2015 Federal Budget Contains Changes to Tax Free Savings Accounts and Registered Retirement Income Funds

The 2015 Canadian Federal Government’s Budget released on April 21, 2015 does not appear to contain any changes that will have an impact on trusts or estate-planning (perhaps mercifully given the problems created by the 2014 Budget). There are a couple of changes that will affect retirement savings.

First, the Government has increased the amount that you may put into a Tax Free Savings Account (“TFSA”), from $5,500 per year to $10,000 per year effective January 1, 2015. The Budget has a nice summary of how TFSAs work.

Available since January 1, 2009, the TFSA is a flexible, registered general-purpose  savings vehicle that allows Canadian residents aged 18 or older to earn tax-free investment income, including interest, dividends and capital gains. TFSAs can include a wide range of investment options such as mutual funds, Guaranteed Investment Certificates, publicly traded shares and bonds. Contributions to a TFSA are not tax deductible, but investment income earned in a TFSA and withdrawals from it are tax-free. Unused TFSA contribution room is carried forward and the amount of withdrawals from a TFSA can be re-contributed in future years.

TFSAs differ from Registered Retirement Savings Plans (“RRSPs”) in a few key ways. Unlike RRSPs, there is no tax deduction available when you contribute to a TFSA. But TFSAs can be withdrawn without tax, while you pay tax on RRSPs when you withdraw funds from them. With both TFSAs and RRSPs, funds can grow inside the plan without tax.

Generally, if you are in a low tax bracket, it probably makes more sense (and cents) to contribute the up to the maximum permitted in a TFSA in priority to RRSP contributions, especially if you think you may later end up in a higher tax bracket. TFSAs are also a better vehicle for saving for things other than retirement, such as buying a home.

But if you are in a high tax bracket, RRSPs may be preferable because you get the tax break when you contribute. The benefits of RRSPs are enhanced if you expect to be in a lower tax bracket in retirement.

Another key difference between RRSPs and TFSAs is that with an RRSP when you reach the age of 71, you have to either withdraw the funds from an RRSP, buy and annuity, or convert the RRSP to a Registered Retirement Income Fund (“RRIF”). In contrast, you can retain and continue to contribute to a TFSA until death.

I suspect the most common approach to RRSPs at 71 is to convert an RRSP into a RRIF. With a RIFF you are required to withdraw a minimum percentage each year, the percentage increasing with age. You may take out more than the minimum, but you pay tax on the withdrawals.

This brings me to the second change in the 2015 Budget. The Government has reduced the percentages that you have to take out of a RRIF each year, the effect of which is to allow you to defer tax longer. Here is a description from the 2015 Budget (tables omitted):

The basic purpose of the tax deferral provided on savings in RPPs and RRSPs is to encourage and assist Canadians to accumulate savings over their working careers inorder to meet their retirement income needs. Consistent with this purpose, savings inRPPs and RRSPs must be converted into a retirement income vehicle by age 71. Inparticular, an RRSP must be converted to a RRIF by the end of the year in whichthe RRSP holder reaches 71 years of age, and a minimum amount must be withdrawn from the RRIF annually beginning the year after it is established (alternatively, the RRSP savings may be used to purchase an annuity). This treatment ensures that the tax-deferred RRSP/RRIF savings serve their intended retirement income purpose.

A formula is used to determine the required minimum amount a person mustwithdraw each year from a RRIF. The formula is based on a percentage factormultiplied by the value of the assets in the RRIF. The percentage factors (the RRIFfactors) are based on a particular rate of return and indexing assumption. Currently, a senior is required to withdraw 7.38 per cent of their RRIF in the year they are age71 at the start of the year. The RRIF factor increases each year until age 94 when the percentage that seniors are required to withdraw annually is capped at 20 per cent.

The existing RRIF factors have been in place since 1992. Economic Action Plan2015 proposes to adjust the RRIF minimum withdrawal factors that apply in respectof ages 71 to 94 to better reflect more recent long-term historical real rates of  returnand expected inflation. As a result, the new RRIF factors will be substantially lower than the existing factors. The new RRIF factors will range from 5.28 per cent at age 71 to 18.79 per cent at age 94. The percentage that seniors will be required to withdraw from their RRIF will remain capped at 20 per cent at age 95 and above. Table A5.2 in Annex 5 shows the existing and proposed new RRIF factors.

By permitting more capital preservation, the new factors will help reduce the risk ofoutliving one’s savings, while ensuring that the tax deferral provided on RRSP/RRIF savings continues to serve a retirement income purpose. For example, the new RRIF factors will permit close to 50 per cent more capital to be preserved to age 90, compared to the existing factors (Table 4.1.2).

Heathfield v. St. Jacques

Although the Wills, Estates and Succession Act has now been in effect for over a year, in most of the court cases being reported now, the Courts are dealing with the law as it stood before the effective date of March 31, 2014. This is because most of the provisions of the Wills, Estates and Succession Act only apply if the date of death occurred after the legislation came into effect. It is interesting to note how the law would have applied in some of the recent cases if the deceased had died on or after March 31, 2014.

The recent decision of Madam Justice Ballance in Heathfield v. St. Jacques, 2015 BCSC 505, provides an illustration.

When Michael Heathfield made his will on August 7, 2004, he was in a common-law relationship with Nicole St. Jacques. They had a child together with another on the way. In his will, he appointed Ms. St. Jacques as his executor. He left his estate to her if she survived him by thirty days, and if not, the will provided that his estate would be held in trusts for his children, until each attained the age of 25.

Mr. Heathfield and Ms. St. Jacques later separated. They divided their property. Their two children resided primarily with her, and he paid child support to her.

Instead of making a new will, Mr. Heathfield wrote in changes on his 2004 will, essentially stating that Ms. St. Jacques would not receive any of his estate, which would go to their two children. These changes were not witnessed by two witnesses as required under the Wills Act. He told others that he wanted his estate to go to his children, rather than to his former common-law spouse.

When Mr. Heathfield died on November 13, 2011, he left an estate valued at approximately $1.2 million.

Ms. St. Jacques as his executor obtained a grant of probate of the will.

The Public Guardian and Trustee of British Columbia brought an application under the Wills Variation Act on behalf of Mr. Heathfield’s two young children to vary the will. The Public Guardian and Trustee argued that the will should be varied so that the estate would be held in trust for each child until that child attains the age of 25, with the Public Guardian and Trustee acting as trustee of the funds.

Ms. St. Jacques opposed the application. She agreed that the estate should be used to benefit the two children, but argued that a formal trust was unnecessary. She as their mother would use the inheritance for their benefit. If the will was varied in favour of the two children, she asked the court to appoint her as trustee of funds.

In opposing the application to vary the will, Ms. St. Jacques relied on a previous Supreme Court of British Columbia decision, Cameron(Public Trustee of) v. Cameron Estate (1991), 41 E.T.R. 30, in which the Court declined to vary a will of a minor child’s mother. In that case, Mrs. Cameron left her estate to her husband, who was the father of the child. The trial judge found that Mr. Cameron was properly maintaining and supporting their child, and refused to vary the will.

Madam Justice Ballance varied Mr. Heathfield’s will by deleting the gift to Ms. St. Jacques, and creating trusts similar to those in the will for each of the two children in respect of the residue of the estate.

In arriving at her decision, Madam Justice Ballance declined to follow the decision in Cameron for two reasons. First, Cameron was decided before the Supreme Court of Canada’s decision in Tataryn v. Tataryn Estate, [1994] 2 S.C.R. 807, which provided a framework for determining if a adequate provision has been made, including an analysis of the will-maker’s legal and moral obligations to a spouse and children. Madam Justice Ballance expressed doubt as to whether Cameron is good authority for the proposition that a will should not be varied whenever a minor child’s surviving parent is the sole beneficiary of the will in light of the Tataryn framework.

Secondly, the circumstances in Heathfield are different. In contrast to Cameron, a case in which the court found that the wife and husband relied on each other to provide for their child, following his separation from Ms. St. Jacques, Mr. Heathfield made it clear that he did not rely on Ms. St. Jacques.

Madam Justice Ballance found that Mr. Heathfield had legal obligations to his children, as reflected in the child support he was paying, and moral obligations to them. In leaving a will that made no provision for them, Mr. Heathfield did not meet those legal and moral obligations. In contrast, he did not have those obligations to Ms. St. Jacques, who was not a person who could have applied to vary the will under the Wills Variation Act.

In her reasons for judgment, Madam Justice Ballance noted how the Wills, Estates and Succession Act has changed the law in a couple of respects that would have been significant to this case if Mr. Heathfield had died after it came into effect.

As she wrote at paragraph 82, under section 56, unless there is a contrary intention expressed in the will, “a gift to a person who has ceased to be a married spouse or a common-law spouse is revoked and must be distributed as if the surviving spouse had predeceased the will-maker.”

Section 58 of the Wills, Estates, and Succession Act would have allowed the court to give effect to Mr. Heathfield's handwritten notes on his will despite the fact that they were not witnessed if the court were satisfied that the notes represented his testamentary intentions.

Accordingly, if Mr. Heathfield had died on or after March 31, 2014, the children would likely have received his estate without having to resort to an application to vary the will under wills variation legislation (now Part 4, Division 6, of the Wills, Estates and Succession Act).

Madam Justice Ballance did accede to Ms. St. Jacques request that she be appointed as trustee of the trusts for the children, and she declined the Public Guardian and Trustee’s submission that Ms. St. Jacques should be restricted as trustee in her ability to access income from the trust for the benefit of the children.

Larson Justice Center, Indio, California

I this photograph of the Superior Court of California, County of Riverside, Larson Justice Center, in Indio, California, a little over a year ago, in March 2014.