Many parents want to leave as much cash and property as they can to their children
During financial literacy month, Canada's top money bloggers are sharing their best piece of advice.
Many parents want to leave as much cash and property as they can to their children. However, there are tax, probate and inheritance traps that can cause missteps.
The most common mistakes, which are often accidental and stem from a lack of knowledge, result in inheritance conflicts, the payment of additional income taxes and most importantly, prevent parents from achieving their goal of maximizing their family's wealth.
Houses and cottages
To save on probate fees or to deal with inheritance issues, parents sometimes decide to transfer 50 per cent ownership of their home to one or more of their children. For income tax purposes, these transfers are equivalent to a partial sale. If the house is the parents' principal residence (or "PR"), there are no tax consequences to the parents (assuming their cottage is not their PR). However, if the child has a PR of their own, they will likely be taxed on 50 per cent of any future appreciation of the parents' home.
As a rule of thumb, parents should not transfer their homes to their children, since the net result is almost always the conversion of a tax-free gain on their PR into a taxable gain in the hands of the children, leading to less overall family wealth.
In most cases, a better tax strategy is for parents to keep the house in their name until they die.
If you own a cottage, the same "phantom sale" results if you transfer it to one of your children. In some cases this is a misstep, which results in a pre-payment of tax.
In other cases, the transfer of a cottage is part of effective tax planning. The idea is that you pay taxes now on the "sale," so that future growth in the cottage value accrues to the child instead of you. Rather than transfer the cottage ownership, some parents obtain life insurance to cover the resulting income tax liability upon their death. However, the cost of the insurance may ultimately reduce the family's wealth, so it is important to weigh these options carefully. Read more about how to transfer a family cottage here.
Bank accounts
As parents age, it is common for one of them to change their bank account (or brokerage account) to a joint account with one of their children (called joint tenancy), to avoid getting hit with probate fees. Despite creating a joint account, these parents often continue to report the income from the bank account on their own tax return. In essence, they just want to avoid probate fees and not actually transfer half the bank account to their child.
This is a common misstep, since Canada Revenue Agency has said that when someone just changes the name on a bank account, yet still has beneficial ownership of the bank account, there is no true joint tenancy and the transfer will fail to reduce probate fees.
So unless you transfer true ownership of the bank account – one indication of this may be your child reports half the income on their return, you have not minimized your probate fees or maximized your family wealth.
Another danger for larger families is that by listing just one child as a joint tenant on the bank account, the child may consider the account theirs and not their siblings, which can lead to estate litigation. Documentation of intention for the account is a must.
When considering changing an account to joint, parents should consider full disclosure to all their children about their intentions and how the account should be reported for tax purposes.
Jewellery, antiques and art
A significant misstep that can come back to haunt children is when parents "pretend" they don't own expensive personal items such as jewellery, antiques and art. Some parents ignore these items purposely in their wills and rely on an understanding with their family that these items will "walk out the door" without being reported for income tax or probate purposes. As a parent you must understand that if you name any of your children as executors of your estate, you are asking them to evade income taxes and the law.
A simple way to avoid this misstep is to buy antiques, jewellery and art in your child's name originally, so that any appreciation in value belongs to them.
Get informed
Too many people are ill-informed when it comes to taxes, probate fees and estate law. They end up making serious blunders that inadvertently reduce their family wealth. If you are looking for ways to pass your wealth to your children, do some research and obtain professional advice before changing the ownership of your most valuable assets.
Mark Goodfield is a tax partner with Cunningham LLP in Toronto. His blog The Blunt Bean Counter was the only Canadian blog nominated for a Plutus Award, for the Best Tax–Focused Blog.