Some clients don’t think about estate planning until they are in their 50s or 60s – when permanent insurance to fund the estate becomes too costly.Pgiam/iStockPhoto / Getty Images
When clients create estate plans, the focus is often on who gets which assets. But clients also need to consider an estate fund and how to pay liabilities, expenses and final taxes due upon death.
“They don’t anticipate the magnitude of the tax bill,” says Tanya Butler, a trust and estate practitioner at Touchstone Legal Inc. in Dartmouth, N.S. “They don’t think about the expenses, such as preparing a property to sell.”
Kevin Wark, managing partner of Integrated Estate Solutions in Collingwood, Ont., says an estate lawyer will typically highlight the probate fees and other tax liabilities that can arise in the estate. But he cautions that these lawyers may not run projections or recommend life insurance or other strategies to fund these estate taxes.
“That should be a trigger for the client to look to their other advisors for assistance,” he says.
Kelly Ho, certified financial planner at DLD Financial Group Ltd. in Vancouver, says she builds estate funds within the client’s financial plan. She goes over all the client’s assets, a projection of their value, and then, with the help of financial planning software, she calculates the approximate taxes that will be owed on death.
“Even before I talk about funding the estate, I need to understand where the assets are intended to be going,” she says. “Then we come up with a strategy of how to pay for those taxes and other things.”
She says permanent life insurance policies are her main strategy to fund estate liabilities and taxes. A beneficiary for the policy is always listed so the insurance bypasses probate assuming the policy is personally owned. The beneficiary can expect the funds within a few weeks once a death certificate is produced, she adds.
Ms. Ho says the beneficiary typically uses some of the insurance proceeds to fund estate liabilities.
Unfortunately, some clients don’t think about estate planning until they’re in their 50s or 60s – when permanent insurance to fund the estate becomes too costly, she says. Another option is selling assets such as non-registered investments and real estate to pay liabilities, expenses and taxes.
She’ll put together a cost analysis so clients can see the cheapest option: the insurance or paying the final tax bill and expenses.
She says more clients are becoming aware of the tax liability issue, especially those who own a cottage or multiple real estate properties. While their principal residence passes to beneficiaries tax-free, any additional property has a deemed disposition at fair market value, triggering capital gains taxes. And recent changes to the capital gains inclusion rate effective on June 25 mean paying taxes on two-thirds of amounts of capital gains more than $250,000 in a year, up from 50 per cent.
Ms. Butler has one more approach. She encourages clients to think of their estate like a “pot” that has assets for heirs and enough liquidity for income taxes, expenses and other liabilities.
“That way expenses can be paid off the top,” she explains. “It’s a lot simpler if you use the pot method if you’re giving a particular asset to a child and you want to equalize among the other ones.”
Otherwise, doing things such as assigning a registered account to one beneficiary and the house to another doesn’t create equal inherited amounts for both people once taxes and market value are considered.
In some dire cases, executors may be faced with an insolvent estate, meaning there’s no money to pay final taxes and expenses, Ms. Butler says.
“Typically, an executor faced with an insolvent estate needs advice immediately. They need to understand what needs to be sold and what has priority,” she says.
One way this can happen is when all assets (likely registered accounts) are set up to flow directly to heirs instead of through the estate. Clients assign beneficiary designations to avoid probate and ensure heirs get their inheritance relatively quickly.
An heir isn’t under any obligation to pay the taxes and expenses, which puts the executor in a pickle.
Executors also need to understand the creditor hierarchy (which varies depending on the province) when it comes to debt payments. They may choose to pay the utility bills on the house, for example, not realizing that mortgage payments take priority.
Also, if inherited assets are already distributed when there’s a tax liability in the estate, Mr. Wark notes that the Canada Revenue Agency can go after those beneficiaries, who are liable to pay any deficiency.
“The executor needs to ensure all liabilities of the estate are paid and a CRA clearance certificate is obtained or [the executor] could be responsible for tax liabilities as well,” he says.