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?


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



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?


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



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


• 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


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


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


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


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






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


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



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



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




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


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



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?

Jane Shanks - Writing the Tax Man Out of Your Will

Documents

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