Jane Shanks - Writing the Tax Man Out of Your Will

Write the Tax Man out of Your Estate Plan

A Wealth Planning Case Study

Jane Shanks, B.A., LL.B., TEPRegional Vice President, Wealth PlanningUnited Financial, a division of CI Private

Counsel LP

Agenda

• Introducing Joe & Susan

• What do they need to consider?

• Gifts and Transfers while Alive

• Tax Savings with Testamentary Trusts

• Strategies to Reduce Probate Fees

• Planning for Second Marriage Concerns

Meet Joe & Susan

Joe, 65&

Susan, 60

Joe’s Daughter & Son In Law

Joe’s SonSusan’s

Daughter &Son In Law

Susan’s Son &

Daughter In Law

Grandchild1

Grandchild2

Grandchild3

Grandchild4

Grandchild5

Grandchild6

Grandchild7

Grandchild8

Meet Joe & Susan

$750,000 $600,000

$800,000

$250,000

$10,000

$250,000

$1,100,000

$10,000

$40,000

Cottage

RRSP

TFSA

RRSP

TFSA

Pension

Boat

Non-registeredHouse$1,060,000 $1,400,000

$3,810,000

$1,350,000

Are they ready for retirement?

What do Joe & Susan need to consider?

• Lifestyle planning

• Living arrangements

• Income security

• Investment strategy

• Physical health and care planning

• Wealth preservation and transfer

• Asset protection

• Incapacity planning

• Important causes and charitable giving

Considerations

Lifestyle planning

• What does retirement look like?

– Joe continued income from publishing and consulting

• Goals and interests?

• New opportunities?

– Susan piano, interior design (renovate house)

– Consider impact on spending

Considerations

Living arrangements

• Home

• Cottage – newly renovated

• Do they need both properties?

– What are the tax considerations for Principal Residence Exemption?

Considerations

Income security

• Do Joe & Susan have enough resources to maintain their lifestyle?

– Do they have a financial plan?

– How much can they spend?

– What do they need to earn?

– Annual review to stay on track

• What should Joe do with his various sources of pension income?

• What income splitting opportunities exist?

Considerations

Physical health and care planning

• Are Joe & Susan protected in the event of serious illness?

Physical/Mental impairment?

• What is the financial impact on Joe, Susan and their family?

• Will there be enough for Susan in the event Joe dies prematurely?

Health and care planning

Other care options

• Should Joe & Susan consider LTC?

– Benefits for assisted living to help preserve their assets for their own use and for a

legacy

– Maintain a sense of independence and standard of living

• Critical illness coverage

Considerations

Wealth preservation and transfer

• Should they consider transferring assets to their children and

grandchildren during life? Should they own the cottage jointly with

their children?

• Can their estate plan help minimize tax for the family? Can the plan protect

their children’s assets from marriage breakdown?

• How can they structure their assets to reduce probate fees and income taxes?

• How can Joe and Susan preserve assets for their children from their first

marriage?

Wealth preservation and transfer

Transferring assets to children and grandchildren during life

• Common “do it yourself strategy”

• Unintended consequences if not properly thought through

• Understand intentions, timing, financial security

• Consider attribution rules

• Consider capital gains consequences for Joe, Susan and kids

• Any transfer of assets is a taxable event

If Joe & Susan transfer assets…

• To their adult children

– No attribution from property transferred

– Deemed disposition of asset at FMV on transfer

– Joe & Susan may incur tax on any capital gain realized

• To their grandchildren (under 18 years)

– Attribution of income, not capital gains

– Deemed disposition of asset at FMV on transfer

– May use “transfer for value” exception

Wealth preservation and transfer

Wealth preservation and transfer

Sale for less than FMV

• Common misconception that tax is avoided

• Asset deemed sold at fair market value

• Joe & Susan may incur tax on any capital gain realized

• ITA rule provides one-sided result:

• ACB equal only to what they paid -- double tax results later

• Gift better than sale at less than FMV?

Wealth preservation and transfer

What about joint ownership of cottage?

Capital gains• Common misconception: transfer to joint ownership avoids capital gains

tax

• If Susan “adds” her 2 children as joint owners of the cottage– Susan disposes 2/3 of the cottage

– Realizes capital gain

– Each of children own 1/3 of the cottage with full cost base for their portion

• General rule: If beneficial ownership has changed, deemed disposition at FMV

Joint ownership: Impact on principal residence exemption

• Recall: children now own 1/3 each with full cost base

• Next 10 years -- cottage increases in value, family decides to sell cottage

• Susan and each of her children will realize capital gain

• Can children’s gains be sheltered with PRE? Maybe...

• Even if they can use PRE, their PRE for other properties for the “overlapping” years is used up

Wealth preservation and transfer

Wealth preservation and transfer

Principal residence exemption: How does it work?• PR exemption is a fraction – basically:

1 + Number of years you say the property was a PR x Gain = Exempt portionNumber of years you owned the property

• Family unit may only treat one property as a PR in respect of a given year

• Common misconceptions: – PR definition is rigid, must “declare” PR each year, mailing address determines status,

etc. – really, “ordinarily inhabited” is liberally interpreted– can pick and choose “which” years to use – really, it’s “how many” years

• Good advice to clients: – If you own two properties and are selling/transferring one: GET TAX ADVICE

Wealth preservation and transfer

• Should they consider transferring assets to their children and grandchildren during life? Should they own the cottage jointly with their children?

• Can their estate plan help minimize tax for the family? Can the plan protect their children’s assets from marriage breakdown?

• How can they structure their assets to reduce probate fees and income taxes?

• How can Joe and Susan preserve assets for their children from their first marriage?

Considerations

Wealth preservation and transfer

Testamentary trusts: How do they save tax?

A. Trust is taxed at marginal rates– Access to an additional set of marginal tax rates (“tax base”)

– Helps a high-rate beneficiary like Susan’s son the doctor save tax

– Beneficiary can still receive the income net of tax!

B. Alternatively, income may be taxed in low-rate beneficiaries’ hands– Example - include Susan’s son and his 2 young children as beneficiaries

– Son can pay expenses for his children -- taxed as their income!

– Access to “basic personal amounts” and lowest tax rates

– Very significant savings are possible

Wealth preservation and transfer

Testamentary trusts: Tax savings

• $700,000 to be inherited by Susan’s son, the doctor• When invested will produce approximately $35,000 income• If son inherits outright:

– would pay tax annually at high 43.7% tax rate (BC) $15,300 tax

• If instead held in trust:

A. Use the trust’s marginal rates

– Income all in lowest bracket (20% in BC) – Son can still receive the income net of tax!

$7,000 tax

– Annual tax saving: $ 8,300

TrustTrust

His childHis child His childHis childSon

Pay children’s expenses out of trust income

Wealth preservation and transfer

Testamentary trusts: Tax savings

$700,000 to be inherited by Susan’s son, the doctor• When invested will produce approximately $35,000 income• If son inherits outright:

– would pay tax annually at high 43.7% tax rate (BC) $15,300 tax

• If instead held in trust:

B. Tax the income in young beneficiaries’ hands

– Pay their expenses – sports, tuition, etc.– Both children combined would pay tax of about: $ 3,000 tax

– Annual tax saving: $12,300

Trust

Trust

His childHis child His childHis childSon

Pay children’s expenses out of trust income

Testamentary trusts: Protection against marriage breakdown

• Beneficiary does not own the trust property

• Beneficiary owns an interest in a discretionary trust – difficult to value (nil?)

• Family property claims: Protection of testamentary trust not completely certain, but much better protection than leaving assets outright

Trust

Trust

His childHis child His childHis childSon

Wealth preservation and transfer

Wealth preservation and transfer

• Should they consider transferring assets to their children and grandchildren during life? Should they own the cottage jointly with their children?

• Can their estate plan help minimize tax for the family? Can the plan protect their children’s assets from marriage breakdown?

• How can they structure their assets to reduce probate fees?

• How can Joe and Susan preserve assets for their children from their first marriage?

Considerations

Structuring assets to avoid probate taxes

• Calculation is based on FMV of property owned at death

• Rates vary by province, particularly high in Ontario, BC and NS

• Some assets excluded from calculation:– Joint Ownership

– Named Beneficiaries

– In Ontario, consider using multiple wills

– Joint Partner and Alter Ego Trusts

Wealth preservation and transfer

Wealth preservation and transfer

Probate Tax: Joint ownership with right of survivorship with spouse?

• Property passes automatically to surviving joint owner without going through the estate

• Not subject to probate tax

• Recommended for spouses (absent other considerations)

• Simplifies administration of the estate

• Joe & Susan’s investment portfolio and principal residence will pass without probate taxes at the first death

• But...if a testamentary trust strategy is recommended for income splitting, would need to sever joint ownership of investment portfolio

Probate Tax: Joint ownership with children?

• Immediate tax consequences - disposition for tax purposes at the time the children become joint owners

• Can produce complications:– Tax on death of parents still applies, tax payable by estate – Child predeceases– Child has creditor issues or other financial difficulties– Child has marital problems– Disputes/litigation among children– Can be difficult to “un-do”

• Not recommended for Joe & Susan - joint ownership is contrary to objective to provide for spouse while also preserving assets for children of first marriage

Wealth preservation and transfer

Wealth preservation and transfer

Probate Tax: Named Beneficiaries

• Registered Plans, Life Insurance Policies, Segregated Funds, Pensions, TFSA’s

• Designate beneficiary or successor annuitant in plan or policy documents, or in the Will

• Consider designations in light of overall Will plan

– If creating testamentary trusts, plan or policy proceeds could be designated to estate to fund trusts

– Separate insurance trust for large amounts

• Joe & Susan’s registered plans will pass outside of the estate without probate fees on the first death

Wealth preservation and transfer

• Should they consider transferring assets to their children and grandchildren during life? Should they own the cottage jointly with their children?

• Can their estate plan help minimize tax for the family? Can the plan protect their children’s assets from marriage breakdown?

• How can they structure their assets to reduce probate fees?

• How can Joe and Susan preserve assets for their children from their first marriage?

Considerations

Joe: Providing for Susan & his children

• Joe may perceive risk that his testamentary intentions will not be realized

• Additional concern: Susan may spend assets imprudently after Joe dies

• Solution:– provide spousal trust for Susan’s lifetime

– provide support during life, but ensure Joe’s Will provides ultimate distribution of his estate

– Note spousal rollover requirements do not interfere with ability to limit capital distributions

• Note spousal trust requires separately owned non-registered assets

Wealth preservation and transfer

Wealth preservation and transfer

Susan: Providing for Joe & her children

• If cottage becomes their primary residence, Susan wants Joe to have the right to live there, but have the kids eventually inherit

• Susan also wants the kids to be able to continue to use the cottage property as they have in the past

• Concerned about potential conflicts over usage while Joe is living and using the property as his home

• Possible Solutions:– Family meeting to discuss options, consider a written agreement to determine periods of usage – Establish a cottage trust to allow Joe to enjoy during life, but ensure Susan’s Will provides

ultimate distribution to the children– Consider giving children an option to purchase – Consider insurance to fund capital gains tax and associated costs of keeping the cottage

The plan for Joe and Susan

• Split pension income

• Designate spouse as beneficiary of registered plans

• Spousal trusts for Joe and Susan

• Testamentary trusts for Canadian resident children

• Cottage trust for Joe and Susan's children

• Insurance to provide liquidity to pay CRA

Questions?