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Estate planning strategizes how, when and to whom, the proceeds of your accumulated wealth will be distributed

 

 Do you know all the legal and tax ramifications that are set in motion when you die?  These restrictions impact the value of your estate, its obligations and your loved ones. Life insurance planning is a key part of Estate Planning, but only one part of the picture. At Life Guard Insurance we believe it’s better to start Estate Planning with the help of professionals — a lawyer with estate experience and an accountant who understands estate taxes and the power of designing Trusts. As your insurance broker, we also play a significant role in the final Estate Plan, but insurance should never drive your plan.

 

To create a final Estate Plan, you need a thorough accounting of all your assets. You then need to identify your desires for division of assets and passing on your inheritance. And finally, you need to look at all the pitfalls that could get in the way of fulfilling your wishes. Without a complete and well thought-out plan, the wealth you have built spent your lifetime building can be eaten away by:

  • Taxation
  • Family conflict over your will
  • Excessive legal costs
  • Double taxation
  • And many other pitfalls

The cornerstone of estate planning is a package that includes your:

  • Will
  • Power of Attorney
  • Personal Health Directive
  • Life Insurance documents for property and health

Ten Estate Planning Tips to Protect Your Estate and Your Family

1. Make sure you plan and discuss with your family and professional advisors how you want your estate to be distributed; don’t keep everybody in the dark until the end.

Estate planning Canada - have a will.

 

2. Draw up a Will with a lawyer. Dying "Intestate: (without a will) increases costs, takes away control of your family’s assets, and adds stress for your family.

 

3. Keep all your valuable papers together such as insurance policies, wills, bonds, investment records, birth certificates, marriage certificates and social insurance numbers. Be sure your family knows where they are; don’t leave it to a game of "hide & seek" after you’re gone.

 

4. Review your life insurance and keep your program up to date. It is the most cost effective way to create the cash to pay bills and provide income.

 

5. If you have insurance, consider a named beneficiary if it is appropriate. Naming your estate could slow down receipt of monies to pay bills and provide income. Having the proceeds paid to the estate increases executor’s fees and gives one more opportunity for the proceeds to go to the wrong people.

 

6. Explore leaving property and investments as "Joint with rights of survivorship" so ownership can be changed with the least cost, "red tape" and time delay.

 

7. Name a beneficiary in your RRSP or RRIF or put an RRSP-RRIF clause in your will to eliminate the potentially biggest tax bill possible. The total value of your RRSP/RRIF could be added to income and taxed at the highest rate, reducing income to survivors. A "spousal beneficiary" defers this tax.

 

8. Keep some of your assets "liquid" so that there is cash to pay bills upon death. This allows flexibility to preserve the value of the estate and avoids a forced sale of assets.

 

9. Suggest that your potential survivors seek advice and do postmortem tax planning. If you’ve done a good job of creating your estate plan, your family will need competent advisors to help manage the assets.

 

10. Annually, fill out a Net Worth Statement showing a detailed list your assets, where they are, and their current values. Prepare an Income Statement showing all current income sources, and also make a list of the type of income and amounts which continue after death.

Life Insurance is a cornerstone of good Estate Planning

An exempt insurance policy is the most cost effective way to create tax-free cash flow at death. This easily accessible cash is very beneficial during settlement of assets. Life insurance proceeds can be used to pay off the final tax bill to the estate from CRA, thus preserving the wealth in the estate.  Life insurance proceeds can also be used to fund charitable donations through the estate, which creates very favourable tax deductions. It is also a way of moving wealth to a direct named beneficiary without public disclosure of assets through the will and wealth losses due to legal, executor and probate fees.

 

 

 

What types of insurance strategies have people in Canada used to create wealth and shelter money from the tax man?

 

 

Life insurance is a unique product in Canada. There are a few key pieces of legislation that make insurance planning so effective.

 

Firstly, the death benefit of a qualifying insurance product is paid out tax-free. Almost all life insurance policies sold in Canada today are qualifying plans, and therefore the death benefits are tax free. You also have the choice to design your plan with a locked-in and stable death benefit or with a growing benefit, increasing over time.

 

Secondly, money that is invested inside a life insurance policy is allowed to grow and compound over time in a tax sheltered fund (up to a certain defined maximum based on the plan you buy). This allows invested wealth to grow and compound through your entire life without the government clawing it down with ongoing taxation.

 

Thirdly, the tax laws around borrowed funds, or leveraging, provides tax free income to the borrower. This allows life insurance policy holders in Canada to invest extra money into their policies over time, have the advantage of a tax sheltered investment plan, and borrow money from their insurance policy tax free.

 

All these unique legal features of life insurance and leveraging money allow you to invest substantial funds into a life insurance policy, reduce taxation both now and ultimately to your estate, and possibly even have access to tax free income in the form of loans.

Some well known life insurance strategies

Insured Annuity: also known as a Back-to-Back Annuity, this strategy enhances after tax cash flow today while preserving your investment capital for your heirs.

 

Estate Bond: this strategy increases tax free inheritance money you have set aside for heirs on a fully guaranteed basis, usually by 250 – 300% immediate growth.

 

Insured Retirement Plan: alson known as an IRP, this is a leveraging strategy, where you can own life insurance, use it as an investment plan to accumulate wealth, and borrow funds from the policy tax free in retirement.

 

Buy/Sell Agreement: this strategy protects your business interest through funding an agreement to buy out partners or major shareholders in the event of death or long-term disability.

 

There are many other strategies that can be used in Canada. The level of complexity can increase quickly, especially when getting into corporately owned life insurance policies.

If you are serious about leaving an inheritance or giving to a non profit in Canada then you need a plan.

Creating an inheritance for you might be as simple as leaving money or assets behind to make sure grand-children get a good education. You might want to help your adult children out so they have a brighter future, or you could have grander aspirations. If you have more accumulated wealth than you can spend in your lifetime and want to pass it on, either inside your family or to not-for-profit organizations, you should always begin with a strategy and a plan.

 

This brief web-page will outline a few common scenarios where you can plan for simple inheritance and legacy creation or you can use Trusts for more complex situations. The process of creating an inheritance could get fairly complex and is beyond the scope of an insurance advisor alone.

Simple Inheritance and Legacy Giving

Inheritance and Legacy planning includes minimizing estate taxes, like Capital Gains Taxes in Canada.If your estate is mainly for family inheritance, and your will is up to date naming beneficiaries and heirs then you are most of the way there. A fundamental piece of the plan would be taxation of your assets at death, and how much will be lost to the Canada Revenue Agency (CRA). Do you own assets that have gone up in value over the years? How much is your recreation property worth today vs. the price you originally paid for it? Very often you can offset high capital gains taxes like this very affordably with permanent life insurance. You might be able to buy $1.00 of tax free death benefit for $0.15 or $0.20 of premiums, all in. That would create a guaranteed, locked in benefit for your estate to alleviate future taxation on the inheritance.

 

Another major concern for you might be that you want to enhance the value of your estate and give more of an inheritance to you children and grand-children. Must you settle for giving what you have saved to date? Are there ways to enhance your gift today? The answer for many Canadians is YES – there are options through life insurance to enhance your gifts to family on a fully guaranteed basis and with a reduction of taxation and final expenses. For example see the Estate Bond concept.

Family Inheritance of the Family Business

If a major part of your estate is the Canada business you have built up over the years, and that business is to stay in the family, some serious inheritance planning needs to take place to minimize the taxes due and expenses of transitioning the business. If your business is a family farm there are special tax roll-over laws that allow family farms to pass within the family at their original cost base – and no capital gains on land need be realized. This is a special taxation exemption that applies only to family farm property. If your family business is not a farm, the entire capital gains of that business will be crystallized at death (can be rolled over until the death of the last spouse, but taxes are due when passing as inheritance to children). These taxes could be in the hundreds of thousands of dollars, and unless the business is sitting on a lot of retained capital, there might be a situation where assets need to be sold just to pay the tax man. That is no way to pass on a successful business.

 

There are a number of options here. One common one is using a Family Trust to create an Estate Freeze on all assets today, lock in the taxation owing for the future and deal with the single problem via a life insurance policy to offset the future tax burden. That last sentance had a lot packed into it – and needs to be unpacked for you with the help of legal and accounting advice. Each situation is unique and will be planned out according to your needs. In the end, the savings your estate will see from inheritance planning for your business far outweighs the professional advice fees or insurance premiums paid to design the plan.

Estate Equalization Planning

Estate equalization for inheritance issues funded with life insurance in Canada.This type of inheritance planning is very common among family farm corporations and family businesses in Canada. Imagine, you own a business that is worth a lot of money in assets, but does not hold large amounts of cash on reserve. In order to make money you invest back into the business. Now imaging you are getting older and one of your children is being groomed to take over the family business, yet you have one or more other children who have moved on to have lives of their own and are not involved. By letting one child inherit the assets of the business he/she will get the lions share of your estate, with only small gifts given to your other children through your will. Is this fair? Would you like to give more of an inheritance to your children who are not involved in the family business?

 

If the answer is yes, you have an Estate Equalization problem. Remember, fair does not mean equal. The child taking over the business has put sweat equity into that business so far, and has earned more than an equal portion. He/she is also taking on all the future financial risks of running the business while the other non-involved children have no risk. The amount of inheritance that is FAIR should be worked out via a family discussion where there is general agreement on the division of the estate (in this case the value non-involved children will be getting while the other child inherits the business).

 

Once you have arrived at a number, life insurance is usually your best investment to make this estate equalization plan a reality. It provides a guaranteed tax free benefit for the non-involved children, payable immediately upon death, and avoids the estate where it would be reduced by probate, legal and executor fees. The proceeds of the life insurance policy could be built into a family inheritance agreement as a part of the will to remove non-involved children from making a claim on the assets of the farm business.

Dealing With Complex Families

Not every family situation is so clean cut. As we know, families are messy – and that mess can create major legal and financial issues upon death. Some of the most common messy situations are blended families, remarriages after you are gone, or children who are irresponsible or have an abuse problem. How do you deal with inheritance of your estate in these situations, and create the legacy for your heirs you really want.

 

Just drafting a will usually does not solve these issues. A will can be contested at your death, and your assets could become tied up in the courts for years while families fight over them – and no one except the lawyers win in that scenario. There are two excellent ways to design an inheritance plan for these situations to make your wishes a reality. Either create a Family Trust while you are alive, or pass your assets into a Trust established at your death through your will. You can set out terms of how you want the assets in the trust to be administered, by whom (the Trustees) and who will benefit from the assets in the trust (the Beneficiaries).

 

All this complex planning is done mainly with an Estate Lawyer to establish the trust agreements, and with a Tax Accountant to value assets and make sure they all pass into the trust, with the proper paper trail for the eventual CRA audit. It is highly likely that some form on permanent life insurance plan will be included in the final plan to create liquidity for the trust and/or pay off taxes owing.

 

Estate Tax and Life Insurance Products in Canada

Estate tax and your life insurance policy in CanadaLife insurance is an attractive tool for dealing with estate tax planning because the proceeds received at death are generally not subject to tax. If you have, or are planning to purchase life insurance in Canada, you should be aware that the tax implications will depend on whether it is “exempt” from taxation of the accumulated income or “non-exempt.”

 

Policies issued before Dec. 2, 1982 fall under the “old rule” status. These policies are exempt from accrual taxation. Policies issued after Dec. 1, 1982, fall under the “new rules” and may be exempt or non-exempt.

 

To distinguish the exempt or non-exempt status of a policy, an exemption test must be administered by the insurance company on each anniversary date of the policy. A policy is considered exempt if its emphasis is “benefits on death.” Non-exempt policies are those policies that offer a substantial lifetime investment including annuity contracts. Exempt policies must meet current test requirements and must also meet prospective test requirements for future anniversaries.

Estate Tax at Death

While there is no true estate tax in Canada there are three potential taxes or pseudo-taxes that may be incurred at death (which many people refer to as estate tax):

Estate Tax (Income Tax) Due to Deemed Disposition

In the year of death, a final (terminal) tax return must be filed by the estate’s executor/liquidator that includes all income earned by the deceased up to the date of death. Also included in income for the estate tax is the net capital gain recognized under the deemed disposition rules.

 

The deemed disposition rules of the Income Tax Act treat all capital property owned by the deceased as if it was sold immediately prior to death. Thus, all unrecognized capital gains and losses are triggered at that point with the net capital gain (gains less losses) included in income.

 

The Income Tax Act does contain provisions to defer the tax owing under the deemed disposition rules if the asset is left to a surviving spouse or to a special trust for a spouse (spousal trust) created by the deceased’s Will. This provision allows the spouse or the spousal trust to take ownership of the asset at the deceased’s original cost. Hence, no tax is payable until either the spouse or the spousal trust sells the asset or until the surviving spouse dies. The tax is then payable based on the asset’s increase in value at that point in time.

A Special Note about RSPs and RIFs

In addition to the potentially significant tax liability from recognized capital gains, it is also necessary to deregister (i.e. collapse) any registered assets such as Retirement Savings Plans (RSPs) or Retirement Income Funds (RIFs) at the point of death. The full value of the RSP or RIF must be included on the deceased’s final (terminal) estate tax return. There are exceptions to this deregistration requirement if the RSP or RIF is left to the surviving spouse, a common law spouse and in some cases to a surviving child or grandchild.

 

An RSP or RIF can be transferred tax-free to a surviving spouse’s own plan. Also, the RSP or RIF can be transferred tax-free to a financially-dependent child or grandchild who is under age 18, or who is mentally or physically infirm, even if there is a surviving spouse. The registered funds must be used to purchase a term-certain annuity with a term not exceeding the child’s 18th year.

 

Life Insurance – a cost effective solution. Be sure to examine the cost of investing into a permanent life insurance policy as a way to deal with deemed disposition estate taxes at death. It often is the most cost effective way to protect your assets from government estate tax that will ultimately erode your estate.

Provincial Probate Taxes

Upon death, the executor of your estate will typically be required to file for probate with the provincial court. The estate’s executor must submit to the court the original Will and an inventory of the deceased’s assets. Upon acceptance of these documents by the court, letters of probate (called “Certificate of appointment of estate trustee with a Will” in Ontario) are issued. This document serves to verify that the submitted Will is a valid document and confirms the appointment of your executor.

 

With the executor’s submission to the court, he/she must also pay a probate tax (a major estate tax). This estate tax is based on the total value of the assets that flow through the Will. The rate charged varies between provinces with some provinces having a maximum fee. All provinces except for Alberta and Quebec levy potentially significant probate taxes.

 

Probate is not required for a notarial Will in the province of Quebec and for those that have other types of Wills drafted in Quebec the probate tax is very nominal.

 

In situations where the estate is extremely simple and does not require any involvement with a third party such as a financial institution, the Will may not need to be probated. As well, probate taxes can be reduced by using strategies such as the naming of beneficiaries, Joint Tenancy With Right Of Survivorship agreements and the use of living trusts.

U.S. Estate Tax

In addition to the estate taxes payable in Canada, you may also be subject to a tax bill from the U.S. Government. Canadians that own U.S.-sourced assets such as real estate, corporate stocks and certain bonds and government debt are required to pay U.S. Estate Tax based on the market value of their U.S. assets at death. Any assets that are considered “U.S. situs” property (i.e. deemed to be located within the United States) will be subject to this tax. Most people do not realize that investing in the securities issued by a U.S. corporation such as IBM or Microsoft in their Canadian brokerage account may result in a U.S. Estate Tax liability for their estate.

 

While changes to the Canada-U.S. Tax Treaty have reduced the number of Canadians that may be subject to this Estate Tax, for many individuals with significant net worth, U.S. Estate Tax will still represent a significant tax burden to their estate. Potential methods of reducing the total cost of U.S. Estate Tax include the following:

 

  • Use life insurance to cover the U.S. Estate Tax bill, allowing your total estate value to be maintained
  • Sell your U.S. assets prior to death. This is the simplest method of avoiding the tax, but timing is everything with this strategy as the sale could result in an immediate Canadian tax liability
  • Individuals with substantial U.S. holdings may wish to consider using a Canadian holding corporation since the assets would be owned by the Canadian corporation and not by the individual
  • Reduce the value of your estate below the current threshold
  • Hold Canadian mutual funds that invest in the U.S. market. While the fund may hold U.S. assets, it is considered a Canadian asset, and is not subject to U.S. Estate Tax
  • Hold the asset in joint ownership. This may serve to defer the tax until the other tenant dies, assuming the surviving tenant can prove that he/she acquired their interest in the asset using their own capital