Stephen Pietropaolo is a wealth adviser at Scotia Wealth Management.
The first time I purchased a new car from a dealership, I was excited. Not only for the car, but because I was prepared to negotiate.
I had heard stories of people being taken advantage of, and made a point to avoid such a thing happening to me. However, I wasn’t really looking to negotiate the price of the new car; I was much more focused on getting a fair price for my rusty trade-in. Other dealerships had offered me $500 for my old car. This time, I went in strong and they caved: $2,000! I was sold before I even picked the colour of my new car. Needless to say, I did a poor job negotiating the price of my new vehicle. I learned two valuable lessons that day. First, buying a new car is not that exciting, and second, losing sight of the big picture can be costly.
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The latter of the two lessons can also be applied to probate planning. Clients often focus on avoiding probate without really understanding what some of the implications of doing so may be. Let’s review what probate is. Probate is the court process that gives the executor of a will the authority to act on behalf of the deceased person. The estate administration tax (EAT), formerly referred to as “probate fees,” is calculated on the amount of assets in the will subject to probate. A probated will is used as a safeguard by institutions to ensure the executor is permitted to transact on the deceased’s behalf and distribute the estate accordingly.
The big question is how much is this dreaded estate administration tax that everyone is trying to avoid? The answer is different in each province or territory. In some areas, such as Alberta, Northwest Territories, Nunavut, Quebec and Yukon, the amount is capped based on the size of the estate. In the other provinces, it is based on a percentage of assets. In Ontario, the first $50,000 of an estate pays $5 for every $1,000 (0.5 per cent), and anything over $50,000 will pay $15 for every $1,000 (1.5 per cent). An estate less than $1,000 does not pay the EAT. For example, a $1-million estate will pay $14,500 in estate administration tax.
Now that we’ve got that sorted, let’s talk about the types of assets that are subject to the tax. Real estate (yes, primary residences are included) less any encumbrances, any bank accounts, investments, vehicles such as cars and boats, business interests, other tangible goods and intangible property are all subject to the estate administration tax. The exception to this is any property that has a joint account holder with right of survivorship (JTWROS), or accounts with a named beneficiary. Things such as your tax-free savings account (TFSA), registered retirement savings plan (RRSP), registered retirement income fund (RRIF), locked-in retirement account (LIRA) and insurance policies are not subject to the tax. Note: if there is no beneficiary listed or it is listed as “the estate,” the asset will be counted in the calculation of the EAT.
At this point, most folks want to know why they should not make everything joint with their children or other beneficiaries. To be clear, it typically is a good idea for spouses to be joint on real property and non-registered money unless there is some other reason not to be, for example, creditor protection, income splitting or other reasons. However, adding other people such as adult children can have several unintended consequences. First, the asset now becomes 50-per-cent theirs, so it is exposed to creditors and a spouse in the event of a marital breakdown.
Take George, a widow, who adds Elaine, his daughter, on title to his $1-million home. If Elaine and her husband Jerry decide to split, Jerry could go after Elaine’s share of George’s house. This could end up costing much more than the $14,500 of estate administration tax George’s estate would be liable for. Inherited assets, as long as they are kept separate, do not constitute net family property. Jerry would have a much harder time getting at the house if it was inherited.
There are other potentially hazardous scenarios, but let’s assume the family is getting along fine. There could still be unwanted tax consequences. Adding a joint account holder to an investment account could trigger a capital gain depending on the ownership structure, because 50 per cent of the account may be deemed to have been sold.
It is important to ensure the intention of the ownership structure is documented properly. Working with a legal professional on this could save thousands of dollars. It is critical to understand that this can become more complex than most people anticipate.
Consider that there may be simpler ways to accomplish the goal of creating a tax-efficient estate. There is no gift tax in Canada. This means that if you have assets that you know you will not use and you’d like to pass on, you can do so during your life by simply gifting the asset. If the asset has accrued gains, for example, on a stock portfolio, you will have to pay tax to dispose of the asset. It is usually a better idea to gift assets with little or no capital gains such as savings accounts or guaranteed investment certificates (GICs). Some folks like this option (as long as it’s financially feasible) because they get to watch their children or beneficiaries enjoy the money. There are other measures that can be taken by using trusts, but they add complexity and should only be employed when the estate in question is at least $2-million.
For most people, it’s far more important to avoid having large balances in your RRIFs when you pass (if you do not have a surviving spouse), since they’ll be fully taxable and you will lose up to half to the taxman. Also ensuring your beneficiary designations and will are up to date can go a much longer way than exposing yourself to the perils of joint ownership. Don’t worry so much about the trade-in.