Ins & Outs of Estate Preservation

Country Routes - October, 1997

This is the first of a two part series by an associate of mine, Brian Quinlan, who is an accountant specializing in estate matters. He has written some articles for various publications including one for the Financial Post magazine in January of this year titled, "Ten Ways to Beat The Taxman". He has given me permission to reprint them here in my monthly column along with the Canadian Moneysaver Magazine where they appeared earlier in the 1990's. I plan to be working with him more closely in the future in matters primarily concerned with Estate Planning. His firm, Quinlan Quinlan, is located at 8 King Street in Toronto. Quinlan merged with Lawless in October 1996 under the Campbell Lawless banner.

What is estate planning and why should it be carried out? Estate planning is a component of financial planning. It focuses on minimizing the work and difficulties faced by executors while maximizing wealth passed to heirs.

Wealth maximization/tax minimization

The first step of an estate plan requires you to decide on the estate's purpose. Who are the beneficiaries -- what family and non-family members, what charities? Should your estate be dispersed to beneficiaries on death or should it carry on? Are funds to be kept aside for a specific purpose, eg. a grandchild's education? Are there assets you wish to be shared after death such as the family cottage?

Once the estate's objectives are determined, a plan is designed and enacted to ensure the objectives are reached. Here, it is vital to assess the income tax consequences. For income tax purposes, you are considered to have sold all your property at the time of your death. An exception is available when property is willed to a spouse. However, the issue will arise on the death of the second spouse. The "sale" proceeds are deemed equal in value to the respective property at your death. The excess of proceeds over the cost is a capital gain of which 75% is taxed. If part of your property includes rental properties there may also be "recapture" of prior year tax depreciation claims. This is fully taxed at death. Remember, this tax must be funded from other sources. As a "sale" occurred for tax purposes, only you do not receive any cash to pay the tax. In the worse case the estate is forced to sell a property to pay its tax.

This may work against your wishes if you want to keep the cottage in the family. The value of your RRSPs and RRIFs at the time of death are subject to tax too! While here you can have access to cash by having the estate liquidate the holdings, the estate value to be passed on to your heirs may be dramatically reduced. Without planning, you can have a significant tax liability on death. As death and death taxes occur at the same time you can easily find yourself being taxed in the top tax bracket. Here, about 50% of your estate can go to Revenue Canada. An effective estate plan will work to eliminate, defer and/or minimize taxes to the extent possible. This plan will involve a lawyer, accountant and a financial planner experienced in both the insurance and investment fields.

Live rich, die poor

One way to avoid any taxes on death would be to rid yourself of all assets (including RRSPs and RRIFs) before you die. However, your estate plan must permit you to live comfortably until your death and have access to the assets you enjoy -- again I mention, the family cottage. You want to ensure that you have sufficient funds to permit you to enjoy life to the extent you desire. You don't want to get involved with the children's squabbles over your property and you do not want to face a significant tax liability now. What to do?

Estate planning tools: Early inheritances to children/grandchildren

If an objective of your estate is to pass property to children, why not do it now? The kids may prefer the money now rather than later -- especially if they have a mortgage. Where cash is given to an adult child there are no income tax implications to you -- regardless of how the money is used. If you liquidate a portfolio of securities you may incur capital gains which are taxed in the year of liquidation. However, this tax may be less than it will be on your death, plus you have the cash to pay the tax. Moreover, your current tax rate may be substantially lower than your tax rate in the year of death.

Consider opening an investment account in trust for your grandchild. Any interest or dividends continue to be taxed in your hands but any capital gains are taxed in the grandchild's hands. A great way to provide for a grandchild's education plus reduce your current tax load.

Family trusts

A family trust is used where a parent (or grandparent) desires to avoid family squabbles or is not at ease with providing children with money now for fear it will not be used in an appropriate manner or fear the wrath of provincial family law acts. A cottage can be transferred to a family trust. The parents become trustees of the trust and, therefore, control the use of the property on behalf of the beneficiaries (the kids). The trust permits the parents to continue the use of the cottage until their deaths. The win? The cottage is no longer owned by the parents. On death, it does not form part of their estate. The cost? The transfer of the cottage to a trust could trigger an income tax liability. This liability may not be too significant compared to the future tax liability and tax rate at death. Furthermore, the principal residence exemption coupled with the 1994 $100,000 capital gains exemption election (file late if you missed it) may cut this tax dramatically.

Rather than giving funds to children, make a loan! The loan can be forgivable on your death. During your life-time this offers you some control as you can "call" the loan. The loan can be interest free if used by your children to pay down a mortgage. (The income tax attribution rules may come into play if your child uses an interest-free or low-interest loan for investment purposes.) If you want to be really careful, you can register the loan as a mortgage against the child's home.

If you have any questions, please call Reg Borrow at (519) 855-6639. He is an Independent Financial Consultant with Regal Capital Planners Ltd.

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Created: Mon Sep 23 10:30:50 1996
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