Part VI – Real Estate: Skipping to Other Generations When Planning Your Estate

With the value in real estate and other holdings, many Canadians have accumulated a significant estate that involves planning.  Talking about estate planning need not be uncomfortable.  For many, this naturally leads to who you would like to receive your estate – either family, friends, and/or charitable groups.  The process involves mapping out a plan that minimizes tax, while at the same time ensuring your distribution goals are met.

The second stage of the estate-planning process is when we ask for clients to bring a copy of the documents they currently have in place. We also obtain a copy of their family tree and information about current executor(s), representative, or other individuals currently named in the will.

To illustrate the process, we will use a typical couple, Mr. and Mrs. Gray, both aged 73. They last updated their wills 24 years ago.  They have what is commonly referred to as “mirror wills” where each leave their estate to their spouse in a similar fashion.  The will also has a common disaster clause that if they were to both pass away within 30 days that the estate would be divided equally amongst their three children.  We will refer this to as the “traditional method”.

Since they last updated their Will, all three of their children (currently aged 56, 54, and 52) have started families of their own. In fact, the Gray’s now have seven grandchildren between the ages of 11 and 32, and two great grandchildren (aged seven and three).  None of which were born when they last updated their Will.

In reviewing their will, we noted that this traditional method of estate distribution left everything to their now financially well-off adult children, to the exclusion of their grandchildren. We highlighted that the current will does not mention the grandchildren or great grandchildren. In exploring this outcome, they expressed they wanted to map out an estate plan that also assisted those that needed help the most.

The last time the Gray’s updated their will they had a relatively modest net worth, but in the last 24 years they were able to accumulate a significant net worth. We had a discussion with Mr. and Mrs. Gray that focused around the timing of distributing their estate.

The traditional method effectively distributed nothing today and everything after both of them passed away.

We discussed the pros and cons of distributing funds early. During our discussion, the plan that was created was combination of components, parts involved a distribution to the grandchildren based on certain milestones.  They also wanted to make sure their grandchildren obtained a good education.  The estate plan details that we outlined in the short term were relatively easy to put in place and were as follows:

  1. For the youngest members of the family they wanted to set up and fund Registered Education Savings Plans (RESP) for all eligible grandchildren and great grandchildren. The RESP contribution shifted capital from a taxable account to a tax deferred structure. This effectively results in income splitting for the extended family. Another added benefit is that RESP accounts would receive the 20 per cent Canada Education Savings Grant based on the amounts contributed.
  2. For the family members already in university, the plan was to assist with the cost of tuition and other university costs up to $10,000 per year per grandchild.
  3. For the grandchildren who were at the stage of wanting to purchase a principal residence, they wanted to set aside a one-time lump sum payment of $50,000 specifically to assist each grandchild with the down payment on a home.

One of the more challenging areas of the Gray’s estate plan dealt with their real estate. In addition to their principal residence, they also owned a recreational property in the Gulf Islands. The recreational property had some significant unrealized capital gains. It was important for the Gray’s to ensure both properties were kept within the family, if possible. We called a family meeting together where we outlined different options to achieve this goal. The key with this part of the estate plan was communication with Mr. and Mrs. Gray and their three children. We were able to obtain a clear plan that was satisfactory to all family members.

The finishing touch to a well-executed estate plan is ensuring the details are clearly documented in an up-to-date will.

 

Kevin Greenard CPA CA FMA CFP CIM is a Portfolio Manager and Director, Wealth Management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week in the TC. Call 250.389.2138. greenardgroup.com

This is for information purposes only. It is recommended that individuals consult with their financial advisor before acting on any information contained in  this article. The opinions stated are those of the author and not necessarily those of Scotia Capital Inc. or The Bank of Nova Scotia. ScotiaMcLeod is a 
division of Scotia Capital Inc., Member Canadian Investor Protection Fund.

Ten Tips on Working With A Portfolio Manager

HEALTHY LIVING MAGAZINE

Over the years, I have had many discussions with people about what is important to them.  Health is nearly always at the top of the list.  Connected to this is having time to enjoy an active and social lifestyle.

Life has become busy, and it is tough to squeeze in everything that you have to do, let alone have time left over for all the things you want to do. Sometimes it is simply a matter of making a choice. One of my favourite concepts I learned years ago in economics is ‘opportunity cost’. It can relate to time, money or experiences. We can’t get it back, borrow or save it. Time is sacred – especially family time and doing your own investing can take time and attention away from your family. So ask yourself – is doing your own investing worth the time you are spending on it?

One way to focus on the things you want to do is to delegate the day-to-day management of your finances to a portfolio manager who can help you manage your investments by creating what is called a ‘managed’ or ‘discretionary’ account. They are able to execute trades on your behalf without obtaining verbal permission, so when the market changes, they are able to act quickly and prudently.

Here are some tips for working with portfolio manager to improve your financial health:

Have a Plan

You are more likely to achieve the things you want if you set goals to paper. With fitness goals it would be things like running your first 10k race or lowering your blood pressure. Financial plans are the same – sit down with your portfolio manager and outline what you want to achieve with your estate, your investments and your retirement. Once a plan is in place, a periodic check-up takes a fraction of the time to ensure everything is on track.

Stay in Control

If you are worried about being out of touch with your investments, there are measures in place to keep you in the driver’s seat. One of the required documents for managed accounts is an Investment Policy Statement (IPS). This sets the parameters with your portfolio manager and provides some constraints/limits around their discretion. For example, you could outline in the IPS that you wish to always maintain a minimum of 40 per cent in fixed income. This lets you delegate on your terms, and ensures a disciplined approach to managing your portfolio. Technology has made it easier and faster for you and your portfolio manager to track your progress, review changes or update the program. Developing a written agenda that gets shared in advance of a meeting, whether in person or virtual, can create efficiencies and ensures nothing is missed. Whether it is email, Skype, or even text messaging – there are many ways for you to stay connected to your finances.

Think About Taxes and Legal Issues

Your finances often involve other professionals such as lawyers or accountants, so it is beneficial to get everyone connected early on. Work with your portfolio manager to complete a professional checklist that includes important names and a list of key documents. If your team can communicate directly with one another, it’s easier to map out planning recommendations and tax-efficient investment strategies. Your portfolio manager can also act as your authorized representative with the Canada Revenue Agency and can even make CRA installment payments on your behalf. Every summer, I am reviewing assessment notices, carry-forwards, contribution limits (i.e. TFSA and RRSP) and income levels to allow my clients to enjoy the outdoors and improve their quality of life

Put Family First

Having a complete picture helps a portfolio manager map out strategies to preserve your capital and to protect your family. If a life event occurs or your circumstances change – from new babies, to inheritances, to critical illness –  your portfolio manager can provide options and solutions. When the family member who manages the finances passes away suddenly, it can be very stressful for the surviving spouse or children during a time that is already emotionally draining. To help in this situation, many families create well thought-out plans that can involve working with their portfolio manager to make discretionary financial decisions in a time of transition. A Portfolio Manager can take care of your finances regardless of the curves that life throws them.

As a portfolio manager, I feel it is critical to be accessible and to keep clients well-informed with effective communication. What I am finding is that conversations are shifting to areas outside of investments, including the financial implications of health issues and changes within the family.

If you are looking for a way to simplify, reduce stress in your life, and proactively manage your finances, a portfolio manager might be a good way to improve your financial health.

 

Financial tips for blended families

Opening the communication channels is key when helping couples in blended family situations.   This communication should absolutely start on Day 1 for blended families, and should be part of the account opening process. A good advisor will ask probing questions beyond the checklist of mandatory questions to first open an account.  

With new blended families, it is not always easy to have open communication with both parties. Often, they have different advisors and different financial institutions.   If this is the case, then it is common for the couple to maintain the status quo with their separate finances.   I always encourage couples in blended families to come in together, even when they are maintaining separate finances. Once this happens, and once there is open discussion and communication, then progress can be made on a variety of financial decisions.

Often there is a disparity between the value of assets, or net worth, of each party. Rarely are the assets equal. One party may have more equity in real estate, while the other has more stock and bond investments.  

Making objective financial decisions can be challenged by the simple notion that “blood is thicker than water.”   For example, many parents want to provide for their children from a previous marriage. However, this can conflict with the many tax benefits provided for married or common-law relationships. This conflict is especially challenging when it comes to estate planning. Below I have listed a few common assets and basic challenges couples in blended families may face.

Non-Registered Account:  The term taxable account or non-registered can be used inter-changeably. Often young people do not have non-registered accounts as they are busy paying off mortgages and/or contributing to their registered accounts, such as RRSPs.   Older couples with adult children are more likely to have taxable accounts when they enter a blended family.   When a person has non-registered investments just in their name, this is called an Individual Account.   The monthly statements and confirmation slips have just the one person’s name on it, and the year-end tax slips (i.e. T5 and T3 slips) are in same one individual’s name.  

Couples in a first marriage, and who have built up equity together, will open up a taxable account called Joint With Right of Survivorship (JTWROS). This type of account has many benefits for couples, including income-splitting. The primary benefits of these joint accounts are probate is avoided, income tax continues to be deferred, such as for unrealized capital gains, and simplicity of paperwork after the first spouse passes away.  

Some couples have two JTRWOS with each person being primary on their own respective account. By primary I mean their name is first on the account and their social insurance number is on all tax slips. This enables couples to still keep funds separate, but it will still provide the same above benefits.

Tenants in Common:  Another option for taxable accounts is Tenants In Common. With Tenants in Common a taxable account is set up with two or more owners, where the ownership percentages do not have to be equal. Upon the passing of any owner, their portion represents part of their estate, and the other owners do not have the right of survivorship.   Many of the benefits of JTWROS are lost with Tenants In Common, but for some couples this may be the right decision. A couple that would like to combine their assets to pay household bills, could simply allocate the ownership based on the amount originally contributed. If Spouse ”A” puts in $300,000, and Spouse “B” puts in $700,000 then the allocation for ownership could be 30 per cent for Spouse A and 70 per cent for Spouse B.   If either spouse passes away, their Will would dictate how their proportionate share is divided.  

Registered Accounts:  The two most common types of registered accounts are Registered Retirement Savings Plans (RRSP) and Tax Free Savings Accounts (TFSA). RRSP and TFSA accounts can only be in one person’s name.  

However, with both of these types of accounts you are able to name a beneficiary. With couples in a first marriage and building equity together, your spouse is likely always named the beneficiary on registered accounts.   At the time of death, Canada Revenue Agency allows the owner of an RRSP (called an annuitant) to transfer their RRSP to their surviving spouse or common-law partner, on a tax-deferred basis. If there are financially dependent children because of physical or mental impairments, then it also may be possible to transfer the annuitant’s RRSP on a tax-deferred basis. Outside of these two situations, the annuitant’s RRSP is fully taxable in the year of death.

A person who has a spouse, and chooses to name an adult child the beneficiary should understand the tax consequences. If you name your spouse the beneficiary, your spouse receives 100 per cent of the value until the funds are pulled out gradually (taxed when taken out). If you name someone other than a spouse, the funds are deemed taxable in one large lump sum, so the marginal tax bracket of 45.8 per cent could easily be reached. Many people would cringe if they could see the amount of tax paid to CRA from RRSP accounts resulting from a lack of planning.  

Although the TFSA has no immediate tax issues on death, there are still some benefits to naming your spouse or common-law partner the beneficiary.   As an example, let’s look at a blended family with Spouses C and D. Spouse C has $48,000 in a TFSA and Spouse D Has $52,000.

Spouse C has the option of naming the Estate the beneficiary, naming Spouse D the beneficiary, or naming another individual such as a child or children from a previous marriage. If Spouse C names the Estate the beneficiary, then the account would likely have to be probated to validate the Will. The Will would provide us direction as to who the beneficiary of the TFSA will be. If Spouse C named Spouse D the beneficiary, then we can roll over the entire $48,000 into Spouse D’s TFSA account (without using contribution room). After the roll over, Spouse D would have a TFSA valued at $100,000 – all of which is fully tax sheltered. The roll over can be done once we receive a copy of the death certificate – and no probate is required for the transfer of assets. The only time individuals are permitted to put more into their TFSA accounts, other than their standard annual limits and replenishing amounts withdrawn in an earlier year, is when their spouse or common–law partner passes away and they are named the beneficiary.

If Spouse C named the children from the first marriage the beneficiary, then Spouse D does not get the additional room and the children could receive the funds but would not be able to roll this amount into their own respective TFSA accounts without using their available room.  

While there are many solutions available for blended families, it is important to talk about these options and then document the plan.   Gathering all the information and creating a plan that both parties are content with can take some time. A plan should include all standard types of assets such as personal residence and vehicles, as well as liabilities. One of my most rewarding moments as a Portfolio Manager is assisting my clients with their plan. A plan ultimately provides peace of mind for clients in what is often viewed as a complex situation that was either too sensitive to talk about or simply not addressed.

Portfolio manager can act for clients more quickly than traditional adviser

Over the years, I have had great discussions with people about financial decision-making. It is tough for most people to make decisions on something they don’t feel informed about. 

Even when you are informed, investment decisions can be challenging.

When you work with a financial advisor, you have another person to discuss your options with. In the traditional approach, an advisor will present you with some investment recommendations or options.  You still have to make a decision with respect to either confirming the recommendation and saying “yes” or “no,” or choosing among the options presented. As an example, an advisor may give you low-, medium-, and high-risk options for new purchases. An advisor should provide recommendations that are suitable to your investment objectives and risk tolerance.

Another option for clients have is to have a managed account, sometimes referred to as a discretionary account.  With this type of account, clients do not have to make decisions. The challenge is that very few financial advisors have the appropriate licence to even offer this option.   To offer it, advisors need to have have either the Associate Portfolio Manager or Portfolio Manager title.

When setting up the managed accounts, one of the required documents is an Investment Policy Statement (IPS). The IPS outlines the parameters in which the Portfolio Manager can use his or her discretion. As an example, you could have in the IPS that you wish to have a minimum of 40 per cent in fixed income, such as bonds and GICs.

Portfolio Managers are held to a higher duty of care, often referred to as a fiduciary responsibility. Portfolio Managers have to spend a significant time to obtain an understanding of your specific needs and risk tolerance. These discussions should be consistent with how the IPS is set up. Any time you have a material change in your circumstances then the IPS should be updated. At least every two years, if not more frequently, the IPS should be reviewed.

The nice part of having a managed account with an up to date IPS is that your advisor is able to make the decisions on your behalf. You can be free to work hard and earn income without having to commit time to researching investments. You can spend time travelling and doing the activities you enjoy. Many of my clients are intelligent people who are fully capable of doing the investments themselves but see the value in paying a small fee. The fee is tax deductible for non-registered accounts and all administrative matters for taxation, etc. are taken care of. A good advisor adds significantly more value than the fees they charge. This is especially true if you value your time.

Many aging couples have one additional factor to consider. In many cases one person has made all the financial decisions for the household. If that person passes away first, it is often a very stressful burden that you are passing onto the surviving spouse. I’ve had couples come in to meet me primarily as a contingency plan. The one spouse that is independently handling the finances should provide the surviving spouse some direction of who to go see in the event of incapacity or death. In my opinion, the contingency plan should involve a portfolio manager that can use his or her discretion to make financial decisions.

In years past it was easier to deal with aging clients. Clients could simply put funds entirely in bonds and GICs and obtain a sufficient income flow. With near historic low interest rates, this income flow has largely dried up for seniors. When investors talk about income today, higher income options exist with many blue chip equities. Of course, dividend income is more tax efficient than interest income as well. A portfolio manager can add significant value for clients that are aging and require investments outside of GICs.

Try picturing a traditional financial advisor with a few hundred clients. A traditional financial advisor has to phone and verbally confirm each trade before it can be entered. The markets in British Columbia open at 6:30 AM and close at 1:00 PM. An advisor books meetings with clients often weeks in advance. On Tuesday morning an advisor wakes up and some bad news comes out about a stock that all your clients own. That same advisor has 5 meetings in the morning and has only a few small openings to make calls that day. It can take days for an advisor to phone all clients assuming they are all home and answer the phone and have time to talk.

A Portfolio Manager who can use his or her discretion can make one block trade (the sum of all of his clients’ shares in a company) and exit the position in seconds.

Sometimes making quick decisions in the financial markets to take advantage of opportunities is necessary. Hands down, a Portfolio Manager can react quicker than a traditional advisor who has to confirm each trade verbally with each client.

Skipping a generation in your estate planning

I’ve heard several people over the years say they never thought they would have so much money. A growing number of aging people have accumulated significant savings and investments from years of savings, investing wisely, inheritances, property dispositions or selling a business – and are looking for different options when it comes to minimizing taxes and structuring their estate plan.

Taking care of immediate children is still very much a priority, but it’s not the only one. Some of their children are often already well off financially and many are retired themselves.

We are seeing more and more cases where grandparents are leaving money to grandchildren, but there should be extra caution and professional advice when structuring plans to transfer wealth. Income splitting can extend to grandchildren and can lower taxes as a family.

The following are a few examples of how we have assisted clients in helping out their grandchildren.

Outright Gift

The strategy of gifting money to adult grandchildren can be very tax smart. A person who is aged 65 or older may have government benefits such as Old Age Security clawed back if income exceeds certain thresholds set annually. In many cases income taxes can be reduced and government benefits increased by gifting funds to an adult grandchild in a lower income tax bracket. We do not recommend significant gifts to minor children directly as this could violate what is commonly known as the attribution rules.

Registered Education Savings Plan

For grandchildren under 19, grandparents should consider the Registered Education Savings Plan. This is a fantastic vehicle to tax-shelter money, income split with family members, and receive government grants. I’ve had clients set up an RESP for every grandchild they have. They require a consent form from the parents, as there is a limit to the Canada Education Savings Grant.

Tax Free Savings Account

For grandchildren who have reached the age of majority, giving funds to contribute to a Tax Free Savings Account can be an excellent way to income split. Your grandchildren can use this account to build up funds to use one day as a down payment on a home. By moving the funds from a grandparent’s taxable account to a non-tax account this will also reduce the family tax bill.

Paying Down Mortgages

Let’s assume you have the option of investing $100,000 into a two year guaranteed investment certificate or gifting these funds to your granddaughter who is paying 4.6 per cent on her mortgage. The $100,000 would result in $2,000 of interest income which would be fully taxable. If the grandparent was in the 30 per cent tax bracket then the government would receive $600 of this money. If you’re in a higher tax bracket, the amount would be higher and you would also be in the position of potentially losing even more government benefits. Your granddaughter is currently paying $4,600 annually in interest on her mortgage and is not able to deduct the interest costs. By gifting $100,000 the government would receive $600 less, you may receive more government benefits next year, and your daughter would save $4,600 a year in interest costs and also have a reduced mortgage.

Buying a Home

Buying a home is perhaps the toughest financial hurdle for most young people to clear, as salaries are insufficient for many to qualify to buy even a basic home. In one case, a grandmother considered moving into an assisted living arrangement. She had a grandson and two granddaughters, who wanted to purchase her home, which has a $600,000 value. The grandmother has significant pensions and capital outside of her principal residence and does not need the full proceeds from selling the home. During a meeting we mapped out a plan where she gifted each grandchild $100,000. The grandson could purchase the home from his grandmother for $500,000 ($600,000 fair market value less the $100,000 gift). The grandson would then be able to qualify for a mortgage for $500,000, the proceeds of which could be distributed as follows: $300,000 to grandmother and $100,000 to each granddaughter for them to each use towards the purchase of a home.

Insurance Products

In a small number of situations where people are wishing to keep certain gifts out of public record, an insurance product is a solution. By naming a specific beneficiary the insurance proceeds would bypass one’s estate and avoid probate fees. We have also seen situations where grandparents have taken out a second generation insurance policy to leave a significant gift to grandchildren.

Is your will in need of being updated?

If you are putting together your annual list of New year’s resolutions, add a reviewof your will. It should be reviewed every three to five years, and you can use these points as a guide:

  • You do not have a will
  • Death of a beneficiary
  • Death of an executor
  • Death of a witness to your will
  • Birth of a child or grandchild
  • Children have reached the age of majority
  • Marriage or divorce
  • Sale of a business or significant asset
  • Change in how you want your estate distributed
  • Any change in the registration of your assets or in the designation of your registered plans
  • You have moved to another province
  • Existing will was not prepared by a notary or lawyer

The last point above is worth discussing in greater depth.  We are seeing more and more “do-it-yourself” will kits and, in our opinion, it is best to seek professional advice when creating a new will.

After a review of your will, you may find that only a small modification is needed.  If this is the case then it may be worth discussing with your lawyer/notary whether it is easier to add a codicil (versus writing a new will).   A codicil enables you to make changes or additions to your existing will, and is a legal amendment that is made on a separate sheet of paper which is added to your will.  Just like a new will, a codicil must be signed by you in the presence of two witnesses and by each witness as well.

A list of the full legal names of your intended beneficiaries, along with an abbreviated family tree, is useful so that your lawyer can refer to it and point out how provincial laws could affect your intended estate distribution.

Be sure to make note of any minors or persons who are incapable of handling their financial affairs. For charities, you can visit Canada Revenue Agency’s website to obtain the legal name and registration number of any charitable organization you wish to benefit. The status of the charity is also recorded.

An updated inventory of assets, including any interest that you may have in other estates, is useful. Sketch out the plan of how you wish to divide your estate, considering smaller amounts (legacies and specific bequests) as “coming off the top” followed by percentages of the balance (residue) to be distributed to your intended beneficiaries.  The percentages must add up to 100%.  It is useful to bring a copy of your present Will, even if you consider it to be sadly out of date, to the meeting.

Now that you have updated your will, we recommend that you shred the old versions and have your new will registered with Vital Statistics.  In order to register your will, a Wills Notice form must be submitted (either by regular mail or in person at a Vital Statistics office).

The following is some information from the Vital Statistics Agency website:

  • A Wills Notice identifies that a will has been registered and describes the person who has made the will, where the will is located and the date of the will.
  • To be eligible to file a Wills Notice you must be over the age of 19 years, or under the age of 19 and married, or under the age of 19 and in the Canadian Forces on active duty.
  • A completed Wills Notice Form (available at any Vital Statistics Agency office or ServiceBC office) must be submitted with the appropriate fee, currently $17.

If your will is in a safety deposit box at your bank, then the Wills Notice would state the bank’s name, address, and safety deposit box.  If your will is stored in a filing cabinet in your home, then the Wills Notice would have your home address and filing cabinet as the location.

Lawyers/notaries have often stored wills for the clients, so the firm’s  name and address would be stated on the Wills Notice.  Lawyers often change firms it is essential you trace the location.

Some lawyers and notaries have begun charging an annual fee to maintain the storage of your will.  In many cases, people are better off avoiding this fee by picking their will up, opening a small safety deposit box and filing another Wills Notice.  A safety deposit box is about $40 a year and is tax deductible.

If you update your will, or move your will, it is important to file another Wills Notice (and pay another $17) to update who has made the will, where the will is located and the date of the will.

Many unintended consequences can occur if your will is not up to date and these can cause much grief to the beneficiaries who are left behind.

 

Trusts provide certainty on distribution of assets

Complicated family situations often involve more complicated financial solutions.

One example of this is the use of a trust in your overall plan. A trust is an equitable obligation binding a trustee to deal with property over which they have control for the benefit of beneficiaries.

The person who creates the trust is referred to as the settlor who transfers legal title of the property to the trustee. This transfer of title to the trustee imposes a fiduciary duty on the trustee to manage the assets of the trust, for the beneficiaries.   The settlor may choose to establish a trust during their lifetime (Inter Vivos) or via his will, upon death (Testamentary).

A trustee can be a lawyer, accountant, trust company, or other trusted individual familiar with the family situation.  The qualities we look for in a trustee are continued existence, residency, impartiality, and expertise.  Two important terms to know are alternate trustee and co-trustee.  An alternate trustee is one that can act in the event that your primary trustee is unable or unwilling to act.  Co-trustees are groups of two or more trustees who act together.  Generally more than two trustees can be cumbersome; however, two can provide group judgement in the right circumstances.

A major benefit of a trust is to provide more certainty with respect to the outcome of the distribution of your assets or estate.  This comes at a cost, but for some the benefits outweigh the costs.  The beneficiaries may not see the same “benefit” in the trust structure as the settlor, especially if access to the funds is restricted in any way.

Here are a few examples  of why a settlor may set up a trust:

Second Marriage

In this case, a trust might be valuable in segregating the ownership of funds received from an inheritance to keep them from being co-mingled with family assets. A trust may provide for the care and maintenance of a spouse during their lifetime, while controlling the disposition of the trust property on the spouse’s death.

Disabled Child or Adult

A trust enables the beneficiary’s trustee to manage the trusted funds for the care and maintenance of a child with special needs. If properly structured, a completely discretionary trust can also serve to keep the trusted funds separate from the child’s personal assets.

Child That May Not Be Responsible Enough

A trust can provide for the care and maintenance of individuals who are unable, for medical or other reasons (i.e. drug or alcohol dependencies), to manage their own affairs.  A trust can be set up to provide a degree of financial independence for an adult child while postponing the time at which the child will obtain full management and control over the property.  It is possible to postpone the payment of a child’s inheritance through a staged distribution.

Charitable Giving

A charitable remainder trust could allow an immediate tax credit while allowing the settlor to receive income from the gifted property during his or her lifetime.  On death, the capital is passed onto the charity.

Need For Privacy

Unlike a will, an Inter Vivos trust is a private document which does not have to be filed with the courts for the public to examine.  Note that this aspect does not apply to testamentary trusts which are created via a will.

Avoid Probate

Assets passing through an Inter Vivos trust on death are transferred directly without probate, outside of the individual’s estate.

Taxes

Testamentary trusts are essentially separate taxpayers and are taxed using graduated rates applicable to individuals. This feature can provide significant income splitting opportunities.  Income earned by a testamentary trust may be taxed in the trust, rather than in the beneficiaries’ hands.  The trustee can elect to have income and gains taxed in the trust even if these amounts have been paid or are payable to a beneficiary.

As a result, income that might otherwise be taxed at the highest marginal tax rate in the beneficiary’s hands can be taxed at a lower graduated rate in the trust. For example, trust investments worth $1 million and earning four per cent per annum generates $40,000 in income. Taxing this income in the trust rather than in the hands of a beneficiary already in the top marginal bracket, may reduce annual taxes by approximately $11,365 in British Columbia at current rates.

Taxes can be reduced by income-splitting capital gains with minor beneficiaries or splitting dividend income from small business corporations to a spouse or child who may be in a lower marginal tax rate.

Generally, when a settlor transfers assets into an Inter-Vivos trust there is a deemed disposition of any capital assets, and the resulting capital gain, or loss is declared in the year of transfer.

The settlement of an Alter Ego or Joint Partner Trust, however does not trigger taxation on the transfer of capital assets.  Instead the settlor can elect to have assets rolled over to the trust at their adjusted cost base without incurring capital gains or losses, where they can then be deferred until the settlor (and surviving spouse) passes away.

Because of the complexities involved, it is important to involve your professional advisors (Wealth Advisor, Accountant, Lawyer and Estate Planner) in the process of determining whether a trust is right for you.

All trust documents should be prepared by a practicing lawyer.  Our thanks to Joseph Taylor, Senior Will & Estate Planner, for providing input into today’s column.

Exploring benefits of ‘in-kind’ transfers

In many situations, we recommend taking advantage of “in-kind” transfers because they can save taxes and commissions and provide flexibility to investors.

The term in-kind means an investment is moved exactly as is.  This is opposite to a cash transfer where the investment is sold, and cash is transferred.

We are illustrating 10 different examples where an investor may be better off to transfer investments in-kind.

Example #1:  Paul is looking to change financial institutions.  After meeting with Paul we recommended several proposed changes to his portfolio.  We noted that his best option was to open a fee-based account and transfer his existing investments in-kind.  Once the investments are transferred into the new fee-based account then the proposed changes can be done.  With fee-based accounts no transaction commissions are charged to restructure the portfolio.

Example #2:  Elaine’s mother recently passed away.  As an only child she is also the executor and sole beneficiary of her mother’s estate.  Elaine likes the investments in her mother’s estate account and asked us about her options.  We suggested to Elaine that she transfer the investments in-kind into her existing investment account to avoid the selling commissions.

Example #3:  David recently opened a Tax Free Savings Account.  He also has a non-registered investment with several different companies.  We suggested he transfer up to $5,000 in equivalent value of investments in-kind from his non-registered account into his TFSA each year.  He should transfer only investments that have a minimal unrealised capital gain.  The transfer into the TFSA will trigger a deemed disposition for tax purposes for the portion of shares transferred in.   Please note that you should not transfer investments that have an unrealized loss (it would be denied as a result of the superficial loss rules).

Example #4:  Every year John gives money to his favourite charities.  We suggested to John that he would save taxes if he donated some of his investments in his non-registered account in-kind to the charity instead of cash.  By transferring the investment in-kind he would not be taxed on the capital gain portion of the shares transferred.

Example #5:  Every February Joanne has contributed cash into her RRSP account.  This year Joanne is having difficulty coming up with the cash although she had a very high-income year.  We suggested to Joanne that she transfer an investment in-kind from her non-registered account into her RRSP account.  This would enable Joanne to receive an RRSP contribution slip for the value of the investment transferred in (note: superficial loss rules would also apply).  All future growth on this investment would be tax sheltered.

Example #6:  Margaret recently turned 72 years old.  She has sufficient cash flow from pensions but is required to begin pulling a minimum amount from her Registered Retirement Income Fund (RRIF) account.  Margaret does not require the cash flow from the RRIF account.  One strategy Margaret liked was an in-kind transfer from her RRIF account to her non-registered account.  This meant that Margaret did not have to worry about having a specific investment maturing each year equal to her minimum RRIF payment.  She has the flexibility to transfer all or a portion of a position.  She could choose to transfer the equivalent market value of one of her investments, including bonds and common shares.

Example #7:  Tim has deferred sales charge (DSC) mutual funds in his RRSP.  He understands that if he sold the funds they would be subject to a fee.  Prior to selling the funds we suggested he transfer in-kind the DSC mutual fund investments into his non-registered account in exchange for cash – this is often referred to as a swap.  After the transfer is complete then he could sell the funds.  By doing this, Tim could at least claim the loss as a result of the DSC fees once the investments are sold in the non-registered account.

Example #8:  Ellen and Scott are proud parents of a two-year old girl named Eva.  They have some shares in an investment account valued at approximately $5,000 that were given to Eva from her grandparents.  We talked about transferring these shares into a Registered Education Savings Plan (RESP).  The transfer will result in an additional $1,000 (20 per cent x $5,000) cash being credited to the RESP as a result of the Canada Education Savings Grant.

Example #9:  Louise has three RRSP accounts, each of which are charged an annual administration fee.  We noticed duplications in the account.  We discussed to Louise that she could consolidate all three accounts into one through transfers in-kind.  This will reduce her annual cost, as she will have only one annual fee (instead of three).   Her individual positions will also be combined.  Most importantly, the transfers in-kind enabled her consolidated RRSP account to be large enough to consider a fee-based account option with no annual administration costs.

Example #10:  Norman has been investing funds in an informal in-trust account for his disabled son.  We recommended Norman open up a Registered Disability Savings Plan (RDSP) for his child.  By transferring investments from the informal in-trust for account in-kind into an RDSP, he will also receive government grants.

 

Have a plan for inheritance

So you have just received an after the death of a loved one.  What happens now?  Although it may be a difficult time, it is also a critical period to get some professional advice.  One positive part of receiving an inheritance is the money is tax-free.  Following are some topics we would discuss when a client receives an inheritance.

Paying off Debt

We like the idea of paying off debt, especially personal mortgages, credit cards, and lines of credit that are not tax deductible.  To begin with, we obtain a summary of all loans, current rates, and repayment penalties, if any.   If only some debt is repaid, then the highest non-deductible interest rate debt should be paid off first.  If fees or penalties apply, it is important to obtain an understanding of these and your advisor should be able to map out the best options.  If you still would like to invest some, or all, of your cash then you’re best to take a new loan out for the specific purpose of investing.  The first step of paying off non-deductible debt first, will ensure that you are able to deduct the interest costs on the new investment loan (if the investments are non-registered).

Increased Income

One of the results of receiving an inheritance is that your annual taxable income is likely to increase.  If you purchase GICs and bonds, you will have to factor in the interest income received.  If you purchase equities, you will have tax efficient dividend income to report and some deferral options.  We provide an estimate of what the income will be once the investments are selected and calculate an estimated income tax liability if the funds are invested in a non-registered account.

Type of Non-Registered Account

If you feel a non-registered account is your best option you should determine the type of account.  If you are single the choice is easy; an individual account.  If you are married or in a common-law relationship, you have a couple of choices.  One is to open an individual account and keep the funds only in your name.  Another is to open a joint-with-right-of-survivorship (JTWROS) account.  This discussion has many components including tax, income splitting, estate wishes, and result of marriage breakdown.

Topping Up RRSPs

One way to defer some of the above income is to deposit funds into a tax sheltered Registered Retirement Savings Plan (RRSP), if contribution room exists.    The greater your income, the better this option is.  If your income is below $40,000 then it is borderline whether this is the best option.  The determining factor is your future income expectations.  As an example.  John received $250,000 as an inheritance.  He is using $150,000 to pay off all debt and would like to invest the remaining $100,000.  John has accumulated a $140,000 RRSP deduction limit, as he has never contributed the maximum each year.    John plans to work for the next five years and earns approximately $80,000 in T4 income.  We recommended that John contribute the $100,000 into his RRSP and claim $20,000 a year as a deduction over the next five years.  One of the main benefits of putting funds in the RRSP (and not claiming the full deduction right away) is that all income is tax sheltered.

Tax Free Savings Account

If you have never set up a Tax Free Savings Account then we would recommend that you take advantage of this type of account and top up to the maximum limit.  If you have opened up a non-registered account and TFSA then we would recommend you transfer the maximum annually (currently $5,000) from the non-registered account into the TFSA to minimize tax.

Structure of Accounts

Many Canadians only have RRSP or TFSA accounts.  Often when significant funds are received (inheritance, sell of a business, life insurance proceeds), people open their first non-registered account.  Unfortunately, one error we see the most is people buying GICs and bonds in a non-registered account while leaving the equity investments within their RRSP.  When this happens, the structure of investments is backwards.   There are many benefits of consolidating investments at one institution, including lower fees and more account options.  It is beneficial to deposit the inheritance cash into a non-registered account at the same institution as the RRSP.  If this is done then the structure can be corrected.  We are able to move cash from the non-registered into your RRSP and move the equivalent value of equity investments out of your RRSP into the non-registered account – this is often referred to as a swap.  A simple swap will ensure that interest income on GICs, term deposits, bonds and other fixed income are tax sheltered within the RRSP.  By holding equities in the non-registered account, you will receive the benefit of the dividend tax credit, and taxation of capital gains and losses.

Updated Documents

Obtain the appropriate forms to update your investment accounts, and update your will, especially if the choice of account  is an individual non-registered account.