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Financial advisors have a key role to play when clients experience major life milestones of separation, divorce, or the death of a partner because it can affect the benefits they receive, the credits they can claim and the amount of taxes they may have to pay.
These situations are an opportunity to prove the value of giving sound financial advice and support to clients as they figure out their futures after a life-changing emotional event. It’s also important for advisors to educate themselves on the tax consequences of such milestones as they could have a big impact on clients’ financial plans.
In fact, one of the first key steps clients need to make after going through such a change is notifying the Canada Revenue Agency (CRA) about a change in marital or cohabitation status.
Robin Taub, chartered professional accountant at Robin Taub Financial Consulting in Toronto, says there isn’t much time to notify the CRA if a person’s marital status has changed.
“Clients should let the CRA know they’re divorced by the end of the month following the month the divorce was finalized,” she says. “So, if you were officially divorced in March, you would have to let them know by the end of April.”
If there’s a separation, the CRA gives a greater leeway of 90 days, she says, because reconciliation could take place within that time. For a death, the CRA needs to be informed as soon as possible.
When it comes to divorce or separation, a change in marital status may mean a change in income and a client could be entitled to new benefits, Ms. Taub says.
“An example of that would be the Canada child benefit, the GST or HST credit, and provincial benefits,” she says. “Even if your own income hasn’t changed, your spouse’s income is no longer combined with yours, so you could qualify for some of these.”
There are other benefits clients should keep in mind, especially if they have kids, says Jamie Golombek, managing director, tax and estate planning at CIBC Private Wealth Management in Toronto.
Parents should claim the amount for an eligible dependent. However, there are specific rules about which parent can claim the credit, especially if child support payments are involved, he says.
If a client pays child support but the other parent doesn’t, the person paying child support can’t claim the amount for an eligible dependent. Only the parent who isn’t paying support can claim the amount.
Other types of spousal support payments can be deducted from a client’s income, which can help reduce their taxable income. If there are any legal fees related to support payments, they could also be deducted.
The fallout when a partner dies
However, when a partner dies, a legal representative has to file a terminal or final tax return on their behalf, Ms. Taub says. This checks if the deceased owes any income taxes or taxes on their estate, which is usually paid out by the estate before named beneficiaries can inherit any assets.
That can also affect the surviving partner, says Trent Hamans, vice president, private banking and wealth planning at ATB Wealth in Edmonton. Typically, everything rolls over to the spouse without little to no income tax liability to the deceased.
“But as you get older, it becomes a bit more challenging,” he says, especially for couples who have lived together for a long time and were able to split their income.
“What happens is that as opposed to being able to split income as in previous years, all of that income in the years going forward is attributed to the surviving partner,” he says.
That can put clients in a whole new tax bracket and impact some benefits they were receiving as a couple such as Old Age Security.
“It’s a real shame because these survivors are often women grieving the loss of their partner,” he says. “Then, they also have to realize that they’re not getting the same benefits anymore and they’re paying more taxes.”
Strategies to reduce taxes on income
There are ways to manage that increase in income from a tax perspective. Mr. Hamans says one way is to use any registered retirement savings plan (RRSP) eligibility room for the deceased taxpayer. The surviving spouse should consider making the contribution.
He says if the contribution is not made by the end of February in the year following the date of death, the eligibility room is lost and it cannot be transferred to the spouse. In using this strategy, the deceased’s estate will get the deduction and that means more funds stay sheltered from taxes for the surviving spouse.
Longer-term planning to address a potential increase in income should include a decumulation strategy.
“It may be beneficial to withdraw funds from an RRSP for lifestyle expenses in the early years of retirement rather than deferring the withdrawals until converted to a [registered retirement income fund (RRIF)],” Mr Hamans says.
That’s because two partners who are drawing on tax-sheltered money can be more effective at splitting taxes compared to the surviving partner drawing on combined accounts.
A decumulation strategy could reduce the balances to the point at which, at the time of the first partner’s passing, the balances in the account may be less than waiting until the accounts are converted to a RRIF. That may result in the surviving spouse having to pay fewer taxes on the terminal tax return.
Overall, a separation, divorce, or death is an unpleasant time, says Mr. Hamans, and that’s why planning can help.
“We spend a lot of time with our clients focusing on what we can control,” he says.
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