Advice for an active senior facing longevity risk

The situation

Winston Chang* is 71, but he doesn’t look a day over 60.

Chang also lives like someone a decade younger: he runs at least one 10-km race each year and, though he retired from his job as manager of a successful nutrition store eight years ago, he volunteers four times weekly as a docent at the Canadian Museum for Human Rights. To keep fit, he always walks the 45-minute round trip—even in winter.

Single and childless by choice, Chang spends his downtime writing music and playing with his two dogs, both rescues from the Winnipeg Humane Society.

He’s fit as a fiddle but, after a few of his friends died recently, he started to think about his estate plan. He’s debating between leaving his wealth to his only living relative, his older sister Theresa (75, married and also childless), or to a combination of the museum and the humane society.

In terms of assets, Chang has:

• a condo facing the Red River worth about $500,000—mortgage-free;
• $900,000 in a RRIF, invested in a balanced fund;
• $50,000 in a TFSA, invested in a balanced fund.

A frugal man, his annual living expenses are about $30,000, which includes premiums toward a $200,000 life insurance policy that names his sister as beneficiary. He also draws CPP and OAS.

As this is the first year he must withdraw from his RRIF, he’s surprised by how much he has to take out (5.28%); the amount ($47,520) exceeds his living expenses.

Chang has a few questions for his advisor, whom he hasn’t visited in some time:

• What should he do with all his “extra” cash?
• Should he leave his estate to his sister, to charities, or some combination of the two? He doesn’t feel comfortable leaving the money to friends or their families.

* These are hypothetical clients. Any resemblance to real persons is coincidental.

The experts

Denis Bourgeois

senior financial consultant, Investors Group, Winnipeg

Kyle McMurtry

managing partner, Grant Thornton, Winnipeg

Susannah Musselman

vice-president, financial planning specialist, RBC Wealth Management, Toronto

A long life

Susannah Musselman: I ran a calculation of his income from the RRIF, CPP and OAS. It comes out to about $69,000 and taxes of $17,000. His expenses are about $30,000, so he might come out with about $22,000 extra.

The first thing is to maximize his TFSA contributions. I’d also encourage him to save money in a non-registered portfolio. At 71, he’s very active, and I think the risk is that there’s longevity. We want to make sure he isn’t leaving himself exposed later on if he needs additional help, like in-home care.

Kyle McMurtry: I agree. The first thing he should be doing with his advisor is not only projecting what the current cash needs are, but also looking forward as to what they could be down the road. Having great health now doesn’t guarantee that to be the case at age 85 or later.

SM: We need to run a financial plan: What’s his maximum spending? We also need to run different scenarios. Maybe he wants to invest in GICs. Then we look at 2% to 3% returns before tax and inflation. How does that impact him?

Denis Bourgeois: Another thing he can do to counter longevity risk is pay into a separate permanent life insurance product. Then if he lives until 110 and needs more money, he can give the insurance policy to a lender and they will collect the money on his death. But in the meantime, they can loan him the cash surrender value before he dies, and it would be tax free. The lender would not advance 100% of the value, but it could be 75% or even 90%, depending on the lender.

SM: Also, since he seems charitable, we need to ask how much in charitable donations he wants to make. How does that impact his net worth over time? He could donate some of his extra money to charity over his lifetime to reduce his tax rates.

KM: He has these two charities that are important to him. He can go down the road of donating money and getting a tax credit for it. He can donate up to 75% of his income, and start to fund some of their operating needs in the short term, as well as set up a strategy to maximize that down the road.

For instance, in Manitoba, he’ll get a 46.4% credit on any donation above $200. If he donates $10,000 in a year, he’ll get a credit of $4,640 as a reduction in his taxes.

DB: He could have had a pension income deduction from age 65 to now. That means taking some cash out to deregister his pension so that he could, at a minimum, get a pension income deduction. There’s still room before OAS clawback.

KM: Yes, Winston has forfeited a few thousand dollars in pension credit for the past six years, which is unfortunate. Can’t go back, but going forward I would suggest that.

Best uses for the RRIF

KM: There is a conversation to be had about taking more money out of the RRIF than the minimum and investing it in an insurance product. It might seem counterintuitive at first, but if that legacy piece is really important to him from a long-term tax planning perspective, it’s likely going to be more efficient.

DB: I agree, there might be more that could be done with his RRIF by putting another life insurance product in place. We’re talking about a separate life insurance policy from the one that names his sister. I would suggest a permanent type of life insurance product. He can leave a legacy to the humane society or the museum. When you name the charity as the beneficiary, your premiums are a charitable donation.

SM: But shouldn’t the RRIF go to the estate? Otherwise the RRIF goes to the charity and the estate is left with the taxes owing.

KM: Yes, there is an estate planning consideration there. If all the money is not going to the estate and there’s nothing left to pay the taxes, that could put the estate in a tough legal position.

I believe if the full amount of the RRIF is going to a charity and would be a charitable receipt then, in theory, that wouldn’t create any tax. The donation would equal what the taxable income would be, so they should offset each other.

More estate planning

SM: With his current insurance policy, and whether his sister should be a beneficiary, I think we have to look at his sister’s needs and if she needs the money or not. If she does, then we want to leave it. You can also put a contingent beneficiary on an insurance policy. So if she dies before Winston, the insurance proceeds can go to charity, for instance.

KM: If he wanted a balance between supporting his sister and leaving a legacy to a charity, he could consider a charitable remainder trust. It would allow a nice bridge. So money could be held in trust until his sister dies, and she could benefit from the income from that property during her lifetime. Then the capital on her death goes to the chosen charity. It would ensure that the capital amount stayed whole and would be able to flow through the charity, while giving her some extra cash flow to support her lifestyle while she’s alive.

But it might be more complex than what he’s used to, given the simplicity of his affairs. One of the complexities is the actual setting up of the trust in the will. That’s going to add some legal costs.

There are also some actuarial requirements that come with charitable remainder trusts. The amount of the donation receipt is based on a life expectancy for the lifetime beneficiary—in this case, his sister. There’s a calculation that has to happen actuarially based on how old she is when he dies. That would determine what the actual tax receipt would be for Winston on his terminal return from a charitable perspective. The benefit of the donation to the charity is still intended to go to Winston on his final return, so it’s a net present value calculation of the expected funds that the charity would receive.

Finally, not all charities are set up for managing that type of relationship. So there can be some complexity from the charity’s perspective, as well, about issuing the donation receipt and how they’re going to account for it in their own financial records because it’s an asset held in trust.

SM: If he wanted to keep it simple and he trusts his sister, he could tell her, “I’m leaving you this money, and it’s up to you to spend it if you need it. If you don’t, then in your will, could you pass this onto the charities I support?”

This way, he could split his assets. Maybe the RRIF he leaves to charity, and there would be no taxes because he could deduct the charitable donation against his income inclusion. Then the TFSA and condo, maybe he leaves to his sister. But it would just be an agreement. She’s not bound to do it. If she doesn’t need the money, she could make the donations during her lifetime and she can get the tax deductions.

KM: Yes, […] he would have to really trust his sister.

SM: Also, with regards to probate, we could structure his assets so there’s less chance for them having to be probated. As long as each of his assets has a beneficiary, it would go directly to them. So his insurance policy goes directly to his sister. If we put beneficiaries on his RRIF and TFSA, then they go directly to the beneficiaries.

With the condo, that would have to go through probate. In Manitoba, the probate fees would not be material. It’s about $3,500 on a $500,000 property.

But if he put his sister on in joint name, and if he was able to structure an agreement with her through a lawyer—so they’re doing this for joint, probate purposes, and she doesn’t actually get the house until he passes away—then when he passes away, it passes to her probate-free. It depends on how much it’ll cost to have a lawyer draft this up. If it’s less than $3,500, it might work out.

Of course, if she dies first, that does create estate planning problems.

KM: Further, there is land transfer tax in Manitoba that would have to be considered if we were putting her on the property title. That tax rate is 2% for over $200,000, dollar for dollar. And there are marginal rates before that. So depending on how title is held, the sister may have to pay Winston consideration, too, and it might make more sense to let the property go through probate.

In final tax considerations, if he donates, he’d get a tax credit against the terminal tax liability. If they’re not using the full credit in the year of death, it could be applied in the year prior as well. And the 75% limit on donations against taxable income doesn’t apply during the year of death, so there’s more flexibility in increasing the amount of donation on his terminal return.

Don’t forget the will

SM: It didn’t mention whether he has a will, so he should get one, detailing how he wants to distribute his assets on death. He also needs a living will, and a healthcare directive. A living will would be for his financial assets. Say he gets Alzheimer’s and isn’t able to make financial decisions; then somebody steps in and makes those decisions. The healthcare directive is if he can’t make a decision about what healthcare he needs, then someone is able to do that for him.

He should talk to his sister if he wants her involved. Ask whether she wants to be an executor on his will, or PoA for his living will or healthcare directive. If not, he could consider friends or a professional executor.

KM: Once he has this aligned and is comfortable with it, it should be reviewed annually with advisors to make sure there’s no changes from a legislative perspective or his personal situation, and his wishes remain the same.