After years of saving to have enough to retire on, it is ironic when later in retirement the client wants to have as little income as possible, so that they may qualify for reduced rent and services in a nursing home, or for continuing care charges in their own home.
The paradox is that it took a great deal of capital to provide them with an inflation-adjusted income in retirement that would last them their lifetime with today's longevity in mind. Now, the client may want to qualify for their share of the government subsidy for elder care. They must therefore dismantle, or rearrange a good portion of their income-producing portfolio in order to qualify.
In Canada retired persons have a situation whereby if they are destitute the government will pay for their care. If they are low income the government will pay some of the cost of their care. If they are high income the government will not pay for any of their care. If a retired person has millions of dollars in assets, but earns little, or no income from their assets, then the government steps up to the plate and picks up all, or some of their expenses. In other words, there is no means test to qualify for this subsidy as it is based solely on income received during the prior tax year and income taxes paid. The government's idea of income is very different from yours or mine.
No one likes to be left out, especially seniors, many of whom feel that they have paid an undue share of the tax burden in prior years. As a result, a lot of planning now starts to take place around reducing a client's income for no other reason than to improve eligibility for government assistance. Some may refer to this as “Welfare for Seniors” but many of them take great delight in reducing their daily charge for nursing care. It seems to be a badge of honour that they can claim bragging rights, because they qualify for more subsidies than their friend down the hall.
I think it helps when planning for a client's retirement to have a good understanding of where their planning may end up, or what they may want you to do for them in the future. With that in mind there are a number of planning strategies in early retirement that will make the costs in later retirement much lower, which we will get into detailing further on. Let me give you an actual example of two clients with not too different situations but very different overhead for their care giving. The formula that follows is that used by the Ministry of Health for British Columbia. As this is a federal cost sharing program the formula is almost identical in each province. Studying this table will show you how to help your client, at this point in their life.
Continuing Care Calculation Client #1 Client #2
Total Income – Line 150 of Income Tax Return 67,174 55,252
Net Income -Line 236 11,189 55,252
Tax Payable – Line 435 0 12,191
Deduct Basic Income 10,284 10,284
Deduct Earned & Business Income 0 0
Remaining Annual Income (RAI) 905 32,777
Client Contribution RAI/720 per day 1.26 45.52
If you study the table you will notice that client # 1 has a higher total income but pays almost nothing (1.26 *30) for continuing care in their home ($37.80 per month) whereas Client #2 with a lower income pays $1,365.60 per month, 36 times as much as client #1. As these charges are a minimum and a maximum for the day, it makes no difference how much care is provided per day. The only determination is net income, not assets, or ability to pay. In this case client #1 has a large margin account, which reduces his net income and improves his contribution rate. The method of calculating the “Remaining Annual Income” is not logical, just government policy.
This formula is used for nursing home care as well as for continuing care providers who come into the home to provide basic assistance. Nursing care expenses are often deductible as Medical Expenses at this stage, but as the credit is applied after the net income calculation (Line 236), they do not help with these calculations. In fact, they hurt it because they reduce the tax payable and therefore the amount of deduction in the above formula.
Our Favorite Methods to Reduce Taxable Income
If the goal of the client is to shelter their assets from taxation either to reduce their nursing care expenses or to avoid probate and other taxes of their estate, then there are a number of planning opportunities we like to use to achieve the client's goal.
Draw R.R.S.P.'s Early. By reducing their R.R.S.P.'s early they can avoid the Claw-Back of Old Age Security payments and not have to draw out as much income later in retirement. Higher withdrawals later cause their income to go up for purposes of calculating their Continuing Care Contribution Rate.
Deposit capital to a “Realistic Elderly Sheltering Plan.” (RESP). Commonly known as a Registered Education Savings Plan. They are probably better understood in this context if named the “Realistic Elderly Sheltering Plan” (RESP). These plans have a great deal of appeal for grandparents and it is a wonderful place to store capital if there is a concern that additional funds may be required in the future. The earnings on the capital are sheltered from taxation while in the plan. In Canada a deposit of $4,000 per beneficiary per annum can be sheltered. For a grandparent with 10 grandchildren they can shelter $40,000 per year. At that rate a large amount of capital can be taken out of taxable circulation in a short number of years. I have found that the grandparents take more interest in the performance and management of the Grandchildren's Education Fund than they do their other investments. The Grandparents control the capital. The plan can and should have multiple beneficiaries. The earnings are taxed only in the hands of the beneficiary and only when withdrawn and not to the grandparents. They find it to be a great place for gifts at Christmas, birthdays and other special events such as making the honor roll. The capital can be withdrawn at any time without tax consequences should the capital be required. The retiree's will can deal with the capital in the plan at their death or direct the capital to remain in the education plan.
Loan money to kids (Participating Mortgage). A Participating Mortgage is perhaps our favorite planning tool for reducing taxable income for a retired client. Giving a second mortgage to their children, or grandchildren helps them and at the same time capital is removed from their taxable investment portfolio. The mortgage is at 0 percent interest, but the mortgage document gives the mortgagee the percentage of the selling price that the loan bears to the original purchase price. For example if their son buys a home for $250,000 and they loan him $25,000 towards the purchase they participate in 10% of the sale proceeds, when the home is sold, or in ten years whichever comes first. If the home later sells for $300,000 the parents obviously get $30,000. The profit of $5,000 in this example is a Capital Gain and not interest income. We insist that the property be in joint names and the mortgage registered on title. The beauty of this plan is that it generates no taxable income for ten years for the retiree. For the offspring, it does not affect their debt-servicing ratio to qualify for the first mortgage because this mortgage has no payments, or interest required to be serviced each month. It also helps them get into their own home sooner. As most parents will want to do this for each of their children to be fair, a large amount of capital can be removed from taxable investments without passing title until it is dealt with in their wills at which time the mortgage is usually forgiven, but deducted from their share of an inheritance to be fair to any of their offspring who did not participate in the mortgage scheme. If you would like to read an additional article about this type of mortgage click here.
Universal Life Insurance. This can be a very effective tool for sheltering capital from taxation in the latter years of retirement. The same plan that can provide an income in retirement can be stopped and allowed to accumulate on a tax sheltered basis if it is advantageous from a tax or nursing home cost point of view. The beauty of this plan is that if the insured passes away the entire amount of the death benefit is paid out to the named beneficiary as a death claim, free of all taxes and probate of the estate. Some of these policies may also allow for additional deposits to be made to the plan up to the limit of the maximum tax assisted rate (MTAR) without affecting its tax deferral advantages
Start a Business/Farm/Rental Loss. The most obvious strategy from this formula will be for those who have retained an interest in a corporation and are able to continue to receive a salary or other business income, as this is a direct deduction for the formula shown in the above table.
Buy Investments that Grow but provide no Income. There are a number of investments, which are held for future capital gains. Raw land is just one example of an investment that may grow in value but not likely provide any taxable income during the holding period. It can also be very profitable over time if it is later converted for higher density use. These investments however are often illiquid. Many mutual funds are designed to produce little or no taxable income and have a long record of earning only capital gains. Although no guarantee can be given against a distribution of capital gains, or other income they have a good track record of managing their portfolio to minimize distributions. Mutual funds have the advantage of being very liquid should the level of care needed increase to the point that more income is required.
Charitable Gifting There are a tremendous number of opportunities here. Many variations of Charitable Annuities can be arranged. Direct gifts while living and especially gifts of appreciated securities. If the client has a favorite charity, or religious group, many of them offer a tax-free annuity income in lieu of a charitable tax receipt, in return for a capital contribution. There are many variations of this theme, which can be used to the client's advantage depending on their tax bracket and income needs. If they need the income but do not want to increase their health care subsidy costs, this can be effective.
Systematic Withdrawal Plans. This is probably the best way to provide liquidity and a well-managed portfolio with tax advantages on the income. I have written extensively on this subject, which can be obtained, on our web site. Or click here to go to a recent article on the tax advantages these plans offer. More
Leveraged Investing. The new reduced inclusion rate for Capital Gains of fifty percent along with low borrowing costs make leverage investing more attractive than ever. The cost of borrowing is of course a reduction of net income, which improves the calculations mentioned earlier for the client's benefit. Click here to go to another article we wrote about leverage investing. More
Swap Securities with RRSP/RRIF. A reduction of taxable income can be achieved by swapping “in species” securities from an open investment portfolio, which earns interest income (such as a term deposit, or GIC) for those inside of a sheltered plan that earn mostly capital gains type income. This can be done without a market risk to the client by executing the buy and the sell on the same trade date. The disposition is done at fair market value on the date of the swap. The best part of it is that it often has the added benefit of increasing the allowable foreign content of the RRSP if there was a significant gain on a security that was swapped out of a RRSP for a GIC.
Gifts &/or Spending Capital. If the client has assets that are in excess of their long-term requirements, gifting and paying out some of their capital while living to their beneficiaries can be very satisfying to them and their beneficiaries. It can also be a great help to reducing the Contribution Rate for Continuing Care. If the client can trust their offspring to look after their income needs if the government funding changes in the future this is very workable. However, many retired persons do not trust their own offspring to provide for their income needs and often choose to hang onto their money. A gifting program while they are living of course reduces the eventual costs to settle their estate.
Trusts: For those with substantial assets the use of an inter vivos trust may offer some tax sheltering advantages.
A person's financial planning goals will change a number of times during their lifetime. After years of helping the client accumulate wealth for retirement, you then shift to structuring income in retirement. In the end the final goal is often one of minimal income. Remember the old saying: “The boss is not always right, but he is always the boss.” The same applies to the client who is our boss. We need to be able to respond to their planning requirements. These ideas help them achieve what is usually their final planning strategy. Knowing where you want to end up makes planning the journey a lot clearer.
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www.money-software.com About the Author
Peter F. Baigent CFP, CLU, CHFC, RFP. is a Past President of the Canadian Association of Financial Planners for British Columbia, a former Director of the Canadian Association of Financial Planners. He has spoken across Canada on financial planning matters and has taught courses for the Chartered Financial Consultants & Certified Financial Planners degrees. He is the founder of Money Minders Software which produces financial planning software.
