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Tax-Effective Estate Planning Requires Will Power

Estate planning is basically the process of taking steps to ensure that:

1. Beneficiaries maintain as much of your estate as possible

2. Your estate ends up going where you want it to go

Both goals are equally important and there will be many people lining up to assist you along the way. There will be lawyers, accountants, investment advisors, insurance specialists (and more) and while they’re important, it’s also crucial you don’t let them dictate the process. 

The primary tool for estate planning is the writing of your will. A will contains the set of instructions on how things are going to go after your passing. It names an executor – the person who’s going to administer your estate. It gives them the power to make decisions and administer the will. The executor role is important (and often an honour), but it also brings with it a lot of work, responsibility and even stress.

As mentioned in our last article (and podcast episode), one of the main goals in estate planning is saving or deferring estate taxes. And a spousal rollover will, in general, accomplish that. By leaving your assets directly to your spouse, the tax will be deferred and triggered later when your spouse either sells the assets or passes away.

A spousal rollover may be tax efficient but may not fit your personal circumstances. For example, if this is your second marriage but your children come from your first marriage, things can get complicated. In this case, you may wish to set up a trust or perhaps divide the assets between your second spouse and your children.

You can also set up trust provisions that limit your child’s access to the estate until they’re older, a little more mature and less apt to do something you may deem to be frivolous.

When leaving something to your children, the assets do not have to be distributed equally. For example, if you have three children and, for whatever reason, you only wish to leave money to two of them, we suggest you include a detailed letter, explaining why you’re doing that. This will make your wishes crystal clear to the courts, minimize exposure to litigation and having your will contested by child number three.

What about other assets? For instance, the beloved cottage that’s been in the family for a long time. You want to pass it on to your family so they can continue to enjoy it. But maybe your children don’t use it equally. Some might live out of town. How will maintenance and operating costs be divided? It’s important to think about what you want to happen and communicate that to the drafters of the will.

For business owners, don’t underestimate the liability that can be created upon your death from owning private company shares. One important tool is an estate freeze. If you have a company growing in value, some reorganizations of your company may be in order, freezing the value of your shares at that point in time. So, if the company continues to get more valuable, it’s not creating a higher tax exposure for you.

Business owners also face the tax hazard of double taxation. Let’s say you have a holding company. It used to be a business but now it’s all stocks and bonds and worth a million dollars. If you pass away and have no spouse, there’s no spousal rollover. Now you’ve got a million dollar capital gain and your estate pays tax on that. Then later on, when your shares pass to your children and they pull money out of the company, that’s going to be a dividend. That will create a second layer of tax on top of the million dollar capital gains tax you paid at the time of your death.

There are solutions to double taxation but they need to be considered at the time of drafting your will.

Another solution to consider is insurance to cover the estate’s tax liability on death. But, just like life insurance, the policies can be expensive for those who are older or not in good health. 

Meanwhile, probate fees (the estate administration tax) aren’t likely to be as costly as income taxes but they’re not inconsequential. One of the ways to mitigate probate fees is to have multiple wills, separating the ones that require probate from the ones that do not. 

With RRSPs, you may also be able to directly designate a beneficiary. By doing so, the RRSPs would bypass your estate and wouldn’t be subject to probate.

A tax effective will is the key to maximizing the value of your estate. And don’t forget to revisit your will often. After all, tax rules change and the value of your assets may change as well. If there’s any complexity at all to your estate, you need to give it long, serious thought. Once you have, then you bring in an advisory team to help you put the most tax-effective wrap around your wishes.

Learn much more about estate planning in Episode 11 of the Vaive and Associates Tax Podcast.

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What Taxes Will be Applied to Your Assets When You Pass Away?

When we think of estate planning, it’s crucial not to overlook the tax consequences. So, in part one of our two part series on estate planning, we’re answering this question: 

From strictly a tax perspective, what happens to my assets when I die? 

Here’s a simple way to look at it. Just pretend that, immediately before your death, you’ve sold everything you own for what it’s worth. You’ve now triggered the appropriate taxes, just like anyone else who sells off their assets. Effectively, this is how the CRA treats the situation, even though your assets haven’t actually been sold yet.

Your assets are now subject to two kinds of taxes: Income tax and probate fees.

Income Tax

The CRA won’t tax your assets on their overall worth. But it will tax the growth in their value. For example, let’s say you owned shares in a publicly traded company and you paid $5000 for them. Then, on the day of your death, the shares have grown in value to $40,000. At that point, you will trigger the capital gains tax on that extra $35,000 increase in value.

The same holds true of most other assets that either show inherent gains or haven’t been taxed before.

So, as you can see, it’s a highly taxable situation. 

But there are exceptions that can help you with planning, and the main one is a rollover. A rollover is basically when an asset passes from one taxpayer to another without any tax consequences. 

When discussing death and taxes, the most important rollover involves leaving assets to a surviving spouse (legally married or common-law). When you leave all of your assets directly to your spouse, there is a complete deferral on the tax. So everything passes over, as is, and no tax is triggered. 

But let’s say you have a spouse and two children. If your spouse one day remarries, it’s possible they may set up their own will so that everything is left to their new spouse. 

You do also have the option of leaving your assets to your spouse by way of a trust. You’ll still get that rollover and tax deferral, but you’ll now have a little more control and ability to direct things, ensuring that—upon your spouse’s passing—any remaining assets go to your children. 

There is one other less common exception. If you have an RRSP, you can leave it to a disabled child or grandchild who’s financially dependent on you and you will get that same tax deferral.

Probate Fees (Estate Administration Tax)

When your family presents your will to a bank or financial institution, looking to remove the money that’s been left to them, the bank will often insist the will be probated first. This means the will goes before the courts to be certified as valid and current. Once the will is probated, the bank will release the money. 

Naturally, there’s a fee for this service. Not all provinces have probate fees but, here in Ontario, we do. The fee is 0.5% of your first $500,000 worth of assets and 1.5% on anything above that. 

So, along with everything else it brings, death can be an extremely taxable event, especially if you don’t plan for it. We discuss more on these topics, along with terminal returns, estate returns, and how Canadians can be exposed to U.S. estate tax in Episode 10 of The Vaive and Associates Tax Podcast.