Strategies to minimize taxes
Death and taxes. At least you can do something about one of them.
Just because you can't take it with you doesn't mean you should let the taxman take it from you. Especially if you want to continue providing for your family.
The taxman cometh.
There are several ways the government can potentially get their hands on your money:
- Deemed disposition. When you pass away, your estate is treated as if you’ve disposed of all its capital assets and is taxed according to their current market value. Things like property or investment portfolios will have appreciated over time and generated a capital gain, which is taxable.
- Probate fees. Probate is a mandatory taxation process where the provincial court verifies your will and estate value and then charges for the privilege. BC has among the highest probate fees in Canada; however, if the estate is very simple and doesn't need to involve a third party like a financial institution, the will may not need to be probated.
- U.S. estate tax. You may be liable for an American tax bill if you own anything considered to be "U.S. situs," (assets located within the States) such as real estate, stocks (even when purchased through a Canadian brokerage account) and certain bonds. You may want to consider either selling or transferring into a Canadian holding company.
The basic strategy behind minimizing taxes is to reduce the value of your estate. This means distributing your assets outside of the estate before it goes to probate. Here are six ways to do just that.
1. Give it away while you're alive.
The simplest way to avoid any tax issues. There may be some capital gains taxes for gifts of property.
2. Own assets jointly.
Otherwise known as Joint Tenancy With Right of Survivorship, taxation is deferred when the asset in question passes directly to a surviving spouse. But when that spouse passes away, the deferral stops, potentially saddling the estate with a substantial tax liability and leaving less for its beneficiaries. You may also want to consider joint ownership with a grown child. (Although there may be tax exposures here as well.)
3. Name beneficiaries for registered investments.
Life insurance† and registered investments such as RRSPs, TFSAs and RRIFs can be passed directly to named beneficiaries, avoiding probate. If a beneficiary isn't identified, they will be considered estate income and fully taxed. To avoid this, your plans will have to be rolled into your beneficiary’s registered plan, so it’s important to double-check their plan is eligible.
4. Use insurance products for tax-free benefits.
Life insurance is an excellent way to offset capital gains taxes. For example, an estate with $400,000 in capital gains could pay as much as $88,000 in taxes. A 20-year policy with an $88,0000 value (and a manageable $35 monthly premium) would cover this tax bill. Alternatively, by taking out a larger policy, the higher benefit could cover funeral expenses or other estate costs. Talk to your financial advisor about what type of insurance is suitable and the amount you'll need to purchase. Products like segregated funds and annuities sold through insurance companies aren’t taxable and can pass directly to beneficiaries.
5. Use joint last-to-die insurance to defer taxes.
By purchasing a joint last-to-die policy for you and your spouse, there'll be enough funds to pay any capital gains taxes when the survivor passes on. This policy pays benefits only when the second of two insured parties dies – just when capital gains taxes become due. Since two people are insured under one policy, joint last-to-die coverage usually costs less than individual insurance. A joint last-to-die policy can also be extremely useful when one spouse has health issues that limit eligibility for life insurance. The healthy spouse would carry the policy.
6. Transfer assets to a trust.
When setting up a trust to hold a major asset, such as a vacation property, you can name your children as beneficiaries. Then, taxes on any capital gains created during the trust's existence will be deferred until they eventually sell or transfer title.