Transferring Wealth: Effective Strategies for the Typical Canadian

Keeping it in the family

You've worked a lifetime to accumulate assets. In fact, the average Canadian family has amassed total personal wealth of approximately $224,633.¹ And whether your nest egg is bigger or smaller than that, there are simple strategies you can use to make sure your wealth passes smoothly and tax-effectively to your children and grandchildren.

Minimize capital gains taxes on your cottage

For many older Canadians, the family cottage becomes a liability. Maintenance expenses are a drain on bank accounts, and the equity tied up in the cottage could be put to better use funding retirement, dream vacations or hobbies. Transferring your cottage to the next generation during your lifetime may solve these problems and provide tax-planning opportunities at the same time.

Imagine that you have a home in the city that you intend to designate as your "principal residence."² You can sell this home without paying tax on the capital gains it has earned through the years. Your cottage, on the other hand, will not be exempt from capital gains taxes when you sell it. However, if you expect the cottage to appreciate in value in the coming years, transferring ownership to your children now allows all future gains to be taxed in their hands rather than yours. It also means there will be no probate fees on the value of the property after your death because the cottage will not be part of your estate.

Of course, selling the cottage now does mean that taxes will be due on any appreciation in value to this point. However, there are smart ways to structure the sale to reduce the immediate tax liability. If you sell the cottage to your children in return for a mortgage or a promissory note (though not a demand promissory note, which is deemed to be due immediately), with equal payments to be made over a minimum of five years, only 20 per cent of the capital gains must be reported each year. Essentially, you can spread the taxes over five years. Then, if you so choose, you can forgive the outstanding loan in your will.

Maximize the benefits of your RRIF

It is very important to name a beneficiary for your Registered Retirement Income Fund (RRIF), and to choose that beneficiary wisely. Like a Registered Retirement Savings Plan (RRSP) and Registered Pension Plan (RPP), an RRIF can be paid directly to a named beneficiary, thereby avoiding probate fees.

In addition, if the RRIF beneficiary is a "qualified beneficiary" (a spouse, common-law partner, financially dependent child or grandchild, or a child or grandchild dependent because of physical or mental infirmity), the RRIF proceeds can pass tax-free directly into the beneficiary's RRSP or RRIF, to be used to purchase a qualifying annuity.

Proceeds from an RRIF left to someone other than a qualified beneficiary will be included and taxed as income on your final tax return, and the bill could be hefty. While you can prepare to cover these taxes in advance with a life insurance policy, it is often preferable to leave RRIF assets to a qualified beneficiary and leave other non-registered assets to your other beneficiaries.

Spread out an inheritance using an Annuity Settlement Option

Providing beneficiaries with lump-sum payments of their inheritances may not be desirable in every situation. For example, if your children are still growing up you may be worried that they might not be able to handle a large amount of money responsibly. Trusts allow you to define how much is paid and when, but they can be costly and complicated. You have another, simpler option.

Investments offered by insurance companies, such as Guaranteed Interest Contracts (GICs) and segregated fund contracts, provide an annuity settlement option.

These investment opportunities allow you to specify that beneficiary payments be made as a lump sum or spread over a defined period of time (for example, for a specific term such as five or ten years, or for life with an optional guarantee period or cash refund option). You can also combine these options and arrange for beneficiaries to receive part of their inheritance as a lump sum and part as regular income over time.

Avoid probate fees with insurance investments³

As long as you name a valid beneficiary on your insurance investments, they will be dealt with outside your will. They will not form part of your estate and therefore will not be subject to probate fees or estate administration costs, and may be protected from any creditors you might have at the time of your death.⁴ 

Investments offered by insurance companies can provide additional benefits. If you name a valid beneficiary, your investments will avoid probate, which can take several months or even years if the will is challenged, and provide direct payouts to your beneficiaries. Generally, they also provide maturity and death benefit guarantees, meaning that upon your death, and subject to certain conditions, your beneficiaries will be entitled to receive a guaranteed sum regardless of the market value of the investment at that time.

Furthermore, investments offered through insurance companies are flexible; it is easier to change a beneficiary designation than it is to change a will. You also have the option of naming a trust as a beneficiary, which may qualify as a testamentary insurance trust. These are taxed at the same graduated tax rates as individuals.

Watch out for U.S. estate taxes

Many Canadians are not aware that holding property situated within the U.S. may subject their estates to U.S. estate taxes. U.S. properties include U.S. real estate, shares of  U.S. corporations (even if they were purchased through a Canadian broker or a Canadian stock exchange), and business interests located in the U.S.

While Canada taxes estates only on income and accrued capital gains up to the date of death, the U.S. taxes individuals on the total value of their estates. Thus, U.S. estate taxes can be significant. The good news is that people with U.S. assets worth less than US$60,000 are exempt altogether, and people with worldwide assets worth less than US$1,200,000 are subject to U.S. estate taxes only on their U.S. real estate and business interests.

Strategies for small business owners

If you own a business, speak with your financial advisor about the many wealth transfer strategies that can minimize taxes and maximize the value of your company when it passes to your children or grandchildren. Here are some ideas to get you started:

• Make full use of your lifetime $750,000 capital gains exemption.⁵
• Consider an estate freeze, which allows you to retain control over the business while freezing the value of your interest in the company so you can pass future growth on to the next generation.
• Think about purchasing life insurance. It can help fund an anticipated tax liability in your estate to keep the company afloat while your beneficiaries search for a buyer or reorganize the management team.

A little planning goes a long way

Every Canadian should have a comprehensive plan for transferring assets to the next generation, no matter how big or small his or her estate may be. Your financial advisor can help you implement strategies that work for you - whether that means moving property or investments into your beneficiaries' hands now or structuring assets so the transfer is tax-efficient upon your death. Careful planning, starting today, will help you minimize taxes, reduce the possibility of a forced sale to cover unanticipated estate costs, and, perhaps most importantly, avoid family conflict and challenges to the wishes you express in your will. Contact your Collins Barrow advisor to discuss the appropriate wealth strategies for you.

Kevin Smith is a chartered financial consultant in the Waterloo office of Collins Barrow.

1. Source: Vanier Institute, January 2005.
2. A taxpayer can only designate one qualifying property as his or her principal residence for a particular tax year, and for years after 1981 only one property per family unit can be designated as a principal residence.
3. Probate is not applicable in Quebec.
4. In Saskatchewan, jointly held property and insurance policies with a named beneficiary are included in the application for probate but do not flow through the estate and are not subject to probate fees.
5. Available on the sale of certain qualified small business corporation shares.