Estate Planning Introduction
Establishing what will happen to your estate when you pass away is the main focus of estate planning. By making these crucial decisions while you’re still alive, you prevent your family from experiencing stress and disharmony trying to make decisions about your estate for you. It also helps to prevent litigation among and between your beneficiaries. One aspect of estate planning is preparing for and minimizing taxes so that your wealth and estate is preserved as much as possible. Another factor in estate planning relates to your physical and mental capacities when you’re older. Choosing someone you trust to control your assets if you aren’t able to is imperative to your estate’s future.
Your estate plan should cover the following key elements.
- Ensuring your assets are protected during your lifetime
- Ensuring your assets are transferred to your beneficiaries in a tax-effective manner
- Ensuring your assets are protected once the transfer has occurred
- Ensuring someone you trust is appointed to care for your assets if you aren’t able to
- Planning and pre-funding the liabilities and costs that occur once you pass away, sometimes using life insurance
- Communicating clearly with your family and other stakeholders the directions of your estate plan
Effective estate planning reduces the taxes due upon your death from transferring your assets or from the growth of capital gains in the future. It can defer some taxes that are related to the transfer of a property to your spouse or to your spousal trust. Your estate plan creates an orderly structure for the transfer of your assets to whomever you designate the beneficiaries for the next generation. It might include using a shareholders agreement or inter vivos trusts. Through exceptional estate planning, you can ensure there’s enough liquidity to pay estate taxes, make charitable donations, or meet cash bequests to beneficiaries.
What’s required for an effective estate plan? Along with your estate planner, you’ll need to create legal structures to transfer your assets to. For example, a corporation or a trust. There will be many documents to execute such as shareholder agreements, trust deeds, partnership agreements, domestic contracts, wills, and powers of attorney. Your estate planner may suggest purchasing life insurance as a method for creating estate liquidity and using those funds for taxes, bequests, and shareholder buyouts upon your death. You might also decide to freeze your estate during your lifetime to decrease possible capital gains tax.
Estate Related Taxes
There are various estate taxes that arise when you pass away. Depending on what you plan to do with your assets after you pass, it’s important to minimize any potential taxes that may occur. Here are some of the potential taxes your estate will face come your death.
Also called estate administration tax, probate fees are based on the value of your assets in your will. When you pass away, your will must first be approved by the provincial courts before your executor can take over your assets. This process of getting your will approved by courts is called probating a will. This must occur before your assets can be transferred to your executor and later your beneficiaries. Without the probate process, your will isn’t legitimate and your beneficiaries aren’t officially entitled to your assets.
There is a fee for this process based on the value of the assets in your estate. In Ontario, this fee is 1.5 percent of your assets’ total value over $50,000. In a situation where the assets have a value of $1 million dollars, the probate tax would be $15,000.
Luckily, there are multiple strategies your estate planner can use to minimize your probate fee. They might use a probated will and a non-probated will. It might be advised to name beneficiaries for your registered accounts and insurance policies. Or, in some cases, transfer you assets into joint ownership with your family members.
Capital Gains Tax
According to the Income Tax Act, it’s assumed that you will have sold your capital property upon death at whatever the current fair market value is. This is also known as “deemed disposition” and it occurs even when the estate will be distributed among the beneficiaries. The exception to this rule is when your property(ies) is transferred to a spouse until being sold.
Basically, if the value of the property is greater than its initial cost, or adjusted cost base, then 50 percent of that increase is taxable. On the other hand, if a property declines in value, then 50 percent of the loss can be used to offset capital gains tax. These figures are required to be included in your tax return after your death, also known as a terminal tax return. There are strategies your planner can use to offset gains, like using your principal residence exemption.
Here’s an example. If you have shares in a company that are worth $10 million at the time of your death and the price you originally paid for them was $1 million, there’s a capital gain of $9 million dollars. That $9 million is subject to a 50 percent capital gain tax of $4.5 million dollars. Part of the estate planning process is planning for this tax and using strategies to fund and minimize it.
Registered Plan Income Inclusion
Registered Retirement Savings Plans (RRSPs), Registered Retirement Income Funds (RRIFs), and Defined Contribution Pension Plans (DC Plans) are common accounts for individuals to save funds tax-free. When funds are withdrawn from these accounts, those funds are considered income for the account holder and can be taxed.
When you pass away, any funds left in your accounts will be included in your terminal tax return. To avoid adding these funds to your apparent income, you can appoint your spouse the beneficiary of these accounts. Your spouse could then decide to reinvest them into RRSPs, RRIFs, or a DC Plan to avoid taxation.
Life Insurance and Estate Planning
It’s common for financial needs and demands to come up when you pass away. Your estate may need to fund capital gains taxes, redeem shares from a shareholders agreement, fund a bequest, or even replace your income for your dependants to use. There are many ways you can prepare to fund these necessities, like using cash assets or selling assets. You could also borrow funds from the bank. The only option that provides funds exactly when you need them is life insurance. Life insurance is a tax-free option you can use for pre-funding and tax liability needs. It retains the value of holding company assets so the next generation can benefit from them. Plus, life insurance proceeds automatically create a Capital Dividend Account credit which further funds future tax liability.