Where there’s a will, there’s a way to cut tax
Federal rule changes will have an impact on estate planning
Changes in estate planning are on the horizon as the federal government proceeds with adjustments to the taxation of trusts and life insurance, two popular tools used to control the distribution of assets while reducing, deferring or avoiding tax.
Trusts involve a settlor who owns the assets while alive, plus a trustee who administers the assets and distributes them to beneficiaries. An inter-vivos trust, sometimes called a family trust, is created while the settlor is alive, and trust income is taxed at the top federal and provincial income tax rates, totalling 39 per cent in Alberta. Conversely, a testamentary trust is created upon death, usually within a will, and includes an estate, with trust income taxed at personal graduated tax rates. An Albertan would pay combined federal and provincial tax of 25 per cent on testamentary trust income starting at $17,593, gradually rising to 39 per cent on income above $135,054.
But the federal government has just released a consultation paper to eliminate by 2016 the use of graduated tax rates by testamentary trusts, estates after a reasonable administration period, plus grandfathered inter-vivos trusts created before June 18, 1971.
“That creates significant change in the usage of any sort of testamentary trust,” said Michael Oseen, senior manager with accounting firm Grant Thornton, at an Edmonton seminar for Canaccord Capital Wealth Management. “A classic move was that every beneficiary of a will had their own testamentary trust and each one had access to a graduated tax rate, starting at 25 per cent tax in Alberta versus 39 per cent.”
The federal government is also proposing to eliminate tax benefits for two insurance products in 2014 — a leveraged insured annuity and a 10/8 arrangement.
“CRA would probably limit the ability to put money into an insurance policy and have it grow on a tax-deferred basis,” said Gary Steen, regional marketing director with Manulife Financial.
Steen says that half of Canadians surveyed in 2007 did not have a will. Dying intestate means losing control over where a person’s assets go upon death, and losing opportunities to preserve as much of the assets as possible through tax avoidance and deferral. He says people in the lifeinsurance industry don’t refer to death, using the euphemism “actuarial maturity,” and a probated will becomes a matter of public record that anyone can get for a fee.
Steen says that assets like Registered Retirement Savings Plans, Registered Retirement Income Funds, pensions, life insurance and certain nonregistered investments allow you to name individuals as beneficiaries, thus reducing or avoiding the cost of probate, deferring tax and allowing a quicker and easier transfer of assets.
“When an asset flows outside the will, it’s not subject to some of the regulations that wills are subject to, it doesn’t flow through the estate. But bypassing an estate doesn’t necessarily mean bypassing tax.”
Some assets can be held jointly, with right of survivorship. But courts can decide if an asset was held jointly to avoid the cost and delay of probate, or if the surviving joint owner was meant to inherit the property outside of the estate. Attaching a form called a Deed of Gift to your will can signify intent.
Other popular estate planning tools are gifting before death, an estate freeze, trusts, life insurance, holding companies and operating companies.
Gifting to registered charities produces federal and Alberta tax credits totalling 25 per cent on the first $200 and 50 per cent on the amount above that. An estate freeze before death makes beneficiaries pay tax on any increase in the value of taxable assets after the time of the freeze. Trusts are used to control the dispersal of assets and reduce or defer taxes. Part of all life insurance payouts can be tax-free. And for business owners, you can combine an estate freeze with an operating company, family trust and a holding company.
Estate freezes are relatively inexpensive to set up, but a trust can cost $4,000 to $5,000 in tax advisory fees, plus a similar amount in legal fees.
“A lot of people think they can benefit from trusts but they don’t really,” Oseen said. “A lot of owner-managers with active businesses can benefit from them, providing access to the $750,000 capital gains exemption, going up to $800,000 January of next year. And it can be an effective way of dealing with significant unregistered investment portfolios, from an income-splitting position and estate tax liability. If the trust is just for an investment portfolio, quite often it only makes sense for $1 million or more.”