Many Canadians are aware of the main features of an RRSP and RRIF including its tax-deductible contributions, tax-deferred growth, and beneficiary designations. However, there is one feature that is less discussed which is the creditor protection that is afforded in the event of a bankruptcy. This protection falls under the federal ‘Bankruptcy and Insolvency ACT’ (BIA).
Few investors envision themselves going through bankruptcy, however, it is important to understand the rights and limitations of this protection as part of one’s wealth management plan.
The BIA provides specific protection to the following registered accounts: RRSP, RRIF, locked-in plans, deferred profit-sharing plans, and registered disability savings plans. In the event of bankruptcy, there is no maximum dollar limit of the amount of assets that are protected. However, there are certain caveats:
1.BIA does not provide protection to registered education saving plans (RESP) and tax-free savings accounts (TFSA).
2. There is a 12-month clawback provision where any contributions made during the 12 months prior to declaring bankruptcy could be recovered by creditors.
3. The creditor in the bankruptcy can request information from financial institutions concerning contributions to your RRSP to determine the amount they are entitled to recover. The financial institution may also freeze the accounts during this process until the bankruptcy is settled.
4. Creditor protection is only offered if you officially declare bankruptcy or are formally involved in a personal/professional liability lawsuit for negligence.
5. One’s children, ex-spouses, and even the CRA can also enforce a payment from your registered accounts in the case of support payments or unpaid taxes.
Some provinces have established legislation that protects registered plans. Hence, it is important to understand how far reaching that legislation could extend. Consulting a qualified legal professional is necessary to understand the protections you are afforded.
There are also other strategies that offer creditor protection that one could consider for non-registered assets. This includes the following but is not limited to:
Segregated funds: These Investments are structured as insurance contracts, which can also provide creditor protection. To ensure that the protection is valid, it must meet certain requirements: 1) The investments were purchased in good faith and there should not be any suspicion that the funds were purchased solely to shield assets from creditors 2) Investments were purchased in one’s own name and not a nominee name, and 3) An irrevocable beneficiary has been designated or the beneficiary falls under a family class (i.e. spouse, child, grandchild or parent).
Life insurance: Life insurance policies are protected from creditor claims under provincial and territorial legislation. Proceeds of life insurance are usually protected from creditors because the policy has designated beneficiaries and therefore the proceeds do not form part of the policy owner’s estate.
Transferring assets to family members: Creditors may not recover assets that are no longer yours. However, you are exposing those assets to the credit risks of your family members. Moreover, if the court determines that the transfer was a blatant attempt to prevent a creditor’s claim, the assets could still be eligible for recovery from the creditor.
Establishing living and testamentary trust: Transferring assets to a trust could also limit the ability of your creditor or your beneficiary’s creditor to lay claim on your assets.
As evidenced above, there are many tools that can be utilized that offer creditor protection. To determine the best strategy, it is appropriate to sit down with professionals. Your wealth advisor, accountant, lawyer, and potentially a trust advisor can work congruently to structure a creditor protection plan that works best for you.