Charity Part of Inheritance Plan

ANDREW ALLENTUCK

In Ottawa, a couple we'll call Jenny and Albert, both 44, recently inherited $120,000 from an uncle. They expect an additional $150,000 from the same estate in a few months. In future, they could receive $1.5-million from Jenny's mother's estate. The money will make a big difference to them and their two daughters, ages four and two. The family's 2007 gross income was $90,000.

"We want to use this inheritance wisely to ensure our daughters' educational needs are met and that we are able to travel and to give to charity. We also want to work as volunteers in the developing world once our daughters are about nine and 11 years of age. We would expect to be out of Canada for two to three years and to return when our eldest is ready to enter high school. Eventually, we would expect to flow half of the funds we inherit to a charitable foundation we could set up and the other half to our daughters."

What our expert says:

Facelift asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Jenny and Albert.

"Good intentions are not enough to make a good plan," he says. "The first step in developing the financial ability to give away money is to ensure their daughters' security and meet their own limited needs."

Those needs include eliminating their $175,000 mortgage. They can reduce their mortgage with $74,000 currently in a money market fund. Albert manages the house and looks after the children while Jenny, the family breadwinner, is at work. The inheritance the family has already received went to her, so any interest earned on the cash is taxed in her hands at 37.2 per cent a year. On a 4-per-cent return from an interest-bearing deposit, after taxes Jenny is left with 2.5 per cent, which is eaten up by inflation.

It makes the most sense to use the $74,000 to reduce the outstanding mortgage balance, cutting amortization to 8.75 years from 20 years and saving $88,308 in interest, he says.

Another inheritance of $150,000 should arrive soon. That money should be used to eliminate the mortgage, which would then be just under $100,000, Mr. Moran says.

The $50,000 remaining from the second inheritance should be used to make the most of Jenny's registered retirement savings plan (RRSP) contribution room. All the family's RRSPs are in Jenny's name. In the future they should go to Albert, who has no taxable income. If Jenny funnels the RRSP to a spousal account for Albert, she'll get the tax deduction and Albert will benefit from income splitting.

Pension splitting provisions in the 2007 federal budget require recipients to be 65 or older. Splitting now by a spousal contribution will allow money to come out and be taxed in two hands at low rates when they retire, Mr. Moran notes.

Without a mortgage, the couple will have an additional $1,200 a month, which can go to RRSPs. By age 60, 16 years from now, the $95,000 in Jenny's RRSP would grow to $451,400 in 2008 dollars, assuming a 6-per-cent return and inflation rate of 3 per cent.

If the RRSPs are converted to registered retirement income funds (RRIF) and distributed over the following 30 years until age 90, the RRIF would produce annual pretax income of $22,360, Mr. Moran says.

RRSP contributions of $14,400 each year at Jenny's tax bracket would generate a $5,550 refund, which could go to charity.

In retirement, Jenny and Albert figure they'll need $60,000 a year after tax. To achieve this, the couple would need $70,000 a year in pretax income evenly split. Canada Pension Plan payments could provide each with as much as $10,615 in 2008 dollars. For estimation purposes, assuming they both receive 70 per cent of the maximum, Jenny and Albert would each have $7,431 at age 65. Each would also receive Old Age Security of $6,028 in 2008 dollars.

CPP and OAS will be the couple's only indexed pension sources, so they should defer applying for CPP until age 65. If they do, their combined registered savings, CPP and OAS would total $49,278. That would leave them with a retirement income shortfall of about $20,000 a year, the planner estimates.

If Jenny works to age 65, RRSPs would increase to $602,000. That capital base would support RRIF income of $33,570 a year for the 25 years until each partner is 90. This scenario would raise retirement income to $60,486, cutting the shortfall in half.

The couple has a major capital asset in their $350,000 house. They could sell it rather than rent it out when they're away volunteering. If they inherit the $1.5-million, they could easily buy another house.

However, the inheritance isn't in hand, and isn't part of this plan. Rather than count on it, the couple should spend conservatively. Life in some developing countries is harsh; the couple could return to Canada sooner than expected. With that in mind, selling their house may be unwise, Mr. Moran cautions.

For now, it would be best to open registered education savings plans for the kids. They can be financed with $2,500 per child a year in order to receive the maximum Canada Education Savings Grant of $500, 20 per cent of the amount, he explains.

If the inheritances arrive, the challenge will be coping with Jenny's increased income and tax burden, Mr. Moran says.

"They owe it to themselves, their children and their planned good deeds to make the most of their wealth."

"I feel an enormous responsibility to use our future wealth responsibly," Jenny says.


Client situation

The Couple

Ottawa couple in middle age about to receive inheritances.

The Problem

Balancing educating children, retirement and work in developing world.

The Plan

Pay off mortgage, plan for charitable work.

The Payoff

Financial security for family, better return on money, more money for charity.

Net Monthly Income

$5,434.

Assets

House $350,000, RRSP $95,000, money market fund $74,000, car $8,000. Total: $527,000.

Monthly Expenses

Mortgage $1,200, property taxes $295, home repairs $200, food $1,000, dining out $300, entertainment $250, clothing $300, RRSP $500, car repairs & gas $200, travel $400, car & home insurance $150, life insurance $45, charity & gifts $200, miscellaneous $200, savings $194. Total: $5,434.

Liabilities

Mortgage $175,000.

© The Globe and Mail Used by Permission