Can Emmett and Lillian arrange their investments to minimize taxes and gifts to their children?

Lillian, 66, recently retired from her teaching career and Emmett, 72, ran a successful business before hanging up his hat a few years ago.Tannis Toohey/The Globe and Mail

Over the years, Emmett and Lillian have amassed considerable wealth, largely through moderate spending and the long-term rise in real estate prices in the Toronto area.

Lillian, 66, recently retired from her career in education and receives an indexed pension of $39,750 per year. Emmett, who is 72, ran a successful business before hanging up his hat a few years ago. They have two children in their thirties.

In addition to their family home, they have a country house where they have spent most of the past two years. They have two rental properties generating $36,900 net per year as well as substantial investments.

Lillian recently renounced her US citizenship due to the “significant costs” of filing US and Canadian tax returns, she wrote in an email. “I am now free to open a TFSA, invest in mutual funds if desired, and own real estate.

Lillian and Emmett consider selling the family home in Toronto and buying a smaller place, maybe a condo. They also plan to gift the country home – and some of their wealth – to their children as an anticipated inheritance. They plan to travel a lot.

Their questions: How to organize their investments and the eventual sale of real estate to minimize tax; and how and when to give assets to their children.

We asked Gordon Stockman and his partner Gregor Daly of Efficient Wealth Management Inc. in Mississauga to look into Lillian and Emmett’s situation. Mr. Stockman is a Certified Financial Planner and Chartered Professional Accountant. Mr. Daly is a CFP candidate.

What the experts say

For dual citizens like Lillian, filing U.S. tax returns can be costly, but damaging tax and reporting issues should be a “very minimal” constraint on designing a good investment portfolio, including a tax-free savings account, says Stockman, who specializes in cross-border tax and investment issues.

Lillian could have opened a TFSA, invested in US securities and reported the income on her US return, the planners say in their report. While not tax-exempt, the resulting tax rate would have been lower than placing those same investments in a regular non-registered Canadian account.

U.S. tax authorities consider TFSAs, Canadian mutual funds, and exchange-traded funds to be passive foreign investment corporations and are therefore not covered by Canada-U.S. tax treaties. Additionally, US citizens pay capital gains tax on the sale of a home over a certain amount, so the couple’s ownership is entirely in Emmett’s name.

At this point in their lives, Emmett and Lillian are more concerned with tax, gifting and financial planning than their investment strategy, the planners say. With their significant assets, they can easily fund the lifestyle they want in retirement without ever running out of savings or having to dip into the equity in their properties.

The couple’s pensions and government benefits currently stand at around $60,000 a year before tax, while their net rental income adds another $36,900, for a total of $96,900. On the other hand, their basic lifestyle expenses are $69,000 per year, their travel budget is $36,000 per year, and their tax payable on the above income is $14,000, for a total of $119,000. They will have to withdraw $32,000 gross from their RRSPs/Registered Retirement Income Funds, planners say. At age 70, Lillian will begin receiving government benefits totaling $32,000 (2022 dollars), eliminating the need for support from their investments.

At age 72, when they begin to make mandatory withdrawals from their RRIF, the extra cash will be more than they need to pay taxes on the withdrawals, offset the clawback of OAS benefits, and pay the bill. tax on any non-withdrawal. gains recorded.

“That’s when I ask clients, what are you going to do with all that wealth? said Mr. Stockman. “We want to make sure there is a plan in place for them to enjoy their wealth, either by improving their lifestyle or by donating to their family or donating to charity.”

In preparing their forecasts, the planners assumed a rate of return on a portfolio of 60% stocks and 40% bonds of 4% (inflation, assumed to be 3%, plus one percentage point ). The rate of return is after inflation and before fees. Because the couple want to travel overseas, planners increased their travel budget from $24,000 a year to $36,000 a year for 15 years.

Gifts to both children and charity work are both possible and encouraged, planners say. “We find that gifts made with a warm hand and early in the recipient’s adult life have both the greatest impact and the warmest thanks attached to them,” Stockman says. “Our hope is that the analysis will give them the confidence to donate as soon as possible.”

If they wish to give the rural property to the children, Emmett and Lillian could consider either an estate transfer after death or a gift during their lifetime. Either way, it will be deemed sold on the date of transfer. An advantage of a current transfer is that upon the death of the couple, there would be no tax triggered. Instead, it is triggered at transfer time. This allows future growth to accrue to the children and reduces estate tax. A transfer to children directly or through a trust will result in the same current taxes payable, planners say.

If they transfer ownership, Lillian and Emmett should retain a lifetime “right to use” as they plan to enjoy it for many years. They may want to watch for a decline in the housing market and take advantage of lower prices to transfer to children – “if that seems wise after a thorough family discussion”.

Of all their investments, the biggest future tax burden is in rental properties, planners say. “Preparing for this taxation will be very important.” Where possible, they should plan not to sell more than one property – not including the house – in a single tax year.

Now that properties are more valuable, rental income should be regularly reviewed to ensure that it is still adequate compared to alternatives. For example, the market value of the two rentals is approximately $2.3 million, while the rate of return on rental income was approximately 1.4% last year and 1.6% annually at the future.

As for their investments, the location of assets – which accounts hold which assets – is as important as the allocation of assets. Lillian and Emmett have TFSAs, separate non-registered brokerage accounts and RRSPs/RRIFs. “Start with the items with the highest expected return and put them in the TFSA,” says Stockman. “We are leaning toward emerging markets and US small caps for TFSAs. Non-registered accounts should hold primarily Canadian stocks. “Finally, put any interest-bearing items or real-return products into RRSPs.”

Status of customers

The people: Emmett, 72, Lillian, 66, and their two children in their thirties

The problem: How to organize assets to minimize taxes, including real estate capital gains. When to donate part of their estate to their children.

The plan: Consider giving presents to children as soon as possible. Try not to sell more than one taxable property per year.

Gain : It’s time to sit down and enjoy the wealth they’ve amassed and think about how to give some away.

Net monthly income: $8,075

Assets: His bank account $8,000; his bank account $25,000; his unregistered portfolio $627,000; his unregistered portfolio $663,000; mortgage investments US$38,000; his TFSA of $93,000; his TFSA of $122,000; his RRSP $547,000; his RRIF of $494,000; residence $2 million; rural property $500,000; two rentals $2.3 million. Total: $7.4 million

Monthly expenses: Property tax (both houses) $900; water, sewer, garbage $300; home insurance $140; electricity $155; heating $245; maintenance $600; garden $100; transportation $475; groceries $600; clothing $150; gifts $275; charity $200; travel budget $3,000; meals, beverages, entertainment $650; personal care $20; pets $100; sports, hobbies $75; subscriptions $10; doctors, dentists, pharmacy $50; health and dental insurance $380; communications $325. Total: $8,750

Passives: None

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