In many cases, widows find that their income taxes have gone up but their cash flow has gone down.SDI Productions/iStockPhoto / Getty Images
When a retired client’s spouse dies, they’re faced not just with grief but a potential drop in income.
Justine Kelly, a financial planner at Modern Cents in St. Thomas, Ont., says it’s common for one spouse to have a defined-benefit pension plan but the other not to have a pension at all. That leaves a significant gap if the spouse with the pension dies first.
Couples often take advantage of pension income-splitting to lower their overall net incomes, but that opportunity disappears when a client becomes single often resulting in higher taxes. Survivor benefits from workplace pensions are considerably lower, and Canada Pension Plan (CPP) and Old Age Security (OAS), in most cases, do not pass onto the surviving spouse at all.
Around 20 per cent of Canadians over the age of 65 are widowed, according to Statistics Canada, with women the more likely survivors.
Evan Parubets, head of advisory services at Steadyhand Investment Funds Inc. in Toronto, says the tax changes widows experience are often a huge shock.
“Their income taxes have gone up but their cash flow often goes down,” he says.
To that end, advisors must plan with widowed clients to make up the shortfall.
Ms. Kelly works with couples ahead of time, testing their financial plan for when one spouse dies. She looks at the income gap and strategies such as electing a higher survivor pension or as increasing the amount of life insurance coverage. Upon death, insurance money is received tax-free and can be used as monthly guaranteed income, she says.
Managing RRIFs
Large registered retirement income funds (RRIFs) can be a problem for widows and widowers. Ms. Kelly gives the example of spouses who each have RRIFs worth $200,000. When one spouse dies, their RRIF rolls over to the surviving spouse, deferring a deemed disposition for estate purposes.
While the rollover means the surviving spouse has a $400,000 RRIF, it also means a larger mandatory RRIF withdrawal and often a higher tax bracket, Ms. Kelly says. “Getting [those assets] out as tax-efficiently as possible becomes a lot more difficult.”
That’s why Ms. Kelly recommends a registered retirement savings plan (RRSP) meltdown strategy for some retired clients in their 60s or earlier. That means withdrawing from an RRSP when the client is in a lower tax bracket and before it’s converted into a RRIF, with the aim of keeping RRIF minimum withdrawals as low as possible. The money withdrawn from the RRSP can be reinvested in a tax-free savings account or non-registered account.
“We try to get the money out earlier so that you’re not stuck in that position with a lot of money [that needs to be withdrawn] in later years,” Ms. Kelly says.
Another concern is OAS clawback for high-income earners, she adds. Previously, the widow may have split the income with her spouse but that is no longer an option.
Managing finances and estates
A surviving spouse who was less involved in managing household money may struggle. That’s why Mr. Parubets advises couples to put together a death binder in advance. This strategy involves gathering credit card, bank and investment statements, contact information for all the professionals the couple used, and offering suggestions on how to manage finances.
“A binder doesn’t solve everything, but it makes things one step easier for the surviving spouse so they’re not looking everywhere for documents,” he says.
Another action point on the to-do list for widows is changing beneficiary designations on all their accounts and assets. It may also be necessary to update the will and power of attorney document to remove the spouse’s name.
Ms. Kelly notes that, sometimes, estate planning was completed in a hurry, with only spouses named.
“After a spouse dies, there’s more worry and thought about what [the surviving spouse] is going to leave behind,” she says.
Advisors need to be patient and compassionate with widows and widowers, Ms. Kelly says, as all the decision-making can be overwhelming.