How to Limit Income Taxes at Death
Upon your passing, your assets aren’t simply transferred over to your loved ones according to your will. In Canada, certain taxes will be applied to your estate. That’s why it’s best to implement sound financial planning before your death so you can make sure your assets are distributed as you wish. Someone familiar with Canadian estate planning will maximize the final value of your estate that your family and loved ones will receive.
Here are some of the nuances that you and your family will need to know to optimize your post-death estate transfer:
Canadian Estate Planning
Estate planning is the first step to minimizing the work your loved ones will need to undergo in order to receive the maximum amount of wealth from their inheritance. This involves planning out exactly what will happen to your estate, including:
-Designating who the beneficiaries and heirs to your estate will be. When arranging this, be sure to name family members, friends, charities, and other organizations. You will need to specifically state who gets what.
-Appointing an executor to carry out your estate plan.
-Considering whether funds will be designated for a specific purpose. This can include funds set aside for a child’s education or funds for a loved one’s continued medical care.
-Deciding if you have assets that will be shared between friends and family after death, like a cottage or home.
While planning for your death is not the most appealing activity to carry out, having an estate plan is the first step towards minimizing the amount your heirs lose to taxes. This is especially important if you are unfamiliar with Canadian estate taxes.
Canadian Inheritance Tax Laws: How They Work
Canadian estate planning requires knowledge of how Canadian inheritance tax laws are administered. Here is an overview of how these tax laws work.
Death Tax and Inheritance Tax in Canada
In Canada, there is no inheritance tax, nor is there a death tax. The Canada Revenue Agency will instead treat an inherited estate like a sale from the recently deceased to the beneficiary. All taxes applicable to the sale will be paid by the estate.
Before the estate can be settled, the Canada Revenue Agency will require a Final Return to be filed by the deceased’s legal representative. Taxes are calculated from January 1st of the year of death until (and including) the date of death. These taxes must be paid by the estate before it can be settled.
Once the estate has been settled, the CRA will require a Clearance Certificate. This certificate will confirm that all taxes, including interest and penalties, have been paid. This will allow the legal representative to freely disperse the deceased’s assets, without being held liable for any taxes owed.
Specifics and Exceptions
Canadian estate planning requires knowledge of the specifics and exceptions in Canadian tax law. This will allow you to minimize the impacts that taxes have on what you leave behind for your heirs. This includes understanding:
Non-Registered Capital Assets
Non-registered capital assets include investment or rental properties, mutual funds, stock, or even a cottage. The CRA designates your unclaimed estate items as sold for their fair market value before death if you are not passing them onto loved ones. 50% of these capital gains incurred would be taxable.
With proper estate planning, these taxes can be deferred. One way to do so is to transfer an asset in kind over to a spouse or create a trust for the spouse. This allows the spouse to own the asset at its original cost. Taxes would not be calculated until the spouse dies, or until they actually sell the asset.
RRSPs and RRIFs
Upon your death, your RRSPs and RRIFs are deregistered. The deceased is considered to have received the fair market value of these assets prior to death. This means that RRSPs and RRIFs are included in the income of the deceased’s tax return.
To defer these taxes, a spouse or financially dependent minor can be named the beneficiary of your RRSP or RRIF. Upon the passing of the original asset holder, the RRSP or RRIF will be transferred to the beneficiary. However, be aware that tax consequences are applicable when the RRSP or RRIF is withdrawn by the beneficiary.
Other Canadian Estate Planning Strategies for Minimizing Taxes Upon Death
Giving your adult children a loan is another way to minimize your estate taxes. Since you created the loan, you’re able to control the terms of the loan agreement. That means you can specify that the loan is interest-free, and arrange the loan so it’s immediately forgiven at the time of your death. In other words, your adult child never has to pay back the loan.
You can give cash to an adult child without worrying about taxes. However, liquidating assets in order to create cash gifts will subject you to taxes, especially if you receive a capital gain. Having said that, the taxes on your cash gifts may be lower than the taxes calculated upon your death, and you’ll already have the cash from your capital gains available to pay off the taxes. This means fewer taxes that your loved ones will have to worry about.
An estate freeze allows you to exchange any growth assets for non-growth assets. This exchange allows you to freeze the taxes accrued from the time you acquire the growth asset to the time you initiated the freeze. The taxes accumulated during this time is payable by you, but not by your heirs. Only taxes accrued after the freeze will be payable by your heirs. This makes it easier to estimate how much will need to be paid in taxes after the freeze to the time of your death, which can often be paid through life insurance.
Charitable donations can be made in the year of death or after the year of death. This will need to be specified in a will. When these donations are made, tax savings become available, lowering the amount owed by the estate.
Strategic Canadian Estate Planning Will Minimize Stress for Your Loved Ones
Well-thought-out Canadian estate planning will save your loved ones plenty of stress when it’s time for them to receive their inheritance. To limit estate tax costs that they would have to pay or worry about, your Canadian estate planning will need to include a thorough understanding of Canadian tax laws, and the specifics and exceptions related to non-registered capital assets, RRSPs, and RRIFs. There are several ways to further minimize the tax burden on your loved ones after your death through interest-free loans, cash gifts, estate freezes, and charitable donations.
If the thought of Canadian estate planning overwhelms you, or if you’re worried about the details, contact the experts at Global Solutions West. We understand that you want your heirs to get the most out of their inheritance, and we’re here to make sure that happens. Contact us today.