Every asset you have has a different tax implication.
It is very important to consider this during the equalization process when going through divorce. While things like the couple’s primary residence and TFSA are not taxable there are many other types of property that will be subject to either capital gains tax or income tax upon liquidation.
While your primary residence is not taxable other matrimonial homes (like cottages) are subject to tax. If the cottage is used as leverage in the equalization process, it is important to consider how much capital gains tax you will pay if you decide to sell.
For example, if you bought the cottage for $100,000 and sold it for $200,000 you will be taxed on half the growth. This means that you will pay income tax based on your tax bracket on $50,000. This can make a huge difference in the amount of tax you are paying because a sudden increase of $50,000 will likely bump you into a higher tax bracket, causing your income to be taxed more heavily if/when you sell the cottage.
When planning for retirement it is important to plan for what your average tax bracket will be once you stop working. This will help you figure out what your pension is worth once you start withdrawing the money and it will be subject to tax. During the equalization process it is necessary to find out what the commuted value of the pension is, meaning how much the pension is going to be worth in total when you start to withdraw the money upon retirement. This helps in the trading of assets in the divorce process.
Knowing what tax bracket you will fall into when you retire will help you figure out how much the pension is worth AFTER tax so that it can be traded fairly. Remember, you can only ever trade 50% of your pension for other assets.
RRSPs and RIFFs
RRSP and RIFF transfers made directly between plans by issuers occur without tax consequences. That being said, when the spouse on the receiving end takes the money out in retirement it is taxed as income. It is important that the equalization process take this into consideration.
Another way for one spouse to compensate the other is to take money out of their RRSP or RIFF as cash. This will however have tax implications for the spouse who is taking the money out of the account as it will be considered income and taxed as such in that calendar year.
Transfers between RESP accounts are tax free as long as the funds are going towards the same beneficiary or their siblings.
Often when a couple gets divorced it is recommended that parents create separate RESP accounts, so they aren’t still tied to their ex through a joint account. This is especially important because RESPs aren’t creditor protected. This means that should either party named on the account file for bankruptcy the money that you have been saving for your children’s education can be seized. The last thing you want is for your ex to have money troubles which lead to you not being able to help finance post-secondary education for your children.
Money put into and RESP is initially tax-free and triggers a contribution by the government up to a certain amount. Funds are taxed as income to the beneficiary once they start using the funds for college or university.
Knowing the tax implications of various assets is very important in creating an equitable division of property in a divorce. Every case is unique so a professional like a Certified Divorce Financial Analyst (CDFA) is important. They will be able to look at your situation and ensure that the separation of assets is fair and equitable taking into consideration all the tax implications involved.