Knowing what you own is the first step to successful estate planning. What could be more obvious? However, knowing what you don’t own is just as important.
And yet, expensive and avoidable mistakes happen on a regular basis. We have seen someone designate a life insurance policy to a new spouse when they were legally obligated to designate it to a former spouse to satisfy the divorce settlement. Another person bequeathed to his children shares of a company that, after a number of tax driven corporate reorganizations, no longer existed.
Estate planning is an ongoing process and needs to be evaluated constantly. Comprehensive estate planning is dynamic—assets and liabilities change. Families, heirs, beneficiaries, and successors evolve over time. And of course, tax and estate law changes.
It is important to understand what assets are owned and how they are owned. Who owns these assets? You need to understand how the assets fit in and create a structure. Are the assets independent of each other or are there co-dependencies?
Business owners and trust beneficiaries often mistakenly believe they own the assets inside their operating company or other corporations they own, or inside a family trust, directly. However, they do not own these assets. There may also be concerns around who actually controls the assets.
Passing down a cottage
As previously mentioned, you can only give away what you actually own. You could run into issues if the building your corporation owns is a cottage that you occasionally visit.
Jeremy Martenstyn, Private Client tax services at BDO Canada, states clients frequently ask whether they can put their new vacation properties in a corporation. If there’s any personal use of the property, which there often is, the answer is “absolutely not,” says Martenstyn.
When it comes to vacation properties like cottages, Martenstyn adds that one of the biggest mistakes in estate planning is to assume your family wants to own it at all.
“Many parents want the family cottage to stay in the family, but the reality is, it’s very difficult for adult siblings to share ownership. It can be a minefield,” says Martenstyn.
If clients insist on passing down the cottage, a family trust may be a good strategy.
“You put it in a family trust, which is good for retaining control of an asset, and at some point, transfer that asset to the beneficiaries at cost,” says Martenstyn.
Setting up a separate trust to pay for cottage upkeep is popular, too, and can smooth the road for future owners. A rule book about reserving the cottage, how to use it, and maintain it, is very helpful.
The Family Trust is a valuable tool as it provides for time, flexibility, and change. It remains important to know that your will only deals with the assets you directly own when you die. This does not include any assets that reside in a family trust.
Misunderstanding your owned assets
Consider the following example—a person gifts individual properties from his estate to his children, with the rest going to his spouse. The house is jointly held with the spouse, so it passes outside the estate directly to her, and he only has a sole bank account. The trust owns all the other assets. The wife ends up with no cash since the bank account was depleted to pay the estate taxes on the two properties given to the children, along with estate administration tax (probate) and legal fees. This was certainly not the intention when the individual prepared the will!
The individual outlined specifics in their will, but the trust owned all the assets. So the individual actually only had bank accounts and a marketable security portfolio that had a total value of $500,000. Now how do you give those kids the value he intended to give them, when they didn’t actually have that value in their hands and therefore didn’t have that value to give?
No longer owning something is tricky, but the opposite sort of problem can happen, too. Someone might casually acquire expensive new assets and forgets to alert their advisor about the transaction. While this may seem unusual, it happens, says Martenstyn.
“They may say off the cuff: ‘Oh, I bought my daughter a house and it closes in 30 days and here’s how I was going to do it.’ The whole thing is sort of an afterthought,” he says. Quite often, no planning has been done or the parents now have an additional property in their name, and they are missing out on key tax breaks.
Other ways of controlling assets
Parents sometimes retain ownership over property to assert control, but Martenstyn says, “there are better ways to do that.”
Joint ownership would let parents keep some control and still allow the family to take advantage of the principal residence tax exemption if the children plan to live in the property. Martenstyn calls it the best deal that Canadian taxpayers have: “It’s a shame to let it go to waste.”
In the rest of Canada—with the exception of Quebec—when you have a joint tenancy, you can have what you call a right of survivorship, which will help to reduce the probate and also ensure that the asset is transferred directly from one spouse to the other. In Quebec, there is no notion of beneficiary, so a spouse cannot be named as a beneficiary.
Does it sound too good to be true? Depending on the circumstance it might be. While individuals can usually avoid probate tax on an asset that is jointly held with a right of survivorship, it is not without its risks. You need to review the risks before transferring the property into joint ownership. You could lose the property if the child’s creditor seeks to sell the property to pay a debt, or even if the child gets a divorce. It will also impact how the estate is balanced or “equalized” among beneficiaries.
Solutions exist for the many ownership pitfalls outlined in this article, but it’s much better to try avoiding them altogether.
“There are a lot of things that can be done if you get ahead of it,” says Martenstyn. “It’s sometimes more difficult and costly to try and undo, or fix, the planning.”
An impactful strategy is to test drive your current plan. Also known as a ‘fire drill,’ this is imagining yourself in the place of your executor just after your death. What do I do next? What are the outcomes if I follow the planning that is now in place? Compare those outcomes with your hopes for the situation. Most of the time, we find there is a significant gap.