For Canadians entering the home stretch in their working lives and shifting focus to retirement, estate planning begins to loom large.
Unless you plan to spend every penny of savings – in other words, if you can gaze into a crystal ball and predict the exact year of your death – you will need an estate plan to transfer assets to your heirs.
The good news is that many of the best practices for maintaining and maximizing inheritance are the foundation of financial planning: get professional help, set realistic goals, create an achievable plan, try to maximize returns (and minimize tax) and make sure all the necessary paperwork (there will be more of it) is complete.
Goal setting for estate planning is the starting point, just as it was when creating a financial plan, said Susan Latremoille, a director of wealth management with Richardson GMP Ltd. in Toronto and author of The Rich Life – Managing Wealth and Purpose.
An estate planning "team" could include a financial adviser, an accountant to help minimize taxes of the estate, and lawyer to handle wills, powers of attorney and even the creation of trusts.
For Ms. Latremoille, who advises wealthy individuals and their families, the next step is creating a wealth and investment plan to achieve retirement and inheritance goals.
"Growing wealth in retirement safely is a lot trickier today than in decades past, when bonds paid returns of 8 to 10 per cent," she noted. Today, bonds are actually a risk asset, so she is turning to so-called alternative investments for the safety and steady returns that bonds used to provide. Those include private equity, real estate, hedge funds and infrastructure investments.
Once that is taken care of, Ms. Latremoille urges clients to tackle the paperwork, especially creating or updating their will. "That is something that shocks me – the number of people who either don't have a will or they haven't looked at it in years." A 10-year-old will, she says, likely won't be able to take account of the current mix of assets or the situation of children and extended family.
Naming the "right executors" is another critical step, Ms. Latremoille said. An executor chosen to deal with your financial affairs should you become incapacitated should also be able to deal smoothly with other family members.
Minimizing taxes paid to the government should be a key component of any estate plan. Most of that planning needs to be done in advance or else rules and rates will kick in automatically.
Estate plans should try to eliminate taxes on the deemed disposition of assets upon death, the taxation of a registered retirement account and the potential of probate taxes in some provinces, said Jamie Golombek, managing director of tax and estate planning with Canadian Imperial Bank of Commerce's Private Wealth Management unit in Toronto.
Any real estate that has gained in value over the years, along with assets held in registered retirement savings plans and registered retirement income funds, can be passed on to a spouse on a tax-deferred basis, he noted.
Non-registered equities and other securities that may have grown substantially in value over the years and could result in a major capital gains tax headache for heirs, can be willed to a charity tax-free and provide tax relief for beneficiaries.
Mr. Golombek views life insurance as "a wonderful way to transfer assets on a tax-free basis." Many of his firm's clients are shifting a portion of their non-registered investments to fund universal or whole life insurance policies.
"By doing so they are taking excess assets that they don't need during their lifetime, moving them inside of a tax-free life insurance policy and that money grows tax-free inside the policy, and upon death it provides a completely tax-free life insurance death benefit" to named beneficiaries who could be a spouse, children, grandchildren or even a charity.
Buying life insurance to cover the capital gains tax hit from the appreciated value of the much-loved family cottage, or even rental properties or an investment property, is proving to be an increasingly popular strategy, said Mark Goodfield, a chartered accountant and partner with Cunningham LLP of Toronto and author of the Blunt Bean Counter tax and investing blog.
"They don't want their kids to be forced to sell the cottage in a fire sale or their stocks if it is in a bad market, so they get life insurance now while they are healthy for $500,000, let's say, and they know that when they die that money can be used to pay the tax bill."
Mr. Goodfield often sees people make fundamental and costly mistakes in an effort to avoid taxes and probate fees.
A common example is in leaving real estate such as vacation or rental property to children. Simply handing the kids the title does not cut the tax man out of the picture. "You are deemed by Revenue Canada as having sold the property to each of those children," he said. "So what they do is create a huge tax liability."
Mr. Goodfield sees a similar mistake being made when couples divide and leave portions of their primary residence to their children. If they are grown and have their own homes, the property can't be considered their primary residence and passed on tax free.
Mr. Goodfield warned that even some professional advisers can get tripped up on the tax implications of intergenerational wealth transfer.
"I just had somebody who came in this week and their lawyer had told them to put their kids' names on a cottage and technically under the Income Tax Act they created a capital gain."
Canadians seeking to reduce the tax on their estate and maximize what they pass on to beneficiaries should consider a testamentary trust. Established as part of a will to take effect upon the death of its creator, the main benefit of a testamentary trust is that it can provide lower tax benefits for your heirs.
"The testamentary trust is considered to be a separate taxpayer that pays not at a high tax rate, but at a graduated rate," said Jamie Golombek, managing director of tax and estate planning with CIBC Private Wealth Management.
The trust allows beneficiaries "the opportunity to have a separate set of graduated rates every single year after you are gone," Mr. Golombek said. The benefits are particularly beneficial for those in higher tax brackets.
A testamentary trust can provide other peace-of-mind benefits for sponsors. Such a trust could be set up to provide for a disabled beneficiary, or for someone with worrisome spending habits or questionable financial acumen. It could also provide protection against trust assets being accessed by spouses of the named beneficiaries.