Leaving a Legacy, Part 2

Values-Based Estate Planning

Over the next few decades the wealthiest generation to have ever lived in the U.S. will be handing down over $30 trillion to their children. This presents a tremendous challenge for beneficiaries who are expected to maintain the wealth beyond their own lifetimes.

In Part 1, we asked:

“If you were going to plant a garden, would you first go to the nursery and buy plants willy-nilly? It’s unlikely. You would have examined the soil you’ll be working with, followed the path of the sun to find out where the light will fall and know what climate zone you are in to ensure you purchase foliage that will have the best chance of not only surviving, but also being aesthetically pleasing. Similarly, if you don’t know the purpose and goals of your wealth, how will you know what tax or investment strategy to implement?”

In drilling down and clarifying the goals of your estate, some questions to ask yourself are:

• Who will benefit from your estate?
• What impact will your estate plan have on your family?
• Are there significant family assets that will need to be addressed (e.g. family cottage)?
• Do you want to divide your estate equally?
• How important is it to minimize taxes?
• Do you wish to leave money to charities?

Once you have prioritized your goals, there are many tools you can use to help you create a well-designed plan, and we’ll examine a few of these. But first, let’s take a look at the exciting and magical world of….taxes!

Tax Arising on Death

As Benjamin Franklin famously said, “In this world nothing can be said to be certain, except death and taxes”. Unfortunately, they come as a package deal.

Two types of taxes that can be triggered upon death are the estate administration tax (commonly called “probate”) and income tax. Assets that pass through the will must go through probate. Many people spend a lot of time strategizing on how to avoid the probate process, so as to avoid the estate administration tax. However, more often than not, the bigger issue is the income tax that is triggered by the deemed disposition of the assets immediately before death and particularly, as it relates to the triggering of the unrealized capital gains on the investments. So, if minimizing tax is one of the goals of your estate, first determine which tax is worthwhile for you to minimize.

Income Tax Planning

You can’t avoid income tax when passing assets on to the next generation. However, there are strategies that can be used to minimize taxes along the way.

Financial Planning

Spending assets wisely while you’re alive can minimize income tax the longer you live. On death, RRSP/RIFs are treated as income, and are taxed in full. Contrast that to a taxable investment account, on which only the unrealized capital gains will be taxed. The difference can be meaningful. If one of your goals is tax minimization, intentionally shrinking your RRSP/RIF during your lifetime could significantly reduce the eventual tax burden on the estate and your beneficiaries.

Lifetime Gifts

This should be considered only if you have assets beyond the scope of what you need. Gifting money to adult children during your lifetime means it won’t be part of your estate. If you have excess funds and your children are in a lower tax bracket than you, there is a opportunity to minimize income tax during your lifetime. There is also the pleasure of seeing your children enjoy the money while you are still alive. On the other hand, the future is unknown, and the longer your time horizon, the more conservative your gifts should be. If you want to gift to children but maintain control over the assets, consider using a family trust.

Charitable Giving

If you have more accumulated wealth than you or your children need, then consider giving it to charity. There are numerous advantages in doing this. In terms of tax benefits, for example, every dollar donated over $200 will get a credit at the highest personal tax rate. As an added sweetener, donating securities “in-kind” can reduce your taxable income because tax on the capital gain is eliminated and you still receive the full tax credit for the value of the securities.

Probate Planning

Property that passes through your will is subject to probate. However, there are ways to avoid probate, and they include designating a beneficiary on registered accounts and life insurance policies, establishing joint accounts and establishing Alter Ego or Joint Partner Trusts. There are benefits and disadvantages to all of these. In designating a beneficiary, there are really only two wise choices – designating a spouse or an adult child. Joint accounts have their pros and cons, and always remember – joint means joint! The joint holder of a bank or investment account can withdraw all the funds. Finally, Alter Ego or Joint Partner Trusts are used as substitutes for wills and powers of attorney in estate planning for those over age 65. There are many benefits to these types of trusts but they are not for everyone. There are costs to setting them up, as well as trustee fees and tax filings.

Conclusion

When you set out to develop an estate plan, understand what you want to achieve first. Evaluate your assets and determine your financial position during your lifetime, determine your tax consequences on death, and only then implement the estate planning approach that is appropriate for you.