The Registered Disability Savings Plan – A Government-Assisted Savings Plan for Family Members that Qualify for the Disability Tax Credit

Last week, Katy Basi wrote about using Henson Trusts to estate plan for disabled beneficiaries.

Today, Howard Kazdan, a tax expert with BDO Canada LLP, discusses what a Registered Disability Savings Plan is and where it may be a useful tax planning vehicle for the parents of a disabled child.

I thank Howard and Katy for their excellent posts.

The Registered Disability Savings Plan – A Government-Assisted Savings Plan for Family Members that Qualify for the Disability Tax Credit

By Howard Kazdan

A Registered Disability Savings Plan (“RDSP”) is a savings plan that is intended to help parents and others save for the long term financial security of a person who is eligible for the disability tax credit (“DTC”). A person is eligible for the DTC only if a medical practitioner certifies on Form T2201, Disability Tax Credit Certificate, that this person has a severe and prolonged impairment in physical or mental functions. This form must also be approved by the CRA.

Where you have a family member living with a physical or mental disability, consideration should be given to opening a Registered Disability Savings Plan.

What is an RDSP?

RDSPs are tax deferred savings plans which can provide long-term financial benefits for a disabled individual resident in Canada. Qualifying individuals may receive grants and bonds that the Government of Canada contributes to the RDSP.

How does the RDSP work?

RDSPs can be opened by either a beneficiary who has reached the age of majority and is contractually competent to open an RDSP for themselves or, before 2019, by their parents or other legal representative.

There is no limit to how much can be contributed to an RDSP in any particular year, however, the lifetime maximum contribution limit is $200,000. Contributions can be made until the end of the year in which the disabled person turns 59.

It is important to note that there is no tax deduction for contributing to an RDSP. These plans are somewhat similar to a Registered Education Savings Plan (if you have opened such an account for your child’s education). On the flip side, when the original contributions are withdrawn, the disabled individual will not be taxed on those contributions. However, income earned and government grants (discussed below) and bonds received will be taxed when they are paid out of the RDSP. If the plan is established for a long period of time, and the investments earn a good rate of return, then this may provide a long deferral from paying tax.

Subject to certain contribution and age limits, RRSP/RRIF proceeds can be transferred to an RDSP through a will if the disabled individual is financially dependent upon the deceased. This allows parents or grandparents of a disabled individual, to tax and estate plan for a future contribution to an RDSP and may provide you with comfort if it is not otherwise possible to maximize the contributions before this point.

Government Grants

The Government of Canada pays a grant to the RDSP, until the end of the year in which the beneficiary turns 49, that is dependent on the beneficiary’s family income and the amount contributed. The maximum grant is $3,500 each year, to a lifetime maximum of $70,000. The contribution rules allow for a 10-year carryforward of entitlements, for those who qualify but cannot contribute every year.

Beneficiary's family income	Grant**	Maximum
$90,563 or less
on the first $500	$3 for every $1 contributed	$1,500
on the next $1,000	$2 for every $1 contributed	$2,000
more than $90,563 or no income information at available at CRA
on the first $1,000	$1 for every $1 contributed	$1,000
**The beneficiary family income thresholds are indexed each year to inflation. The income thresholds shown are for 2016.

For minors, family net income is that of their parent(s) or legal guardian(s). From the year the beneficiary turns 18, family net income is the combined net income of the beneficiary and their spouse.

The Government of Canada may also pay up to $1,000/year, to a maximum of $20,000, in a Canada disability savings bond to low-income Canadians until the beneficiary turns 49. No contributions are required once the RDSP is opened.

Taxation

Since RDSPs are intended to be a long-term savings vehicle, if money is withdrawn, all or part of the government grants and bonds that have been in the RDSP for less than 10 years may have to be repaid. The beneficiary must repay $3 for every $1 that is taken out, up to the total amount of grants and bonds paid into the RDSP in the last 10 years. This can be very punitive if funds are required urgently.

The minimum regular scheduled payments that must begin when the beneficiary turns 60 are determined by a complicated formula.

If an RDSP terminates because the beneficiary no longer qualifies for the DTC or dies, then:

• grants and bonds that have been in the plan for less than 10 years must be repaid, and

• amounts paid to the beneficiary or his/her estate related to investment income, grants and bonds will be taxable.

If you are disabled, or have a disabled child, you should consider opening an RDSP if you have not already done so, to provide additional government-assisted long-term financial security. Before opening the plan, confirm with the Canada Revenue Agency that the DTC eligibility status of the plan holder is up-to date so the DTC can be claimed and the benefits of an RDSP can be enjoyed. This should be monitored in the future so the benefits are not lost. RDSPs can be a useful tax planning tool for the parents of a disabled child. However, as noted above, there are many rules for which you need to familiarize yourself with. Howard Kazdan is a Senior Tax Manager with BDO Canada LLP. He can be reached at 905-946-5459 or by email at hkazdan@bdo.ca This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation. Please note the blog post is time sensitive and subject to changes in legislation or law.

Estate Planning for Disabled Beneficiaries – Henson Trusts

I have received several requests to write about tax and estate planning for disabled individuals. Thus, this week I have enlisted the help of Katy Basi, my resident wills and estate planning contributor, to write about Henson  trusts, an estate planning opportunity for disabled beneficiaries. Next week Howard Kazdan, a tax specialist with BDO Canada LLP, will write about Registered Disability Savings Plans ("RDSP's").

As Henson trusts are complex, I appreciate Katy providing a detailed analysis of the important issues to be considered in whether or not to use such a trust. So without further ado, here is Katy.

Estate Planning for Disabled Beneficiaries - Henson Trusts

By Katy Basi

It is fairly common for a client to come to me and say "my child has a disability and I've been told I need a Henson trust in my will - whatever that is...." My usual answer is "maybe - let's discuss your situation" - typical lawyer-speak but true nonetheless!

What is a Henson Trust

A Henson trust is a trust created in a will, or by way of a free-standing trust deed, which is completely discretionary and has a disabled beneficiary who is not also a trustee of the trust. “Completely discretionary” means that the trustee will have all decision making power with respect to the timing and amount of all payments made out of the trust. The benefit of having a Henson trust is that the disabled beneficiary’s interest in the trust is not considered to be an asset for purposes of the rules surrounding disability benefits in Ontario and in some other provinces (the “asset test”, in particular, limits the value of assets a recipient of disability benefits may own – further discussed below).

The term “Henson trust”, while common, does not have legal meaning in and of itself, but is generally taken to mean a trust having the attributes set out in the above paragraph. These trusts are called “Henson trusts” due to a court case in Ontario involving a father (last name being Henson) who established a trust of this nature for his disabled daughter. Her right to claim disability benefits was challenged (the government’s position was that her beneficial interest in the trust was a valuable enough asset to disqualify her). The Hensons won the case, based on their position that the beneficial interest in the trust did not have any value due to the discretionary nature of the trust. As the trustee could choose not to pay any of the trust funds to or for the benefit of the daughter, the beneficial interest was held not to have value for purposes of the disability benefit rules.

Planning Using a Henson Trust

In order to ascertain whether a Henson trust is appropriate planning for a client, I will usually ask about the nature of the disability, as this may impact:

• the child's ability to eventually make capacitated financial and or health care decisions for him or herself,
• their prospects of getting married and having children,
• their life expectancy,
• their ability to be financially independent,
• their care requirements at various life stages, and
• other factors that are relevant to their parent’s estate plan.

I will ensure that my client has investigated whether the disability tax credit (“DTC”) is available in relation to their child. We then discuss whether the child is likely to start claiming provincial disability benefits when they attain age 18, as the value placed on the availability of disability benefits varies greatly from parent to parent and affects whether Henson trust planning is appropriate.

Some disabled beneficiaries have good employment prospects, now or in the future, in which case disability benefits are really not relevant. When a disability does not affect the financial acumen of a beneficiary, and they are a relatively high functioning adult, the beneficiary may even receive an outright inheritance (i.e. not in any form of a trust, Henson or otherwise).

Some parents have a large estate, and want their child to have more access to their inheritance than would be permitted by Henson trust planning. These clients find the rules surrounding disability benefits very limiting and essentially assume that their child will not apply for benefits, which in turn makes other estate planning options available.

If disability benefits are important, then we discuss whether the child should inherit by way of a Henson trust set out in the parent’s will. Unfortunately, inheritances received in any way other than a Henson trust usually result in the recipient being cut off from disability benefits (for having access to assets valued at greater than $5,000 (the “asset test”)).

A Henson trust is, by necessity, limiting. As noted above, in order to have the Henson trust assets excluded from the asset test, the Henson trust must be drafted as a fully discretionary trust and the beneficiary cannot be the trustee. Essentially, the beneficiary cannot have the right to demand trust assets at any time, but must rely on the good judgment of the trustee. I have had a few clients decide against Henson trust planning for this reason alone.

When a Henson trust is a good choice, the selection of the trustee, and alternate trustees, is very important given their broad powers. The trustee has the fairly onerous task of managing the trust funds to optimize the quality of life of the disabled beneficiary, without cutting them off from disability benefits – like walking on a tightrope, with significantly more reading and longer telephone calls to the government.

Also, a beneficiary in addition to the disabled beneficiary is usually named in the Henson trust in the event that the trust lasts longer than 21 years. (After 21 years, all trust income must be distributed by an Ontario trust to or for the benefit of a beneficiary. Without an alternate beneficiary, this rule could force a trustee to allocate income to a disabled beneficiary, and disability benefits could potentially be lost.) Sometimes the alternate beneficiary is a charity, and sometimes a family member such as a sibling.

When, as commonly happens, a sibling is both the trustee and alternate beneficiary, there can be a conflict of interest, and the parent needs to be very sure that the sibling will “do the right thing” and not profit personally from the Henson trust unless absolutely necessary. In addition, Henson trusts are often drafted to last for the lifetime of the disabled beneficiary unless the trustee decides to wind up the trust early. (In the latter case, common planning is to require the trust funds to be paid to the disabled beneficiary, which may, or may not, be appropriate under the circumstances.)

Upon the death of the disabled beneficiary, there is often a distribution of remaining Henson trust funds to the siblings of the beneficiary. If a sibling is also the trustee, we can have a conflict of interest, as minimizing distributions for the benefit of the disabled beneficiary during their lifetime maximizes the funds potentially received by the sibling/trustee upon the death of the beneficiary. Obviously, the trustee must be a very trustworthy, morally upstanding sibling!

We also generally ensure that the Henson trust terms specifically permit the trustee to make contributions to a Registered Disability Savings Plan (“RDSP”) set up for the disabled beneficiary in order to optimize the payment of government grants and bonds. We usually advise that the trustee exercise some caution here, as any funds left in the RDSP upon the death of the disabled beneficiary flow in accordance with the disabled beneficiary’s will (or the law of intestacy if there is no will). This may, or may not, be the result desired by my client…

Finally, as of 2016 it will be helpful, from an income tax perspective, if a Henson trust meets the “qualified disability trust” (“QDT”) definition. QDTs are one of the few remaining trusts able to access the graduated rates of tax on income. (All trusts other than QDTs and graduated rate estates pay tax at the highest rate). For a Henson trust to qualify as a QDT, the disabled beneficiary must receive the DTC and elect with the trustee that the Henson trust is their one and only QDT. One issue (yet to be resolved) is that a recovery tax is applicable if anyone other than the disabled beneficiary receives capital from the trust. As noted above, this can easily happen upon the death of the disabled beneficiary. Another issue is that many disabled beneficiaries are not sufficiently mentally capacitated to sign the QDT election form for themselves, and have no court-appointed guardian to sign the election form for them. (Contrary to common belief, parents are not automatically the guardians of an incapacitated adult beneficiary, at law). To ensure QDT status, it may be necessary to apply to the court for a formal appointment of a guardian for the incapacitated beneficiary – which is, of course, costly and time consuming.

The good news is that careful estate planning can ensure that disabled beneficiaries are well cared for their entire lives, even after their parents are deceased, giving peace of mind to the entire family.

Please note that as I am licensed to practice law in Ontario only, this post is based on Ontario law. If you live outside of Ontario, it is strongly recommended that you consult with an estates lawyer licensed to practice in your province – the member directory of the Society of Trust and Estate Practitioners (“STEP”) at step.org is a good place to begin.

Katy has written numerous popular estate planning posts for this blog over the years including Estate Planning for Blended Families, Qualifying Spousal Trusts - What are They and Why do we Care? and a three part series on new will provisions for the 21st century dealing with your digital life, RESPs and reproductive assets, the family cottage and a very well received post titled, An Estate Fairy Tale.

Katy Basi is a barrister and solicitor with her own practice, focusing on wills, trusts, estates and income tax law (including incorporations and corporate restructurings). Katy practiced income tax law for many years with a large Toronto law firm, and therefore considers the income tax and probate tax implications of her clients' decisions. Please feel free to contact her directly at (905) 237-9299, or by email at katy@basilaw.com. More articles by Katy can be found at her website, basilaw.com. 

The above blog post is for general information purposes only and does not constitute legal or other professional advice or an opinion of any kind. Readers are advised to seek specific legal advice regarding any specific legal issues.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation. Please note the blog post is time sensitive and subject to changes in legislation or law.

Recent Changes in Legislation Make Reviewing Your Will A Must

Tax changes that will become effective January 1, 2016, may have a harsh and surprising effect on your will and estate planning. To explain these new changes, I have a guest poster, Howard Kazdan, a tax expert with BDO Canada LLP.

Below, Howard highlights some of the more significant changes in the legislation.

Recent Changes in Legislation Make Reviewing Your Will A Must

By Howard Kazdan

 

The interaction of life’s two certainties – death and taxes – is about to get more complicated effective January 1, 2016, due to legislative changes to the taxation of trusts and estates that have been enacted. You may wish to review your will after considering the information discussed in today's post.

Change in tax rates for estates and testamentary trusts, except for Graduated Rate Estates ("GRE")

 

Currently, estates and testamentary trusts (i.e. trusts that are created by will upon death) are subject to tax at graduated tax rates. Under these old rules, you could set-up multiple trusts (generally for each child to control their inheritances) to be taxed at the lower graduated income tax rates.

Effective January 1, 2016 only a GRE will be eligible for graduated tax rates. The lower tax rates may only be available during the first thirty-six months of the estate if that period is required to settle the estate. All of the income in other estates and testamentary trusts will be taxed at the highest personal tax rate. Under the new rules, if you had set-up say 3 separate trusts for each of your children, all of them will be subject to the highest tax rate, as they will not be considered GRE’s (however, there may be non-tax reason for still creating multiple trusts, such as to protect against spendthrift children, protect assets for family law purposes and asset protection).

The administration of these new rules may also become challenging where you have multiple wills (some provinces allow for two wills, one for personal assets and one for assets that are not required to be probated) and have different executors, since all of the wills may make up one estate. If one component of the estate no longer qualifies as a GRE, the entire estate may no longer qualify, and therefore all income will be taxed at the highest marginal tax rate.

Finally, the availability of tax elections for income to be taxed in a trust at graduated rates, even if such income was paid or payable to a beneficiary will now be extremely limited.

To qualify as a GRE certain conditions must be met, which include: 

 

• The estate must arise as a consequence of death

• The determination time is within the first thirty-six months of the estate

• The executor must designate the estate as a GRE

• No other estate can be designated as a GRE

Other benefits that will only be available to a GRE also include:

• ability to maintain an off-calendar year end

• ability to avoid capital gains on taxation of donated securities

• no requirement to make tax installments

• ability to carry losses back to terminal return

• more flexibility for claiming tax credits in respect of donations made by will/bequests

Due to the significant benefits of qualifying as a GRE, it will be necessary to plan accordingly.

Change in taxation of Life Interest Trusts

 

These trusts are often used to provide an income stream to a surviving spouse during their lifetime with the residual assets being distributed to other beneficiaries after that individual dies.

For example, spousal trusts are common in a blended family where husband and wife were previously married and each has children from a previous marriage. The husband may have established a spousal trust in his will whereby his wife was to receive income during her lifetime, but his children from previous marriage will receive the capital of the trust after she dies, and her children from a previous marriage are the beneficiaries of her estate after she dies.

Currently, when the wife dies, there will be a deemed disposition of the assets of the trust at fair market value and any income arising from the deemed disposition will be taxed in the trust.

The new rules will shift the reporting of income arising in the final year before death of the wife, including income on the deemed disposition of the assets, to her final income tax return. Since the beneficiaries of her estate and the spousal trust are different, this will lead to inequitable results (estate beneficiaries will owe tax, but the trust beneficiaries will own the assets). If the Canada Revenue Agency is unable to collect this tax from the estate, then it will have the ability to demand payment of the tax from the trust beneficiaries.

Planning for Disabled Persons

 

The new rules provide for a Qualified Disability Trust (“QDT”) which can be established for a beneficiary that qualifies for the disability tax credit. A QDT will allow for the taxation of income at marginal tax rates during that beneficiary’s lifetime, provided all of the required conditions are met.

As the conditions are very complicated and potentially require elections, it is imperative to review any wills that have provisions for a disabled person in context of the new rules with your lawyer and accountant.

Charitable Bequests On Death

Currently, on death, donations in the will are included in the final tax return of the individual or in the prior year, not in the estate return. Under the new rules, the donation will be deemed to be made from the estate which may result in additional flexibility in claiming the donation tax credit if the estate qualifies as a GRE.

The new rules are very complex and it would be prudent for your accountant and/or lawyer to review your will and any current estates, testamentary trusts or other life interest trusts that you may be connected with as a trustee, executor or beneficiary because planning strategies previously anticipated may no longer be effective. Where it is possible to amend such documents, it may be advisable to do so. Where it is no longer possible to amend such documents then additional planning may be required to determine next steps.

Here is a link to an excellent BDO tax memo which you may also wish to read if you want more detail.

Howard Kazdan is a Senior Tax Manager with BDO Canada LLP. He can be reached at 905-946-5459 or by email at hkazdan@bdo.ca

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.