WHAT IS ESTATE PLANNING?
Estate Planning is the term used to describe the techniques an individual can employ to provide for his or her own financial safety, and that of their family. In times when the private sector employment is less secure, and benefits reduced, while the public sector safety nets are shrinking and unravelling, individual responsibility for their own financial health is critical.
Estate planning consists of three stages:
- Wealth creation, which is the process by which one builds up assets. This process includes strategic investment, maximization of resources, debt reduction and cash flow management. Helpful professionals include lawyers, accountants, investment brokers and other financial consultants.
- Wealth preservation, means the various ways in which the money we earn and the assets we build up can be protected against creditors and taces. Accountants and lawyers can usually assist in planning techniques to preserve your hard-earned estate.
- Succession planning, refers to the manner in which the assets you still retain at the time of your death are passed on to your spouse, children and other heirs to protect and provide for them. Taxes, probate taxes, creditors, court costs, family disputes and other risks must be identified and avoided in the planning process. Here again, lawyers and accountants are the professionals best trained to ensure your estate flows effectively to your chosen beneficiaries.
It is becoming increasingly important to make plans now for the eventual passing of an estate to the next generation. Capital Gains Taxes, probate taxes and the threatened Wealth and Inheritance Taxes all combine to create a hostile environment for children in which to inherit form their parents.
This is not to say that we should hoist the white flag and voluntarily donate all of our assets to the various levels of government! There are many approaches to limit the exposure to tax. One route that has been mentioned before is for parents who have real estate (other than their own home) to transfer the property to children. Properly handled, this can result in substantial savings of Capital Gains Taxes as compared to leaving the property to the children in a will. Anyone with a cottage, commercial property, rental units or even vacant land should consult a lawyer or accountant without delay to determine how much tax can be saved by this transfer.
Another popular technique is for a spouse who owns real estate in his or her name alone to transfer it into joint tenancy with the other spouse. This low cost step will not save any Capital Gains Taxes, but it will avoid payment of probate taxes on the value of the property on the death of one of the spouses.
Despite the fact that there are frequently benefits to such family transactions, they are not always appropriate. We were once requested by a widowed client to transfer her house into joint ownership with her children. She wanted to ensure that the house transferred to her children without payment of probate taxes.
We advised her not to do this as there was a detrimental aspect to this plan that more than outweighed the benefit. The home was her princpal residence, and as such all capital gains are completely exempt from taxation. If the house remained in her name, it could be transferred to her children or sold following her death without the estate being liable for any Capital Gains Taxes whatsoever.
Had we changed the title into joint ownership with her three children, the result upon her death would be very different. If the house increased in value by even 10% between the date of the change in title and her death, and was then sold, the Capital Gains Tax paid would significantly exceed, and perhaps even double, the predicted probate costs. The reason is that only the mother’s one quarter ownership would qualify for exemption as a principal residence, and the three quarters owned by the children would be subject to capital gains.
Successful estate planning cannot be purchased from a shelf or learned from a book. It requires the involvement of a team of expert people with the common goal of creating, managing and protecting your wealth. However, the most important “expert” for your own financial well being is you.
AVOIDING PROBATE TAXES
We have all heard the phrase, “You can’t take it with you.” This may be true, but it does not necessarily mean that your affairs should be arranged to give it to the government when you die.
Most people, in their Wills, leave their estates to their spouse. Most go on to say that if the spouse has already passed away then the estate goes on to the children.
This is sensible planning, but prudent drafting of the Will should include protection against double probate.
Double probate is the unhappy result of a tragedy. If both husband and wife die simultaneously or within a short time of each other, all of the probate taxes and legal costs will be incurred to administer the estate of one spouse. Then that estate is turned over to the other spouse’s estate. The second estate is then administered, resulting in duplication of probate taxes and legal costs before the children inherit.
Since the provincial government tripled the probate taxes in 1992, this adds insult to injury. No one wants to have thousands of dollars unnecessarily diverted from their loved ones to the government.
Fortunately, there is a simple solution available to minimize this problem. The Will can include a clause that states that the spouse only inherits if he or she survives the death of the first spouse by a certain period of time.
Determining how long a period of time should be provided requires a balancing of the wish to ensure that the spouse does live long enough to inherit, against the risk of an undue delay in the administration of the estate. For example, a typical “double probate” clause will provide that the spouse must survive 30 days before inheriting. However, this may be too long. If a real estate transaction is in progress, or if investments must be dealt with, or if bank accounts are in the name of the deceased spouse only, forcing a wait of one month before even starting the process of probate and administration may cause serious difficulties. It is not unknown for the surviving spouse in these circumstances to have to borrow to pay bills and buy necessities until things get under way.
We normally recommend a 10 day period in the “double probate” clause. Usually this is a sufficiently short a wait that no hardships arise. However, if the spouse is still alive then he or she is likely to survive indefinitely.
If you have a Will, we suggest that you check your copy to ensure that it has appropriate protection against the perils of double probate. If you can’t find your copy, then you certainly should obtain a copy and conduct a thorough review. If you don’t have a Will at all, the government will be very pleased, as you have “arranged” your affairs to maximize the probability of payment of maximum probate taxes!
JOINT OWNERSHIP FOR SPOUSES
When we discuss estate planning with our clients, we do not stop after reviewing the Wills and the Powers of Attorney. Usually the discussion continues to analyze the estate to avoid or minimize probate taxes.
Probate taxes are taxes, despite the more palatable but misleading reference to “fees”. Upon death, when the executor applies for court authority to deal with the estate assets, the court charges probate “fees”. The fees start at $5 per thousand on the first $50,000 and then triples to $15 per thousand on everything above $50,000.
One common way to avoid probate taxes upon the death of a spouse is to ensure that assets are jointly owned. When one spouse dies, ownership of the asset passes to the surviving spouse. Since this does not happen through the Will, but through right of survivorship, the probate taxes do not apply.
Accordingly, it generally makes good sense for spouses to hold their assets in joint ownership. The family home and bank accounts are commonly held this way.
Frequently, investments such as GICs or Canada Savings Bonds are not. The reason given for this is the wish to keep these income producing assets in separate names so as to allow each spouse to report their own income on their own tax returns. The same money comes into the family, but because it is divided between the spouses the effective rate of taxation is lower. This income splitting should produce more after-tax disposable dollars for the family.
The fear of losing the income splitting advantage by joint ownership is unfounded. You can have your cake and eat it too. The investment can be in joint ownership to avoid provincial probate taxes, and the advantage of income splitting can be retained for federal income tax purposes.
We recommend to all our clients that the investments be changed into the names of both spouses, with right of survivorship. There should be no charge for this, although with Canada Savings Bonds this has to be done during the annual sale period.
For ease of reporting at income tax time, we suggest that the husband put his name first on his investments, and the wife puts hers first on her investments. Then, when the T5 information slips are provided for tax reporting, it is easy to tell what income is to be reported in each spouse’s income tax return.
The benefit of the joint ownership is primarily probate tax savings. On a $50,000 GIC, the savings to the surviving spouse may be as much as $750. As well, the transfer of the asset is simpler and quicker.
Remember, the joint ownership technique of avoiding probate taxes works best for spouses. It is not recommended between parent and child, without additional protective steps. Otherwise, the parent may suffer loss of control and be exposed to creditor risks, while the child may have income tax problems. If you wish to use joint ownership between parent and child, please see your lawyer for the appropriate protective measures.
PERILS OF JOINT OWNERSHIP
We all hope to arrange our affairs to minimize probate taxes and simplify our estate administration. These are worthwhile goals, and many look to joint ownership of property and investments as the solution. Joint ownership of assets is often recommended for spouses. However, joint ownership of assets has hidden pitfalls if children are involved.
I have frequent requests by a widow to put her house in joint ownership with one or more children. Usually I try to convince her not to take this step. The problem is that when the house is sold, either during the mother’s lifetime or after her death, capital gains taxes may have to be paid. While Mom is the sole owner, the whole gain is exempt because the house is her principal residence. If she owns only 50% of the house because of the change to joint ownership, then capital gains will be triggered on the child’s half. The capital gains tax payable, even on half the value of the property over a relatively short time, is almost certain to be more than probate taxes avoided.
What about joint ownership with children of other assets, like Guaranteed Investment Certificates? Again, this may result in serious problems. To cash or renew the GIC on maturity, the child’s signature will be required. This may be easy and quick, or it may be inconvenient and delayed. In a worse case situation, the child may be incompetent or refuse to co-operate. Either way, the parent has lost control of the asset.
Another problem is the risk of exposing the parent’s assets to the child’s financial difficulties. If a judgment is obtained against the child, or if the child goes bankrupt, then the jointly owned GIC will be vulnerable to the creditors.
The child may have tax problems from jointly owned investments as well. Since the child’s name is on the investment, the tax information slips will be in both names as well. Revenue Canada may take the position that the child should include half the income in his or her tax return, even though all income was retained by the parent.
Some still insist upon joint ownership of investments. If so, they should have a Joint Ownership Trust Agreement prepared and signed that will avoid the problems.
I do not mean to say that joint ownership of assets with children is never appropriate. The point is that no single solution will work well in all cases. For joint ownership, the technique that worked so well to pass assets from spouse to spouse at minimal cost and delay may actually create greater problems if used with children.
Many people have not contributed the maximum entitled amount each year. Fortunately, we are permitted to carry forward any unused contributions since 1991. Accordingly, you may have “room” to contribute much more to your RSP than the limit of a particular year.
If you have made your contribution limit this year, but did not in the last few years, then the unused amounts can be contributed now. This carry forward contribution will also reduce this year’s income and tax payable, just like your usual annual contribution. As well, the carry forward contribution will generate and accrue interest on the same tax free basis. Of course, when any money is drawn out of the RSP, it is then treated as taxable income.
Every taxpayer should find out how much extra room he or she has to contribute to the RSP because of the carry forward, and make every effort to use up that contribution room. If you have some money in investments outside the RSP, like a savings bond or GIC, it can be rolled into your RSP. This will trigger a tax reduction this year, and permit the income to accumulate tax free from now until you draw it out of the RSP.
If you find that you have room, you can make your RSP carry forward contribution at any time. The cut off date of March 1 does not affect this. Remember that many existing investments, like Canada Savings Bonds, stocks and GIC’s can usually be rolled directly into your RSP. From that moment on, all income will accumulate and compound tax free, and you will no longer receive those pesky T5’s to add to your income and trigger tax payments from your pocket.
LEAVING YOUR HOME TO YOUR CHILDREN
One of the estate planning questions we are asked most frequently, both by clients and at seminars, is: “What is the best way to leave my house to my children?”
This is a very good question to ask, since the family home is often the single largest asset in the estate. If no planning is done, the house passes through the will to the children. The advantages are that there is no cost now to this “planning,” and the parents can change their minds and sell the house without any obstacles should they need or want to do so. The disadvantage is that the estate will likely pay probate taxes (over $2000 on a $135,000 house). In addition, there is the threatened Inheritance Tax to consider.
What are the alternatives? There are three basic options, each with their advantages and disadvantages.
- The first is to put the house into joint tenancy with the child or children. The advantages of this option are the relatively low legal taxes and disbursements: no land transfer tax is payable, and the parent retains a measure of control as a joint owner. The child can not sell or mortgage the house without the parent’s consent. The disadvantages are that the child’s portion of the house may lose the principal residence exemption from the Capital Gains Tax, the home may be attacked by the child’s creditors if there are financial problems, and if the parent needed to sell the home the child’s co-operation would be required. In a worst case scenario, if the child refused or was unable to co-operate, the parent might be prevented from selling when he or she deemed it necessary. Then litigation might be required.
- A second alternative would be to transfer the house to the child now, but the parent would retain a life interest. Again, the legal costs are low, and no Land Transfer Tax is payable. No capital gain would apply, since the disposition of a principal residence is exempt. Upon the death of the parent, the child would be the sole owner, and no probate taxes would be payable. Unfortunately, the subsequent capital gains exposure, vulnerability to the child’s financial problems, and dependency on the co-operation of the child to sell during the parent’s lifetime are still applicable, as with the transfer into joint ownership.
- The third alternative has great potential benefit for estate planning and probate tax avoidance. Its benefits go beyond the family home. This alternative is the use of a revocable trust. The ownership of the house is transferred to a trust. The trust terms provide that upon the death of the parent, the house is to be transferred to the child. During the lifetime of the parent, the house could be sold by the parent without the necessity of involoving the child. The proceeds of sale could be left in the trust and used by the parent as he or she saw fit. Any balance left in the trust upon the parent’s death would go to the child, without probate taxes.
This last technique avoids the loss of the principal residence exemption, and is therefroe the safest from a capital gains viewpoint. It completely insulates the house from problems arising from the child’s financial affairs, mental incompetency or lack of co-operation. There is no income tax savings or cost. Complete control of the house or sale proceeds are retained by the parent during his or her lifetime.
The bad new is that although no Land Transfer Tax is payable, the legal costs of setting up such a sophisticated and flexible vehicle are considerably higher than for a simple transfer of deed as in the first two approaches.
The good news is that once the trust is set up, it can be used for many other purposes at no additional cost. For example, the parent could transfer investments such as GICs into it. Again, so long as the parent is alive he or she has full control over the contents of the trust. All of the income goes to the parent, and investments can be cashed in and the proceeds spent by the parent. A lack of co-operation with the child, or the actions of the child’s creditors, would have no impact upon the security of the trust assets for the parent.
If income producing investments are transferred to the trust, then an annual trust income tax return will have to be filed. This is very simple though. All of the trust income goes out to the parent, so the trust pays no tax. The parent’s income tax situation is exactly the same as if the income was directly received.
The revocable trust offers substantial advantages in avoiding probate taxes, with little complexity and low cost once it is in place. Best of all, there is no risk for the parent whatsovever. The only disadvantage is the cost of setting it up, but that cost is only a fraction of the potential savings. The trust technique will not be everyone’s solution, but it should be seriously considered by parents with real estate and other assets.
Your lawyer will be glad to analyze the benefits for you, and to provide you with the information you need to make a decision.
LOANS TO CHILDREN
Parents are expected to provide for their children while they are growing up and acquiring their education and job skills. Even when children are adults and self-supporting, parents often provide further financial assistance. This generosity can sometimes result in serious family problems after the parents die. One of our recent estate files provides an excellent illustration of this.
Our client, a widower, had passed away leaving a son and daughter. Over the years he had given his daughter loans for various purposes. He had never charged interest or demanded repayment, but from time to time, as she could afford it, the daughter had repaid portions.
Following our client’s death, the son located a list of loans and repayments, showing a balance of about $12,000 still outstanding. When he approached his sister, she told him that really she owed only about $8,000 and that their father had forgotten to record some payments over the years. Unfortunately, she was unable to provide clear proof of this. She had not demanded receipts of her father, nor kept precise track of dates and amounts of payments, since it was “all in the family”.
The son and daughter were able to hammer out a compromise. Although the sum involved was not huge, the effect on their relationship was devastating. To this day, the son harbours a suspicion that the daughter had not really repaid the amount she stated and accordingly cheated him out of his fair share of the estate. The daughter’s feelings were badly hurt that her story was not accepted without question, and she feels that she was bullied into paying back more than her actual debt.
Needless to say, this is a terrible inheritance to leave to your children, and one that can be avoided. If loans have been made, the Will could state that all loans to children outstanding at the date of death are forgiven. This avoids disputes over the amount to be repaid, but it also contains a potential time bomb. If one forgiven loan is larger that those to the other children, the effect is that one child will have received a larger portion of the estate. You may think this is perfectly justifiable, but you should also acknowledge that this situation might well leave a legacy of resentment or guilt once you are gone.
The fairest solution, if loans are made to children, is simply to keep good records of the loans and the repayments, and to have the child confirm in writing the actual balance from time to time. Usually, the outstanding loan can then be adjusted out of the net estate, without difficulty or dispute. The result is that all children will receive equal benefit from the estate, thus avoiding sibling strife. This is certainly an area where an ounce of prevention is worth a pound of cure.
NEW WAYS TO PROTECT YOURSELF, YOUR SPOUSE, AND YOUR FAMILY FROM TAXES
Will Rogers, the noted American humourist, once said: “The difference between death and taxes is, death doesn’t get worse every time Congress meets.” Will was nobody’s fool, and so when our federal government announced changes to the Income Tax Act in June 2001, the first instinct is to scurry to clasp our purses or clutch our wallets. This is a natural reaction to tax legislation, particularly when the government stops crowing about budget surpluses and starts warning about holding the line on budget deficits!
A suspicious attitude to tax changes is usually justified, but these recent amendments are the exception that prove the general rule. They actually provide battered senior taxpayers with a new way to reduce their taxes. Don’t rush off to send your MP a note of thanks just yet, though. In typical government fashion you have to die to take advantage of the tax break.
The significant change to the legislation allows Canadians over 65 the use of a special type of trust technique. It is called an Alter Ego Trust if used for yourself, or a Joint Partner Trust if employed to benefit you and your spouse. The actual change to the legislation is technical, but the result is beneficial. Now you can transfer into this Trust any assets you choose without triggering a capital gains tax liability. This includes investments like stocks or mutual funds, as well as cottages, rental or other real estate properties. Assets without capital gains can also be placed in the trust, such as your home, your bonds, GICs, and bank accounts.
How it works
What does "Alter ego" mean? It is Latin for “one’s other self”, and that’s what this type of trust really is, just an extension of your own self. You create it, you select which of your assets you wish to put into it. You get all of the income and value, you personally control it during your lifetime, you can move assets in and out whenever you please. After your death, you decide who gets what’s left over.
A Joint Partner Trust works the same way as an Alter Ego Trust. One or both of the spouses will be the trustees, making all of the investment and operation decisions. Both are beneficiaries until the first spouse dies, then upon the death of the second spouse, the Joint Partner Trust passes its unused assets on to the chosen beneficiaries.
How it helps
Why would anyone want to put valuable assets into such a Trust, even if the government promises not to punish us for doing it? Lots of good reasons:
- Save probate tax: Every province and territory has some form of probate tax. This tax is usually a percentage of the value of an estate that passes to the beneficiaries after death of a taxpayer by the Will. The calculation formula and actual amount of the probate taxes vary from province to province, but in most estate situations it will be thousands of dollars, and in larger estates can be tens of thousands. The good news is that, no matter where you live in Canada, the value of your assets in one of these Trusts is always exempt from probate tax. At the least, this automatically reduces the estate expenses. At the best, if you choose to put all your assets of value in one there will be no probate tax whatsoever.
- Reduce legal costs: Usually a lawyer’s services are required to some extent after someone passes away. Depending on the size of the estate and the number and complexity of hurdles to overcome, these services can range from hundreds to thousands of dollars. The use of an Alter Ego Trust will reduce the legal costs. The larger the portion of your estate you arrange to flow through the Trust to your beneficiaries, the smaller the chance that the probate process will be required. If probate is not needed, then the lawyer’s fees will reflect this.
- Speed estate administration: By avoiding the probate process, weeks and months of delay in estate administration can be saved. There are also some simplicities built into the Trust that make the job of the trustee easier and quicker than the doing the same tasks as an executor. A speedy administration is not only a blessing for the trustee, but it reduces tension and stress on the beneficiaries who are awaiting their inheritances. The sooner the beneficiaries receive their shares, the quicker mortgages can be paid off, investments for retirement made, and your grandchildren’s educational needs met.
- Protect your beneficiaries: It is clever to arrange our estate affairs to ensure the maximum money goes to our families in the minimum time, but there are other considerations. Another fundamental function of estate planning is to protect the inheritance of our beneficiaries. These Trusts provide the same important protections of a Will. As a few examples, if you choose you can creditor proof the inheritance of your son so that it survives even his bankruptcy. You can exempt your daughter’s inheritance from claims by a son-in-law who divorces her years after your death. You can ensure a disabled child will continue to receive vital government support without losing the benefit of the inheritance nest egg.
- Protect Yourself: You can also obtain a measure of personal protection by moving your assets into an Alter Ego Trust. If you ever have a period of mental incapacity following a stroke, or because of advanced age, the Trust ensures that your own selected back up trustees automatically take over management of the Trust assets. Then you can be confident that your investments will be renewed, the bills paid, even your house sold if necessary, all by your chosen people, and without government interference or Court involvement. You could also decide to have a child or other dependable person step in as trustee at any time, because of your health problems or emotional difficulties. He or she then looks after the management until you are well enough. You always retain the right to resume control or appoint a different trustee.
- Keep your privacy: No one wants friends and neighbours laughing about your bank account balance or admiring your investment portfolio. After you die, if your Will is probated, much of your personal financial life becomes a matter of public record. Detailed information about the value of your house, how much money you have, which children play roles in the estate administration, who benefits under your Will and how the inheritances are handled are available for any curious friend, neighbour, creditor or newspaper reporter to comb through. If this thought troubles you, then be happy! The Trust and the particulars of all of its assets and workings remain private, seen only by those people directly involved.
- Leave your options open: A fundamental advantage of this type of trust is its flexibility. You can amend your choice of trustees, the number of beneficiaries, or the structure of the inheritances whenever you feel like it. You may change your mind completely, take all of your assets out of the trust and spend every last penny if it suits you. This Trust also has wide application, working not just for an individual, but also for married couples, common law spouses and same sex partners.
How it starts
Think an Alter Ego or Joint Partner Trust sounds good? Want to check out this new and appealing approach? Here’s how to get started:
- Make a list of your assets and their approximate values. Don’t forget to include life insurance policies, registered retirement plans and pension death benefits.
- See how much probate tax will be paid on your estate if it passes through a Will (in Ontario the taxes are: $1 000 on a $100 000 estate, $4 750 on a $350 000 estate, and $14 500 on a $1 000 000 estate).
- Call an estate planning lawyer to find out the cost of doing the trust. Typically this is more than a Will, but the cost must be considered in view of the total financial and personal benefits to your self, your spouse and your family. Speed, simplicity of operation and privacy are worth money too.
- If you are convinced of the value of the Trust, tell your lawyer to proceed. If not, stick with your existing Will and succession plan.
- If you choose to set up a Trust, once it is signed you start moving your selected assets into it. There may be a modest cost to transfer assets like real estate, but typically no cost to change GIC or bank account.
- Finally you set up a bank account in the name of the Trust, with you as the signing person. You may want to arrange to have all the income from the Trust investments deposited automatically into that account to make life simple.
- Now you are free to spend your own money as usual, or save it for reinvestment, or, chortling with glee, spend your probate tax savings on a spectacular trip, courtesy of the provincial government!
A word about Wills
Don’t think that these Trusts remove all need for your Will. The Trust can, but often does not, involve every single one of your assets. Many people will decide not to put the house or the car, or each bank account and investment, or all household contents and personal possessions into the Trust. It is then your Will that operates to pass these on to your family. In most cases an existing Will works well for this purpose, and may not need changes to play its role. The risk of being forced to probate the Will is lessened, because much or most of your estate value will be in the Trust, The probate tax is substantially reduced by value of assets in the Trust, if the Will must be probated. Your lawyer can help you predict what assets are likely to trigger the probate process, helping you decide what goes into the Trust.
Wills may have advantages over the Trusts in some estate planning situations. If each child beneficiary may receive a large inheritance, a special Testamentary Trust Will can save tens of thousands of dollars of tax on the income produced by the inheritance compared to a direct inheritance. The novelty and sophistication of the Trust approach means that the legal costs for preparing the Trust is probably more than for a Will. On the other hand, one Joint Partner Trust can effectively provide for both spouses, while each requires an individual Will.
DEFUSING EXECUTOR TIME BOMBS
When her Mom passed away, Sally was distraught. The oldest of three daughters, she was always the responsible one, looking out for her younger sisters. After Dad died, she tried hard to be there for Mom. Sally knew that she was the sole executor of Mom’s Will. As always, she was determined to do the job to the best of her ability. The lawyer advised that the first responsibility of the executor is to make the funeral arrangements. That’s when the trouble started.
Sally asked the funeral director to do things pretty much like Dad’s funeral, with no visitation and a simple family only service, followed by interment at the local cemetery. When sister Susan heard this, she hit the roof. Susan said that Mom had told her she thought cremation was simpler and better than an elaborate funeral and burial. Susan warned Sally she would be betraying Mom’s wishes if the current arrangements proceeded.
Then sister Sara stepped in. Mom was a regular church goer, and had many friends and acquaintances. Sara said that Mom would certainly want a church service with visitation. Sara said it was insulting to Mom’s friends not to allow them an opportunity to pay their respects. She was appalled at the thought of cremation.
Sally was in a quandary. She couldn’t please both of her sisters, and final decisions had to be made quickly. Unable to come up with a compromise, she stuck with her original plan. During the funeral, her sisters would barely talk to her. As soon as the interment was over, they left with their families.
Sally hoped her sisters would come around after they got over the shock of Mom’s death. She set her worries aside and got on with her executor duties. Actually the next part of the job turned out to be easier than she feared. The Will required all of Mom’s assets to be divided equally among the three girls. The lawyer helped by telling her what needed to be done, and how to go about the estate administration.
The main tasks went quite well. A realtor listed the house, and before long Sally signed up a sale at a good price. She retained an accountant to take care of income tax returns for Mom and for the estate. She tracked down the few outstanding debts without difficulty, and there was enough in the bank account to pay for the funeral, the charge cards, electricity and miscellaneous expenses. Sally began to hope that things would work out quickly and smoothly, doing much to patch up the hard feelings from the funeral.
This fond hope was dashed when the sisters met to get the house contents sorted out before moving day. Long before Mom died, she told Sally that as the eldest, she could have her pick of the family heirloom furniture. When she told the girls that she wanted to have their grandparents’ dining room suite, the fur flew. Sara said Mom had promised the dining room suite to her. Susan said it was not fair for Sally to have first choice, but that everyone should take turns. To complicate matters even more, both Sara and Susan made it clear each expected to get Mom’s wedding and engagement rings.
Sally is at her wit’s end. She tried hard to do the right thing, for her Mom and for her sisters. Despite this, the family is upset and not speaking to each other. She wished she could resign as executor, but knew this would just make things worse. If only Mom was around to sort things out!
Sally’s sorry situation is not really her fault. She and her sisters are far from alone in suffering these problems. Many families, all decent people, experience the same dysfunctional tendencies at times of great stress.
Executor time bombs:
The root of the problem is that Mom handed a time bomb her executor, with no instructions on how to defuse it. Many people find out too late that the worst estate troubles arise not from the biggest chores, like tax returns, house sales and debt payment. Usually the Will itself provides a clear framework for accomplishing those necessary goals. Expert advisers, like the lawyer and accountant, play a valuable role in assisting the executor to overcome any obstacles.
For many families it is the overlooked aspects of the executor’s job that create the headaches. Where the Will does not provide clear guidance, the executor has the obligation and the discretion to come up with a solution. Usually this works out fine, but the emotional decisions of arranging the funeral and dividing up the heirlooms and other items of a sentimental nature are flash points for family friction. Fortunately, the cure for these problems is easy and inexpensive. It just takes a little foresight, a bit of thought, and a piece of paper.
The funeral should help pull the family together, but too often it tears them apart. Each child will have his or her own opinion about what is appropriate, or what Mom or Dad would have preferred. The potential for disputes and discord is obvious, particularly when emotions are running high and everyone is upset and grieving. The hapless executor is required by law to make the funeral arrangements, and this explosive situation may well blow up in his or her face.
Share your preferences:
Some people will already have prearranged their funeral, and if so you have spared your executor a minefield of decisions. If not, then at least you should write out your preferences. The points might include:
- the type of funeral service, whether church or private
- open or closed casket
- family only or public visitation
- burial or cremation
- which funeral home
- which cemetery or other interment
The guidance you provide need not be extensive or detailed. You do not have to spell out which psalms are to be sung, or the style of the casket handles. You do owe the executor, and by extension the rest of the family, clarity about your general inclinations to avoid confusion and dissension. You may not even care much about the funeral arrangements, but your family most certainly will.
Don’t play hide and seek:
You may choose to distribute this note to the executor and/or other children so that all are aware of your wishes and there are no unsettling surprises after your death. If you are not comfortable with that approach, then at least take steps to ensure the written funeral wishes come to the attention of your family as soon as possible after death. Leave the note with the family lawyer, with instructions to deliver it to the executor after your death. You could also put it in your safety deposit box or file cabinet, but make sure your executor knows about the note and where to locate it without delay. No matter how thoroughly you set out your instructions, if the note doesn’t show up until after the funeral your effort is wasted and it will be your children who pay the price.
Assist with a list:
Most people have several items with special meaning. These could be heirlooms or jewellery, photo albums or other family treasures. Handling these items of sentimental value can create headaches for the executor and hurt feelings for the beneficiaries. If you want to avoid these for your loved ones, take the time to help them out. Here’s how:
- Make a list of the items of sentimental value. This should not an inventory of all the nice things you own. No one cares about the television, or the self cleaning oven, or the car. The guiding principle is, would you spin in the grave because an executor, ignorant of the heirloom aspect, takes your grandfather’s rocking chair to an auction sale? If so, put it on the list. This saves the executor the headache of guessing what should be kept in the family, and having his or her judgement second guessed later. Add to the list additional items that have the potential to create dissension. Both children covet the silver service and the china cabinet? Put them on the list.
- When the list is complete, start over at the top. Do you care whether grandpa’s rocking chair goes to your daughter or to your son, or just that it is not mistaken for junk and included in the auction sale? If you care, put his or her name beside it. If you don’t care, and if you don’t think the kids will either, then just move on to the next item.
- When you reach the bottom of the list, then congratulations! You have just defused one of the trickiest challenges your executor will face. Of course you can’t please everyone. No doubt a child would make the division of special items differently. The inevitable disappointments are not critical, nor will they have long lasting effect. A daughter who gets the wedding band rather than the preferred engagement ring may be disappointed, but will not blame her sister. This was clearly Mom’s intention, confirmed in her own writing. Disappointment will in time become acceptance, instead of festering into a feud.
- Don’t get bogged down on the relative value of the items designated to each child. Your diamond engagement ring may well have a higher resale value than your plain gold wedding band. Neither child will be running off to the pawn shop to flog the family jewels anyway. It is the sentimental value that counts, not the fair market value.
- Don’t worry about the formalities of this list. Just write it out in your own handwriting, without witnesses or dates. This is not a legal document, like the Will. Everything is going to be divided equally among the children anyway, by the general terms of the Will. The list just provides guidance as to how that division should best be made.
- Once the list is complete, make sure that it can be easily located by the executor. Leaving it with your Will copy, or at the lawyer’s, or in the safety deposit box gives you confidence that this important problem avoidance tool will show up when it is needed.
- Don’t forget to pull out the list and look at it once in a while. You may change your mind about some decisions, or give some items away during your lifetime, or remember to add something else. It doesn’t cost anything to change or update the list, and may well avoid another potentially divisive issue for your executor.
It takes two to tang:
The responsibility to defuse estate time bombs is on both the person making the Will, and on the executor. If you have a Will, but have not prearranged your funeral or left a list of guidance, you owe it to your loved ones to spare them the consequences of your failure to share your wishes.
If you are an executor, take the time to ask about any funeral wishes, and request that any preferences be written down. If upset siblings confront the executor with opposing views about “what Dad would have wanted”, showing them Dad’s actual hand written note will not only get you as executor off the emotional hook, but also reassures the upset siblings that the right thing is being done after all.
Similarly, if you have not provided written guidance about family heirlooms and sentimental value items for your own estate, you are setting your executor and beneficiaries up for a rough ride. Take a few minutes and avoid a legacy of hard feelings. On the other hand, if you are an executor, persuade your parents that it’s far better to leave you a list of guidance rather than to leave you a legacy of family squabbles to sort out.
Get it in writing!
Discussing these important issues with family members is good, but not good enough. Don’t forget that memories fade and different people will recall different versions of the same conversation. If written down, this guidance will avoid hassles for your executor and heartaches for your children, without confusion or conflict. A family should be left a legacy of love, not executor time bombs.
THE INHERITANCE LEARNING CURVE:
PREPARE YOUR CHILDREN AND PRESERVE YOUR INHERITANCE
One of the most frequent concerns I hear from clients when assisting in their estate planning is, how will my children cope with their inheritance? The economic reality is that over the next 15 years an unprecedented transfer of wealth will take place, as the generation born before World War II passes its accumulated assets to the next generation. In Canada this has been estimated at over one trillion dollars. Governments, economists and the financial services industry are still trying to determine the magnitude of the impact on our society in the new millennium.
While governments plot to have their taxing mechanisms finely tuned, and financial institutions upgrade their products and services, the segment of the population most directly affected are the children who will be the beneficiaries of the trillion dollar wealth transfer. Perhaps the most important question is, will they be prepared for the windfall, or overwhelmed by it?
Many people unwisely dismiss this risk. Lack of money is certainly a problem, but how can receiving an inheritance be difficult?
The reality is that statistically most children are in their fifties when they inherit. They probably acquired decent money management skills. Often this will have been the hard way, by making mistakes and learning from them.
The money management skills developed however are not likely to be of great assistance in coping with an inheritance. The mature children are probably good at matching their incomes to their expenses, paying off debt such as the mortgage. and even putting aside some savings for retirement. Those are quite different from receiving a lump sum when the parents pass away.
Don’t underestimate the scope of this challenge. Even parents of modest means typically have an estate of some hundreds of thousands of dollars, comprised of the sale of the house, possibly a cottage, usually savings and investments, often some life insurance proceeds. Children can be predicted to receive tens, even hundreds of thousands of dollars.
Parents are expressing their love for their children when they leave an inheritance. They hope the fruits of their hard labour will make a lasting difference for their children. Too often this turns out to be a false hope.
In real life, when children do receive their inheritance, some will react impulsively, buying that new car, going on that lifelong dream cruise, handing out money to their own children. Others will be intimidated, not able to cope with the responsibility, and unwise investment decisions follow. The result is far too frequently the same. A year or two after receiving their once in a lifetime opportunity to make a lasting difference to their lives, many children are instead scratching their heads and wondering where the inheritance has gone.
What can parents do to help their children cope with the challenges of an inheritance? Fortunately, there are approaches that parents can take now that will greatly improve the chances of their inheritances continuing to be a benefit for the children and grandchildren.
The problem lies in the children’s lack of preparedness to deal with such a windfall. Nothing in their financial lives to that point has taught them skills of dealing wisely with large lump sums of money. For some, the learning curve takes too long to catch up to the spending curve, and easy come, easy go. For others, lack of experience leads to unwise investment decisions. Either way, the inheritance the parents hoped would be a lasting benefit can be a squandered opportunity.
Estate planners are well aware of this challenge, and there are several good techniques available to help. One advances the children’s financial learning curve during the parents lifetime, the other provides a safety net after the parents have passed away.
The first technique is to start the children’s learning curve now while the parents are alive. When your children were little and you proudly gave them their first two wheel bike, did you then take them to the top of a big hill, give them a shove, and wish them well? Of course not, You first took time to tell them what they needed to know, left the training wheels on for a while, and likely ran along beside the bike the first few times.
Parents can provide similar training for inheritances by providing an advance on the inheritance, if their resources permit them to do so safely. Recently I recommended to a client that she gift her daughter $10,000, with a string attached. The string was that the capital was not to be spent during the parents’ lifetime, but she could spend the income if she so chose.
My role as the lawyer was to prepare the agreement confirming that the daughter would not use the gift immediately for new furniture, and to ensure that this advance inheritance was protected against claims if a divorce occurred, as the Will wording protects her main inheritance.
The parents’ investment adviser also plays a role, agreeing to meet with her twice a year to review the portfolio and provide advice. The parents will also make a point of discussing their hard won knowledge about fixed income, mutual funds, bank account, term deposits, savings bonds etc. No doubt the daughter will acquire over the next several years learn much of value, painlessly and gradually. This is much safer than attempting to cope with a lot of information in a short time after the death of the parents, when she is already upset.
Even if the children are mature adults who manage their own household budgets competently, coping with an inheritance of tens or hundreds of thousands of dollars is a new challenge. Like all new challenges, there is a learning curve before the necessary skills are achieved. Unfortunately, many inheritances are diminished or lost before the learning curve catches up.
What can parents do to help ensure the once in a lifetime opportunity for a child to secure his or her financial future is not fumbled? One technique was explained in my previous column. It involved the parents “seeding” the child with a modest advance inheritance. The capital is agreed to be invested, not spent, during the parents’ lifetime. During that time the child has the chance to accelerate the learning curve with guidance from both the parents and their investment adviser.
The second technique provides a further level of protection for the inheritance, even when the parent is no longer available to provide direct advice or assistance. This structures the children’s inheritance through the Will in stages, rather than as a lump sum.
In my experience, a large percentage of people, regardless of age or financial expertise, are prone to mistakes when a large sum is dumped on them in an uncontrolled fashion. Many will make impulsive purchases, or take expensive trips, or shower money on their own children, or make hasty investment decisions. Usually they regret some or all of these later, but too often it is too late to do anything about it except kick themselves.
Parents can do their children a big favour by arranging their Wills to have the inheritance paid out in stages, rather than all at once. A daughter may stand to inherit $100,000 from her parents. If it comes as one cheque, her first impulses as to expenditures or investments may later be regretted, but the money is still gone.
Alternatively, it would be much safer if her parents arranged for her inheritance to be paid to her in 5 equal instalments over 5 years. She might still make initial poor choices, but then she has a full year to dwell upon her mistakes and make more prudent plans for the future. At worst, her first distribution is gone, but 80% is still there for her, now as an older and wiser child.
To prove that with good planning you can have your cake and eat it too, not only is this form of staged inheritance safer for the child, it can also be much more income tax effective than a direct inheritance.
The planning techniques of advance inheritances during the parents’ lifetimes, and staged inheritances in the parents’ Wills, are not suitable for everyone. If you want to ensure that your children have the maximum chance to enjoy the maximum advantage from inheriting, see a lawyer to discuss these valuable approaches. The inheritance is not the most important legacy you can leave your children, but it is your last best opportunity to protect and benefit them. It is worth every effort to make sure it is a lasting legacy.