How to Avoid Probate and Excess Tax in Canada with Estate Planning

Video Script

In this video, I’m going to walk you through who needs to do estate planning and what you should know before you get started.

If you’ve accumulated a lot of assets or you have a large or blended family, then estate planning is particularly important for you.

And stay to the end to find out the truth about probate and why it’s more useful than you might think.

I’m Tiffany Woodfield, a Cross-Border Financial Advisor and the co-founder of SWAN Wealth Management. From speaking with many cross-border families, I’ve found that estate planning is often overlooked.

But if you want to leave a legacy, estate planning is a critical part of your financial planning process, particularly if you want to reduce your tax bill. Keep in mind that the information in this video is general in nature. You should work with your financial advisor and lawyer to create an estate plan tailored to your needs.

Now let’s get into the strategies and tips you need to know when considering your estate planning process.

We’re going to cover six main things that you need to know about estate planning.

TAX PLANNING

Tax planning is an important part of estate planning because a big chunk of your estate may end up going to the government if you don’t do this planning correctly.

Most people don’t work hard and make sacrifices so they can pass along a large portion of their estate to the government upon death. Instead, most of us want to leave a legacy that helps the causes we believe in and the people we love.

There are three possible goals with any tax planning strategy:

1. Deferring the tax so that it can be paid at a later, more convenient date.

2. Reducing tax.

3. And completely eliminating tax.

PLANNING FOR THE YEAR OF DEATH

In Canada, the year of death is a major taxable event. Aside from a few exceptions, in the year of death your estate is treated as if you sold everything you personally owned at the current market value. Those capital gains are then taxed.

Here’s an example: Let’s say you’re single, and you have an investment portfolio worth $1,000,000 in the year of death. When you initially purchased all the investments, the total cost was $400,000. So your capital gains are $600,000.

In Canada, 50% of capital gains are taxable. So on your final terminal tax return in the year of death, half of the $600,000 in capital gains will be subject to tax. In this case, that means $300,000 will be added to your final tax return and potentially taxed at your marginal rate.

Next, let’s say you also had a retirement account such as an RRSP. For tax purposes, after death, the RRSP is treated as though it were collapsed, and the total value of the RRSP is included in the final tax return.

(Add on screen: This example assumes that you are not doing a rollover to a qualifying beneficiary.)

Let’s say your RRSP is worth $2 million upon death. It would be treated as though you had just earned $2 million dollars. The RRSP may then be taxed at the highest marginal tax rate if you don’t use a rollover or have it taxed in your beneficiaries’ hands.

We’ll talk more about rollovers later in this video.

You also need to consider that, in most cases, your estate will need the money to pay the tax liability.

(Add on screen: If there isn’t an election to tax in the beneficiaries' hands or use a rollover, your estate will have to cover the tax bill.)

All of this can get complicated.

However, there are many strategies you can use to ensure your estate planning meets your needs.

There are various trust options which can help mitigate the taxes on your estate and ensure that everything is handled exactly the way you want it.

ELECTIONS AND ROLLOVERS

So now you are starting to understand that tax in the year of death may well be a larger amount than any other year. But you can take action to prevent excess taxation of your estate.

For example, several elections and rollovers are available in the year of death. An election is when you request that an asset be treated with an alternative set of tax rules based on specific circumstances.

A rollover is when you move funds from one eligible retirement account to another. These elections and rollovers can be used in estate planning to mitigate tax.

There are also strategies around capital losses, exemptions, and charitable giving.

Unless you want the government to take more of your estate than necessary, it is important to seek tax advice to preserve as much of the estate as possible for your loved ones.

DOCUMENTS

Now, let’s go over the estate planning documents you’re going to need in Canada.

You will likely want to have a will, financial power of attorney and a durable power of attorney for healthcare.

You may also consider various trusts. You will need to know the tax implications of each trust in the country where your assets are held and where you reside.

It’s important to note that what the beneficiary receives after taxation depend on where they live. And the provincial or state tax jurisdiction is also important.

If you’re considering using a trust as part of your estate planning process, please look at the extensive blog I’ve written about Family Trusts in Canada.

Now, let’s talk about probate.

Probate has been given a really bad rap. Don’t get me wrong, I am all about saving money and taking steps to name beneficiaries on registered accounts and hold joint accounts.

But I have seen people so worried about paying probate that they do things that end up compromising their intentions. So keep in mind that probate has a purpose. The purpose of probate is to make sure your wishes are followed.

Let me explain.

Consider that someone might have multiple wills, and they may have named different executors over their lifetime.

How would a financial institution know which executor and will is valid?

Imagine if someone shows up claiming to be the executor. They have a will in hand, so the bank says “Yes, this looks valid,” and gives out the assets. The next day another person arrives claiming to be executor with a different will. But there is nothing left to give.

This is why we need probate.

Your will is validated through a process called probate. Probate essentially grants the legal authority for your executor to act.

(On Screen: Your executor is the person who you have entrusted to give out your assets and make sure your wishes are followed.)

Now you might be wondering how probate is calculated.

Probate is based on your estate. So anything owned only by you when you die will be included. The larger your estate, the larger the probate fees will be.

So to reduce your probate fees, you may want to name beneficiaries for registered accounts and insurance policies. And you may want to gift some assets to beneficiaries while alive.

Where I have seen people go too far is that they add their kids to the title of their home to avoid probate. This can cause another set of problems, so make sure you get advice from your lawyer before making these decisions.

Also, your probate fees will be much less than the income taxes in the year of death. So tax planning should be a priority when doing your estate planning.

ESTATE FREEZE

The last thing I’m going to go over is when to use an Estate Freeze. This is a process that your tax lawyer or accountant may recommend.

If you have a corporation and would like to transfer the future growth of the company to other family members or heirs, you may wish to use an estate freeze.

This strategy “freezes” the value of the owner’s pre-existing shares. The future growth shares will be held by the heirs of the business, which are usually the children.

So when the owner dies, or there is a sale, their capital gains are based on the value of the shares at the time of the freeze.

One of the main benefits of an estate freeze is that you reduce the tax liability of the capital gains on the shares held by the owner when they die.

It is also a powerful incentive for family members who will inherit the company because they can participate in the growth of the company.

There are many factors to keep in mind with an estate freeze, so you’ll want to work with your estate lawyer, accountant and financial advisor to ensure you do this correctly.

So, how do we help you with estate planning at SWAN Wealth?

Having everything taken care of under one roof can simplify your estate planning. At SWAN Wealth, our clients have access to Raymond James Trust services. And in collaboration with this service, we can help with a wide variety of estate planning services.

We can act as executors of your estate. This support means you are not alone in managing the responsibilities of this challenging role.

We can act under a power of attorney to make sure bills are paid, taxes are filed, and your investments are managed.

We can act as sole or joint trustees for a wide variety of trusts. We bring technical, tax and reporting experience, as well as impartiality to the administration of trusts.

We can help you set up a Charitable Giving Fund. This is a cost-effective, flexible, and simple solution to help clients incorporate philanthropy into their financial plans.

All these services take the burden off your loved ones.

Now that we’ve covered some of the most important things to consider when doing your estate planning in Canada, I hope you feel ready to put together your team and get started.

If you’re planning on updating your will and estate plan, then make sure you consider all the options available to you and build a team around you so that you're not doing your estate planning alone.