5 tips for reducing the tax impact for your heirs

Planning ahead is key for minimizing the tax impact on your estate (Getty Images/Dean Mitchell)

You may have been putting considerable energy into saving for retirement, but what about estate planning? If you want your assets to pass through as easily as possible to your beneficiaries, it’s worth speaking to an adviser and doing some planning early on.  [Read The Last Act, which covers all aspects of estate planning, from writing a will to settling and creating a trust.]

“There are many things to consider during the planning process,” says FCPA Bruce Ball, vice-president, taxation for CPA Canada. “You’ll want to consider if you have any desire to make charitable donations on death and assess how you’ll deal with ownership structuring and coordination with the will, among other things.” It’s also important to do some more basic things, such as clearly documenting where all of your property is held.

Here are some key things to consider.  

1) Have powers of attorneys in place, along with a will. “Powers of attorney are important to have in place in case you become incapacitated. It’s often recommended that you have one drafted for financial matters and one for health,” says Ball. (Once you die, the powers of attorney cease and the will takes over.) Also, if your affairs are particularly complex, you might want to add a statement of wishes supplement that explains why you have written your will in a particular way. “You can’t really put your ‘whys’ in a will, only the ‘whats’,” says Bob Gore, principal of Robert Gore & Associates Chartered Professional Accountants. 

2) Name your executors carefully. As Gore explains, the first person you name might no longer be capable of fulfilling the role when the time comes. You can name as many people as you want; but first consider their values and their life, judgement and financial experience. And be sure to check with them beforehand to make sure they accept. It can be a significant task and there may be reasons why they may have to decline. Also, if at all possible, do not appoint a non-resident executor (or someone who may become non-resident), as this may create financial and tax concerns. There is also the option to appoint a trust company, or an individual and a trust company, suggests Ball.

3) Consider the use of joint accounts (one of whom may also be the executor), for situations where they may not already have access to your bank accounts. “That way, they can pay the bills until the will gets probated,” says Gore. Inform your financial institution in writing about this intention and make it clear in your will that this transfer to joint ownership has been done only to facilitate estate planning and management, and that there is no beneficial ownership change in the account. Keep in mind that transfers to a joint account may not be reversible, so the decision should be considered carefully. It may be possible to pay for some expenses with a deceased’s bank account, so it may be worth determining what can and can’t be done after death before a new account is set up.  

4) Determine if life insurance is needed. Life insurance can help deal with two factors in estate planning—creating an estate to support your heirs after you are gone and preserving an existing estate if costs such as tax will arise on death. In either case, an evaluation should be done to establish the estate that you want to leave and determine if insurance is needed to bridge any gap. “If there will be a significant amount of funds in the estate and your heirs are not in need of specific financial assistance, then life insurance may not be necessary as the costs over the years may outweigh the benefits,” says Ball. One key issue to consider will be whether there will be assets that will not be liquidated after death and, at the same time, unpaid taxes. If there will not be enough funds to pay the tax, this may be a good situation to consider life insurance to make up the difference.

As an example, “you might have a cottage that you would like to leave to your children,” says Gore. “You might have paid only $200,000 for it, but it’s now worth $4 million. When you die (and if your spouse predeceased you), the deemed disposition of the cottage will trigger a capital gains tax assuming it is not designated as a principal residence. An insurance policy can put the cash into the estate to pay the tax bill.” Otherwise, it may be necessary to sell the cottage. Similar issues arise for those in business where business ownership will be transferred on death within the family.

5) Consider a trust, which can be created on death as part of your will or in advance. “A trust could be useful in a number of circumstances, such as where a beneficiary may not be competent with money, they are a minor or there are children from a previous marriage where a spousal trust may make sense,” says Ball.

The funds generally will be held in trust until the trust is no longer needed. Using a spousal trust as an example, the property can be held in trust during the surviving spouse’s lifetime, allowing him or her to benefit from the income earned on the property while naming children from an earlier marriage as residual capital beneficiaries. The tax treatment of trusts can vary significantly depending on when and how they are set up, how long they will remain in place and who the intended beneficiaries are. Specific tax advice is highly recommended.

PLAN AHEAD 

However you arrange your affairs, remember that you should do it as early as possible, and ensure everything is well documented and easy to find. It is also important to get legal advice when creating a will and powers of attorney. Financial and tax advice is also recommended. As Gore explains, “There’s really no such thing as retroactive tax planning. You cannot say, ‘We bought this cottage for $100,000 and now it’s worth $1 million. Can we just transfer it into a trust for the kids?’ No, you cannot, because the transfer is assumed to take place at market value.” 

Gore adds that it’s fine to give cash gifts to your children while you are still alive. “But, for assets that gain in value, such as businesses or shares, you will pay capital gains tax on the gift because a gift is considered the same for tax purposes as selling it at fair market value,” he says. “You need to be planning way ahead.” Also, care should be taken to ensure that you don’t give away too much money too soon. It’s much safer to keep more than you think you’ll need and then distribute what’s left as part of your will.

BE PREPARED 

Want to learn how to create a plan to distribute assets? CPA Canada has resources that can help, including a book entitled The Last Act and a webinar outlining how to prepare a will and the process behind settling an estate or creating a trust.

If you’re looking for more general financial planning tips, read The Procrastinator’s Guide to Retirement, as well as A Canadian’s Guide to Money-Smart Living. Plus, read more about how to anticipate the tax impact on your assets and the importance of succession planning for businesses.