Lifetime benefit trusts protect RRSPs for children with special needs
By AdvocateDaily.com Staff
Financial planning for the future needs of a child with special needs is a challenging responsibility, but starting early can give parents peace of mind, says Ottawa disabilities and estate planning lawyer Kenneth Pope.
Registered Retirement Savings Plan (RRSP) or Registered Retirement Income Fund (RRIF) “rollovers,” are a way of transferring assets from parents or grandparents to financially dependent children and grandchildren, but there can be challenges if the beneficiary has a mental or cognitive disability, Pope tells AdvocateDaily.com.
“For example, there can be practical and legal obstacles that stand in the way of the beneficiary establishing, administering and managing the account — not to mention drawing up the documents necessary to leave the assets to the next generation of heirs,” he says.
It’s also important to consider that RRSP or RRIF rollovers to a child with special needs only qualify as tax-free under certain conditions and that a beneficiary’s eligibility for government benefits could be affected when assets are transferred to them, explains Pope, principal of Kenneth C. Pope Law, a special needs and disability estate planning law firm.
“The government provides a disabled person with income support and programs under two conditions: they can’t have more than $5,000 in assets and they can’t have much of an income. For some, the government support isn’t necessary, but it helps pay for essential drugs that are very expensive,” he says.
The most common way parents provide for their adult dependent children is through Henson trust provisions in their wills, which are exempt from provincial asset tests, Pope says.
“Many parents across Canada — except in Alberta — have structured their estate plans to pay bequests and inheritances into Henson trusts so that the assets and income from the trust don't interfere with the beneficiary’s eligibility for government benefits,” he says.
But there are drawbacks to this approach, Pope says.
“Registered assets that flow into a Henson trust must first be de-registered, the taxes paid by the estate — not the designated beneficiary — and then the after-tax cash goes into the trust. This can skew overall estate division calculations. The implication is that RRSPs or RRIFs cannot be rolled in directly. The estate can then set up a Henson Trust for the benefit of the disabled child and deposit the after-tax money,” he says.
In 2013, the government received Royal Assent for the lifetime benefit trust (LBT), a “radical change for the better” when it comes to financial planning for children with special needs, Pope says.
“An LBT is a specialized personal trust where the beneficiary is a financially dependent or cognitively impaired spouse, child or grandchild of the deceased. It allows for the rollover of RRSP and RRIFs if the trustee purchases a special annuity and the annuitant is not the disabled person, but rather the trust established for him or her,” he explains.
“Essentially, when family members establish an LBT in their wills, RRSP or RRIF assets flow into the trust in a tax-free rollover and are used to purchase an annuity that pays income to the trust — not directly to the beneficiary. The trustee can allocate additional funds to the disabled child, but they must be careful not to exceed the maximums allowed by government benefits programs,” he says.
The income paid out by the trust is taxed only when it’s received — or deemed to be received — by the beneficiary using the "preferred beneficiary" election, Pope says, noting deemed receipt does not affect provincial benefits.
“He or she will be in a lower tax bracket than the testator upon death, and as a result, the money will be taxed at a lower rate, or in many cases, not at all,” he says.
To illustrate the difference between the Henson trust and an LBT, Pope cites the example of John, a widowed man with two sons, George and Frank — the latter is cognitively impaired.
“John receives a regular pension of $60,000 a year and has his own RRSP and the RRSP of his late wife, Martha, totaling $500,000. John’s house is paid off and he doesn’t need more income than his pension provides,” he says.
With a Henson Trust, after John’s death, the estate would receive the $250,000 after-tax amount from the RRSP, which can then be placed into the Henson Trust in a pure cash form, Pope notes.
“With an LBT, John would leave Frank the full $500,000 in his will. The RRSP is received on a tax-deferred basis and, once in the hands of the beneficiary, it can be targeted to offset against their disability tax credit and basic personal amounts totaling approximately $19,000,” he says.
This may change the way John divides the balance of his estate between the sons, Pope says.
"Since Frank receives the full amount of the RRSP, perhaps George receives more of the residue of the estate. In any event, there is more for everyone, and that's a great outcome for the family.