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Planning for the family windfall

Aging Canadians set to bequeath billions to relatives, who should be prepared

Fotolia files</p><p>Knowing how to invest an inheritance can be beneficial and save you from future tax trouble.</p></p>

Fotolia files

Knowing how to invest an inheritance can be beneficial and save you from future tax trouble.

Hey there, time traveller!
This article was published 30/6/2017 (1109 days ago), so information in it may no longer be current.

It’s a potential trillion-dollar elephant in the room.

Depending on the study, it’s estimated a few hundred billion to more than $1 trillion will pass from older Canadians to the next generation in the coming decade. And in some cases, the windfall will be life-altering. Obviously, having a plan is crucial to making the most out of what can be a truly meaningful gift from loved ones, says Rob Harder, an investment adviser and certified financial planner with Family Wealth Group of IPC Securities Corporation.

"In a lot of cases, it’s a planned transition where parents and children have talked about what’s happening, so it’s an expected wealth transfer," he says. "It’s much less common that it’s out of the blue."

Still, as a beneficiary, it’s difficult to predict just how much you will get until you have it.

And then there’s the matter of deciding how best to use the new wealth to help you and your family. To this end, Harder says he spends significant time helping clients understand the potential benefits and pitfalls of an injection of what can be a very large sum of cash.

Among the challenges is taxation. While an inheritance is generally taxed as part of the estate before it reaches the beneficiary, it’s likely a large portion will then be invested for the future, and that can have an impact on taxes.

"In a lot of situations, the increase in their portfolio could move them to a higher tax bracket," he says, referring to money invested in a non-registered, taxable account.

That’s when professional advice can come in handy for picking tax-efficient investments suitable to an individual’s comfort level.

On the one hand, an investor comfortable with stock market risk and wanting to build long-term wealth may consider creating a portfolio of blue chip, dividend stocks (such as Royal Bank of Canada) that pay dividend income, which is often taxed at a lower rate than interest income.

On the other hand, someone who stays awake at night worrying about the markets or needs money in short order may select low-risk, liquid GICs or other near-cash savings instruments. In this instance, the money is less tax-efficient because interest is taxed like income. But at least an investor won’t incur capital losses and can gain access to it rather quickly without negative consequences. Plus, interest rates are so low, the taxes may not be all that significant because the income isn’t significant either. That said, the money is exposed to inflation erosion over the long-term.

Others may consider making a massive contribution to theirs and their spouse’s RRSP. On the surface, this makes sense. The contribution will result in a big tax refund on their earned income come tax-filing time. But Harder says it can lead to problems down the road.

"A future consequence of any (money) put into the RRSP is that it will become taxable income at some point."

So a tax break today could lead to a major tax headache during retirement or for the estate (upon which the entire registered account is taxable at the deceased’s marginal rate).

A more risk-free alternative may be filling up the TFSA.

"Not all Canadians have maximized their contributions to the TFSA," Harder says. "While there’s no tax deduction when you put the money in, there will be no tax when you take the money out."

Figuring out the right investment strategy ultimately boils down to comprehensive planning, generally with the assistance of a financial professional who can run the numbers, says Patrick O’Connor of Blackwood Family Enterprises Services, which works with multi-generational family businesses.

"It is essential for people to do projections of their financial future so that they can get a good handle on the impact of this wealth," says O’Connor, a certified financial planner.

Regardless of whether it’s done with the help of a professional or on your own, planning should be able to examine different scenarios, weighing their pros and cons against each other.

Portfolio manager and author Doug Nelson with Nelson Financial Consultants in Winnipeg says the process should generally involve three steps.

"Step one is to assess your current situation with and without the inheritance," the author of Master Your Retirement says.

Consider your objectives and needs. You may have large debts — a.k.a. the mortgage — or lifestyle goals such as buying a cabin.

"Once you have a good understanding of your current situation without the inheritance, redo the financial analysis with the inheritance added into the calculations."

In most cases, Nelson says the windfall — even it’s significant — will not be as impactful as you assume.

"This is the power of this type of calculation," he says. "As a result, your understanding of what this money will provide to you is based on reality instead of perception."

The next step is creating buckets of money to match your objectives. This helps limit overspending on one area at the expense of others. As well, it encourages wise spending for each need.

"Therefore, setting aside $50,000 to spend only on travel may be one way that will encourage you to do your research for the very best use of this money."

The last step is to recognize money is a tool, not a panacea.

"Someone else created this wealth," Nelson says. "Does this mean that this wealth is yours — or are you its steward, instead?"

This process encourages people to think about using the money for needs rather than wants, as well as recognizing it is family money, which, when managed properly, can act as a safety blanket for the future, Harder says.

"When family wealth is properly managed, it can really become a family’s legacy and provide that security for future generations."


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Updated on Friday, June 30, 2017 at 8:14 AM CDT: Adds photo

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