Christine Conway sees it all the time: parents riddled with anxiety at the thought of passing down wealth to heirs who may not be ready to handle it. The New Westminster, B.C., financial planner has witnessed firsthand how things can go wrong – from a young man who dropped out of school after receiving a windfall, to children who blew their inheritances on luxury trips.
But it’s not always about frivolous spending, and one story in particular stands out.
“We had a dad whose daughter was on disability; she’d been through bankruptcy before. She has lots of trouble managing money. He was worried that she would just, you know, blow through everything, and it was a considerable amount of money,” she said. “We’ve seen things go wrong.”
While the reasons for concern vary, a Manulife Private Wealth report shows that almost one-third of older Canadians worry about passing down wealth to heirs they feel are ill-equipped to accept it.
As the biggest intergenerational wealth transfer in history unfolds – one U.S. estimate says US$84-trillion is expected to pass from the Silent Generation and baby boomers to their millennial and Gen Z heirs by 2045 – worried parents, grandparents and relatives have to grapple with additional considerations to safeguard their funds from mismanagement. While trusts are often the best-known option, there are other strategies to consider, each with fees and tax implications.
A good first step before diving into the wealth transfer process itself, is to get a more concrete understanding of your heir’s financial habits, said Daniel La Gamba, a Toronto lawyer who advises on wills and estates, as well as real estate. Putting a child on a joint account can be a good way to test the waters.
“You still maintain oversight and you see how the child is managing the money on that fund,” Mr. La Gamba said. “Parents can limit the risk by only funding a nominal amount that they are prepared to lose in case the test goes sideways.”
How do I transfer wealth to my friends or non-family members?
When it comes down to actually passing down an inheritance, staggering a wealth transfer is the best way of doing this cautiously, said Cassandra Cross, a wealth advisor at Nicola Wealth in Calgary.
“The beautiful thing about a trust is that you can build a lot of stipulation,” said Ms. Cross. “You can indicate a certain schedule as to how the funds should be distributed – 10 per cent to be distributed when the child is 18, a further 10 per cent when they’re 25,” and so on.
But not all trusts are made equal, and there are different fees to consider, which grow depending on the terms and type of trustee.
When done right, a trust has the benefit of assets being protected from a deceased’s creditors as well as safeguarding against marital disputes, said Ms. Cross. And despite the loaded meaning of “trust fund baby,” trusts can be useful for estates of any size.
Payment schedules can even be set based on milestones. “You can indicate, for instance, 50 per cent of the trust is to be distributed when the child finishes postsecondary education,” said Mr. La Gamba.
Jessica Elie, a wills, trusts and estates lawyer in Toronto said that clients whose children are on the Ontario Disability Support Program often benefit from a Henson Trust. It protects a person’s eligibility for government benefits and is named after a 1989 court decision. “It’s set up in such a way as not to impact the beneficiary to collect ODSP funds,” she said.
Though trusts offer a lot of flexibility and customization, they’re not cheap and require upkeep. According to B.C.-based Onyx Law Group, the initial cost to set up a trust in Canada is between $2,500 and $10,000.
Appointing a family friend or sibling as a trustee can cut costs compared with going through a trust company. Legally, a family member is entitled to two-fifths of 1 per cent of the value held in trust, but in practice, many don’t ask for this payout, said Emily Hubling, a wealth management and estate-planning lawyer at Fasken in Toronto.
That said, this arrangement can quickly turn messy for obvious reasons. And a lot is at stake: Ipsos data shows Canadian boomers who plan to leave everything to their heirs will pass on about $960,000 on average.
“More people are gravitating towards trust companies now because they don’t want to burden their families,” said Ms. Elie. “They don’t want tension.”
An even bigger consideration with trusts is taxation. “The trust has to pay tax annually at the highest personal tax rate on any income and realized capital gains,” said Aurèle Courcelles, a chartered professional accountant specializing in tax and estate planning. However, trustees could allocate income to beneficiaries in lower tax brackets, potentially reducing the overall tax burden.
Most trusts are deemed to have disposed of all their assets every 21 years. If the assets of the trust have an accrued capital gain, and are not distributed before then to Canadian resident beneficiaries, tax on the gain becomes payable, said Ms. Hubling.
“If the value of the assets at the time the [trust] was established was $1 and now it’s $100, 66 per cent of that is taxable at the top rate,” she said.
A life annuity is another option for passing on wealth cautiously. Instead of a lump-sum payout, an annuity converts the proceeds of a segregated fund or other funds, such as the proceeds from the sale of real estate, into a series of payments after death.
Ms. Conway often combines the annuity settlement option with a segregated fund, a type of mutual fund typically sold by insurers that protects 75 per cent to 100 per cent of the principal investment.
“What that does is it takes that mutual fund and instead of going through the person’s will, a segregated fund will bypass probate,” she said. The money in your policy won’t be reduced by taxes and the fees associated with settling an estate, though taxes may still apply to underlying investment.
This option was chosen for the father whose daughter was on disability, she said. “She receives in her bank account for the rest of her life a dollar amount, no more, no less – like a pension.”
Though an annuity involves less upkeep than a trust, there’s less flexibility and control over how funds are distributed. There’s also no potential for growth. ”Payments are fixed or indexed,” said Ms. Cross.
But there’s a hybrid approach too. “You can look at a trust for a larger controlled payout – for example: education, school purchases,” said Ms. Cross. “And look at an annuity to cover day-to-day expenses with steady income.”
In addition to a will, Ms. Conway often recommends parents write “love letters” to heirs as part of their estate planning process. A way to jot down a heartfelt final note while disclosing some of their thinking process behind the way the inheritance is set up.
“At a time of so much grief, it is an incredible comfort to hear their loved one in their own words share not only how much they valued the relationship and special times together but explain what they have done and why they have done it,” said Ms. Cross.
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