Investment planning with couples

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1 Investment planning with couples Couples generally plan and work together to improve their future; this may include growing their assets, managing debt and property. As part of this process, spouses may employ different planning methods and use various tax-effective strategies to help accomplish their goals. The example below is provided to highlight general tactics couples may consider when optimizing their tax planning. Note: The following information in general in nature and applicable to all provinces except Quebec. Please see page seven for specifics related to Quebec. Example: Meet Tom and Louise After 15 years of marriage, Tom and Louise have developed a detailed investment plan for their life. This plan includes: Spousal registered retirement savings plans (RRSPs)* Tom has an annual income in excess of Louise, so they plan to split retirement income in the future by Tom contributing into Louise s RRSP in addition to his own. This will enable Louise to draw from her RRSP once the couple is retired. The couple has designated each other as the beneficiary on their RRSPs to ensure they take advantage of the tax-free spousal roll-over at death. Their children have been named contingent beneficiaries. *Note: contribution limits to deposits made to spousal RRSPs exist. Consult a tax professional for more details. Tax-free savings accounts (TFSAs) Tom and Louise are also fully funding their TFSAs. They plan to supplement their retirement income with tax-free withdrawals from their TFSAs on an as-needed basis. This will help them control their taxable income level in retirement and also provide them an emergency source of funds that is not taxable when accessed. Tom is able to gift money to Louise for contribution to her TFSA without attribution consequences. The total contribution limit since inception is $25,500. The couple has designated each other as a successor holder on their TFSAs to allow them to keep the TFSA intact upon rollover to the spouse at death (if the spouse was a beneficiary only, there are certain conditions that must be met in order to have the TFSA transferred tax-free). They also have their children listed as beneficiaries. 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, advice should be obtained from the appropriate professional advisors. This information is provided by London Life Insurance Company and is current as of November, London Life Insurance Company, all rights reserved. London Life and design are trademarks of London Life Insurance Company.

2 Segregated fund policy The couple has their non-registered savings invested into a segregated fund policy. They like the death and maturity guarantees with this investment, as well as the potential for creditor protection it may provide 1. This investment is a joint-owned policy with Tom as the annuitant and their children as beneficiaries. Other assets The couple has also amassed other assets such as their matrimonial home, term life insurance policy to cover their mortgage, and Tom has a pension plan at his place of employment. Any property amassed during a marriage would be considered matrimonial property. Here is a summary of the couple s assets: Asset Amount RRSP Tom 250,000 RRSP Louise 150,000 TFSA Tom 25,500 TFSA Louise 25,500 Segregated fund policy 200,000 House (net of mortgage) 300,000 Pension plan 200,000 Divorce No discussion about marriage would be complete without a brief discussion about divorce. Approximately 70,000 divorces every year in Canada 2, and these have an impact on the financial security plans couples make. When a divorce occurs, spouses will have to consider how to handle the division of assets. This will usually involve a separation agreement, which would specify how all assets would be divided. Generally, any tax planning the couple have in place to date would be undone during this process of splitting assets. This will likely be an emotional negotiation, but it is important to try to put emotions aside so spouses can protect themselves. The assistance of a mediator or a legal counsel will help keep emotions out of decisions. 1 Creditor protection depends on court decisions and applicable legislation, which can be subject to change and can vary from each province; it can never be guaranteed. Your client should talk to their lawyer to find out more about the potential for creditor protection for their specific situation. 2 Statistics Canada, 2008

3 There are some immediate concerns for certain types of assets that will have to be considered: Change PINs and access codes for bank cards, credit cards and investments Notify financial institutions to freeze any joint accounts, lines of credit or credit cards Open own bank accounts and apply for own credit card(s) Review and potentially change beneficiary designations on life insurance policies, segregated fund policies, pension plans and other registered accounts o Beneficiary designations revoked upon divorce o Potential for creditor protection Update will and powers of attorney information Tom and Louise revisited Tom and Louise have decided it is in their best interest to divorce. At this point in time, an agreement has been made to settle on a division of matrimonial property in the amount of 50 per cent each. At the point of asset division, there are a number of concerns to address from both a planning and tax perspective. Here is a summary of the couple s assets split up: Asset Amount Tom Louise RRSP Tom 250, ,000 RRSP Louise 150, ,000 TFSA Tom 25,500 25,500 TFSA Louise 25,500 25,500 Segregated fund 200, , ,000 policy House (net of 300, ,000 mortgage) Pension plan 200, ,000 Total 1,151, , ,000 Spousal RRSPs Each person will keep their RRSP intact at the current value. This is the easiest way; even though upon a divorce, an RRSP can be split with an ex-spouse on the break-down of a marriage tax-free, many forms are required to ensure the transfer happens in this manner. It s possible for errors to occur and cause taxable income to one or both parties. A new beneficiary would have to be named by each person.

4 TFSAs As above, each person will keep their TFSA intact at the current value. The successor holder should be removed from each TFSA and the beneficiary designation reviewed. There are no tax implications to this split. If there is a situation where the TFSA must be split, it cannot be processed as a partial intact transfer; it must be handled as a redemption and purchase. Some difficulties may surface; when an amount is redeemed from a TFSA, contribution room is generated for the same amount, but it is not effective until Jan. 1 of the following year. Segregated fund policy This policy will be split to ensure the division of assets is 50 per cent each. Half of the policy value is able to be transferred to the ex-spouse, based on the separation agreement or court order received. However, the policy would be processed as a non-intact transfer and any deferred sales charges, if applicable, would be charged. Each will become an annuitant of their own policy. The original beneficiary designation of the spouse will be revoked automatically upon divorce. Beneficiaries will have to be renamed on each policy. Potential for creditor protection and multiple designations can be maintained by naming at least two children. Other assets The house (net of the mortgage) will be transferred to Louise, so she has a place to raise the children with the least disturbance possible. The term policy on the mortgage really has no value at the current time, but should remain in place to protect the mortgage The transfer of the house deed and mortgage documentation may take some time and have slight fees involved. The value of the pension plan was determined by an actuary to be $200,000. This amount will remain the property of Tom in the calculation of his 50 per cent. Remarriage If remarriage is considered, clients should ensure the new marriage won t leave the first family vulnerable. It might be surprising to learn a new spouse may have rights that will supersede a first family s rights when it s time to settle an estate. Legal counsel and/or financial security advisors can help with strategies that may gift money to a first family or setting up a trust. A client may also want to consider: Cohabitation agreement before moving in together Prenuptial agreement before marrying Marriage or civil union agreement after the second marriage

5 These legal arrangements can spell out the ownership and inheritance of property and minimize conflict down the road. A formal agreement will establish each partner s rights and obligations. This is especially important for: Matrimonial home o When a new spouse moves in, the house may be included in any future divorce settlement. Investment assets and business assets o If there is no effort to keep these assets separate from a spouse s assets, they may be considered as jointly held assets and subject to consideration in any future settlement. These are important considerations if an individual is planning to leave a portion of these assets to their first family. Additional considerations: Status of a common-law spouse A common-law spouse s rights may be quite different from a married spouse s rights. For example, in Ontario, the Family Law Act does not entitle common-law spouses to an equal share of matrimonial assets, although, they may be eligible for support payments. Similarly, the Succession Law Reform Act of Ontario does not give common-law spouses any automatic inheritance rights. Estate plans In most provinces, a new marriage revokes an existing will, so it s critical, at a minimum, to have a new will drawn up. If an individual dies intestate (or without a will), a default division of assets occurs and the beneficiaries of the individual may have wanted to leave certain assets to, may not be included. Spousal trust A useful estate planning tool is a spousal trust. When a spouse dies, this trust would ensure the surviving spouse is looked after while they re alive. After the surviving spouse dies, any money remaining can be passed along as designated. However, without a spousal trust, the surviving spouse is free to leave inherited assets to anyone of their choosing. Living happily ever after Over the years, client s needs, along with their first and subsequent family s needs, will change. Additional considerations for clients: Update estate plans as any life events occur, including any trust arrangements that may be required as beneficiaries age Amend cohabitation, marriage or separation agreements as required Occasionally confirming all beneficiary designations on life insurance policies, segregated fund policies, pension plans and other registered products are appropriate

6 Segregated fund policy based strategies are especially helpful; they provide the ability to directly name beneficiaries to each policy and can help protect the intended recipient from future court challenges. These investments can also protect privacy (except in Saskatchewan), provide a timely payout to named beneficiaries, and bypass the estate. In provinces where provincial estate administration taxes (probate) are a percentage of estate assets, significant dollars can be saved. Segregated fund policies may also offer an annuity settlement option that allows the transfer of assets into a payout annuity that provides ongoing cash flow to beneficiaries instead of a lump sum. All provisions made to protect loved ones should be discussed with those involved to prevent surprises and costly court battles. Clients should ensure their executor and legal advisor know where to find the will and powers of attorney if anything were to happen. Advanced planning and professional guidance from legal counsel and financial security advisors will allow clients to create a plan to take care of all the loved ones in their life.

7 Insights into the Quebec landscape The Civil Code of Quebec treats certain aspects of marriage, civil union, divorce and inheritance differently than the common law that governs the rest of Canada. Here is an overview of some Quebec rules: Wills can be prepared by the testator himself or by either a lawyer or a notary (both are referred to in this article as a legal advisor ). Common law spouses have no rights under the Civil Code of Quebec and the family patrimony rules do not apply to them. The division of assets will be of a contractual nature depending if there was an agreement between the common law spouses when they decided to live together. Common law spouses are not considered legal successors, so a will is important to protect each spouse. The Quebec Tax Act recognizes common law spouses, hence some tax benefits may be used (for example, the tax-free rollover between spouses). Common law spouses are also recognized by the Supplemental Pension Plans Act; hence, any locked-in plan recognizes a common law spouse and this person could take precedence over any beneficiary. The owner of a RRSP or TFSA issued by a trust cannot name a beneficiary or a successor holder (subrogated policyowner in Quebec). Only life insurance policies or annuities issued by a life insurance company allow for the designation of a beneficiary. These contracts can be registered as RRSPs or TFSAs. A divorce, nullity of a marriage, dissolution of a civil union or separation from bed and board will provoke the division of assets. The majority of divorces are settled during mediation. When a married spouse is named as a beneficiary within a life insurance policy or a segregated fund policy, the default designation is irrevocable unless stipulated otherwise on the form, which means an individual cannot change the designation without the spouse s consent, except after divorce. When a common law spouse is named as an irrevocable beneficiary, the designation can never be changed without the spouse s consent. A divorce, nullity of marriage or dissolution of a civil union automatically revokes the ex-spouse as revocable or irrevocable beneficiary of a life insurance policy or a pension plan; it also revokes the exspouse as subrogated policyowner, successor holder or annuitant/payee. A marital breakdown also revokes the ex-spouse as legatee or liquidator of the estate. After the marital breakdown, the owner should rename a new beneficiary and a new successor holder. As a general rule, when discussing property accumulated by a couple during their marriage, keep in mind that the family patrimony rules apply to all married or civil union spouses, notwithstanding their marital regime. Not all assets form part of the family patrimony. For example, insurance policies and non-registered annuity contracts are not part of the family patrimony, but they can form part of the matrimonial regime.

8 Non-registered segregated fund policies do not form part of the family patrimony. Therefore, they are not automatically subject to a division. If the spouses were married under the partnership of acquests, an amount could be requested as compensation. The policy itself would not be divided. Pension plans are part of the family patrimony and they can be divided equally; half of the value of a participant s account could be transferred into his/her ex-spouse s locked-in account. If the house was the property of one of the spouses before the marriage, it does not form part of the familial patrimony. A trust can be appointed as beneficiary, provided it has been established by a contract or a Will. No payment can be made to a person designated as trustee based only on a designation made on a life insurance form. The trust needs to exist at the time the benefit becomes payable. A policyowner is not entitled to choose a life annuity settlement option for the beneficiary. This can only be elected by the beneficiary once the sums