How can I leave more money to my children?

The oft-cited RRIF meltdown tactic is a distraction. Concentrate instead on leaving a bigger legacy—or giving it away right now.

Hi Mary. What exactly do you mean by a RRIF meltdown? I used to think a RRIF meltdown was borrowing money to invest and using the tax deduction on the interest to offset or reduce the tax on registered retirement income fund (RRIF) withdrawals. Today it seems a RRIF meltdown is associated with any withdrawals above your income need or starting a RRIF before age 72.

Let’s forget about the term RRIF meltdown and talk about what you really want: getting more money to your children.

Right now, you are drawing the minimum from your RRIF and I can see, based on your current spending and assets, you will eventually have to pay about $352,000 in tax through your estate once you die. We will use this scenario as our base to test against other scenarios. I assume your investments will grow at 5%, your home at 3%, inflation is 2%, and you both live to age 90.

Now, let’s increase your RRIF withdrawals from the minimum to $65,000 per year so your RRIF is almost depleted by age 90. In that case, your final tax will be about $147,000. Good, drawing more from the RRIF reduced the tax at death; however, there is about $1,000 less to distribute to your three children. Effectively, there is no difference in the amount going to your children. Drawing extra from your RRIF to reduce the tax in the estate didn’t have the impact you expected.

The reason is that when you draw from your RRIF you have less after-tax money available to invest. In addition, you have already maximized your tax-free savings account (TFSA) and are using your non-registered account to make future contributions. As a result, when you draw money from your RRIF, it is reinvested into your non-registered account, which has annual taxable distributions, capital gains tax when sold, and is subject to probate fees. The RRIF and TFSA will avoid probate fees if your kids are named as beneficiaries.

Money left in a RRIF grows tax-deferred, and although more tax is paid through the estate, the estate is larger. This is why drawing more from your RRIF is not working the way you expected.

Let’s not give up, though. There is a way.

How to improve tax efficiency

Your husband is 10 years older than you, and you are not experiencing any Old Age Security (OAS) clawback. Once your husband dies, assuming you are still alive, you will have some clawback because you will no longer be able to split pension income. You can reduce the possibility of a clawback by reducing your taxable income.

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The dividend fund you are holding has large annual taxable distributions pushing you closer to the OAS clawback threshold. You may want to consider switching from a fund with high annual distributions to a more tax-efficient fund with low annual distributions, such as an index-like fund, assuming it is within your risk tolerance and other objectives.

When I run a scenario with a more tax-efficient, non-registered fund, your final net worth at age 90 is about $81,000 more than if you stick with the dividend fund. Again, I am assuming both earn a 5% return, but the dividend fund has higher annual taxable distributions.

What is interesting is that if you look at the amount available to distribute to your children, there is a difference of only a few thousand dollars, essentially none. The tax-efficient fund let you accumulate more, but it also left a larger capital gain to be taxed at death. We saw something similar with the RRIF.

Consider giving while you’re alive

So far we haven’t done anything significant to increase the amount of money you can leave to your children. Drawing extra from your RRIF to reduce tax at death didn’t work and using a more efficient fund in your non-registered account didn’t work.

Let’s bring both strategies together to increase the amount you can leave to your children. Consider drawing more money from your RRIF while your husband is alive and, rather than investing the money yourself, give it to your adult children to add to their TFSAs, a tax shelter.

Keeping the dividend fund will allow you to draw an extra $15,000 above your RRIF minimum with no OAS clawback. You can then give your children $5,000 each to add to their TFSAs. With your non-registered money in a tax-efficient fund, you can draw an extra $24,000 above your minimum from your RRIF with no clawback, and give your children $8,000 each to add to their TFSAs, assuming they have unused contribution room.

Comparing the different scenarios, I can see that switching to a more tax-efficient fund, drawing an extra $24,000 from your RRIF, and gifting to your children while alive will leave an extra $260,000 in total over what you are currently doing. That is significant.

Mary, I have given you some ideas to think about. You will still want to work through this with your correct numbers—for example, I assumed switching to a tax-efficient fund won’t create a large capital gain for you.

If your goal is to leave your children as much money as possible, why not give a little now? Based on the numbers you shared with me, you can afford to do it without putting your lifestyle at risk and you get to see the difference it makes for them while you’re still here. Combine this with a tax-efficient fund and additional RRIF withdrawals and you have a RRIF meltdown strategy that works.

About Allan Norman, MSc, CFP, CIM

With over 30 years as a financial planner, Allan is an associate portfolio manager at Aligned Capital Partners Inc., where he helps Canadians maintain their lifestyles, without fear of running out of money.

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