Oliver and Jessica received bad news earlier this year that is about as awful as it gets. Oliver was diagnosed with terminal cancer.
"He’s not showing any signs of illness yet, so we’re hoping we at least have the summer together," says Jessica, a health-care worker in her mid-50s.
Oliver, in his early 60s, ran a business after retiring from the civil service. Only $30,000 remains in the corporation to fund a $100,000 life insurance policy. He also has a $56,000 group policy from his previous employment.
The couple has been preparing financially as best they can for the inevitable. Everything, aside from their RRSPs and TFSAs, is jointly held.
"We thought we were prepared, but when I met with a financial adviser, I was told I should set up a testamentary trust because I am going to have income from investments that will increase my taxes," Jessica says.
The couple has about $498,000 in investable assets, a cottage and no mortgage. But Jessica wonders if the trust is worth the trouble.
"Am I barking up the wrong tree if I agree to this trust?"
Furthermore, Jessica says she has other worries about her financial future and wants advice on how to invest and plan on one income.
In the first of a two-part Money Makeover, a lawyer and chartered accountant will provide Jessica and Oliver with advice regarding a testamentary spousal trust. Part 2, next week, will deal with how she should plan to manage their money to meet her future needs.
But the dilemma regarding Oliver’s estate and the trust requires resolution first and foremost, says lawyer Caroline Kiva, who practises estate planning with Pitblado Law in Winnipeg.
Typically, people create spousal testamentary trusts for more than tax savings alone.
"It’s often useful when the surviving spouse is unable or unwilling to manage assets left in the will, and a trustee can be appointed to ensure those assets are handled in his or her best interest," she says.
But Jessica is financially savvy, so the main reason for a trust would be to reduce taxes.
Generally speaking, the benefit of creating a trust for this purpose is only worthwhile at a certain level of wealth.
"If the numbers were $300,000 as a starting point, then right off the bat we’d see savings, given the assets are invested properly," Kiva says.
The couple has about $498,000 in assets, so a trust at first glance should be beneficial. That’s because any income from investments held within the trust will be taxed at a lower marginal rate than if the income is lumped onto Jessica’s employment income, about $63,000 a year, says chartered accountant Bob Walker, director of PKBW Group in Winnipeg.
Investment income in her hands would be taxed at a marginal rate of about 40 per cent, whereas inside the trust, the marginal rate would be about 25 per cent.
"Investment income in the trust would be taxed at a rate approximately 15 per cent less than that taxed personally," Walker says.
But not all of Jessica’s and Oliver’s investments are eligible for a trust.
TFSAs, RRSPs and the cottage can roll over automatically tax-free to the spouse. If these assets were transferred to the trust instead, the RRSP would be taxed as if Oliver had earned that income in his year of death, and the cottage and TFSA would be taxed on gains. For these reasons, a trust is not a good option.
Furthermore, jointly held investments are also ineligible, which presents a problem for them if other assets are held in both of their names.
Kiva says they could change all of their nonregistered assets to be under Oliver’s name to make those assets available to a trust.
"They’d just need to go to their financial institution to sign the papers."
If they did, the trust would likely create tangible tax savings on an annual basis.
If assets were invested 50-50 in fixed-income and dividend-yielding stocks, for example, the annual income might be three per cent of $280,000 — the sum of their assets after excluding RRSPs and TFSAs.
"The tax savings would be approximately $1,260 annually," Walker says.
But trusts also involve costs, such as accounting, probate and legal fees.
Probate fees — about 0.7 per cent of assets — will apply because this capital is now flowing through the estate instead of flowing directly to Jessica. Walker says the one-time probate fee would be about $1,960.
The annual cost of a trust would likely involve only accounting fees, $300 minimum, he says.
But a trust might make tax sense for other reasons, too. For one, Oliver owns a corporation with about $30,000 remaining. Unless that capital is held as a shareholder’s loan, which can be paid tax-free to Jessica, it would be paid out as dividends, which are taxable.
In this case, corporate assets flowing into the trust would be taxed at a lower rate than in Jessica’s hands, and she’d still have access to the money.
Walker says the one-time tax savings would be about $4,500. The trust could also provide about $135 in ongoing annual tax savings if the corporate assets are invested using the same 50-50, fixed income/ dividend strategy.
The trust could also provide tax savings on investment income from the proceeds of Oliver’s insurance policies.
"There would be an additional tax saving of approximately $700 annually, making the total tax savings on ongoing investment income approximately $2,095 annually," Walker says, adding the sum includes corporate assets.
But this figure reflects gross savings, before the annual accounting costs, probate fees and lawyer’s bill to redo the will.
"This isn’t a plain vanilla will and it needs to be done quickly," Kiva says, adding the legal fees may be upward of $1,500. "And there is some question whether the trust would be an eligible beneficiary for the $56,000 group insurance policy."
In addition, the tax savings of the trust are assuming the assets are invested to yield three per cent a year. Right now, almost half of those assets are held in savings, which earn much less. And the projected earnings also are based on Jessica — the trustee with full control — not withdrawing the capital, which would reduce annual investment earnings and lessen the trust’s utility.
Properly setting up the will and the assets also takes time, and they may not have much to spare or the capacity to make decisions if Oliver’s health deteriorates.
Walker says provisions can be made in the will to create the trust but, as trustee, Jessica can decide once the will is settled what assets will be held inside it so long as those assets flow through the will and are eligible.
Still, Oliver and Jessica may not want to spend their days together sorting through documents and sitting in offices.
A couple whose time is not limited would have the luxury of reviewing options with legal, tax and financial advisers thoroughly, whereas Oliver and Jessica may find they’re rushing through complex issues to save less than $2,000 a year in taxes, Kiva says.
"If this is all the time you have left, you have to ask yourself whether this is how you want to be spending it."
Part two next week