It's often said that death and taxes are inevitable. Yet even after death, taxes can dog investors who want to leave money behind for loved ones and charities.
In most cases, the tax collector gets one last cut of your wealth, and the final bill can be supersized – coming close to 50 per cent of the value of your investments. For this reason, adequate planning is worthwhile, says accountant and financial planner Fabio Campanella.
"One of the most basic things people must consider when leaving securities such as stocks to others in their will is the tax considerations," says Mr. Campanella, a money manager and partner at Campanella McDonald LLP in Oakville, Ont.
"In a nutshell, when you die, there is a deemed disposition of all your assets at their fair market value," he says. This means your investments are cashed out, as far as the Canada Revenue Agency is concerned – whether they've been sold or not – and applicable taxes are determined.
The one big exception is that, generally, most assets can be passed tax-free to a spouse. But if you have no spouse, or you leave assets to other beneficiaries in your will, your estate will likely face a tax bill.
Complicating matters are investment accounts such as registered retirement savings plans (RRSPs) and tax-free savings accounts (TFSAs).
"Each of these has a different tax treatment with different implications and planning opportunities," says Abby Kassar, vice-president of high-net-worth planning with Royal Bank of Canada's Wealth Management Services in Toronto.
RRSPs, registered retirement income funds (RRIFs) and other registered accounts often present the biggest tax liabilities because all their assets are considered fully taxable upon death. "So the full value would be included on your final tax return, subject to tax at your marginal tax rate," Ms. Kassar says.
For individuals who spent much of their adult lives paying taxes in low to middle brackets, it's often a shock to realize their estate could end up being taxed at the highest marginal rate, she says. In Ontario, for example, the combined federal and provincial taxes can be as much as 49.53 per cent on income exceeding $220,000.
Non-registered assets, however, may be taxed more favourably. Cash in savings accounts and guaranteed investment certificates (GICs) is non-taxable – except for interest earnings accrued for the year – and can flow through the estate to beneficiaries.
Over all, stocks and other investments with capital gains in taxable accounts receive more favourable tax treatment than those earning interest, Ms. Kassar says. The main advantage is that only half of the capital gain is taxable, compared with interest earnings, which are fully taxable.
If an asset has dropped in value, you could potentially have a capital loss, too, Ms. Kassar says. This could be beneficial, because losses can help offset taxes owing on capital gains associated with other investments.
Yet regardless of whether the deceased's will instructs that investments be sold and divided up among beneficiaries or passed on in kind, the associated capital gains are taxable.
The exception to this rule is investments held inside a TFSA. Capital gains, dividends and interest earnings can be passed on to beneficiaries without tax consequences, though some taxes may be applicable afterward.
"That's because at the time of death, the tax-free nature of the plan ceases," says Caroline Kiva, a lawyer specializing in estate planning with Pitblado Law in Winnipeg. "The earnings in the plan become taxable from the time of death onward."
Taxes on gains from that point would be payable by the estate. If the assets have not gained any value – or lost value – from the time of death until they're bequeathed, the beneficiaries can contribute them directly to their own TFSA if they have the contribution room, Ms. Kassar says.
While most people have all their assets pass through a will, some designate direct beneficiaries on specific accounts – like the RRSP – to avoid probate fees, Ms. Kiva says. "But you're only avoiding probate fees, not the taxes," she says, adding the estate must pay taxes on assets even if they are not considered part of the estate.
If, for example, one beneficiary receives the registered plan outside the estate and one beneficiary receives the assets in the estate, this can cause a problem. The former receives the gross value, while the latter has his or her inheritance reduced because some of the money was used to pay taxes associated with the assets that passed outside the estate.
In the event the estate does not have enough to pay the tax bill, the CRA can go after the beneficiary receiving the asset outside probate.
Yet in many instances, tax planning can help reduce these liabilities.
"You can do some predeath selling," Mr. Campanella says. "You can start realizing some of those gains over several years, thereby taking advantage of the lower marginal tax rates you get year over year if you are not in the highest tax bracket."
Or individuals with plenty of cash flow can purchase whole life insurance that will pay a non-taxable lump sum that will cover the taxes associated with the portfolio. While the premiums are often costly, this strategy can be helpful when passing stock in kind in the estate and spare the executor from having to decide which securities to sell to pay taxes.
"I'm not a big fan of this strategy if the tax will be payable on an investment portfolio, as no one really has any emotional attachment to stocks – as opposed to a family cottage – and you can just as easily liquidate a portion of the portfolio to cover the tax bill at death," Mr. Campanella says.
Another strategy is donating securities in kind to registered charities. While donating cash will also reduce taxes payable by the estate, donating in kind offers another advantage, Ms. Kassar says.
"You eliminate taxes owing on the capital gains on the securities that would have been owing if they had been sold by the estate, and then there's the tax credit for the value of the donation that can be used to reduce taxes owing on other sources of income."
And while estate planning for your investments may involve considerable complexities – on par with planning for retirement – it's generally an afterthought, Ms. Kiva says.
"A lot of people are not fully aware of the potential complications, and at first glance, they believe a will covers off how they want all their assets distributed," she says. "But it's important to take a comprehensive approach so no loose ends are left untied."