Estate Planning: The Finer Points - Direct Bequests or Transfers to Your Spouse

Most estate plans provide that all property is to be left to the surviving spouse on the death of the first spouse. Although well intended, this may not produce the best tax result. At times, it is better to structure things differently for the surviving spouse and the entire family. 
 
A little background knowledge of the Income Tax Act is necessary. The funds held at death in all RRSPs and RRIFs are taxable in the year of death as income. This does not apply to funds that are transferred to a surviving spouse. These plans can be "rolled over" to the surviving spouse. Capital assets, such as mutual funds, stocks, bonds, and real estate that is not the principal residence, may be subject to capital gains tax if the fair market value of the assets at death is greater than their adjusted cost base. Valuable personal property, like jewelry, art, china, silverware, coins and stamps, is also subject to similar rules and can be rolled over without tax consequence to the surviving spouse. 

Despite these obvious tax benefits, there are other options to leaving assets to a surviving spouse that might provide better tax results.

Spouse or common law partner trust

The Income Tax Act provides that all capital assets can be transferred to a spouse or common law partner trust created by a will. This may also occur on a rollover basis, without immediate tax consequences. The spouse must be entitled to all of the income of the trust during his or her lifetime, and be the sole beneficiary of the capital of the trust during his or her lifetime. A spousal or common law partner trust created by a will that satisfies these conditions will benefit from a separate graduated tax rate, saving up to about $10,000 to $12,000 in ongoing investment income. Rather than being taxed at high marginal rates (and perhaps resulting as well in a claw-back of Old Age Security) in the surviving spouse's hands, the income may be taxed at the lower marginal rate of the spouse or common law partner trust.

Proper drafting of the trust documents must address a host of related issues, including:

• Loans and transactions by the trust with persons other than the spouse or common law partner, during lifetime, must be on reasonable commercial terms, otherwise it may be argued that the trust is not solely for the benefit of the spouse or partner.
• the assets must vest indefeasibly in the trust within 36 months of the death. This requirement can impact on shareholder agreements.
• The disposition of the remainder of the trust on the death of the surviving spouse must be addressed, and it may be advisable to include a limited power of appointment in favor of the surviving spouse. The CRA has expressed some concern that where a person is sole trustee, with absolute discretion, and is the sole beneficiary for a period of time, there may be a legal question as to whether or not a trust exists.(see doc 2007-0256521E5).

Family Trusts

If there are insurance proceeds or cash on death, it may be best to leave these to a broader trust for the possible benefit of the whole family. Although such a trust is not a spousal trust, it can also benefit from a separate graduated tax rate if set up and funded on death. This may provide an additional set of marginal rates, and additional flexibility. It may be best to leave discretion to the estate trustee to allocate assets to the spouse or partner trust and to the family trust after death, as specific assets will change over time. It is necessary to provide for the distribution of the Family Trust on the death of the surviving spouse, and perhaps to leave a limited power of appointment to the surviving spouse to permit flexibility.

RRSPs and RRIFs to children

RRSPs and RRIFs can be rolled over not only to surviving spouses or common law partners, but also to dependant children or grandchildren (dependants with physical or mental impairment are subject to special rules). For example, a surviving spouse or partner with young children and employment income may be a candidate for this treatment. If the surviving spouse wishes to access the RRSP funds, he or she will be taxed fully at his or her marginal rate. However, if the RRSPs are rolled over to dependant children who have no other income, no tax will be paid on about $10,000 per child per year.

Since there can be a lot of tax payable on death, it is important to structure clients' affairs properly. Accountants and tax lawyers should work together to ensure that proper, complete estate tax planning advice is given.

Guy A. Desmarais, B. Com., LL.B. TEP. Guy is a partner in Collins Barrow's Sudbury-Nipissing member firm. He can be reached at gudesmarais@collinsbarrow.com, or 705-560-2056.