Each year in Canada, billions of dollars in assets are transferred at
death. If you plan to transfer all or some of your assets to your
heirs, you want to make sure your money
goes to the people you selected in the manner you intended.
Unfortunately, wealth transfers don't always occur as planned. Outlined
below are some common mistakes people make when trying to transfer
wealth.
Failing to have a will
A basic and all too common mistake is failing to have a will. A will
communicates your intentions and allows you – and not the government –
to determine how your assets will be distributed upon your death. Having
a will facilitates the administration of your estate and can help you
save taxes. It also allows you to choose the executor of your estate ant
the guardian(s) of your children.
Treating equal beneficiaries unequally
Often, when splitting assets, the intention is to divide them equally
among beneficiaries- for example, equally among three children.
However, if you fail to take into account the tax consequences, the
wealth transfer may not be equal. Take a simple example in which you
have three assets: a Registered Retirement Savings Plan (RRSP), a home
and a non-registered mutual fund
portfolio. Each asset is worth $1 million. You name your first child as
beneficiary of you RRSP, and in your will you leave the house to your
second child and the mutual funds to your third child. You think you are
leaving $1 million to each child, but the reality is that the third
child, who is receiving the mutual funds under the will, is going to
have his or her share reduced by any tax your estate pays on the RRSP
and the mutual funds. Assuming a 40 percent effective tax rate, your
estate will pay $400,000 in taxes on the RRSP, in addition to any
potential taxes on the deemed disposition of the mutual funds, which
we'll assume are $100,000. As a result, the third child will be left
with $500,000- significantly less than the $1 million the first and
second child each received, and not what you had intended.
Spousal issues
Another example of failing to consider the tax implication often
involves second marriages or separated and estranged spouses. For
example, let's say you name your spouse as the beneficiary of your RRSP
or RRIF to provide for him or her after your death, and you name your
children (perhaps form a previous marriage) as beneficiaries under your
will to inherit the rest of your estate. You assume that your spouse
will roll over your RRSP or RRIF to his of her own RRSP or RRIF, and pay
tax on any withdrawals. But what if your spouse doesn't do this?
Instead, he or she just takes the cash. Well, your estate will be
responsible for any taxes on the RRSP of RRIF, which effectively means
that money comes out of your children's inheritance. Under These
circumstances, it is possible that the legal representative of the
estate to make a unilateral election to deduct the amount paid form the
RRSP or RRIF in the estate. This effectively transfers the income
inclusion to the surviving spouse. Alternatively, if you have a RRIF,
consider naming your spouse as successor annuitant or Joint Life. This
will automatically transfer the RRIF to your spouse on a tax deferred
basis.
Minor beneficiaries
It is important to consider the age of the individual you name as
beneficiaries. Remember that generally death benefits cannot be paid
directly to minors, so if you name a child as beneficiary the funds
often have to be paid into court or to the Public Trustee. In addition,
once a minor reaches the age of majority, he or she will be entitled to
the funds, without any restrictions.
If you want the death benefit to go to a minor, it is recommended
that you establish a trust to receive the funds on behalf of the minor.
The terms of the trust can set out how you want the funds to be invested
and when payments are to be made for the benefit of a minor. If done
properly, the trust could qualify as a testamentary trust and benefit
from being taxed at the graduated tax Rates.
Failing to name a beneficiary on insurance polices and contracts
Unless there is a specific reason for having assets flow through your
estate, such as to make use of tax losses or deductions or to apply any
special instructions contained in the will, it may be a better idea to
name a beneficiary directly on an insurance contract where possible. If
your will is submitted for probate, it becomes a matter of public
record, available for anyone to view. This may delay the distribution of
your estate by weeks months or even years if your will is challenged.
When a beneficiary other that your estate is named on an insurance
policy or investment contract (such as a segregated fund contract), the
death benefit bypasses your estate and therefore avoids probate fees
(and potentially other estate administration fees). The proceeds are
paid directly to the beneficiary, usually within two weeks of receiving
all necessary documents. By avoiding your estate, the death benefit may
also avoid claims by creditors of the estate and challenges to the
validity of the will.
Unused charitable donations
If you are planning on making a significant charitable donation at
death, steps should be taken to ensure that your estate will be able to
use the entire donation receipt. While the limit for claiming donation
receipts at death is 100 percent of net income in the year of death and
the year prior to death, it is still possible for there to be unused
receipts. Individuals making extremely large donations relative to their
annual income, who die early in the calendar year of who name a charity
as beneficiary of their non-registered investment or life insurance
policy nave a greater risk of having unused charitable tax credits.
Naming a charity as a beneficiary of an RRSP or RRIF is usually not a
problem because charitable receipts van be used to offset the tax on the
income form the RRSP or RRIF. If you have a spouse with sufficient
income, he or she could also claim any unused charitable receipts for
the next five years.
If you are concerned that you may have unused charitable receipts at
death, consider making some charitable donations during your lifetime
and reduce your taxes payable now.
As you can see, there are many reasons why it is important to plan
for a wealth transfer if you don't have a will, arrange for your lawyer
to prepare one. Review your will and beneficiary designations regularly,
particularly after a life-changing event, to ensure they still reflect
your wishes – and amend or update them as necessary. In addition, meet
with your advisor to discuss your wishes for wealth transfer. He or she
will be able to help ensure that your assets are distributed as you
wish.
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