Estate Planning

 

ABOUT estate planning

 

 

 

The information on this website is designed to give you a broad, basic and general overview of estate planning considerations.  General rules are discussed only.  This is not legal advice, and is not to be relied upon as legal advice. There are many complexities and exceptions which exist in each particular situation which affect the outcome.  Professional assistance should be sought. 

 

 

Estate Planning for the Average Person

 

Estate planning is not just for the wealthy.  If you own a home, have savings, investments, Registered Savings Plans (“RSP’s”), or an interest in a business, there may be considerable tax savings and other advantages to your surviving spouse and children or other beneficiaries if you have an estate plan in place now.

 

The purpose of an estate plan is to insure that the beneficiaries you specify actually receive what you want them to receive, while income and other tax are minimized.  A proper Estate Plan will minimize taxes at the time of death, and possibly for a period of many years thereafter.

 

A good estate plan may also protect a disabled beneficiary from loss of government benefits due to receiving an inheritance.  It can also protect your estate from a quick and wasteful depletion by a spendthrift beneficiary or a beneficiary with a problem such as drug or alcohol abuse.

 

Estate Planning is planning for your survivors upon your death.  It is different from financial planning for your lifetime finances, but the two are related.

 

 

What assets are in your Estate?

 

You may own assets which would not form part of your estate and would therefore not pass according to the terms of your Will.  These assets include assets owned in true joint tenancy with a right of survivorship, and assets where there is a beneficiary designation such as RSPs, and life insurance.

 

On the other hand, assets which you own in your own right such as your car, an interest in real property which is not held in joint tenancy with anyone else, your own bank account and investments not held in joint tenancy with anyone else, would form part of your estate and would pass according to the terms of your Will.

 

 

Taxation of Estates – Capital Gains Tax

 

There is no gift tax in Canada.  However, there is a capital gains tax in Canada.

 

A capital gain occurs on a “disposition”.  A sale to a third party is a disposition, but it is not the only time a disposition occurs for capital gains tax purposes.  A disposition also occurs when a gift is made.  A deemed disposition occurs when someone dies.

 

Capital property includes such things as company shares and real estate.  Land is the perhaps the most common capital property, although many people have shares in their own company, and many people have stock market investments in shares.  When there is a disposition of capital property, if the net sale proceeds are greater than the adjusted cost base, then this is a capital gain.  Although a principal residence (the house and a limited amount of land) is exempt from capital gains tax, other capital gains must be declared.  The way the tax is applied is that the difference between the net sale proceeds and the adjusted cost base is considered to be the capital gain, and one half of the gain is included in the income of the person who made the disposition in the year that the disposition was made.

 

There is another aspect of a disposition of capital property and tax which is important to know.  Capital property can be transferred to a Canadian resident spouse without the transfer being considered to be a disposition and without triggering the capital gains at that time.  Although it can be possible to elect out of the rollover, so that the disposition is taxable, when a rollover occurs, the recipient spouse acquires the property at the adjusted cost base of the transferor spouse, so the tax on all of the gain is deferred until the recipient spouse disposes of it, either by sale, gift or death.  This is referred to as a “rollover”, and specifically as a “spousal rollover”.

 

Upon death, all the capital property of the deceased is deemed to have been disposed at its fair market value at the time of death unless there is a spousal rollover.  If the surviving spouse is entitled to receive the capital property, then there is a rollover to the spouse, capital gains tax is deferred until the surviving spouse disposes of the capital property, and the surviving spouse inherits the deceased spouse’s cost base.

 

Upon the death of the second spouse to die, however, there is no further rollover, and there will be capital gains tax on capital property which is not an exempt principal residence.  In some cases the capital gains tax exposure can be quite significant.  For example, where portfolio investments containing shares, or real estate, are owned by the deceased and have gone up in value substantially since the time of acquisition, then there will be taxable capital gains.

 

Capital gains tax arising on death can present a cash shortage problem.  Sometimes people plan for this by buying life insurance to fund the tax.  Sometimes a charitable donation can lessen or eliminate the tax, but this of course means that the donation goes to a charity, and not to family or other beneficiaries.  Planning for dealing with capital gains tax on death is important.

 

It is to be noted that you can gift non capital property without triggering disposition tax or gift tax as there is no gift tax in Canada.  You can give away money, for example.  Money is not capital property, and if it is gifted during your lifetime, or through your will, it attracts no capital gains tax.

 

 

What Does an Executor Do

 

When someone dies, the Executor is responsible to preserve and protect assets, pay all bills, including taxes, and to liquidate assets as appropriate.  The Executor must ensure that the income taxes to the date of death are reported and paid.  The tax return for the date of death would include all of the income to the date of death of the deceased for the year during which the death occurred.  This income could be from all the usual sources, for example from employment income, from interest, from dividends, from pensions, and so on.  It must also include one half of any capital gains on capital properties deemed to have been disposed of at the time of death (excluding an exempt principal residence), even though these properties were not actually sold.

 

The Executor uses estate assets to pay the debts and income tax of the Estate, and the income tax could include capital gains tax.  Once debts and taxes are paid, the Executor can then distribute the remaining estate to the beneficiaries.  At this point the beneficiaries receive their share of the remaining estate without further income tax.  The tax at that point has been paid by the Estate through the Executor.  Each beneficiary then becomes the owner of his or her share of the residue of the estate, and thereafter to the extent his or her share earns income, the beneficiary must report that income each year on his or her tax return.

 

 

Testamentary Trusts

 

One of the most important estate planning tools is the testamentary trust.

 

A Testamentary trust is created on and as a consequence of the death of a person.  No one other than the deceased must have contributed to the trust.  Testamentary Trusts are most commonly found in Wills, but they can be created by separate documents which set up Insurance Trusts and trusts for RSP proceeds.  Testamentary trusts do not impede in any way a Will Maker’s ability to deal completely and freely with his or her own assets during his or her lifetime because they only come into effect upon death of the Will Maker.  Therefore, the effect of making a will with a testamentary trust is not to tie up or to put any assets of the Will Maker into trust during his or her lifetime.

 

The Will Maker can specify that the beneficiaries of a child’s trust are that particular child, and the issue of that child, meaning the children of the child and the grandchildren and so on.  The spouse of the child and even the spouses of the issue of that child can also be named as potential beneficiaries.

 

Common examples are testamentary trusts for a surviving spouse and testamentary trusts for children or children and their families.  The surviving spouse or each surviving child may be named as the trustee of the testamentary trust set up for him or her, and that trustee is often given full discretion and complete control of the trust assets by virtue of the trust terms of the Will or other document establishing the testamentary trust.  The fact that the trustee has complete control means that the trustee, who would normally be the Will Maker’s spouse or adult child, can decide to collapse the trust and transfer all of the trust assets to the beneficiary or beneficiaries of the trust, including exclusively to himself or herself.  A decision to do this would have to be carefully made, since this step could throw away what could be years of possible future advantages.  However, having the freedom to be able to do this, even if it is not done, is attractive to people.

 

 

Protection of Assets Features of Testamentary Trusts

 

Domestic Separation  Perhaps the single most attractive advantage of Testamentary Trusts is that they can provide a protection of assets feature in a domestic separation context since the terms of these trusts can specify that the persons named as beneficiaries are not entitled to receive anything from the trust whatsoever unless the trustee actually makes an advance out of the trust to a beneficiary.  Therefore, even where the spouse of a child of the Will Maker is named as a beneficiary, the usual terms of the trust will make it clear that no beneficiary, including a spouse of any child of the Will Maker, is entitled to assert that he or she has any absolute right to receive any part of the trust assets, whether capital or income, unless it is actually given out of the trust to the beneficiary (including a spouse of a child) by the Trustee.

 

The Family Law Act states that family property is normally subject to the starting point of presumed equal ownership and division in a domestic separation.  However, the Family Law Act excludes as family property of the child of the Will Maker property held in a discretionary trust to which the child of the Will Maker did not contribute, of which the Will Maker’s child is a beneficiary, and that is settled by a person other than the child of the Will Maker.  The testamentary trust and the assets contained in it can meet this description of excluded property.

 

It should be noted that any gain in the value of excluded property during the domestic relationship remains included as family property, the basic capital which funded the testamentary trust is excluded to the extent it remains in the trust.

 

It is also often specified in the Will or other document setting up the trust that no spouse of any issue of the Will Maker can be the Trustee unless, for example, there is a Court Order to that effect.  This is to prevent a beneficiary spouse of a child or the spouse of another descendant from becoming the trustee and then arrogating the trust assets to his or her own benefit.

 

Wayward Child or other Beneficiary  This protection of assets feature is also important where a testamentary trust is set up for a beneficiary who has a problem such as an addiction problem or a spendthrift problem.  In these special cases, someone other than the beneficiary must be appointed as the trustee of that testamentary trust, and there should be one or more beneficiaries other than the particular beneficiary with the disability or difficulty.  The trustee is given the usual complete discretion to make or not to make advances and discretion as to the amount of the advances to the spendthrift or wayward beneficiary.  This can protect the trust assets from dissipation because the beneficiary with the difficulty cannot control advances out of the trust and perhaps waste the trust assets.

 

Disabled Beneficiary  A testamentary trust can also be set up for a disabled beneficiary in such a way that the trust assets are not counted as assets of the disabled beneficiary for government income assistance purposes.  Funds can be selectively paid out of the trust for disability related expenses for the benefit of the disabled beneficiary by the trustee, in the trustee’s discretion, without being considered as unearned income of the disabled beneficiary.  Unearned income would be deducted from the benefits otherwise payable.

 

Creditor Protection  Finally, whether or not a beneficiary is disabled, a spendthrift, has an addiction problem or is otherwise wayward, the creditors of the beneficiary of a testamentary trust cannot attach to or seize the trust assets as long as there is no absolute entitlement in favour of the beneficiary; that is, as long as the advance of any assets from the trust is always in the discretion of the trustee and the beneficiary has no right to insist on any particular advance or amount from the trust.

 

 

Income Splitting Advantages of Testamentary Trusts

 

A second advantage of testamentary trusts is that Testamentary trusts for a child or children and the family of the child or children allow the splitting of trust income among their various family beneficiaries such that a lower aggregate tax rate might apply.  Further, testamentary trusts for children and their families can also allow the taking advantage of various basic personal exemptions of those family members who are beneficiaries of the trust, which exemptions might otherwise go unused without income advances from the trust due to lack of income otherwise.

 

Because a child of the Will Maker can be the Trustee having complete control of the trust fund, the child as Trustee is the one who has the discretion to say which beneficiary or which of the beneficiaries of the trust ever receive anything.  The child can keep all of the capital and interest for himself or herself, and that is completely within his or her discretion as Trustee.

 

However, in cases where the child’s children (who are the grandchildren of the Will Maker) might not have any income or much income of their own, and when they have a need for money such as when they are taking post secondary education, then some or even all of the income earned by the child’s testamentary trust can be diverted to that particular grandchild and thus not reported as trust income, and that grandchild would then be required to bring that income which came from the trust into his or her income.  The grandchild may pay little or no tax on that income because of lack of other earnings or modest earnings otherwise, and because each individual is presently entitled to a basic personal exemption of about $10,000.00. When the grandchild pays the tax on that income, then the trust itself does not have to pay any tax on it.  Only one person, either the trust or the beneficiary who received the income, must pay the tax on that income.

 

 

Tax Returns and Legal Costs for Testamentary Trusts

 

The disadvantage of testamentary trusts includes the need to usually file an income tax return for the trust each year after the Will Maker is gone and the trust is set up and running.

 

Further, wills setting up testamentary trusts are more complex than straight gift wills, and thus cost more to prepare.

 

 

Insurance Trusts

 

Testamentary trusts can also be created by trusts set up to receive life insurance proceeds.  These trusts can be set up in a trust document separate and distinct from the Will, and could be beneficial where the beneficiaries of the insurance proceeds do not match exactly or at all the beneficiaries in the Will.  The trust which is set up must take effect upon death and not be funded from the life insurance proceeds.

 

 

 

Appendix

 

 

Some Basic Concepts and Tools

 

There are some concepts and tools of estate planning that you should know about.  The following is a broad overview to give a general idea.  There are refinements and exceptions, so it is important to consult your professional advisors.  This is not legal advice.

 

 

Graduated Rates of Taxation– In Canada, we pay income tax at graduated rates.  The first dollars of income that we make are taxed at a low rate.  As we earn more and more income for the year, we are taxed at a greater percentage rate.  The starting minimum rate in British Columbia is about 21% and the maximum rate is about 44%.  Individuals reach 44% at about $120,000.00.

 

         

Joint Tenancy–  A true Joint Tenancy is a form of ownership where two or more people acquire ownership of property at the same time having an equal interest and all being entitled to possession.  Joint Tenancy carries with it the right of survivorship such that if one of the joint tenants dies, the other joint tenant or tenants automatically become entitled to the whole interest.

 

The most common example of a joint tenancy ownership is where spouses own a house together as joint tenants, or have a bank account together as joint tenants.

 

Joint Tenancy can be a true joint tenancy as described above, or a false joint tenancy.  A false joint tenancy can be created where two or more people hold an asset and it is registered in a public office or is shown in the records of an institution as owned by those persons as joint tenants, but where there is an agreement between them that the asset really belongs to one of them only, in spite of the fact that it is registered or shown in the records of the institution as jointly owned.

 

          An example of where a false joint tenancy is created is where an elderly parent puts her home into her name and the name of an adult child as joint tenants, but it is agreed that the parent is still the real owner, and would be entitled to all the proceeds should she sell the home.  Another example is where an elderly parent puts a bank account into her name and the name of an adult child as joint tenants, but where it is agreed that the money still belongs to the parent.  False joint tenancies are created sometimes for convenience (as in the case of the joint bank account), and sometimes to attempt to avoid probate and the time, expense and provincial probate fees that go along with probate.  Where a false joint tenancy is created, it is extremely important to document the intention of the parties at the time of its creation.

 

 

Probate Fees– Probate Fees are a Provincial Tax levied on the gross value of an estate at the time application is made to the Supreme Court for Probate.  In British Columbia, probate fees are about $14 for each $1,000.00 of the gross estate.  Probate Fees are chargeable on assets which are part of the estate, and are not chargeable on assets which pass by survivorship through a true joint tenancy ownership, or assets which pass by beneficiary designation such as life insurance and RSP’s.

 

         

          Registered Savings Plans – Canadians are allowed to place a portion of their earned income into a Registered Retirement Savings Plan without paying tax on that sum at the time the money is contributed to the plan.  When the money is taken out, it is considered to be income in the year that it is withdrawn.

 

          When an RSP owner dies, either the whole amount contained within the RSP is added into the income of the deceased for the year of death or the RSP is “rolled over” to a surviving spouse and the tax is deferred until the spouse takes it out or dies.  Even though the surviving spouse will pay tax on the RSP funds, if it is taken out over a period of years by the surviving spouse, it may thereafter be taken out in amounts which do not attract as high a rate of taxation as if it were all included in income in the year of death.  Generally speaking, it is advantageous for spouses to take advantage of the spousal rollover for RSP’s because of this.

 

          The rollover to the surviving spouse is the most common rollover for RSP’s, but there are rollover provisions for dependants who are under 18, or who are physically dependant or mentally dependant.

 

 

          Taxation of Trusts –The trustee must file a tax return for the trust. Testamentary trusts are taxed at graduated rates. However, the income earned by a trust can be paid to the beneficiary and the trustee can elect to have the income tax paid by the beneficiary and not by the trust.  Generally speaking, if the income which is earned by the trust assets is either brought into the trust’s tax return or the tax return of a beneficiary, or a combination of both, that is sufficient.  Tax is only paid on the income once in a year.

 

 

          Taxation of Life Insurance Proceeds –  Payment of life insurance proceeds due on the death of a person does not attract income tax on those proceeds.  Therefore, if a person dies and there is $200,000.00 life insurance policy in effect, the full $200,000.00 goes to the beneficiary without income tax.

 

          Of course, those proceeds then belong to the beneficiary and they might then be invested by the beneficiary and earn income, and that income is taxed each year thereafter in the hands of the beneficiary.  However, the initial payment of the life insurance proceeds to the beneficiary does not attract income tax.

 

 

          Wills Variation Act – In British Columbia, the Wills Variation Act represents a significant infringement on testamentary autonomy.  It allows a surviving spouse (including a common law spouse) or a child to apply to vary the terms of the will which the Court can do if it decides that adequate provision for the maintenance and support of the surviving spouse or child has not been made.  In B.C., “maintenance” is broadly viewed, and even adult children who are independent financially can sometimes qualify for a variation.

 

However, the law does not go so far as to say that all children must be treated equally.  Where a testator is concerned about a WVA Claim, then other estate planning steps can be taken to keep assets out of the estate and thus not included in assets which the Will affects and which the Court can reapportion.

 

 

 

Estate Planning With Joint Tenancy and Lifetime Transfers from Parent to Adult Child

 

 

There is a common misconception that it is always advantageous for an elderly parent to transfer land and other assets including bank accounts and investment accounts into joint tenancy with the parent and an adult child or the adult children as part of the parent’s estate planning.    It is not uncommon for both of the elderly parents or for the surviving elderly parent to propose to do this to avoid probate of the estate of the second parent to die, and it is sometimes hoped that this will avoid capital gains tax.  However, this needs careful attention.

 

The misconception seems to arise from the belief that any asset held in joint tenancy does not have to be brought into probate.  However, if probate is otherwise necessary, then any asset that belongs to the deceased must be disclosed and brought into probateIf there was an asset held by the deceased and another person registered in joint tenancy, but the deceased had retained full beneficial ownership in spite of the registration of the asset in joint tenancy, then this remains an asset belonging to the estate of the deceased.  This is so even though the surviving joint tenant alone may be able to deal with the asset without Letters Probate.  In such a case, the surviving joint tenant would hold the asset in trust for the estate.  See the discussion of false joint tenancies above under “Estate Planning Information”.

 

Furthermore, even if joint tenancy planning is being considered to avoid probate, there are several matters that ought to be dealt with before making a decision to carry out such a plan:

If this is a gift where all or part of the beneficial ownership in the property is changing, or simply a change in registered ownership only where the person transferring retains full beneficial ownership. If this is a real gift of a part interest to the adult child, then a Deed of Gift ought to be made by the parent in favour of the child;

If this is just a change in registered ownership, with no gift, then a Declaration of Trust ought to be signed by the adult child indicating that there has been no change in true beneficial ownership in spite of what the title says about who the legal owners are;

If this is a gift of a part interest to the adult child, then there is a disposition for tax purposes which may mean that there will be a capital gains tax.  Has this been anticipated?

What about creditors’ claims or matrimonial claims against the adult child and the assets of the adult child?  Whether or not the transfer is a gift still raises the question of whether or how this transfer might expose all or part of the parent’s assets, or what recently were the parent’s assets, to those claims unnecessarily.

If there are other adult children who do not go on the title as joint tenants, how do they fit in?  What happens if there is a conflict or estrangement with or between the child or children “owning” the property?

What if the parent wants to sell the asset during his or her lifetime?  How is that done?  Who gets the proceeds?  Who has to consent?

Who pays property taxes, maintenance and insurance etc. on real property after the transfer?

How is rental income on real property or interest or other income earned on bank or investment assets which were placed into joint tenancy apportioned between the apparent owners on their tax returns?

Should Powers of Attorney between all the joint owners be taken so that if one of them becomes incompetent, the others can still deal with the property if necessary without obtaining a Court Order?

 

Any transfer of the beneficial ownership in capital property is a “disposition” under the Income Tax Act which raises the capital gains tax issue.  Further, “disposition” for income tax purposes includes a gift, and a gift is deemed to be made at fair market value for the purposes of determining the amount of any capital gain realized.  Unless it is a gift or transfer to a spouse, one cannot avoid the capital gains tax simply by making a gift or selling at an undervaluation (and selling at an undervaluation can create even further tax problems).  The fact that there are no sale proceeds to pay capital gains tax in the case of a gift makes no difference.  The tax liability is still there.

 

Where there is a transfer of capital assets from an elderly parent to an adult child into joint tenancy with the parent and the child, it is very important to document and for all parties to understand at the time the transfer is made whether or not the transfer is a gift of ½ of the true beneficial ownership in the asset, or if the transfer is not a gift but simply for convenience for the parent or for an estate planning purpose for  the parent.  In the former case, there would be a disposition of ½ of the asset for income tax purposes.  In the latter case, there would be a change in the registered ownership only, but no change in the true, beneficial ownership, and therefore no disposition for income tax purposes, in spite of the fact that the new title would show both the parent and the adult child as owners in joint tenancy.  The intention of the parties as to which of these alternatives is to apply should be documented at the time of the transfer, and not as an afterthought.

 

It should also be understood that avoiding probate, even though it can result in the saving of Probate Fees upon death, may preclude other estate planning steps that result in income tax savings to the beneficiaries over many years after death which could be significantly greater than the immediate Probate Fee savings upon death.  Refer to the discussion of testamentary trusts above.  As a rough rule of thumb, if there is a minimum of $200,000.00 to $300,000.00 to be gifted through the use of a testamentary trust to a beneficiary, there can be a net advantage in using a will which sets up the testamentary trust or trusts.

 

There are limited circumstances only where avoiding the probate procedure and the Probate Fees going with it could be a reasonable estate planning strategy.  For example, in a case where:

 

  1. the parent is quite aged and is not likely to want to deal with his or her assets further to any great extent, other than for routine transactions;
  2. the assets of the parent are not numerous such as, for example, where there is a condo, a bank account and a RRIF; and,
  3. the assets are not substantial enough so that estate planning with testamentary trusts through the parent’s will is advantageous;

 

then taking deliberate steps to avoid probate may be worthwhile. 

 

Remember that avoiding probate through the use of false joint tenancies can only succeed if there is no asset left upon death that would require Probate, because if there is even one asset that would require Probate in order to enable the transfer of it, then all of the assets held in false joint tenancy would have to be included in Probate and Probate fees would be payable. This is because the joint tenancy would be a false joint tenancy and the parent would still remain as the beneficial owner of those assets even though the registration and ownership documentation would show otherwise. The adult child who would be the surviving joint tenant would be holding the assets in trust for the parent’s estate.

 

 

What about the parent’s principal residence?

 

If a parent’s principal residence is placed into joint tenancy with the adult child and the parent, this would not normally trigger capital gains tax at the time of that transfer.  This is because the principal residence is usually fully exempt from capital gains tax.  However, if the transfer is an immediate lifetime gift by the parent of a ½ interest thereby creating a true joint tenancy, then from that time on, only the parent can shelter the capital gain in the parent’s ½ interest in the home and the tax on the gain in the other half then belonging to the child would be for the child to pay when he or she disposed of the home.  This loss of a part of the principal residence capital gains exemption is something that could likely have been avoided.

 

The parent’s principal residence can be placed into joint tenancy with the adult child and the parent where the transfer is not intended to be an immediate gift of a ½ interest.  In this case, the property would continue to belong to the parent, in spite of the registered ownership showing 2 owners.  All of the property would be part of the parent’s estate when the parent passed on, even though registered in joint tenancy because this would be a false joint tenancy.  Again, it is very important in such a case to document the fact that the transfer was not intended to amount to a gift or transfer of a beneficial interest in the home by having a Declaration of Trust signed by both the parent and the child at the time of the transfer.  This can then be shown to CRA should there be any question as to whether or not there was a taxable disposition.

rev 04/03/14 ljb