With the aging of the boomer generation estate planning is becoming a much more significant concern. Combine that with the precarious status of the Canada Pension Plan, the ever increasing taxes and the rather onerous tax liabilities that can occur on death and you have a recipe for panic.

The good news is that estate planning is a lot easier a process than many think. Often a few simple steps will fend off the taxman and insure that your loved ones are adequately provided for upon your passing. Taxes can also be minimized by carefully structuring your portfolio of holdings. Given the ease of achieving these objectives, it is surprising that so few Canadians actually sit down to insure that financial matters are appropriately dealt with.

Let’s go over some of the basics.

What Is an Estate?

An estate is the inventory of assets that an individual leaves to posterity upon passing. The estate is a kind of interim vehicle into which assets are deposited prior to their finding their permanent-resting place. This could be either an intended beneficiary, the government in payment of taxes, or a creditor of the deceased. The estate is a method of sorting out the affairs of the deceased in an orderly manner, and is designed to respect the rights of beneficiaries and creditors. An executor specified in the will of the diseased administers it.

Examples of assets in our estate: are

Most of us will have at least some of the foregoing unless we are homeless and bankrupt, in which case we are more than likely not reading this web page.

The estate excludes assets that are bequeathed to specific individuals in such a way that ownership reverts directly to them. Examples would be the beneficiaries of life insurance where a beneficiary other than the estate is referred to in the policy, or the beneficiaries of RRSP’s where a specific individual is referred to. Even real-estate ownership can be structured in such a way so as to allow it to pass directly into the hands of an intended beneficiary outside the operation of the estate.

The estate had jurisdiction over assets that fall under its control. As noted above, not all assets fall into the estate. Furthermore, you cannot will an asset to someone who is a specific designated beneficiary. For instance, someone who is the beneficiary of a life insurance policy cannot have their rights to the proceeds undermined by a will. This is discussed in more detail in the section on wills below.

Taxation Upon Death

The good news is that there is no estate tax in Canada per se. In other words, unlike our less fortunate neighbors to the south, the government doesn’t take a flat percentage of all the assets that a person has accumulated upon passing – hence the expression "Live in the United States, die in Canada." With such foresight in industrial planning, we’re lucky that the Government of Canada didn’t make this a nation of corpses.

The bad news is that the government has figured out a way of getting their pound of flesh even in the absence of an inheritance tax. They do this by what is known as a "Deemed Disposition". The government assumes that you have disposed of all of your earthly goods upon dying. What’s more, they attribute their own sales proceeds to this "deemed" transaction.

The government considers that all your goods were disposed of at "Fair Market Value" at the date of death. Fair market value is the value that similar goods would get in an open market – what they would be sold for to a complete stranger. For example, if you have shares of Bell Canada, the government would first look up the value of the stock in the stock listings at the date of death. They would then determine a gain or loss on the deemed disposal of those by calculating the difference between the price you paid for the shares and their value at death. The same or a similar procedure would have to be undertaken for every asset you own. First market value would have to be estimated for all your assets, then an initial cost would have to be determined. Needless to say this procedure is not always that simple, since market prices are not available for all assets. This could be a tedious and disquieting experience for your heirs if the asset were acquired twenty years ago. A good part of estate planning is just having organized accounting records.

One can see from the above, that the potential taxation upon passing is quite onerous. If you tally up all the gains and losses of all the assets you’ve accumulated over a lifetime, you may find that your income for the year of death is well in excess of $100,000. The net result of this is tax rate of 50%. This translates to the government scooping a good chunk of your estate.

All is not lost. Exceptions have been built into the tax law to eliminate the more onerous consequences of these provisions. For example, certain assets left to a spouse or dependent child will not be taxed when transferred, but only when the beneficiary (wife or child) disposes of the assets down the road. In addition, other vehicles are available to effectively freeze the potential gains on disposal of certain assets so as to reduce the taxes that will eventually be owing on them.

We will now look at the tax affects of death on some of the assets mentioned above together with some strategies to minimize any taxes owing.

Your Home

Your principal residence is one of the few assets you possess that you can dispose of without any taxable gain. In other words, if your house goes up in value over the period of ownership and you either sell it at a gain, or die and leave it to a child, no tax will result. There is little to consider in the way of taxation here.

On the other hand, you may want to consider ownership. You may not want to leave a valuable property directly to a minor child regardless of the tax implications, but you may want that child to have the benefits of ownership non the less. These twin conflicting objectives could be achieved with the help of a trust. Trusts are discussed in more detail below.

Stocks and Bonds

Stocks and bonds generate capital gains or capital losses when disposed of. Capital gains are taxed at a maximum rate of 37.5%. These types of taxable gains would become payable if the securities are left to anyone other than the taxpayer’s spouse. In other words a well-meaning parent can unwittingly burden his estate with a large tax liability simply by leaving the securities to the wrong family member. Part of estate planning is taking due care in assigning assets to beneficiaries. In this case it might be better to leave the kids other assets that won’t attract an immediate tax liability.

RRSP’s

RRSP’s are treated differently for tax purposes than the other assets we discussed. RRSP’s are called tax deferred savings plans. The reason for this is that you get a deduction when you put the money in, and presumably pay tax on it when you take it out upon retirement (hopefully at a lower rate). When you die you no longer need retirement funds however, so the plan is immediately collapsed and fully taxable in your hands in the year of death. For those of us who have put aside a few hundred thousand dollars over the years, the tax bill could be extortionate – generally 50% of everything in the plan.

There are several exceptions to this rather hefty tax. One is the case where RRSP’s are left to a spouse, the spouse can deposit the entire amount of the RRSP in her own RRSP account with absolutely no immediate tax consequences. Another exception is the case of minor or disabled children. In both of these cases, the tax affects of the collapse of RRSP’s can be greatly reduced.

Again by simply considering tax affects when specifying beneficiaries of pension plans, money can be saved.

Shares in Family Businesses

Generally shares in family businesses or interests in partnerships are treated as capital properties much in the same way as other securities. The difference between these and other securities are twofold:

An improperly planned estate can cause great hardship to a family business. Often large tax bills can accrue upon succession giving the heirs no choice but to dispose of the business. A thorough analysis of the affects of succession together with alternative estate plans should be undertaken.

Life Insurance

One often hears of life insurance as an estate-planning tool. Life insurance is a significant tool of several reasons. One is that life insurance proceeds are received tax-free by an estate. Unlike other assets there is no gain on the realization of a life insurance policy. It can often be an important source of cash for beneficiaries who feel desperate around the time of a loved one’s passing. It can also be used to pay the taxes that may result from the deemed disposals of all the assets referred to above.

Life insurance is generally useful in those situations where an individual does not leave adequate cash and saleable assets to support his or her family. If on the other hand, an individual has a million dollars in the bank, life insurance may well be a waste of money.

The amount of life insurance carried is an important decision that requires a careful review of one’s entire portfolio, and the likely outcome of an untimely passing.

Trusts

Trusts are vehicles designed to hold assets on behalf of a third party, when you don’t trust the third party to hold and administer the assets themselves. This could be in the case of minor children, a spouse with little business acumen or a history of irresponsibility, or a mentally or physically infirm child or other relative.

Generally the trust assumes ownership on behalf of the third party, but a responsible person paid for his efforts known as a trustee administers the asset. Often trustees can be trust companies, lawyers, accountants, or trusted family friends. The assets within the trust are held on behalf of the beneficiary, and released to him or her in compliance with the trust document.

Trusts can keep all of their income in which case the income is taxed in the trust’s hands, or allocate the income out to beneficiaries in which case the beneficiaries would pay the tax.

Trusts assume the tax personality of the beneficiary. In other words, assets left to trusts on behalf of individuals would be taxed as if the assets were received by the individuals themselves. For example, assets left to a spousal trust would not trigger any gains, as if the spouse received the assets directly. The tax benefits could be reaped without giving control of the assets to an irresponsible individual.

Wills

The will is a set of instructions left by a testator (the person with the estate) determining which assets are left to whom. It is important to note that the will governs only the assets in the estate. Assets bequeathed to individuals outside of the operation of the estate are not governed by a will. For instance, if a spouse is a designated beneficiary of RRSP’s and life insurance, these assets will revert directly to him or her upon death, and not go through the intermediate step of an estate. In addition, any property owned jointly (with two names on title) will go immediately to the partner and not through the estate. If all you have is life insurance and RRSP’s, then you need not enter into a will at all if each designates a beneficiary.

For wills to be valid they have to be executed by someone of sound mind and appropriately witnessed. Once a person dies a will has to be presented to a court where it will be probated. This is an exercise whereby a court certifies the will to be valid (for a small probate fee, equal to 1 to 2 percent of the estate). Once the will is probated its instructions can be executed. It is generally a good idea to have a lawyer draft your will. There are just to many issues to attempt to do it yourself.

Conclusion

The above is a very cursory view of some of the issues involved in estate planning. It is not intended to guide a member of the lay public through a very perilous and complicated process, but merely make you aware of some of the risks involved in either ignoring the subject, or preparing an estate plan without the requisite knowledge. I hope it’s been informative.