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If you have clients with a disability or support someone with one, it’s important to know about the available tax and estate planning options.
Disability Tax Credit (DTC)
The DTC is a non-refundable tax credit. It can be claimed by the person with the disability on their tax return to reduce taxes payable. Any amount they can’t use may be transferrable to a supporting family member, such as a spouse or parent.
There are several criteria to meet to claim the credit. A qualified medical practitioner needs to certify the criteria are met on the CRA form T2201, Disability Tax Credit Certificate and note the year(s) the DTC can be claimed for.
If someone can claim the DTC for a prior year, but didn’t, all isn’t lost. They may be able to get the credit for up to 10 years prior by requesting an adjustment to their income tax returns. This could produce a significant tax refund if taxes were payable in those years.
Registered Disability Savings Plan (RDSP)
An RDSP is a savings plan that helps people eligible for the DTC save for their future. Anyone can contribute to the plan with permission of the plan holder. Beneficiaries can only have one RDSP at any given time and must:
Contributions are not tax-deductible, but are non-taxable to the beneficiary when taken out. There is no annual contribution limit, but there is a lifetime limit of $200,000. Contributions can be made until the year the beneficiary turns 59.
To assist with saving, the beneficiary may be eligible for the Canada Disability Savings Grant (CDSG) and/or the Canada Disability Savings Bond (CDSB). The CDSG has an annual limit of $3,500 (up to $10,500 if there is a CDSG carryover) and a lifetime limit of $70,000. The totals for the CDSB are $1,000 (up to $11,000 if there is a CDSB carryover) and $20,000 respectively. Both programs are income-tested and are available until December 31 of the year the beneficiary turns 49.
On the death of a beneficiary, the RDSP is paid to the estate of the beneficiary, net of any unvested CDSG and CDSB. The proceeds will usually be distributed according to intestacy laws unless the individual has a will.
Trusts
A common estate planning tool for people with disabilities is a trust. Reasons to use a trust include:
Henson Trust
A Henson Trust is discretionary trust where the trustee has complete discretion to distribute income and capital to the beneficiary. This is commonly used in estate planning for individuals with disabilities. It can be either inter-vivos or testamentary. The person with the disability will usually be the only beneficiary during their lifetime.
In most jurisdictions, a properly structured Henson Trust can protect the disabled individual’s access to government disability benefits, without any limit on the amounts contributed into it. This is because many jurisdictions specifically exclude the trust’s assets when calculating support program eligibility. However, distributions from the trust to the beneficiary can, potentially, impact income support and benefits.
Another benefit of a Henson Trust is the ability to name residual beneficiaries. They’ll receive any remaining trust assets when the disabled beneficiary passes away. This can help avoid intestacy on the assets if the disabled beneficiary is mentally incapable of making a will.
Trust taxation
A trust is typically taxed at the highest marginal tax rate in its jurisdiction on any income it earned and retained. Any income paid or payable from the trust to the beneficiary is taxed at the beneficiary’s marginal tax rate. There are two exceptions to this general rule:
Qualified Disability Trust (QDT)
A QDT is a testamentary trust that allows for income earned and retained in the trust to be taxed at graduated tax rates. This reduces the need to allocate income to the beneficiaries, as the trust can benefit from graduated tax rates, just like they would.
To qualify as a QDT, a trust must file a joint election with one or more beneficiaries (electing beneficiaries) to be a QDT for the year. As well, there are a number of conditions that must be met, including:
A Henson Trust could, potentially, qualify as a QDT.
Preferred Beneficiary Election (PBE)
A trust and a “preferred beneficiary” (defined below) can file an election to have some, or all, of the income earned and retained in a trust taxed to the beneficiary. In other words, with the PBE, income doesn’t have to be distributed from the trust to potentially take advantage of a beneficiary’s lower marginal tax rate.
A preferred beneficiary must be:
This election will be beneficial when the beneficiary of the trust has a lower tax rate than the trust. In most jurisdictions, the income “allocated” to the beneficiary won’t affect their access to government support and benefits. Allocated income could create a personal tax liability that may need to be funded with distributions from the trust. This, in turn, could impact access to support and benefits.
The PBE can be used for both inter-vivos and testamentary trusts. It isn’t limited to use on just one trust. As well, the PBE doesn’t prevent the use of the QDT election on the same trust. In fact, the use of the PBE and QDT on the same trust can result in additional tax savings, by allowing the multiplication of graduated taxation rates between the trust and the beneficiary.
Finally, the PBE may be available with a Henson Trust.
Inheriting RRSP and RRIF assets
Normally on death, the fair market value of a Registered Retirement Savings Plan (RRSP) and/or a Registered Retirement Income Fund (RRIF) is taxable on the deceased’s final tax return. This could significantly reduce the amount left for beneficiaries if the deceased was in a high marginal tax bracket.
Fortunately, there are planning options available when the beneficiary of an RRSP/RRIF is a child or grandchild of the deceased who was financially dependent on the deceased due to a physical or mental disability. If properly undertaken, the planning can result in the tax burden on the RRSP/RRIF capital being:
To qualify for the tax deferral, the beneficiary inheriting the assets can either:[1]
The account transfer or annuity purchase must take place in the year that the inherited funds are received or within 60 days after the end of that year. The income inclusion from the RRSP/RRIF capital of the deceased is deferred until the beneficiary eventually takes money out of their own RRSP/RRIF or receives a payment from the annuity. In such a situation, withdrawals from their RDSP are also taxable to the beneficiary but, potentially, may not impact eligibility for government supports and benefits.
Lifetime Benefit Trust (LBT)
When certain RRSP/RRIF beneficiaries have a mental infirmity,4 another tax-deferral option is available in addition to the ones listed above.
An LBT is a testamentary trust where the beneficiary is the only person entitled to receive or use any of the income or capital of the trust during their lifetime.
The beneficiary of an LBT must either be a:
The beneficiary doesn’t have to qualify for the DTC to be considered mentally infirm.
The trustees of an LBT must be empowered to pay amounts from the trust to the beneficiary. They are also required to consider the needs of the beneficiary in determining whether to pay out amounts.
To avoid the RRSP/RRIF property being taxable to the deceased at the time of death, the trustee must use the property to purchase a qualifying trust annuity. The annuity is owned by the LBT and must either be for the life of the beneficiary or for a term equal to 90 years minus the beneficiary’s age on their last birthday.
The annuity income is paid to the LBT but is deemed taxable to the beneficiary, even if no income is distributed from the trust. This avoids a high-rate tax within the trust.
For estate planning, it’s possible to name capital beneficiaries of the trust. They will receive any after-tax amounts on the death of the disabled beneficiary. This helps avoid intestacy on these amounts.
Conclusion
Planning for a person with disabilities can involve competing interests. While striving to ensure that the person will be financially secure, protection of government benefits and tax minimization may also come into play. This article detailed several tax and estate planning options available, but there are more to consider.
Information contained in this article is provided for information purposes only. It’s not intended to provide or be a substitute for professional, financial, tax, insurance, investment, legal or accounting advice and should not be relied upon in that regard. It also does not constitute a specific offer to buy and/or sell securities. You should always consult your financial advisor or tax specialist before undertaking any of the strategies discussed in this article to ensure that all elements and your personal circumstances are taken into consideration in developing your individual financial plan. Information contained in this article has been compiled from sources believed to be reliable, but no representation or warranty, express or implied, is made with respect to its timeliness or accuracy and SLGI Asset Management Inc. disclaims any responsibility for any loss that may arise as a result of the use of the strategies discussed.
1 May require a guardian of property to complete if child or grandchild has a mental disability.
2 For an RRSP, beneficiary must be 71 years of age or younger at the end of the year the transfer is made.
3 Subject to lifetime contribution limit of $200,000.
4 These are the terms used under the Income Tax Act.
SLGI Asset Management Inc. is the investment manager of the Sun Life family of mutual funds. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the fund’s prospectus. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.
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