Inheritance planning: When equal and fair aren’t the same thing

Dividing your estate equally among your loved ones may seem like the simplest way to keep everyone happy, but what could seem fair to one family member might not to another.

Do you reward the kid who served as your caregiver during the final years of your life and is entirely self-sufficient, or do you support the child who could really benefit from your gift? Before planning your estate, Michelle Munro, Director of Tax and Retirement Research for Fidelity Investments Canada, has a few suggestions to help ensure your final decisions are made with fairness in mind.

Be honest with your beneficiaries about their inheritance.

When it comes to estate planning, you can’t assume your beneficiaries will be on board with your decisions. The best way to avoid future acrimony – and potentially lengthy legal battles – is by maintaining honest communication with your loved ones about your final wishes.

Munro recalls a conversation with a friend who discovered her parents were planning on leaving their entire estate to her older brother. “They felt he was the least financially stable of their three kids and, therefore, needed the most help,” she says. “She had been financially responsible her entire life and had done most of the caregiving for her parents, but she was being penalized for doing the ‘right thing.’”

Once Munro’s friend shared her concerns with her family, her parents decided to split their estate equally between their children. “If she had just assumed it was going to be an even split, she would have been pretty bitter after they were gone,” Munro says. “That’s not the kind of legacy most people want to leave behind.”

Addressing the legal and financial Issues

Canadian laws and regulations on estate planning

In Canada, the process of transferring wealth is governed by a variety of laws and statutes that can vary by province or territory. Having a will and an estate plan can help ensure your final wishes are followed.

When you’re working through the estate planning process, Munro says, it helps to have a detailed list of your assets, and a good idea of what your goals and objectives are. If you have a spouse or partner, you’ll want to have a conversation about your joint vision.

Inheritance tax

Canada doesn’t have an official estate tax like some other countries do, but your estate can still get hit with a potentially hefty final tax bill on death through a process called “deemed disposition.” Under Canadian tax rules, any property or non-registered assets you leave behind are deemed to have been disposed or liquidated at the time of your death. Any taxes on the capital gains arising from the deemed disposition of these assets must be paid in a final income tax bill filed for your estate.

The deemed disposition of the deceased’s assets at fair market value takes place at the time of death. It should be noted that there is a tax-deferred rollover that allows non-registered assets to be transferred to a surviving spouse at cost – but this only defers the deemed disposition and taxes thereon until the death of that surviving spouse.

Another item to note: a recent change to increase the capital gains inclusion rate to 66.7% on any gains above $250,000, up from 50%, means your estate could face a larger tax bill. Any gains below that threshold continue to be subject to a 50% inclusion rate, taxed at your marginal rate. In other words, if you plan to bequeath the family cottage, and it has increased in value by $300,000 since the time it was purchased, a portion of the gain on the property could be subject to the higher tax rate.

Probate fees

Probate is another fee that can erode your estate. This is a process by which a court formally accepts a will or, if there is no will, the process of appointing someone to act on behalf of the deceased. The fee for the probate varies by province and the size of the estate, and the process can take several months to be completed.

Minimizing taxes and fees

Gifting assets

One way to reduce the tax burden on your estate is to make gifts while you’re alive, so you can watch your beneficiaries enjoy them. “They say it’s better to give with warm hands than cold,” Munro says. When you sell an asset to give money to your children or future beneficiaries, you’re triggering that disposition today. “You pay the taxes today, and the recipient doesn’t pay any additional tax on receiving the gift,” she explains, adding that you need to ensure you have enough money for your own retirement needs.

Life insurance

An insurance policy can be a another way to help beneficiaries cover any hefty taxes or fees they inherit along with a family cottage or other assets. Any benefits paid out by a life insurance policy are usually not subject to income tax.

Setting up a trust

A trust can help you reduce your tax burden while maintaining greater control over how your assets pass to your beneficiaries. Generally there is a deemed disposition on the assets transferred to a trust, but any assets inside a trust are no longer subject to probate fees, so depending on where you live and the size of your estate, you could save your loved ones a fair bit of money. It’s important to note that trusts can be complicated and have their own setup and ongoing costs, so be sure to talk to a financial advisor to see if one makes sense for you and your beneficiaries.

How you divide your assets is ultimately up to you, but communicating your final wishes to your loved ones is the best way to keep everyone happy. Enlisting the aid of a financial advisor, accountant and or estate lawyer will be instrumental in helping you navigate this process and the unique dynamics of your family. The alternative is far worse. “If you don’t have a will or any designated beneficiaries, you could lose control of your estate,” Munro says. “You do not want to go down that road.”