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Invest Well. Live Well: How much tax do I pay when I die? (Part 1)

Invest Well Live Well2

As the old saying goes, “The only two guarantees in life are death and taxes.”

Many of our clients often ask how much will be lost to taxes upon death. It is a challenge to try to answer this question in 500 words or less, but hopefully this will provide some insight.

We have included some tips and strategies below to help reduce estate taxes in B.C.

There are two main tax burdens when an individual passes away:

i) Probate taxes: Apply to all assets that fall into the estate. This typically excludes assets in joint names and those with a named beneficiary. Probate laws vary across provinces and territories in Canada.

ii) Income taxes: In Canada, a person is deemed to have disposed of all assets upon death and may be subject to income tax. These must be paid upon completing their terminal tax return.

Generally speaking, when someone passes away, the surviving spouse is often the beneficiary and would typically inherit all assets tax-free as a spousal rollover.

These include: real estate, bank accounts and other investments kept in joint names as well as Registered Retirement Savings Plans (RRSPs), Registered Retirement Income Funds (RRIFs) and Tax-Free Savings Accounts (TFSAs) that have the surviving spouse named as beneficiary.

The larger tax bill often applies when the surviving spouse passes away. This is also typically the case for single or divorced individuals.

For illustration purposes, let’s consider a scenario in which Jane, a widow, has two adult children and passes away with the following assets:

• $800,000 principal residence paid • $400,000 in sole name

• $400,000 rental property paid

• $300,000 in sole name

• $500,000 RRSP/RRIF beneficiaries are two children

• $100,000 Tax Free Savings Account beneficiaries are two children

• $100,000 investment account in sole name with a $50,000 cost base

• $100,000 Vehicle and Bank Accounts

That is $2 million in total assets and net worth.

Probate tax in B.C. is approximately 1.4 per cent on all assets that fall into estates valued over $50,000.

Assets such as RRSPs, RRIFs, Tax Free Savings Accounts and life insurance with direct beneficiaries generally fall outside of B.C. probate.

For Jane's estate, everything except the TFSA and RRSP would be subject to probate. This would result in 1.4 per cent x $1.4 million, resulting in $19,600 her executor would need to pay prior to distributing the estate.

The larger bill comes from Jane's terminal tax return. Assuming she passed away on Jan. 1 and had no pension or other income, she would owe the following:

• No tax on principle residence since capital gains are exempt on primary residence

• $100,000 capital gain on rental property, of which 50 per cent is taxable

• $500,000 RRSP is fully taxable despite having named beneficiaries

• No tax on TFSA

• $50,000 investment capital gain of portfolio, of which 50 per cent is taxable

• Nothing on bank accounts or personal assets

Therefore, total Income is $575,000.

Using the Ernst & Young BC online tax calculator (www.ey.com) and assuming no other credits nor deductions, the deceased would owe about $263,290 in taxes, or an average of 46 per cent.

All said, the kids would be inheriting an incredible legacy valued at $2 million, minus $19,600 and minus $263,290, leaving $1.7 million, or $858,555 each, assuming the estate was divided equally between the two children.

We purposely left out private corporations due to their complex nature. New B.C. rules exist where it could make sense for shareholders to implement a secondary will specific to only their corporation. Given the unique nature of this, we recommend seeking trusted legal advice.

We often talk with clients who had the best intentions when trying to reduce estate taxes, but who were unaware of the potential ripple effects. Given the world of blended families, ever-changing tax rules and the sensitivity of money, we always feel it is best to review these with an estate/tax specialist.

Our next article will go over some of these potential tips and strategies to help reduce taxes.

The views expressed are those of Eric Davis, Senior Portfolio Manager and Senior Investment Advisor, and Keith Davis, Associate Investment Advisor, TD Wealth Private Investment Advice, as of May 4, 2022, and are subject to change based on market and other conditions. Davis Wealth Management Team is part of TD Wealth Private Investment Advice, a division of TD Waterhouse Canada Inc. which is a subsidiary of The Toronto-Dominion Bank.