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 answer this question in 500 words or fewer, but hopefully this will provide some insight. We have included some tips and strategies below to help reduce estate taxes.
There are two main tax burdens when an individual passes away:
• 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.
• Income taxes: In Canada, a person is deemed to have disposed of all assets upon death and subject to income tax. These must be paid upon completing their terminal tax return.
Generally speaking, when a spouse passes on, 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, registered income funds and tax-free savings accounts that have the surviving spouse named as the beneficiary.
The larger tax bill often applies when the surviving spouse passes away. This is also the case for single or divorced individuals.
For illustration purposes, let’s consider a scenario in which Jane, a widow with two adult children, passes away with the following assets:
• $800,000 principle residence paid $400,000 in sole name;
• $400,000 rental property paid $300,000 in sole name;
• $500,000 RSP/RIF beneficiary are two children;
• $100,000 tax-free savings account beneficiary are two children;
• $100,000 investment account in sole name with a $50,000 cost base;
• $100,000 vehicle and bank accounts;
• Zero debt;
• $2 million in total assets and net worth.
Probate in B.C. is approximately 1.4 per cent on all assets that fall into estates valued over $25,000. Assets such as RSPs, RIFs, tax-free savings accounts and life insurance with direct beneficiaries generally fall outside of probate.
For Jane's estate, everything except the TFSA and RSP would be subject to probate. This would result in 1.4 per cent multiplied by $1.4 million equalling $19,600 that 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 primary residence as exempt from capital gains;
• $100,000 capital gain on rental property of which 50 per cent is taxable;
• $500,000 RSP is fully taxable despite having named beneficiaries;
• No tax on TFSA;
• $50,000 investment capital gain of which 50 per cent is taxable;
• Nothing on bank accounts or personal assets.
Total Income = $50,000 + $500,000 + $25,000 = $575,000.
Using the Ernst & Young BC online tax calculator (www.ey.com) and assuming no other credits or deductions, the deceased would owe about $264,270 taxes, or an average of 46 per cent. All said, the kids would be inheriting an incredible legacy valued at $2 million - $19,600 - $264,270 = $1.7 million — or $858,065 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 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 specialist.
Our next article will go over some of these potential tips and strategies to help reduce taxes.
Until next time, Invest Well. Live Well.
Written by Eric Davis. This document was prepared by Eric Davis, vice-president, portfolio manager and investment advisor, and Keith Davis, investment advisor, for informational purposes only and is subject to change. The contents of this document are not endorsed by TD Wealth Private Investment Advice, a division of TD Waterhouse Canada Inc.-Member of the Canadian Investor Protection Fund. All insurance products and services are offered by life licensed advisors of TD Waterhouse Insurance Services Inc., a member of TD Bank Group. For more information, call 250-314-5124 or email Keith.firstname.lastname@example.org.