By Stephanie Farrington
Few people want to think about dying. Even for those who will discuss their own mortality, some consider it morbid and shallow to talk about the financial aspects of their own or their loved ones’ deaths.
While refusing to engage with this tragic reality is understandable, refusing to accept its inevitability leads to more anguish in the end. And it can be costly.
(For more information on the basic costs (by province) of transferring an estate, please refer to this chart from ScotiaMcleod.)
Although many Canadians may expect an inheritance in the next decade, too few are prepared to pass on their own estates, and even fewer are prepared for how to accept an inheritance.
There are several schools of thought on the subject of passing on your estate while minimizing fees and taxes; here are two ways that can be considered when creating your estate plan.
According to Stephen Pollan, the way to deal with your estate is simple: die broke. Pollan, a New York-based professional coach and lawyer, authored the first book on the subject of dying broke (aptly named “Die Broke”) and since its publication in 1997, the idea has caught on.
To die broke Pollan suggests you figure out how much you need to live and then give the rest away while you’re alive. The theory is making financial gifts allows you to help your family while you’re still around to see them benefit. Pollan even goes so far as to say your last cheque should be to the undertaker — and that cheque should bounce.
Pollan urges his readers to live life to the fullest and die used up. Seems like good advice, but as most financial advisers will point out, accepting your own mortality will not give you control over its method or timing. Prolonged stays in hospital or residential care can throw your budget a curve ball. You may become disabled, or you may simply live a lot longer than you expect and want to work a lot less. You may outlive your heirs. The bottom line is: things change and change is unpredictable.
Creating a testamentary trust
Instead of spending it all before you die, you might consider establishing a testamentary trust to protect your heirs after your death.
A testamentary trust, which is created by your last will and testament, can hold funds for your beneficiaries’ use without making those funds vulnerable to ex-spouses or creditors. While there may not be any taxes levied directly on an inheritance, money you receive from an inheritance still qualifies as income.
Dylan Reece, a financial adviser at Nicola Wealth Management in Vancouver explains it like this:
“Let’s say I inherit a million dollars with no debt. If I earn a return on that investment of $50,000, I will have to pay tax on it and the rate will be quite high because it will be added to my regular annual income, putting me in a higher bracket.
If I get my parents to allocate it to a trust, I will put that money in an account for the trust; it’s a separate legal entity, so it is taxed as an individual. The trust will have to report its income and pay its own taxes, but since that is a separate income, it will be at a very low tax rate.”
Income splitting with a trust
Because a trust is a separate legal entity, you can choose to apply income splitting to your combined incomes.
“By having the income go into a trust, you can have a lifetime of income splitting,” says Reece.
“Of course, you must appoint a trustee to make decisions about when to disperse funds, but it is possible to be both beneficiary and trustee at the same time,” he adds. “This way you can have complete control over your own trust and you still retain the income splitting benefits.”
That said if you’re your own trustee, you have slightly less creditor protection. “If you wanted ironclad creditor protection, you would appoint someone else as trustee,” says Reece.
Using a testamentary trust means your inheritance is not absorbed into joint assets shared with your spouse, so in the event of a marital breakdown, future ex-spouses will have more trouble getting that money. Your inheritance stays with you.
Whether you choose to spend every penny and die broke, create a trust or just let things unfold as they will, maybe the best thing you can do is accept that after death, taxes still go on. But how they do it is a choice you can make while you’re still alive and kicking.