50% of the pension income can be split with a spouse. Note that the above is only a general description of Individual Pension Plans and there are several other additional details to review and consider for you to ensure that this type of plan is appropriate for you and your company. Please ask John Bell for copies of our IPP articles and other materials. Recommended Action: We recommend that you speak with a qualified tax advisor to confirm whether an IPP is appropriate for you and your company, and if so, that you establish a plan with the assistance of John Bell. Compass Financial Plan for Bob and Mary Smith 17

22 Business Planning Business Planning Advice and Strategies to Consider: Through our analysis we have identified the following advice and strategies that would likely enhance your financial situation. Withdrawing Sums of Money from Your Company Since the corporation is a separate legal entity from you, the shareholder, there are certain methods of withdrawing funds or income when you have immediate or short term cash flow needs. Each available method to extract corporate funds results in its own individual tax implications. This allows significant flexibility to choose the method that best fits your own personal and business circumstances. Of the numerous methods available, the most common mechanism to pay funds from your business is to arrange for your corporation to pay you a mix of salary and dividends. The best mix of salary and dividends for your case will require careful consideration of factors such as your cash flow needs, your income level and that of your corporation, as well as your corporation s tax status. Assuming you need to withdraw the cash immediately, your optimum salary and dividend mix will generally ensure that your corporation pays out enough salary to reduce your corporation s active business income to the small business deduction limit. This maximizes the amount of active income that is taxed at a significantly lower small business tax rate while minimizing the impact of higher tax rates on active income beyond the small business deduction limit. Any excess funds that you require may be withdrawn as dividends to take advantage of their favourable tax treatment due to the dividend tax credit. Alternatively, if your company earns active income that is less than the federal small business limit, it s generally better to declare dividends. However, drawing dividends alone will not provide you with earned income to make contributions to your RRSP, CPP benefits, and Individual Pension Plan (IPP) as well as the ability to claim the maximum child care expenses (if their spouse works and earns a higher income). Despite the above general rules concerning whether your company earns active business income over or under the federal small business deduction limit, it is important to note that there is no simple formula that applies in all cases. You should always consult your personal tax advisor to determine the optimum withdrawal strategy that reflects your personal situation. This will require a careful analysis to assess the merits of paying yourself enough salary against foregoing the benefits of a salary in favour of dividends, and perhaps even leaving funds invested in your corporation where your cash flow needs are not immediate. Recommended Action: We recommend that you consult with a qualified tax advisor annually to determine the best salary and dividend mix from your private corporation. Compass Financial Plan for Bob and Mary Smith 18

23 Business Planning Your Corporation s RDTOH and CDA When a corporation earns passive investment income, the corporation must pay an amount of refundable income tax. This refundable tax is intended, among other things, to prevent the deferral of tax when passive investment income is earned through a corporate structure. The total amount of corporate taxes payable on passive investment income (including the refundable tax) varies by province and also depends on the type of investment income earned in the corporation. This refundable tax is tracked through the use of a notional account referred to as the Refundable Dividend Tax on Hand (RDTOH) account and the RDTOH will get cleared out (i.e., the tax is refunded to the corporation) when the corporation pays out sufficient taxable dividends. Paying out taxable dividends would result in the corporation receiving a dividend refund equal to the lesser of 38 1/3% of the taxable dividends paid and its closing RDTOH account. Also, the individual shareholder receiving the taxable dividend must then pay taxes on the dividend income in the year it is received. Based on current income tax rates in Nova Scotia, there may be a deferral of tax when investment income is earned by a corporation and not distributed as a taxable dividend to its shareholders during the same year. The following table illustrates the amount of tax deferral on various investment income earned by the corporation as compared to paying a dividend to a shareholder in the top marginal tax rate. Type of Investment Income If Retained in the Corporation Combined Corporate and Personal Rate When Distributed to Shareholders Resulting Prepayment (or Deferral) of Tax if Left in Corporation Interest 54.67% 59.70% -5.03% Capital Gains 27.34% 29.85% -2.51% Eligible Dividends 38.33% 41.58% -3.25% Non-eligible dividends 38.33% 46.97% -8.64% The above figures are based on the assumption that the shareholder pays tax at the top marginal tax rate, and are based on 2016 Nova Scotia personal and corporate tax rates. Planning Opportunity Regarding the RDTOH In preparing your financial projections, we have made a simplified assumption that investment income earned in your corporation is left in the corporation (with the possible exception of certain significant transactions) unless you require taxable dividends from the corporation to fund your financial goals. Compass Financial Plan for Bob and Mary Smith 19

24 Business Planning Tax-Free Amounts Paid From Your Capital Dividend Account Corporations, like individuals, are subject to tax on only 50% of realized capital gains. When your corporation realizes a capital gain, it may elect to distribute the tax free portion of the gain to you, Canadian resident shareholders, as a tax-free capital dividend. The amount of capital dividends that the corporation may elect to pay is tracked through the use of a notional account balance referred to as the Capital Dividend Account (CDA). The CDA aggregates (among other things) the non-taxable portion of capital gains in excess of capital losses, non-taxable life insurance proceeds and capital dividends received. The aggregate balance in the CDA is reduced by the amount of capital dividends paid. Planning Opportunity Regarding the CDA In preparing your financial projections, we have made a simplified assumption that the corporation does not elect to distribute capital dividends to you in every year that it realizes capital gains even though the nontaxable portion of the capital gains realized is credited to the corporation s CDA balance. However, since a future capital loss could reduce or eliminate the CDA balance (depending on the size of the loss), the corporation may wish to consider making capital dividend payments to you when the CDA has a positive balance. This would provide you with the opportunity to reinvest these funds in your personally owned portfolios and earn investment income which in most cases will be taxed at a lower rate. Recommended Action: We recommend that you consult with a qualified tax advisor about planning opportunities regarding your corporation s RDTOH and CDA to ensure the ideal amount of taxable dividends and capital dividends are paid from your corporations to yourselves each year. Compass Financial Plan for Bob and Mary Smith 20

25 Your Investments Portfolio Asset Allocation The right portfolio asset allocation for you will depend on a number of factors such as your risk tolerance, the purpose of the funds, and the time remaining to meet your financial objectives and goals. Achieving a balance between a variety of investment options such as cash, fixed income, Canadian and or foreign equities is a key element in any investment portfolio. Each investment type provides the investor with different attributes and tax implications. Investment Type Cash Fixed Income Equities Attributes Liquidity for emergencies and investment purchases Stable income and in some cases capital appreciation Capital growth and tax efficiency Tax Treatment Interest income fully taxable at marginal rate Interest income fully taxable at marginal rate Potential for some capital gains; 50% of which would be taxable at marginal rate CDN dividend income taxable at preferred rate Foreign dividends taxable at marginal rate Capital gains; 50% taxable at marginal rate Tax Considerations You can maximize the benefits of your asset allocation by looking at not only the type of investment income being earned, but also by considering which assets you hold in which of your accounts. To maximize tax efficiency the following concepts should be considered: Investments that generate interest and foreign source income (i.e. dividends from non-canadian companies) are fully taxable and should generally be held within your registered accounts in priority to non-registered accounts. Investments that generate capital gains and Canadian source dividends should be generally held within your tax-exposed investment accounts to benefit from their tax preferred treatment. Where possible, investments in individual U.S. stocks (and other securities that are considered U.S. situs assets ) should generally be held in a corporate investment portfolio to reduce potential exposure to U.S. estate tax. It is very important to consider the quality of the investment, and not just the potential tax advantage of the investment. Be sure to speak with John Bell to ensure the investment type is suitable for your situation. Recommended Action: We recommend that you speak with John Bell to evaluate your asset mix and tax efficiencies to determine if adjustments are necessary at this time. Compass Financial Plan for Bob and Mary Smith 21

26 Education Funding You wish to ensure there is a plan in place to provide for the post-secondary education of your grandchildren. We recommend that you consider the following Education Funding Strategy: RESP Contributions by Grandparents Contributing to a Registered Education Savings Plan (RESP) is a wonderful way for you to provide for your grandchildren in a meaningful way. As a grandparent, you may wish to establish an RESP for your grandchildren as the contributor or subscriber of the plan. However, you may also want to consider a slightly different approach. You may want to consider gifting the funds to your son John, who in turn contributes it to an RESP for your grandchildren. In both cases you are providing the financial gift and your grandchildren are the beneficiaries of the RESP. The difference is that, in the latter case, your child is the subscriber of the plan. The advantage of the second approach is that under certain circumstances, if the RESP funds are not used by a qualifying beneficiary, there is an opportunity for the subscriber to transfer the earnings from the RESP to their own RRSP, within certain limits. In order to do this, the subscriber must be 71 years of age or less by December 31 st of the year of the transfer. Considering RESP plans have a potential life span of 35 years (40 for a specified plan, a plan in which the beneficiary is entitled to the disability tax credit), this opportunity, may not exist for you if you are 71 years of age by the time it is known that your grandchildren will not attend school, however it may exist for your son or daughter at that point. The disadvantage of this approach is that you have little or no legal control over the funds. When contributions are made to a plan for which your child is the subscriber, your child has control over the funds, makes the investment decisions and has the ability to withdraw the funds. There may also be a risk that the assets could be subject to claims from your child s creditors or child s spouse in the event of a breakdown in their relationship. Note that the above is only a general description of this strategy and that there are additional details for you to consider. Please ask John Bell for further information and copies of our RESP articles. RESP Subscribers May Wish to Appoint a Successor Subscriber If you choose to establish an RESP plan yourself, the plan belongs to you as the RESP subscriber and not your RESP beneficiaries and therefore you may wish to make arrangements to ensure that if you pass away while the plan is still in existence, that the plan is preserved and maintained for your RESP beneficiaries after your death. The simplest method for you to achieve this is to appoint a successor subscriber someone who will take on your duties with respect to the RESP as part of your Will. If a subscriber passes away, and if the Will does not either appoint a successor subscriber, or give the executor the power to make such an appointment, the RESP may have to be wound up. This may involve returning the RESP contributions to the estate, repaying the remaining grant money to the government and paying regular income tax and a 20% additional tax on the accumulated income within the plan. Recommended Action: We recommend that you speak to John Bell about the different options you have with respect to contributing to an RESP for the benefit of your grandchildren. If you choose to establish an RESP plan yourself, please speak with your estate planning professionals about appointing a successor subscriber for your RESPs in your Will. Compass Financial Plan for Bob and Mary Smith 22

27 Risk Management We will now provide an analysis of your exposure to financial risk in the event of premature death or disability. Risk of Premature Death The following is an analysis of the potential financial impact of a premature death on your financial situation. In addition to the emotional impact associated with the death of an individual there can also be significant financial consequences due to the loss of a spouse s income. A Snapshot if Either Spouse Were to Die Prematurely We have assumed the following would occur if Bob were to die at the end of 2017: All assets will be transferred to Mary. A total of $500,000 would be paid out in existing insurance benefits to Mary. The annual expenses would represent 80% of lifestyle expenses. All other expenses remain unchanged. We have not considered the inheritance of $300,000 that would have been received by Bob. Bob s employment income would cease at the end of Bob s share of the private company would transfer to Mary at the end of The earnings of your private company would remain the same. We have not considered dividends from your private corporation in this analysis. We have assumed the following would occur if Mary were to die at the end of 2017: All assets will be transferred to Bob. No insurance would be paid out. The annual expenses would represent 80% of lifestyle expenses. All other expenses remain unchanged. Mary s employment income would cease at the end of Mary s share of the private company would transfer to Bob at the end of The earnings of your private company would remain the same. We have not considered dividends from your private corporation in this analysis. The following projects the value of the survivor s net worth should either spouse die at the end of 2017: Your Current Financial Situation If Bob were to die in 2017 If Mary were to die in 2017 Projected Net Worth in 2053 Excluding Private Shares Projected Value of Private Shares in 2053 Total Projected Net Worth in 2053 $7,877,978 $8,864,604 $16,742,582 $8,898,863 $8,864,604 $17,763,467 $7,546,459 $8,864,604 $16,411,063 Finding: Our analysis indicates that your current life insurance coverage and financial resources are sufficient to provide for the survivor s needs in the event of either spouse s premature death. Compass Financial Plan for Bob and Mary Smith 23

28 Risk Management Risk of Permanent Disability The following is an analysis of the potential financial impact of a permanent disability on your financial situation. A Snapshot if Either Spouse Were to Become Disabled We have assumed the following would occur if Bob were to become disabled at the end of You do not currently have disability insurance coverage. We have assumed that you will not be entitled to any CPP disability benefit. Your annual expenses in the event of disability remain unchanged. Your employment income would cease at the end of The earnings of your private company would remain the same. We have not considered dividends from your private corporation in this analysis. We have assumed the following would occur if Mary were to become disabled at the end of You do not currently have disability insurance coverage. We have assumed that you will not be entitled to any CPP disability benefit. Your annual expenses in the event of disability remain unchanged. Your employment income would cease at the end of The earnings of your private company would remain the same. We have not considered dividends from your private corporation in this analysis. The following projects the value of your net worth should either spouse become permanently disabled at the end of 2017: Your Current Financial Situation If Bob were to become disabled in 2017 If Mary were to become disabled in 2017 Projected Net Worth in 2053 Excluding Private Shares Projected Value of Private Shares in 2053 Total Projected Net Worth in 2053 $7,877,978 $8,864,604 $16,742,582 $7,219,877 $8,864,604 $16,084,481 $7,235,950 $8,864,604 $16,100,554 Finding: Our analysis indicates that your financial resources are sufficient to provide for your needs in the event of a permanent disability. Compass Financial Plan for Bob and Mary Smith 24

29 Risk Management Risk Management Advice and Strategies to Consider: Through our analysis, we have identified the following advice and strategies that would likely enhance your overall plan to manage risk. Critical Illness Insurance Being diagnosed with a critical illness is a growing concern for many people because of the physical, emotional and financial challenges it can present and as a business owner the implications can be far greater and affect many other people. Critical Illness Insurance (CII) was designed to help people, diagnosed with one of many serious illnesses covered under the plan, fund their treatment and recovery by providing a lump sum, tax-free benefit. You may use the funds in any way you feel is appropriate which may include: Helping to cover costs of health care or treatment services that aren t covered in your province (such as alternative treatments, private clinics, access to foreign specialists, etc.). Having access to a lump sum for any type of expenses without having to redeem, withdraw from or sell assets which you may not be otherwise ready to do. Providing additional cash to help maintain your business while you are away or focused on your health. Critical Illness Insurance may provide you with additional funds to supplement the personal care you may need in your home. The benefit could give you options to choose how you are treated or cared for. As business owners, your ability to generate income for yourselves and your family and to maintain the business for your employees and clients can be seriously affected by a critical illness affecting either one of you. Critical Illness benefits can provide your business with additional funds so you can continue to pay your staff, hire someone to take your place while you recover and have additional choices as to how your family will deal with these challenges. A Critical Illness plan may help you guard your net worth and family assets by providing you with additional options. This may relieve some financial pressure for you and your family so you can focus on your priority your health. Recommended Action: We recommend that you, together with John Bell, meet with a licensed insurance specialist to further explore the benefits and details of Critical Illness Insurance. Compass Financial Plan for Bob and Mary Smith 25

30 Risk Management Asset Protection with Long Term Care Insurance The success of your goals is based on certain assumptions in income, savings, and expenditures which effectively shape your financial future. What if something unforeseen happens and you become unable to care for yourself? You may have to sacrifice your savings (non-registered and registered) or sell your assets (home, cottage, art collection) to provide the care you need. Requiring long term care can be a challenging time emotionally but also financially as you try to meet costs related to care. It can also be a burden on families who try to pool resources (time and money) to try to help. Long Term Care Insurance provides an income stream and was designed to help people receive the treatment they need in the location that they desire. This can include facility care (such as nursing homes), or care can be provided in the comfort of your own home or retirement dwelling. The choice is yours. As a wealth management planning tool, Long Term Care Insurance (LTCI) provides asset erosion protection. The benefits may help protect the estate you ve worked hard to accumulate and grow. Even if the entire care cost is not covered, because care costs can change at any time, even being able to cover a portion of your care need can have a substantial estate planning effect. Recommended Action: We recommend that you, together with John Bell, meet with a licensed insurance specialist to further explore the benefits and details of Long Term Care Insurance. Compass Financial Plan for Bob and Mary Smith 26

31 Your Estate Plan We will now provide an analysis of the following key areas of your estate plan: The Status of Your Wills and Powers of Attorney. Taxes upon Death. The Status of Your Wills and Powers of Attorney Your Wills There are generally four methods of transferring assets (illustrated below) that should be considered when creating or refining your estate plan. Your Will represents the most common means of transferring estate assets. Your estate planning professional can provide you with details on how all of these methods can be combined to achieve the intended distribution of your wealth during your lifetime and on death. A sound financial plan should consider the effective transfer of your estate to your intended beneficiaries. Ignoring this aspect of your financial plan could result in additional costs and complexity and may result in undue hardship for your heirs. The distribution of an estate can be an emotionally charged period that may result in friction between family members. It may be beneficial to discuss your estate plan with beneficiaries to ensure your intentions are understood. Having a valid Will that reflects your wishes is likely the most important element of your overall estate plan. Compass Financial Plan for Bob and Mary Smith 27

32 Your Estate Plan Your Powers of Attorney These types of documents are referred to by different names depending on your province of residence. Powers of Attorney generally provide a designated individual with the ability to represent you in two main areas; dealing with your financial and business arrangements (managing property) and dealing with matters that involve your personal care. Powers of Attorney are very important documents to have in place, particularly in the event that you were to become incapacitated or otherwise unable to manage your affairs on your own. If you do not have a named attorney to act on your behalf, it may be necessary to apply to the courts for the appointment of someone to attend to your affairs. Findings: You have indicated that although you have Wills in place, they do not reflect your current wishes and need to be reviewed and updated. You have also indicated that you do not have Powers of Attorney in place. Recommended Actions: We recommend that you review your Wills with a qualified legal advisor, and update them if necessary. We also recommend that you have a qualified legal advisor draft your Powers of Attorney as soon as possible. Review your legal documents on a regular basis. Compass Financial Plan for Bob and Mary Smith 28

33 Your Estate Plan Estate Planning Advice and Strategies to Consider: Through our analysis we have identified the following advice and strategies that would likely enhance the effectiveness of your overall estate plan. Appointing a Professional Executor An important decision to make when updating your Wills is choosing your executor. Settling an estate can be a very time consuming and complicated process. You will want to ensure you choose someone who you trust and who has the required time, knowledge and desire to carry out the required work. Naming someone as your executor who is not able or does not have the time or expertise to settle the estate can be a disservice to them and to your beneficiaries. As a result of owning a business, settling your estates may involve additional complexities. A more complicated estate could result in a greater risk of errors, missed tax planning opportunities, and other issues for an inexperienced executor to address. Duties of an Executor Take Preliminary Steps Protect Estate Assets Assemble Inventory and Value Assets Read and interpret Will and meet with family, Safeguard all assets, Communicate with all beneficiaries in the Will, Review the estate settlement and administration process with the beneficiaries. Review insurance required on estate assets, Ensure on-going management of private business, Protect real estate. Write to financial institutions, Notify Investment Advisors, bankers, business associates, Complete claims for life insurance, & company & government pensions, Value investments, collect income and manage investments, Value real estate, business, cars, household and personal effects, Prepare inventory of assets and liabilities, File notice of closure of inventory with Registrar. Administer Estate Distribute Estate Close bank, investment accounts, safety deposit boxes, collect insurance proceeds, Arrange for the residence(s) to be emptied, locks changed and the property sold, if necessary, Register assets in estate s name, Arrange for sale of business and/or real estate if required, Deliver household and personal effects bequeathed to beneficiaries, Convert assets to cash to pay off debts and taxes if necessary, Prepare and file income tax returns, Maintain all necessary tax and financial records, Obtain tax clearance from the Canada Revenue Agency and discharge debts. Pay legacies, other bequests, and residue of estate, Establish trust(s) per instructions in the Will, Submit full accounting to beneficiaries and obtain release, File notice of closure of accounting with Registrar, Act as trustee per instructions in the Will. Please ask John Bell for a copy of our publications which provide more information about the executor s role and responsibilities and options with respect to appointing a professional executor. Recommended Action: We recommend that when updating your Wills, you consider appointing a professional executor. Compass Financial Plan for Bob and Mary Smith 29

34 Your Estate Plan Testamentary Trusts As an alternative to an outright distribution of your estate assets, you may want to consider using a testamentary trust to provide for your beneficiaries as part of your estate plan. A testamentary trust is created when estate assets are transferred into a trust based on instructions in your Will. In order for this strategy to be successful, arrangements must be made in advance and specifically documented in your Will. The assets are held in the trust, invested and managed by the person you appoint as the trustee and the income and capital is distributed to the beneficiaries in accordance with your wishes. Holding assets for a minor beneficiary As part of your estate plans, a testamentary trust can be established to hold assets for a minor beneficiary until they reach the age of majority, or another age which you deem appropriate. If you wish you could make provisions for the trust to fund certain expenses such as private school or post-secondary education, general living expenses, a down payment on a home, or any other expense until the balance of the funds are distributed. As an alternative to distributing all the assets to the beneficiary at a certain age, you could have certain amounts you feel appropriate released at specific points in time or specify a regular distribution over time. Protecting a beneficiary s inheritance from potential claims from creditors or their spouse in the event of a breakdown in their relationship Assets which form part of a testamentary trust are legally owned by the trust. This could help you to protect your beneficiary s inheritance from their potential creditors, including their spouse or future spouse in the event of a breakdown in their relationship. Leaving assets for the benefit of a beneficiary without providing them with outright control A testamentary trust is a very flexible tool which could help you to leave assets for your beneficiaries without providing them with outright control of the assets. When assets are transferred to a testamentary trust, the trustee you appoint will be responsible for managing the funds in the trust on their behalf. A testamentary trust also allows you to make provisions to have certain amounts you feel appropriate released at specific points in time or to set-up a regular distribution over many years. You also have the option of providing the trustee with some or full discretion in making decisions with regards to how much or how often funds are made available to your beneficiaries. As a result of recent legislative changes, beginning in 2016, all income earned in most testamentary trusts will be subject to taxation at the top marginal tax rate, subject to two exceptions. First, graduated tax rates will generally apply to income earned in an estate for the first 36 months after a taxpayers' death. Second, graduated rates will continue to apply to testamentary trusts for the benefit of disabled individuals who are eligible for the disability tax credit, where the trust and the qualifying beneficiary jointly elect for the trust to be a qualified disability trust for a particular tax year. It is important to consult with a qualified tax and legal advisor regarding these changes. Recommended Action: We recommend that you consider the use of a testamentary trust as part of your estate plan and that you speak with a qualified legal advisor to discuss the most appropriate way of structuring it based on your specific situation. Compass Financial Plan for Bob and Mary Smith 30

35 Your Estate Plan Vacation Property Succession Planning When you own a vacation property, there are implications on gifting the property during your lifetime or transferring it as part of your estate. The following are three main ways to transfer your vacation property and subsequent issues to consider when choosing the option that best suits your needs and objectives. Option 1: Give the property away to your intended beneficiaries during your lifetime: If your children will inherit the property and you expect it to appreciate significantly, consider gifting it to them now. Although this results in a disposition at market value which will trigger accrued capital gains to you today, the future capital gains tax is deferred to your children and probate taxes on the vacation property may be avoided in your estate. Also, if the property is sold to your children, in some cases you can spread the recognition of the capital gain for tax purposes over five years. Some of the reasons why you might want to transfer it to them now include: You are comfortable giving up ownership & control. You are prepared to pay taxes on a disposition at market value today. Your use of the property is minimal, and your children regularly use the vacation property. Option 2: Transfer the ownership to an Inter-Vivos Family Trust Another option is to transfer the vacation property to a trust for the benefit of your beneficiaries. This method allows you to maintain control over the property; however, it also results in a disposition at market value. In addition, every 21 years, there is a deemed disposition at market value of the vacation property within the trust and tax on any accrued gains must be paid at that time. Some of the reasons why you might want to transfer ownership to an Inter-Vivos Family Trust include: You want to maintain control over the property and structure it in such a way that sets clear guidelines on use and maintenance of the vacation property. You are prepared to pay taxes on a disposition at market value today. You want to control how your beneficiaries interests in the Trust are treated upon your death. Option 3: Gift it to your beneficiaries through your Will Leave the vacation property to one or more family members under the terms of your Will. Some options include granting children the option to buy the property, allowing a child to take the property as part of their share in the estate, or creating a trust to hold the vacation property under the terms of your Will. Some of the reasons why you might want to transfer the property at death include: You want to retain ownership and controls over the use of the vacation property while you are alive. You would prefer to have your estate pay any taxes on the disposition of the vacation property, deferring taxes for as long as possible. Compass Financial Plan for Bob and Mary Smith 31

36 Your Estate Plan Minimizing the Capital Gain Regardless of the succession planning option chosen, two strategies to minimize capital gains tax on the disposition or deemed disposition of your vacation property are: Ensure that vacation property renovation costs are tracked as they add to the cost of the property for tax purposes and will reduce any future capital gain. Use your principal residence exemption to reduce or eliminate capital gains tax on the property. Note only one principal residence can be designated per family unit for years after If the exemption to minimize the capital gains tax is used for the vacation property, then it cannot be used to reduce tax on the disposition of your family home or on any other property related to years after Insurance Considerations Life insurance can be used to pay any capital gains taxes triggered by the disposition of the property when your estate is settled. It also creates a pool of funds to pay children who may not be interested in inheriting the property. In addition, life insurance can be used to provide your children with the money necessary to pay for the maintenance and expenses related to the property. Since your children will benefit from this insurance coverage, consider asking them to pay the premiums. Recommended Action: We recommend that you speak with a qualified legal advisor about the different succession planning options for your vacation property. Compass Financial Plan for Bob and Mary Smith 32

37 Your Estate Plan Taxes upon Death When you die, there are potential taxes and fees that may be payable by your estate. These generally consist of the following: Income Tax Due to the Deemed Disposition Rules: The deemed disposition rules of the Income Tax Act treat all capital property owned by the deceased (including shares of your private corporations) as if it was sold at fair market value immediately prior to death (unless your assets are transferred to a surviving spouse). Therefore, all unrealized capital gains and losses are triggered at that point, potentially resulting in an income tax liability. Deregistration of Registered Accounts: It is necessary to deregister (i.e. collapse) any registered assets such as RRSPs or RRIFs at the point of death. The full value of any registered asset must be included on the deceased s final tax return. There are exceptions to this de-registration requirement: If the registered asset is left to the surviving spouse and under certain circumstances to a financially dependent child/grandchild, it can be transferred on a tax deferred basis to the surviving party s own plan. U.S. Estate Tax on your U.S. Assets: In addition to the taxes payable in Canada, your estate may also be liable for U.S estate taxes if the value of your worldwide estate and value of assets considered to be situated in the United States (referred to as U.S. Situs Assets ) exceed a certain threshold amount. Estate Tax Issues Related to Your Private Corporations: Individuals owning shares in a Private Corporation at death can be subject to double-taxation. First, there is tax on the capital gain, if any, resulting from the deemed disposition at death of the shares of the Private Corporation owned by the shareholder. Second, on the actual sale of the underlying capital property within the Private Corporation there is tax to pay on any gains realized. It may be possible to defer or eliminate this potential double tax if the shares of the company were to pass to a spouse or a spousal trust, or if the Private Corporation was wound up within the first taxation period of the estate. In our estate calculations, we assume that your Private Corporations will be liquidated upon your death, and the net proceeds, after-tax, in the company will be paid to your beneficiaries during the first taxation year of your estate. Be aware, however, that the actual taxes will differ from that shown if these actions are not taken during that one year time frame. Probate Fees: Upon death, the executor of your estate will typically be required to file for probate with the provincial court. The executor of your estate must submit the original Will and an inventory of your assets. With the executor s submission to the court, he/she must also remit a probate fee. This fee is based on the total value of the assets that flow through the Will. Nova Scotia Probate Fee First $100,000 $973 Plus: More than $100,000 $16.45 per $1,000 For example, an estate of $1,000,000 would be subject to $15,778 of probate fees. Note that we have not considered probate fees or U.S. estate taxes in our projections. Compass Financial Plan for Bob and Mary Smith 33

38 Your Estate Plan Projected Estate Shrinkage - End of 2017 We will now provide an estimate of the expected reduction in the value of your estate, known as estate shrinkage. Estate shrinkage is due to taxes payable upon death and estate expenses. The calculation of estate shrinkage consists of comparing the total of income taxes payable and estate expenses to the amount of insurance coverage in place at death. Estate enhancement (negative estate shrinkage) will arise when your insurance benefits exceed the additional taxes and expenses payable on death in a given year. The following analysis illustrates the impact of insurance, taxes and expenses on your estate should you both die at the end of 2017: Bob Mary Non-Registered 585, ,585 Non-Registered Portfolio Registered RRSP 366, ,340 TFSA 58,808 58,808 Sub-Total 425, ,148 Lifestyle Home 433, ,500 Cottage 102, ,000 Sub-Total 535, ,500 Net Worth 1,546,373 1,730,233 Life Insurance Proceeds 500,000 0 CPP Death Benefits 2,500 2,500 Estate Before Taxes & Expenses 2,048,873 1,732,733 Estimated Taxes (204,209) (247,923) Funeral Expenses (15,000) (15,000) Sub-Total 1,829,664 1,469,810 Estate Shrinkage / (Enhancement) (283,291) 260,423 Private Shares Bob Mary Value of Private Shares 1,121,687 1,121,687 Estimated Taxes 1 (442,954) (442,954) Sub-Total 678, ,733 Estate Shrinkage / (Enhancement) 442, ,954 Final Estate 2,508,397 2,148,543 Total Estate Shrinkage / (Enhancement) 159, ,377 Should you both die in 2017 our projections indicate that your estate would decrease by approximately $863, In estimating the taxes payable on death relating to your private shares, we have assumed that the shares would be redeemed by the corporation. Compass Financial Plan for Bob and Mary Smith 34

39 Your Estate Plan Projected Estate Analysis - Over Time The following graph illustrates the amount your estate would be reduced if you both were to die in a given year. This reduction in the value is due to estate expenses and taxes payable upon death and is called estate shrinkage. We have analyzed your plan from 2017 to 2053 to estimate the amount of estate shrinkage you are likely to encounter on death in each of these years. The average estate shrinkage you will face is approximately $2,600,000, with the largest estate shrinkage of about $5,000,000 occurring in The change in estate shrinkage between the years 2028 and 2029 is due to the assumption that Bob s term insurance coverage will cease at the end of 2028, at the age of 65. Finding: The total average estate shrinkage you will face is approximately $2,600,000. Recommended Action: If you wish to preserve the full pre-tax value of your estate for your beneficiaries, we recommend that you meet with John Bell and a licensed insurance specialist to discuss insuring the average estate shrinkage expected over the projection period. Compass Financial Plan for Bob and Mary Smith 35