Kate’s existing estate plan makes it likely that her children will quarrel over her estate, Mr. MacKenzie says.Sarah Palmer/The Globe and Mail
Kate has a house in small-town Ontario, a cottage and substantial investments, so she is well fixed financially. Now, at age 76, estate planning is her most pressing challenge.
Kate and her partner share their home equally under a co-habitation agreement. While her partner helps with living expenses, they keep their investments separate.
Kate has two children, both in their early 40s, who will inherit her estate. “One is very good with finances and the other is not,” Kate writes in an e-mail. “One child could inherit outright, but I have to make alternate arrangements for the other” – something that is not a cash payment, she adds.
Another key concern “is how to best protect my estate from being consumed by probate fees and income tax.”
Kate plans to continue travelling as long as she is able. While she plans to leave a substantial estate, she wants to ensure she has more than enough resources to pay for home care or a nursing home if she eventually needs it.
How can she arrange her financial affairs to put her mind at ease?
We asked Warren MacKenzie, a Toronto-based certified financial planner, to look at Kate’s situation. Mr. MacKenzie also holds the chartered professional accountant designation.
What the Expert Says
Kate’s existing estate plan makes it likely that her children will quarrel over her estate, Mr. MacKenzie says.
She has named her son executor and asked that he distribute his sister’s share to her as he sees fit. “She has no worry about her son being able to manage his inheritance wisely, but her daughter has a history of making bad financial decisions,” the planner says. “This plan almost guarantees that her two children will be in conflict and communicating to each other mainly through their lawyers.”
Instead, he recommends that Kate appoint a corporate executor and perhaps instruct them to purchase a life annuity for Kate’s daughter with her share of the inheritance.
The planner’s forecast assumes an inflation rate of 2 per cent and an average annual rate of return on her investments of 5 per cent. It also assumes that at age 85 Kate sells her home and moves into a nursing home costing $6,000 per month in dollars with today’s purchasing power. “If she makes it to age 100, she is expected to leave each child more than $1-million,” Mr. MacKenzie says.
“What Kate really wants is for her children to be happy and financially secure,” Mr. MacKenzie says. “She should understand that there is little evidence that inheriting more than a million dollars increases an heir’s long-term happiness.”
After her investment portfolio, Kate’s most valuable asset is her cottage, estimated to be worth $1-million. Her plan is to leave the cottage to her son and make some arrangement for the daughter to be able to use it part of the time. “The problem with this approach is that even if the children were getting along well, this could turn into a source of conflict and almost guarantees legal action after Kate is gone,” the planner says.
Kate lives about half an hour from her cottage and spends most of the summer there. “As long as she continues to enjoy the cottage, she should keep it,” he says. “If a time comes when she is unable to enjoy it on a regular basis, she should consider selling it” rather than leaving it as part of her estate.
Kate should update her will and discuss it with her children to avoid surprises, Mr. MacKenzie says. “Her daughter may be assuming that the assets will be equally split.”
Next, the planner looked at Kate’s cash flow. She spends about $26,000 a year on travel and about $30,000 on other personal expenses excluding income tax. Her personal expenses are reasonable because she and her partner split most expenses, the planner says.
Based on conservative assumptions, in 2025 her cash flow will consist of $10,700 in Canada Pension Plan benefits, $9,600 in Old Age Security, a withdrawal from her registered retirement income fund of $14,700, and a withdrawal of $40,000 from her non-registered investment portfolio, for a total of $75,000, the planner says. Her cash outflow will be income tax of $12,000, a $7,000 transfer to her tax-free savings account and $56,000 in travel and basic lifestyle expenses.
Kate is paying a 1-per-cent investment management fee to her bank investment adviser. She doesn’t know if they are adding value because she does not receive a performance report that compares her results with the proper benchmark, Mr. MacKenzie says. “It’s not possible to manage money wisely without knowing the rate of return you are earning and how this return compares to the proper benchmark.”
Her asset mix is about 60 per cent fixed income and 40 per cent equities, “which is not unreasonable,” he says. But it would be better to use a goals-based asset mix – one that is designed to achieve her financial goals without any undue risk. “Following a disciplined investment strategy yields better results than trying to pick the best equities,” Mr. MacKenzie says, “but her investment adviser has not been able or willing to explain the investment strategy that is being followed.”
Kate wants to minimize income tax and probate fees and there are things she could be doing to achieve this goal, the planner says. “For example, she could be giving the children inheritance advances. This might also help her daughter learn to manage money carefully.”
Almost half of Kate’s registered retirement income fund (RRIF) is invested in large-capitalization, dividend-paying Canadian equities. RRIF withdrawals are fully taxable so she is losing the benefit of the Canadian dividend tax credit and the tax-free portion of capital gains, he notes. “A better approach to minimize tax would be to hold these securities in her non-registered account and hold her fixed income in her RRIF.”
To minimize taxes, Kate might want to consider an investment in tax-exempt whole-life insurance, Mr. MacKenzie says. By using the tax-exempt dividends to increase the paid-up value of the policy, she would reduce tax on the investment income. Eventually, the full death benefit would be received on a tax-free basis. “This type of policy is guaranteed and simple to manage,” the planner says.
Finally, she should continue making the maximum allowable contribution from her non-registered accounts to her TFSA. That way, if she designated her children as beneficiaries of her TFSA, they would receive the funds tax free.
“No one wants to pay more income tax than necessary, but it is unwise to focus almost entirely on saving income tax and overlook simple steps to manage her money more effectively and reduce the possibility of conflict when the will is read.”
Client Situation
The Person: Kate, 76, and her two adult children.
The Problem: How to create an estate plan that will be fair to both children, one a good money manager, the other not. How to minimize taxes on the estate.
The Plan: Reduce the potential for conflict by appointing a corporate executor for her will. Consider giving the children advances on their inheritance. This will lower her income tax payable and possibly give her daughter an opportunity to learn to manage money.
The Payoff: Problems solved.
Monthly net income: As needed.
Assets: Her share of the home $400,000; cottage $1,000,000; non-registered cash and guaranteed investment certificates (GICs) $662,000; non-registered stocks $789,480; tax-free savings account (TFSA) $106,825; RRIF $234,560. Total: $3,192,866.
Monthly outlays: Property tax $480; water, sewer, garbage $70; home insurance $125; electricity $100; heating $175; security $40; maintenance $655; transportation $280; groceries $500; clothing $100; gifts $100; vacation, travel $2,200; dining, drinks, entertainment $175; personal care $25; club membership $25; health care $160; phones, TV, internet $175; TFSA $585. Total: $5,970.
Liabilities: None.
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