“In this world, nothing is certain except death and taxes” – Benjamin Franklin
No matter how financially successful you are in life, two things are certain; you can’t take it with you when you die, and whatever you leave behind is going to get taxed!
That’s why estate planning shouldn’t just be a consideration for your twilight years, but an essential part of your financial strategy here and now. To be successful, you must understand how wealth is taxed upon death and utilize appropriate strategies to protect your assets.
This article discusses the key factors involved in creating a tax-efficient estate plan, from Canada’s deemed disposition rules to establishing different types of trusts. With the right knowledge, expert advice and proactive planning, you can ensure the preservation of your legacy for future generations.
What Gets Taxed at Death?
At the time of death, an individual’s estate is subject to various taxes that can significantly impact the value of the assets transferred to beneficiaries. While Canadians aren’t subject to a true “estate tax” like our neighbours in the U.S., we do have to contend with “deemed disposition tax” and provincial/territorial probate taxes.
Deemed Disposition – Under Canadian tax law, a deceased individual is deemed to have disposed of their capital property immediately before death. This does not involve an actual sale, but is a hypothetical transaction that assumes all property, whether it be real estate, stocks, or bonds, has been disposed of at fair market value (FMV).
The estate’s executor must file a terminal tax return on behalf of the deceased that includes any net capital gain realized under the deemed disposition rules. The full value of any registered assets, such as Registered Retirement Savings Plans (RRSPs) and Registered Retirement Income Funds (RRIFs), will also be included in the final return as taxable income. The estate must then pay any taxes owing to the CRA before distributing the remaining assets to beneficiaries.
Probate Taxes – When an individual passes away, their will must go through a legal process known as probate, where the document is validated by the court. Probate serves multiple purposes: it protects the interests of beneficiaries and creditors, confirms the executor’s authority to administer the deceased’s estate and ensures that the will’s directives are honoured. However, it also incurs costs in the form of probate taxes (commonly referred to as estate administration taxes), which can be significant depending on the size of the estate.
In Canada, probate taxes are not uniform across the country; they vary by province and territory, reflecting different rates and structures. Generally, these taxes are calculated based on the total value of the deceased’s estate that passes through the court. In Ontario, the first $50,000 of the estate is now exempt from probate tax. For amounts over $50,000, probate tax is calculated at $15 for every $1,000 of the estate’s value.
U.S. Estate Tax – It’s important to note that while Canada does not impose an estate tax, Canadian residents who are not U.S. citizens may be required to pay U.S. estate tax if they own U.S. situs property, such as real estate and shares in U.S. corporations.
Strategies for Tax-Efficient Wealth Transfer
Tax-efficient wealth transfer requires a multifaceted approach tailored to your individual situation and future goals. It is essential to seek appropriate advice from expert legal and accounting professionals who can guide you through the complex financial processes involved. A well-structured estate plan ensures your loved ones receive the maximum benefits from your assets while minimizing their tax liabilities. Successful plans often employ a combination of the following strategies:
Spousal Rollover – The Income Tax Act (ITA) includes provisions to defer capital gains tax incurred under the deemed disposition rules if the asset is left to a surviving spouse or a testamentary spousal trust. In this scenario, ownership of the asset is transferred to the spouse or spousal trust at the original cost, meaning no tax is payable until the asset is sold or the spouse is deceased.
Establishing Trusts – For estate planning, there are two categories of trusts; testamentary trusts and inter-vivos trusts (sometimes referred to as living trusts). Testamentary trusts arise from your will and are only created after your death. They allow control over the timing and distribution of assets, which can be useful for minor children, disabled beneficiaries and creditor protection. Other scenarios where testamentary trusts may be used include Spousal Trusts and Irrevocable Life Insurance Trusts (ILITs).
Inter-vivos trusts on the other hand are established during your lifetime. This creates several benefits including income-splitting opportunities, the flexibility to alter the trust (if revocable), and reduced probate taxes upon death (as the assets transferred to them will not form part of your deemed estate). Inter-vivos trusts can also be a vehicle for charitable donations and are useful when the preservation of privacy is a concern, as they are not public record.
Gifting Assets During Your Lifetime – This approach not only allows you to see your beneficiaries enjoy the assets but can also significantly reduce the taxable value of your estate upon death. In Canada, gifting money or assets to family members is generally not subject to tax, which means you can transfer wealth without incurring a tax liability. However, it’s important to consider potential capital gains taxes if you are gifting income-producing assets that have appreciated in value. You should also be aware of income attribution rules when transferring gifts to your spouse or minor child, whereby income earned on these gifts is still taxable in your hands.
Utilizing Life Insurance – In general, life insurance proceeds are paid out tax-free making them an efficient way to transfer wealth to your loved ones in the event of your death. By naming your intended beneficiaries on the policy, the proceeds can bypass the estate, avoiding probate fees and providing liquidity to cover any taxes owing at death.
Transferring Registered Accounts – Registered accounts such as RRSPs and RRIFs can often be transferred tax-free to a surviving spouse’s own plan. For non-spousal beneficiaries, such as financially dependent children or grandchildren under the age of 18, it may be possible to transfer the registered account by purchasing a fixed-term annuity. RRSPs and RRIFs may also be transferred to a Registered Disability Savings Plan (RDSP) for a disabled child or grandchild. To minimize probate taxes, registered accounts can be transferred outside the estate by designating the beneficiary on the account itself.
Joint Ownership – The two forms of co-ownership in Canada are Joint Tenancy with Right of Survivorship (JTWROS) and Tenancy-In-Common (TIC). Both have distinct characteristics and tax implications that can significantly affect estate planning outcomes.
JTWROS is a form of co-ownership where each owner has an equal undivided right to the asset. Upon the death of one owner, their interest in the asset automatically passes to the surviving co-owner(s), bypassing the estate and potentially avoiding significant probate fees. However, it’s important to note that while JTWROS can simplify the transfer of assets upon death, it may not always align with the owner’s intentions for asset distribution, as the asset does not form part of the deceased’s will.
On the other hand, TIC allows individuals to own property in proportionate shares, which can be unequal. Each owner’s share forms part of their estate upon death and is distributed according to their will. This can offer more flexibility in estate planning, allowing for specific asset distribution wishes to be fulfilled. However, TIC can lead to more complex estate administration and thus higher probate taxes.
Final Thoughts
Tax-efficient estate planning is a complex but crucial task that requires careful consideration of various factors and potential tax liabilities. Through strategic financial decisions, Canadians can ensure their wealth is preserved and passed on according to their wishes, with minimal tax impact.
To learn more about estate planning and explore personalized strategies, it is advisable to seek the guidance of tax professionals who can help you navigate the intricacies of Canadian tax law. At NVS, our expert Taxation Team specializes in developing comprehensive estate plans tailored to your individual circumstances and future goals.
Remember, the key to successful estate planning is proactive and informed decision-making. Start planning today to secure your legacy for tomorrow!
This article was written by the NVS Professional Corporation team, your knowledgeable Barrie and Markham accountants. The content is intended as a general guide for informational purposes only. For specialist advice tailored to your specific situation, please reach out to our expert team.
