While most people understand the importance of estate planning, it’s a task that’s often put off because people aren’t sure where to start.
According to Raymond Adlington, a lawyer and partner at Miller Thompson LLP, determining the value of someone’s property can be complicated. Often, there are things that cannot be split equally because they hold sentimental value, which far outweighs their financial value.
“This is an area of common dispute among beneficiaries, so it’s a good idea to have family discussions about those types of things,” he says.
Other things, like the family cottage, stocks, or even cash are easier to appraise, but their worth still needs to be considered to determine the overall value of the estate, especially if a person wants to leave behind an equitable inheritance to all their recipients.
While he cautions that these matters should always be discussed with each person’s financial planner or tax expert, Adlington spoke with the Financial Pipeline about about the four key things to consider to maximize your estate planning while writing a will or making a lifetime gift.
1. Lifetime Gifts
Many Canadians choose to make charitable donations and lifetime gifts as part of their estate planning.
From a tax perspective, it’s often more beneficial to donate publicly-traded securities rather than cash. This is because the capital gains tax is deemed to be zero with a gift of traded securities.
“Let’s say that you’ve got publicly traded securities with a $50,000 capital gain. That’s going to result in a tax bill of, let’s say, $15,000. But, if you donate the securities, that tax bill disappears. If you donate an extra $50,000, now, you still owe $15,000 in capital gains tax.”
If a gift is being given towards a family member, Adlington says it’s key to think about attribution.
“Attribution is a concept in our Canadian tax regime, associated with making gifts to spouses or children under the age of 18, where if income is earned on a gift by recipient (A), the donor (B) has to pay tax on it. So if ‘B’ makes a gift to ‘A’ of income-producing property, then the income from that gifted property would have to be attributed back to ‘B’.”
This applies if the parties “A” and “B” are married at the time the gift is made. Whoever made the gift would have to continue to pay tax even though the spouse is receiving the income. The same holds true if a person makes a gift to a child who is under 18 years old, a grandchild who is under 18 years old, or to a trust fund of which their spouse or their children under 18 are beneficiaries of.
Attribution becomes especially important during tax season.
“You have to plan for and be aware of attribution so that you are reporting your income correctly. If the wrong individual reports that income, it means it is going to be subject to tax twice, by the person who reported it and by the individual to whom it gets attributed,” says Adlington.
2. Equitable inheritances
Two of the most important questions people need to ask themselves before writing a will are: “who are my beneficiaries?” and, “do I want them to get an even split of all my things?”
For those people that have multiple beneficiaries and want to leave an equitable inheritance, understanding the overall value of their estate is crucial. In second or third marriage situations, it’s also important to consider the division of assets between current and previous spouses and any children from these relationships.
If people have assets in more than one country, then they need to think about how to comply with the laws where the property or bank account is located. The formalities, laws, or religious traditions may be different for execution of wills.
“It may be that you need to have more than one will, one for your home country and a will for the country where your other assets are located,” says Adlington.
When someone dies, the deceased has to pay tax on everything they own. Knowing how that owed tax affects the value of an inheritance can help dictate one arrangement over another to achieve an equitable split between all relevant individuals.
Additionally, if a person has made lifetime gifts to their recipients, Adlington says it’s important to account for these in the will with a “hotchpot”.
“For example, I have a brother. Let’s say that my parents gave each of us a loan to help us buy our houses. But the amount of the loan that my parents gave me was less than the amount of the loan they gave my brother. For example, let’s say I got a $100,000 loan and my brother got $200,000.
A legal hotchpot says, ‘Okay, at the time of my parents’ death, because they’ve said they want everything treated equally, effectively, I get the first hundred thousand dollars out of the estate and then everything else is divided equally.’ Because he got an advance that was more than what I got.”
3. Beneficiaries with Disabilities
Adlington says that if someone plans to bequeath an inheritance to a disabled beneficiary who might have access to social benefit programs that are income tested, it is important to plan ahead.
“We generally put in place a Henson trust, where instead of leaving the amount to a disabled individual, we establish a trust fund for their benefit. Usually, we make it a discretionary trust so that the trustee has full discretion to pay amounts out of the income or capital of the trust to the benefit of the disabled individual, but has no obligation to.”
This protects the inheritance because Canadian courts don’t count these payments as income for the disabled individual, when deciding whether they’re entitled to welfare or disability support programs, which are based upon the income that an individual might have.
This way, the disabled recipient can get both the disability supports available from the government and benefit from the trust fund for other things that will help supplement the quality of life that they enjoy.
4. Protecting inheritances and gifts
In cases where there is family strife, it’s not unusual for people to divide their inheritance unequally, leaving some things to specific people to the exclusion of others. But protecting a will against claims, or completely disinheriting someone can be tricky. Across the country, from province to province, different laws govern dependent relief claims.
“In situations where you don’t have a prenuptial agreement, in most provinces and territories, the surviving spouse is going to be allowed to treat the death like a divorce and make a claim accordingly. It’s very difficult to completely disinherit a surviving spouse,” says Adlington.
Surviving common-law partners don’t have the same luxury, since they aren’t equally protected by Canadian law.
“They can make a claim called a constructive trust that says, ‘I contributed to the building of these assets, therefore I should be entitled to a share.’ But that’s an uncertain proposition, in terms of what they’re going to receive from such a claim,” says Adlington.
Disinheriting children is easier, as long as the children are not financially dependent upon the deceased. If they’re financially dependent on them either by virtue of age or disability, then some relief is most likely going to be granted.
“In situations where children are going to either receive a very limited inheritance or no inheritance to all, we would generally get the testator to commit to writing the reasons for that. That can then be used as evidence in any sort of future claim made by the child,” says Adlington.
Of course, the starting point for analysis is that an individual is free to leave his or her property as they choose. But these other individuals may have the ability to bring a claim to court, indicating that they ought to have received some inheritance, “then the court gets to decide within the parameters and the previous jurisprudence, what the individual should actually get.”
In the case of protecting lifetime gifts, and gifted property from third-party claims, there’s a few tricks lawyers use.
For example, let’s say a parent fully owns a cottage, meaning that they no longer hold a mortgage on it, and wants to transfer ownership of the house to their child. But, their child is being sued or going through a divorce.
First, Adlington says, the parent should gift their child some money to allow them to put a down payment on their cottage. Then the child would use that money to buy the cottage from their parents.
In this scenario, the child is returning that monetary gift almost immediately in the form of a “down payment” for the cottage.
And then, the parent would give their child a “mortgage” for the balance of the purchase price, like a bank would, but would never expect actual payments to be made on that property.
Legally, this means the parents own the mortgage on the cottage that the child bought, which allows them to take it back, should things go bad for the child.
If the child then goes through a divorce, or faces other circumstances where the ownership of that property is put at risk, the parents can foreclose on the mortgage, and retain ownership.
“Then, in their will, they could forgive the mortgage so at the time of their death, that mortgage would be gone, and the child would own the property free and clear. But meanwhile, the property is protected from third-party claims against the child, even though they own it. So it works as a strategy that parents can consider, if they are concerned about their children having claims made against them and their assets,” says Adlington.
What happens when there isn’t a last will and testament
When people don’t write a will, anything left behind can cause a lot of fighting or legal disputes between the surviving family.
Adlington says who the inheritance is awarded to depends on the hierarchy of kinship. Spouses are always first in line, and then children. After that come parents, and then siblings in equal shares.
“If there are no parents or siblings, then it would go down to uncles and aunts, then nieces, in equal shares.”
Writing a will can be very emotionally charged. But it gives people the freedom to really think about their loved ones, and consider the best way to take care of them, and really express their wishes after they’re gone.