inkwellHave you established a Revenue Canada Agency pre-paid Capital Gains Tax Account? How about a pre-paid RRIF tax Account?
You have invested wisely, purchased a summer home, cottage, or snowbird condo and built up a successful family business. If this is some or all of your successes, you probably also had the savvy to be able to defer most of your tax liabilities on your successful asset accumulations. That’s like an albatross over your head that in some cases may be manageable, while in others that deferred tax liability can become “current” unexpectedly and create undue financial hardship to the family in a real hurry.ca16x11

Let’s examine the most common situations that can create a “deferred” tax liability.

  • RRSP accumulations – Savings inside an RRSP comprise of pre-tax capital and tax deferred growth.
  • RRIF accumulations – RRIF is the income format of an RRSP once the RRSP accumulations end and become income streams inside a RRIF.
  • Personal Pensions and Locked in Retirement Accounts [LIRA] – All are comprised of pre-tax capital and tax deferred growth. Once funds are removed from those tax shelters, their “deferred< tax liability status becomes “current”.

Unrealized Capital Gains are another form of tax deferral permitted by the tax code. Some of the situations that give rise to such a deferral are growth in the capital value of appreciable property like,

  • Real Estate such as a summer home, snowbird condo, or rental property;
  • Stocks, Bonds individually held or inside a mutual funds
  • Precious metal and stones like gold, silver or diamonds;
  • Art and other collectibles like paintings and antiques;
  • Business Ownership – like the family business.

Suppose at the beginning of the year you purchased stocks worth $1,000 and at the end of the year those stocks were deemed to be worth $1,200. That has created an appreciation, or a “gain” in the value of the stocks of $200, or 20%. Since you have not sold or “disposed “ of the stocks, the gain while real is deemed as an “unrealized” gain. It becomes a “realized” gain once you sell it or “dispose” of it. Upon such disposition, the “deferred” tax liability or “unrealized” gain becomes a “current” tax liability.

During your lifetime, with few exceptions, you can defer the tax liability of RRSPs and unrealized capital gains indefinitely if you don’t remove your asset from an RRSP or RRIF, ( RRIF Personal Pensions and LIRAs force systematic minimum withdrawals) or dispose of the appreciable asset like stock, bonds or real estate. One event that does trigger the deferred tax liability into a “current” tax liability situation is the asset owner’s death. In most normal circumstances, the timing of one’s death is an event that is unplanned and often unexpected. This event if occurs unexpectedly triggering those tax liabilities can create serious cash flow issues.

Disposing of assets to create the cash necessary to meet those tax liability and other obligations may force “fire sale” dispositions at below the assets’ values [Fair market Value], further decaying the total value of your assets, or estate.
A little advance planning can mitigate such unnecessary and unwanted circumstance. How?

Step 1. Set up a notional long term liability account called Capital Gains Tax Liability in your family balance sheet.
Allocate existing life insurance on your life to fund this account. If insufficient, purchase additional sums to cover the deficiency.

The advantages of this strategy are huge and here is why.

A dollar isn’t always 100 cents. If you owe $10,000 and you have to borrow to get it; the cost of borrowing makes your dollar substantially greater than 100 cents. Similarly, if you have to sell an asset in a “fire sale” to create the $10,000 cash flow, you may not get FMV for your asset making your dollar cost more than 100 cents. On the other hand, if you systematically invest over time to fund the notional the Capital Gains Tax liability account, the present value of your out of pocket cost of the same dollar will be less than a 100 cents. Lastly, if you use life insurance to finance your dollar significantly less than 100 cents, in fact, depending on the age, gender and insurability factors it could be as low as 12 to 22 cents on the dollar.

If this sounds confusing its probably because I made it sound that way unintentionally. Contact me and I would be happy to take another stab at it. If you haven’t as yet set up your Pre-Paid Capital Gains Tax Liability account, keep repeating it to yourself until it drives you nuts and entices you to action.

set up Pre-Paid Capital Gains Tax Liability account

Here is where to start