The March 22, 2016 federal budget has resulted in significant changes to the credit to the capital dividend account arising upon the receipt of life insurance proceeds. While these proposals are not yet final, it is expected they will be enacted before the end of 2016 with certain retroactive effect.
The credit to the capital dividend account for the receipt of life insurance proceeds is found at paragraph (d) of the definition of “capital dividend account” in subsection 89(1) of the Income Tax Act (ITA).
In general terms, paragraph (d) of the definition of the “capital dividend account” is comprised of a series of components (subparagraphs i through vi) as follows:
• Subparagraph (i) is the proceeds of a life insurance policy of which the corporation was a beneficiary onmor before June 28, 1982 received by the corporation in the period and after 1971 in consequence of the death of any person.
• Subparagraph (ii) is the proceeds of a life insurance policy (other than a “LIA policy” – leveraged insurance annuity policy) of which the corporation was not a beneficiary on or before June 28, 1982 received by the corporation in the period and after May 23, 1985 in consequence of the death of any person.
The June 28, 1982 and May 23, 1985 dates referenced above are to recognize that for a period of time there was the “life insurance capital dividend account” that tracked life insurance proceeds received by a corporation. This account ceased to track life insurance proceeds received by a corporation after May 23, 1985.
It is important to note that if a life insurance policy meets the definition of a LIA policy (as defined in subsection 148(1)), then the proceeds are not added to the capital dividend account.
The change to this provision creates some uncertainty in situations where there are multiple corporate beneficiaries of the same policy (i.e., such as a split dollar arrangement, shared ownership or split beneficiary designation). This now creates the question: does each beneficiary reduce their capital dividend account calculation by the entire policy’s adjusted cost basis, or a proportional amount based on the amount of life insurance proceeds received?
New subparagraph (v) will reduce the capital dividend account credit by $125,000 when Stan’s company eventually receives the life insurance proceeds. This represents the amount by which Stan’s consideration of $200,000 exceeds the greater of cash surrender value ($50,000) and adjusted cost basis ($75,000) immediately before the transfer.
The reduction caused by new paragraph (v) will be a fixed amount and will not vary over time. The information necessary to make this calculation will likely be available from the original transfer documents. This necessitates that information be preserved and made available to the tax professional, who will be calculating the company’s capital dividend account credit after the insurance proceeds are received.
This $25,000 amount can be reduced and possibly eliminated if the policy’s adjusted cost basis immediately before death has been reduced below zero because of the annual deduction of the net cost of pure insurance in the formula of the policy’s adjusted cost basis.
These proposed changes create an essential need for accurate and long-term corporate record retention with respect to transactions over the policy’s lifetime. It would be prudent for the corporate policyholder to retain these records, as such information will be required to properly determine the credit to the capital dividend account upon the receipt of the insurance proceeds. Such record keeping can certainly span many decades over the life of the policy.
(Reprinted with permission by the Institute for Advanced Financial Education, Toronto, Canada, Edition 300, November – December 2016)
An RRSP offers taxpayers the opportunity to utilize a tax-preferred approach for accumulating assets for retirement. Within pre-determined limits, RRSP contributions can be deducted against a taxpayer’s total income lowering his or her overall income tax liability for that particular year. In addition, investment earnings within the plan grow tax deferred.
Effectively, the contributions and earnings are tax deferred until removed from the plan. As such, withdrawals from an RRSP during the annuitant’s lifetime are subject to tax. In addition, the death of an RRSP annuitant creates an income inclusion for the deceased equal to the fair market value of the property held within the RRSP. This income amount is included in the annuitant’s income for the year of death, adding to other tax liabilities that may arise in the final tax return.
There are some rollover situations that create exceptions to the general rule. For example, when the deceased’s spouse or financially dependent children or grandchildren are named as beneficiaries, the flow of the funds can create an offsetting deduction for the deceased and eliminate the tax liability that would otherwise arise from the deemed disposition. Through these rollover exceptions, an amount equal to the RRSP “refund of premiums” (which is essentially the value of the plan at the date of the annuitant’s death) offsets the deceased’s income inclusion. Funds are then taxed in the hands of the beneficiaries when withdrawn from the plan.
A beneficiary designation on an RRSP directs the funds to the named beneficiary. When a beneficiary receives RRSP funds directly under the terms of the plan, and no rollover applies, he or she becomes jointly and severally liable together with the deceased for the amount of taxes owing in respect of the proceeds received.
The issue of joint and several liability arose in a July 2016 Tax Court of Canada case, Sylvia O’Callaghan v. The Queen. The facts of the case were quite simple.
• Siegfried Starzyk passed away on July 19, 2007.
• Sylvia O’Callaghan (Siegfried’s sister) was the named beneficiary on his RRSPs and received $274,050.83 directly from the RRSP carrier.
• Sylvia paid $135,000 to Bruno Starzyk (Siegfried’s brother) who, nine months later, became the executor of Siegfried’s estate.
• The estate filed the deceased’s final tax return that showed all taxes owing were in respect of the deemed disposition of the RRSP. The estate subsequently paid $38,980 toward the total income taxes owing, leaving an outstanding tax liability of $57,704.54.
• The CRA issued a reassessment against Sylvia because they had reason to believe that the estate did not have sufficient funds to pay the remaining taxes owed.
Justice Favreau concluded that Sylvia, as beneficiary of the RRSP, was jointly and severally liable with the estate in respect of the income taxes owed on the disposition of the RRSP at the time of Siegfried’s death. It was Justice Favreau’s position that the joint liability provision of the Income Tax Act “does not impose any obligation on the Minister to attempt to collect an amount from the estate or from the legal representative of the estate before issuing an assessment.”
While Sylvia attempted to persuade the court that her payment of $135,000 to Bruno was in his capacity as the estate representative, Justice Favreau concluded this was not the case. He explained that the payment to Bruno was in his personal capacity, several months before being appointed the estate representative. In addition, he noted “payment of any tax amounts owing should be paid directly to the Receiver General.”
The take away from this case is that named beneficiaries of an RRSP should consult appropriate professional advisors for guidance. Planning might involve setting aside a portion of the RRSP funds received and communicating with the CRA and estate representativemto ensure all taxes have been paid.
(Reprinted with permission from The Institute for Advanced Financial Education, from Comment, edition 299)
Financial literacy and retirement planning tend to go hand-in-hand; both subjects capture media headlines and are the focus of a great deal of government attention. Financial literacy refers to the set of skills and knowledge that allows individuals to make well informed and effective decisions with respect to their financial resources, including earning, managing and investing money. Retirement planning is the process of preparing financially for the type of lifestyle individuals desire after their working years. This includes accumulating adequate savings during one’s working years to afford a particular lifestyle and managing those funds during the accumulation and post-retirement phase. There is a growing sense that stronger financial literacy leads to better retirement planning.
In late June, federal Finance Minister Bill Morneau announced that he and his provincial counterparts had reached an agreement in principle to enhance the Canada Pension Plan (CPP), a significant element of Canada’s public pension system. The phased-in design changes to the CPP include increasing the upper earnings limit to $82,700 by 2025 (currently $54,900), with the income replacement level increasing to one third of income (currently one-quarter). To finance these objectives, employer and employee plan contributions will be subject to a series of increases over a seven year period beginning January 1, 2019.
As plans are underway to strengthen the public portion of Canadians’ retirement resources, Statistics Canada recently issued a new report that looks at how well Canadians are preparing for retirement along with perspectives on the relationship between financial literacy and retirement planning. The 2014 survey captured data from individuals, ages 25 to 65, within Canada’s labour force – employed and unemployed. The report, released in March of this year, provides some interesting statistics based on four age bands: 25 to 34, 35 to 44, 45 to 54, and 55 to 64.
Seventy-eight per cent of those surveyed indicated they were preparing financially for retirement, although only 45 per cent indicated they knew how much they needed to save. Of particular interest is the group of individuals ages 55 to 64. Within this group there was a significant decline, from 56.8 per cent in 2009 to only 47.4 per cent in 2014, when asked if they knew how much to save to fund their retirement. Two of the other three age categories, 35 to 44 and 45 to 54, experienced slight increases, 2.8 and 1.9 per cent respectively, when asked if they knew how much to save, while ages 25 to 35 dropped slightly.
Looking at the youngest generation in the study, more than one-third of people ages 25 to 34 indicated they know how much to save but the number who are actually saving for retirement declined from 75 per cent in 2009 to 66.3 per cent in 2014.
The survey also analyzed the results based on household income divided into five categories (quintiles). As would be expected, those with the highest household income were the most financially prepared for retirement and 62.5 per cent of the group indicated they knew how much to save. These numbers were quite consistent between the 2009 and 2014 surveys.
In general terms, there seems to be a slight drop across all households, except the top quintile, as to who is preparing financially for retirement. Household incomes in the third and fourth quintiles indicated less knowledge about how much to save when comparing the 2009 and 2014 results. No explanation for these variations is offered by the study, but theories could include a shift away from employment pension plans in general and, more specifically, the shift away from defined benefit pension plans that provide a predetermined amount of retirement income.
As is evident from the report, older, higher household income individuals are more likely to be preparing for retirement and are confident with their knowledge of how much to save. However, there appears to be a growing sense of uncertainty by the older, middle household income group with respect to how much is enough. This might be attributable to the fact that higher-income individuals are generally less reliant on public retirement programs, whereas the middle income have a greater reliance and sense of uncertainty with respect to the reliability of public programs in the future.
The survey asked respondents what sources of income they were including in their retirement income planning:
(Reprinted with permission from The Institute Comment, edition 298)
Estate planning with respect to children is not child’s play; for many, it is one of the most important elements of their estate plan.
As a parent of minor-aged children, capturing the full breadth of financial needs and providing appropriate resources can be a challenging exercise. A parent’s estate plan should consider all of the following income or cash flow needs that may arise in respect of a minor child:
• The daily requirements of life such as food, housing, clothing, sports, travel, and all of the activities that fill a child’s growing-up years.
• Sufficient funds to complete a reasonable education including tuition for private school, if desired, and post-secondary education. Added into the mix are books and supplies, room and board while away, tutors and supplemental sessions, and resources to replace the role a parent might otherwise play in the child’s education cycle.
Beyond the childhood years, parents with sufficient estate resources may consider:
• Providing financial resources for the child’s first home or a contribution toward reasonable down payment that might allow the child’s earnings to support the resulting mortgage.
• A financial contribution toward wedding festivities or other memorable contributions to a child’s personal milestones.
• Miscellaneous gifts that might have been otherwise provided, such as a post-graduation trip aboard, first car, etc.
Once the full breadth of financial needs has been captured, an analysis of the various structures that could be utilized to hold the appropriate funds will help to shape the estate
plan. The first option that most couples often consider is leaving sufficient funds for the surviving parent to meet the ongoing financial needs of the children. In these situations, however, it is easy to miss the cost of the smaller, less obvious items which can leave a single parent without sufficient resources that might otherwise have been available if a death of the co-parent had not occurred.
If the surviving spouse is going to assume financial responsibility for the children, the testator typically leaves his or her financial assets and life insurance policies to the surviving spouse with the expectation the spouse will provide for the child. This makes sense when the surviving spouse is also the parent of the children so has a similar interest in the children as that of the testator. However, there could be situations where this may be inappropriate and other structures should be considered for some or all of the funds planned for the child.
The surviving spouse may be a spend thrift or may not be the child’s parent. For example, a second marriage can often involve children from the spouses’ prior marriage (or relationship) and non-traditional family responsibilities can create unusual financial needs.
Sometimes the child may be older and mature enough to accept and manage an outright gift or support payment from the parent’s estate. There are times, however, when some parents might hesitate to leave outright gifts because their frame of reference is based on today’s world where they can adjust or redirect support if they observe the child making what they feel are inappropriate or bad decisions. Each situation is unique and, as a child ages, a parent’s confidence in their financial savvy will evolve.
Another structure that should be considered is a testamentary trust arising upon the parent’s passing, which is funded with resources from the deceased’s estate or from a life insurance policy. The testator is the settler of the trust and chooses appropriate trustees. The design of the trust creates comfort for the parent because the trust provisions can offer directions to the trustees. For example, the provisions can set out how the funds are to be invested, how and when income and capital is to be distributed, directions as to what happens if a child does not survive to a distribution date and details about the eventual winding-up of the trust, if desired.
A parent is not limited to one approach but can use various structures for different portions of the estate. Customization is easily achieved to ensure the parent’s objectives are reflected in the overall estate plan. The planner’s role is to ensure that objectives are actionable using appropriate structures.
There are times when a plan is in place, but a change in circumstances creates unexpected consequences. Look at the recent case of Dagg v. Cameron Estate.
The case begins with a couple, Steven and Anastasia, who were married in 2003. In January 2012 the couple separated, but remained legally married. In 2010, while married, Steven purchased a life insurance policy from Canada Life with a $1 million face value. At the time of separation, Anastasia was named as beneficiary of the policy. As part of a series of ongoing court proceedings between Stephen and Anastasia, which commenced in September 2012, Steven was subject to a consent order that included child and spousal support provisions and required that he maintain Anastasia as the irrevocable beneficiary of the life insurance policy.
Immediately following his separation from Anastasia, Steven re-established a relationship with Evangeline, whom he knew prior to his marriage. In July 2012, Steven moved to British Columbia and frequently travelled to Bellingham, Washington, where Evangeline lived. Evangeline became pregnant in April 2013 and while the couple intended to marry, their plans were delayed because of prolonged divorce proceedings between Steven and Anastasia.
In November 2013 Steve was hospitalized, and shortly thereafter executed a new will together with a change to the beneficiary designation on his life insurance policy. He changed the beneficiary from Anastasia, as the sole beneficiary, to Anastasia (10 percent), Evangeline (53.6 percent) and his two living children (17 and 19.4 percent). Anastasia became aware of the beneficiary change and immediately obtained a court order requiring Canada Life to restore the previous designation listing her as sole beneficiary.
Steven, age 48, passed away on November 23, 2013, with the insurance policy forming the bulk of his estate.
Evangeline filed a dependant’s support claim, with the Ontario Superior Court, on behalf of herself and her newly born child (she was pregnant when Steven passed away). She sought to have the proceeds of life insurance form part of Steven’s estate so they would therefore be available to satisfy a dependant’s relief claim under the Succession Law Reform Act (Ontario). The trial judge agreed and ruled that the proceeds of the life insurance policy would form part Steven’s estate and would not be paid to the named beneficiary.
Anastasia appealed the trial judge’s ruling, asking the Divisional Court to award all of the life insurance proceeds to her as set out in the consent order. Anastasia’s position was that the consent order should be interpreted as a bare trust and Steven did not have the authority to change the beneficiary.
The Divisional Court agreed with the trial judge confirming that Steven remained the owner of the life insurance policy irrespective of the Family Court order requiring Anastasia remain as the named beneficiary. Of significance was the Court’s finding that Steven remained in control of the policy. They found no evidence of any intention to change legal or beneficial ownership of the policy. The court noted that under “Ontario succession law, ‘any amount payable under a policy of insurance effected on the life of the deceased, and owned by him or her,’ is available for satisfaction of dependent support claims.”
The court noted that if Anastasia and Steven had wanted the insurance proceeds to be paid to Anastasia under all circumstances, they should have stated this explicitly. The couple could have referenced the policy proceeds as “security” for the support payments, moved the policy into Anastasia’s ownership or into joint ownership. Without some evidence of their intentions the court is obligated to ensure that dependents are supported.
While Anastasia attempted to claim the position of a creditor of the estate because of the Family Law Act support order and irrevocable beneficiary designation, the Insurance Act “provides that where a beneficiary is designated, the insurance money, from the date of death, is not subject to the claims of the creditors of the insured.” As such, the court concluded that “Anastasia’s interest in the insurance proceeds was not that of a creditor, but rather as a dependant, along with her children, and Evangeline and James.”
The Divisional Court also concluded that Evangeline and her child, conceived with Steven and born after his death, were dependant on Steven. They observed that Steven’s attempt to provide adequately for Evangeline and her child was circumvented by the court order requiring Canada Life to restore the original designation. The Divisional Court confirmed Evangeline and her child’s entitlement for support from Steven’s estate.
Of significance is the fact that there are situations where an individual could be viewed as having two spouses for support purposes, creating significant financial obligations. Arrangements of this nature require careful attention to both financial and moral responsibilities when undertaking estate plans. If a life insurance policy is intended to represent future support for one particular spouse or group of dependants, it may be wise to ensure ownership of the policy remains with the intended beneficiary or in joint title.
Plans should reflect the objectives of the client, but more importantly the plans need to be well documented so that the intentions of the parties are well known and alternative interpretations will be limited.