Canadians who declare bankruptcy have one less thing to worry about, thanks to new regulations passed into law this past summer. Assets held in registered plans —RRSPs, RRIFs and deferred profit-sharing plans — are now protected from creditors, provided that the assets have been held in the plan for at least a year.

The new rules are a relief for small-business owners and self-employed people who run the risks associated with being entrepreneurs. But all kinds of people are vulnerable to losing their life savings in the event of bankruptcy: doctors, lawyers and other professionals who can be sued for malpractice or negligence; or anyone with insufficient liability coverage in the case of a personal-injury lawsuit. Officers and directors on corporate boards are also vulnerable to liability issues, putting their personal assets at risk in the event of a lawsuit. Although some companies offer insurance to their directors, it is not always sufficient.

“Given the risks that many people face in their business ventures, creditor protection is a welcome change,” says Rick Claydon, partner and financial advisor with Stonegate Private Counsel LP in Toronto.

It’s important to note, however, that the new law applies only to clients who enter formal bankruptcy proceedings; it does not provide blanket protection of RRSPs from credi-tors. The law is effective for all bankruptcy claims initiated after July 7, when the law was amended under the Federal Bankruptcy and Insolvency Act.

“The risk of being sued by credi-tors or customers is still a risk that small-business owners face,” says Tina Tehranchian, certified financial planner and branch manager with Assante Capital Management Ltd. in Richmond Hill, Ont. “The only sure protection from creditors is some kind of life insurance product, such as segregated funds.”

Insurance legislation protects insurance policies — including seg funds, annuities and guaranteed minimum withdrawal benefit plans — from claims made by creditors of the policyowner or annuitant, provided that a spouse, child, grandchild or parent is named as beneficiary. However, seg funds and GMWBs tend to have higher management fees than regular mutual funds due to the guarantees on the asset value or income stream. The protection applies whether or not the insurance product is held in a registered plan.

“Some clients are moving out of seg funds and into regular mutual funds to save on management fees,” says Carol Bezaire, vice president of tax and estate planning at Toronto-based Mackenzie Financial Services Inc. “But they don’t realize the new law does not provide blanket creditor protection in registered plans, and applies only if they declare bankruptcy.

“Seg funds offer the added value of creditor protection to a non-bankrupt individual’s assets,” she adds. “The new law is better than nothing, but it doesn’t go the whole way.”

Bezaire points out that if an individual who has not declared bankruptcy is forced to collapse an RRSP to pay off creditors, he or she also faces a tax liability on the proceeds of the RRSP, which are fully taxable as income: “The new law doesn’t go far enough to protect retirement assets from creditors, [who] will go after anything they can get.”

And even if bankruptcy is declared, the one creditor no one can hide from is the Canada Revenue Agency, which is entitled to seize assets if taxes are owing.

Clients declaring bankruptcy must keep in mind that assets must be held in their registered plans for at least a year before declaring bankruptcy in order to receive creditor protection. This prevents last-minute topping up of RRSPs to keep assets out of creditors’ hands. Even outside the one-year period, the courts can deny any blatant attempt to transfer assets to a registered plan in anticipation of bankruptcy.

“If the client is operating a business for which the risks of being sued or going bankrupt are high,” Tehranchian says, “it’s a good idea to protect assets when there is no immediate problem.”

In addition to insurance products, spousal RRSPs can provide a means of protecting registered retirement assets from creditors, she adds. Outside of a registered plan, various trust vehicles and corporate holding companies can be used to provide creditor protection. Locked-in plans, including LIRAs and LIFs, also enjoy full creditor protection under pension legislation.

Before the new federal law was passed, some provinces had already moved to enact laws to protect registered assets from creditors. Where provincial legislation already existed — Saskatchewan, Manitoba, Quebec, Prince Edward Island, and Newfoundland and Labrador — provincial law takes precedence in protecting registered plans from creditors in bankruptcy, and sometimes in cases of financial insolvency without bankruptcy. IE