When it comes to estate planning, one common mistake you can make is not having an effective plan on how to manage the taxes.
Failing to do so might cause a heavy tax burden for your beneficiaries, who may end up getting a smaller share once all the taxes are settled.
Here are some estate and tax planning tips to help you get started:
Estate Planning Taxes and How to Manage Them
Tax planning for your estate is an important part of personal financial planning in Canada that many people neglect. Here are some quick tips on how you can help manage taxes for your beneficiaries.
#1 Income Tax due to Deemed Disposition Rules
Unlike many other countries, Canada does not impose taxes on the deceased’s estate. For income tax purposes, all capital properties owned by the deceased are deemed to be sold at fair market value upon death. Excess from the proceeds versus the cost will be subject to capital gains tax.
How to defer taxes under deemed disposition:
- Consider transferring assets to a surviving spouse or placed in a qualified spousal trust as outlined in your last will. That way, capital gains of these assets can only be subjected to tax upon the death of the spouse or if the surviving spouse initiates a sale of any of the assets.
#2 Probate Fees
A will is part of the essential documents one should have when estate planning. To initiate the administration of your assets, the executor of your estate will be required to submit the original will and inventory of assets to the court.
The court will then issue documents called letters probate, which are documents that certify that the will is valid and collect probate taxes. Probate fees vary per province or territory.
How to potentially reduce probate fees:
- Consider placing assets in Joint Tenancy with Rights of Survivorship (JTWROS) where two or more people can hold assets together.
- Name your spouse (or another individual) as the beneficiary of your life insurance instead of naming the estate as beneficiary in order to minimize probate fees on the death benefit value
- Trusts are legal entities that hold assets on behalf of the beneficiary and can only transfer the estate upon the trustor’s demise. Setup and transfer your assets into a trust so they will not form part of your estate.
- Donate investment portfolio or other funds to charitable organizations and get credit in return to further reduce taxes (it’s easy to leave a legacy gift on Willful - read more here)
#3 RRSPs and RRIF Management
Upon death, your Registered Retirement Savings Plan (RRSP) and Registered Retirement Income Funds (RRIF) are deregistered. Unless the plan is left to financial dependents such as your spouse, common-law partner, or children, either directly on the plan or in your will, the plan’s full value is included in the deceased’s final tax return.
How to defer taxes from deregistered RRSP/ RRIF
- Consider transferring your RRSP or RRIF to the surviving spouse’s plan or financially dependent minors with the provision that a term-certain annuity not exceeding the child’s 18th year of age must be purchased.
- You can also name financially dependent minors who are physically or mentally infirm as beneficiaries and transfer your RRSP or RRIF to their Registered Disability Savings Plan (RDSP)
#4 U.S. Estate Tax
According to StatsCan, Canadian investors have a total net investment of $563.2 billion in US assets as of the first quarter of 2021, where $308.3 billion of that are US equities. When you have assets that are considered “US situs” (property or securities that are US-sourced), this will be subject to US estate tax, regardless of whether these are lodged in your RRSP or RRIF.
US estate tax rates range from 18% to 40% and will only be triggered when you meet two thresholds: (1) if the US situs assets you own are greater than US $60,000 and (2) if your worldwide estate is greater than US $5,000,000.
How to minimize US estate tax exposure
- Reduce the value of your worldwide estate to below the threshold
- Sell US assets before death
- Instead of direct US securities, hold shares or units in Canadian ETFs or mutual funds and other pooled funds that invest directly in the US market.
- Consider placing US holdings in a Canadian holding corporation so that ownership of assets will be owned by the corporation.
Use life insurance to cover the estate tax but consider transferring the policy to a trust. The death benefit may form part of your worldwide asset if you have incidents of ownership.
Remember, you don’t need to have a vast estate to start planning. Not having a large estate does not exempt you from paying taxes. As mentioned, tax rates may vary between provinces and territories so check first with the CRA on the prevailing estate laws so you can plan effectively.
Which strategy do you think can benefit you the most? You can speak with your accountant on the best possible tax workaround that applies to your estate. But before that, make sure to prepare the basic documents that you will need in estate planning, starting with writing a will.
This post does not constitute tax advice - you may want to seek advice from an accountant or tax advisor if you’re looking to reduce taxes on your estate after you pass away.