What You Need to Know About Estate and Tax Planning in Canada
As a Canadian citizen or resident, you’re privy to more comprehensive estate planning benefits than your American neighbors. There is, however, a deemed disposition tax that applies when you pass away and operates similarly to the estate taxes in the United States. This tax can have a debilitating effect on your estate’s worth over time. Additionally, other costs could compromise your wealth transfer as you look to hand over your assets to future generations.
Fortunately, there are ways to optimize your estate planning strategy to mitigate the issues that the disposition tax and other taxes will have on your wealth transfer capabilities.
The deemed disposition tax got its name based on how your investments are immediately deemed to be sold when you die. Furthermore, capital gains earned following the sale of these investments are included in the last income tax return in the year the person passed away.
The rise in federal income taxes in Canada has become financially debilitating for families as rates have climbed as high as 33% in 2021. When you factor in probate fees and provincial taxes, families are taking on increasingly difficult financial burdens. These concerns illustrate why estate and tax planning must go hand-in-hand to ensure a safe wealth transfer.
The deemed disposition tax can be successfully deferred whenever one transfers assets to a spousal trust for a surviving spouse or partner. A spousal trust is a tax planning alternative for many families who look to put off selling the deceased’s assets until a later date. A failure to establish a trust could also lead to assets being unclaimed, with distribution left at the behest of the authorities. Simply put, the tax is applied should the spouse ever decide to sell these assets. If the surviving spouse passes on, the assets are passed on to their heirs, and so on. However, half of the capital gains of any real estate investments, stock and bonds, plus other assets, are taxed through the personal income tax rate.
To avoid probate, you can establish revocable living or inter-vivos trusts. Any property in the trust that isn’t probated is sent directly to your inheritors. All you need to do is create a trust document. Then, you can transfer the title of the property to the trust.
Most people name themselves as trustees so they maintain full control over the property. Alternatively, you can create tax-free gifts, giving money to your beneficiaries without facing a penalty, reducing probate costs. Joint ownership is another route you can take, using any of the following to bypass probate:
- Joint Tenancy With Right of Survivorship
- Community Property With Right of Survivorship
- Tenancy By The Entirety
If you’re hesitant about giving assets to your adult children, you should investigate loans as an estate and tax planning strategy. The loan should be set up so that your debt is relinquished at the time of your death. The loan is interest-free so long as your adult children use the loan to pay mortgage fees, pay for tuition, or buy a new vehicle.
You can also attempt an estate freeze. As assets grow, so do tax liabilities you face when you die. You can create steps to facilitate asset growth without having the growth accrue under your watch. To do this, you should exchange a growth asset with a non-growth asset. By doing such an exchange, you freeze the growth in your hands as well as the tax liabilities accrued when the exchange took place. However, the asset growth between the time you made the asset acquisition and the exchange will be taxed until you pass away. Growth accrued after your passing will accrue to your heirs.
One type of estate freeze you can use is a portfolio of investments. A portfolio of growth investments, such as real estate and mutual funds, is moved to a privately-owned family corporation, tax-free. In exchange for your portfolio, you receive preferred non-growth shares that have a fixed value. These shares have to equal the value of the portfolio, leading to the freezing of the portfolio shares. On the other hand, you can also do an estate freeze for family business succession, with common shares (a parent-owned growth asset) exchanged for preferred shares on a tax-free basis. Tax liability attributed to the parent will then be frozen, with subsequent steps taken to pay this liability when death occurs.
Without a will, you’re deemed to have died intestate, leaving your provincial government in control of asset distribution. This can also trigger delays and lead to extra expenses that your family has to absorb. By creating a will, you make sure that your financial affairs are appropriately managed, according to your best wishes, when you pass away or are physically/mentally incapacitated. You can establish a last will, a power of attorney that gives someone the authority to handle your financial affairs or living will.
Trusts, particularly offshore trusts, offer you asset protection and diversification, allowing you to distribute your assets to beneficiaries the way you want to while also reducing tax burdens.
Taxes are inevitable. But, these measures can help you get around things in such a way that estate planning becomes a less arduous process.
Ryan Faridan is the Principal Advisor at Global Solutions West, an advisory company dedicated to wealth preservation and long-term financial stability. With nearly a decade of experience in risk management, tax planning, and insurance, Ryan has made a name for himself as a Canadian wealth preservation expert.