Estate Planning 101

1. What is Estate Planning?

Estate planning involves determining how an individual’s assets will be preserved, managed, and distributed after death. It also takes into account the management of an individual’s properties and financial obligations in the event that they become incapacitated.

Assets that could make up an individual’s estate include but are not limited too are, houses, cars, stocks, artwork, life insurance, pensions, real state investments and debt. Individuals have various reasons for planning an estate, such as preserving family wealth, providing for a surviving spouse and children, funding children's or grandchildren’s education, or leaving their legacy behind to a charitable cause.

The most basic step in estate planning involves writing a will. Other major estate planning tasks include the following:

• Limiting estate taxes by setting up trust accounts in the names of beneficiaries
• Establishing a guardian for living dependents
• Establishing a living will if mentally incapacitated
• Naming an executor of the estate to oversee the terms of the will
• Creating or updating beneficiaries on plans such as life insurance and retirement plans.
• Setting up funeral arrangements
• Establishing annual gifting to qualified charitable and non-profit organizations to reduce the taxable estate
• Setting up a durable power of attorney (POA) to direct other assets and investments.

2. Do I need a will?

Yes, Absolutely! A will not only ensures that your estate is allocated according to your desires, it can also help you reduce expenses. If you die without a will, the court will appoint an administrator as executor – and this person will have to be paid, cutting into your estate. If there are minor children a will, will direct who will assume guardianship. If no will is in place the courts will make that determination. 

3. How much of an estate is taxable in Canada?

There is no estate tax in Canada. However, every provide except Quebec and Alberta has a probate fee. For example, in Ontario there is no fee on small estates up to $50,000. There is a fee of !15 per $1,000 on estate assets over $50,000. This can add up quickly. On an estate worth $1,050,000 the probate fee would be $15,000.

The good news is that there is not estate or inheritance tax in Canada. The bad news is that taxes on income and capital gains must be paid when someone dies.

Fortunately, assets can be transferred to the surviving spouse or common-law partner without taxes being paid. It's important that the spouse be named as a designated beneficiary of an RRSP or RRIF.

If there is no surviving spouse, the estate must pay any taxes owing. The executor of the estate is responsible for ensuring that taxes at death at death have been paid and that the Canada Revenue Agency issued a "clearance certificate" confirming that no additional taxes are owed. 

Depending on the size of the estate and the nature of the assets (properties, stocks, RRSP's and other investments), this can be quite complicated. So, if you are the executor of a large estate, you may wish to get tac and legal advise about Canadian tax laws.

4. What are the tax exemptions upon death in Canada?

There are two main exemptions to avoid paying tax upon death. First of all, there is no tax on capital gains of a principal residence. The second exemption is called the Lifetime Capital Gains Exemption. In 2021, this amount is $892,218 and can go a long way towards reducing owing on any capital accumulation on investments and properties. However, note this is a lifetime exemption- so if the deceased has used part of it to reduce taxes over the years, only the remaining part of the exemption can be used at death.

5. Do I have to pay taxes on a house I inherited in Canada?

Generally, no. There is an exemption for any capital gains on a principal residence the deceased person owned. If there is a surviving spouse, there is no tax payable on transferring ownership. However, there may be situations where taxes must be paid:

  · If the house has appreciated in value since the owner died, there will be taxes owing on that change in value. With some Canadian real estate market home prices growing rapidly, this could be a significant amount.

  ·If the house was NOT a principal residence, capital gains taxes could be owed. For example, if the deceased had a principal residence plus a vacation home such as a cottage, the capital gains on the second home would be taxable.

6. Will my inheritance be taxable?

A common misconception among Canadians is that they can be taxed on money they inherit. The truth is, there is no inheritance tax in Canada. Instead, after a person is deceased, a final tax return must be prepared on income they earned up to the date of death. Any monies owing are paid out from the estate assets before the remaining funds are transferred to the various beneficiaries. There are other costs involved in settling an estate, however, so it's good to have a basic understanding of how it all works.

7. How are estate assets treated for income tax purposes?

Any assets included in the estate are considered to have been sold for fair market value at the time of death. This includes any real estate, businesses, land, investments, even RRSPs. It's important to note that each of these assets will generate income differently, and they are not all taxed the same way. Here are a few examples of how the income from estate assets might be treated:

Example 1: Shirley passes away with $230,000 of individual stock held in a non-registered discount brokerage account. It's determined that the stock has an adjusted cost base of $150,000, leaving Shirley's estate with a capital gain of $80,000. Her executor will need to report $40,000 as income on Shirley's final tax return (50% of $80,000).

Example 2: Bob has $50,000 in RRSPs. As soon as he dies, the full balance of his RRSPs are considered to have been sold, generating an income of $50,000. This amount will be included on the final tax return.

Example 3: John has recently passed away. 15 years ago, he inherited the family cottage from his parents, which, at the time of his death, was worth $500,000. When he inherited the cottage, it was worth $350,000. Because John's parents would have paid any capital gains up to the time of him inheriting the cottage, his estate is required to pay a 50% capital gain on $150,000 ($500,000-$350,000). Thus, John's final tax return will need to report $75,000 of additional income for the sale of the cottage.

Example 4: Sue owned a bungalow which she has rented out for the past 3 years. She originally paid $200,000 for the home, and it's now worth $300,000. Sue passed away on March 31, which generated a $100,000 capital gain as of that date. The income reported on the final tax return will include 50% of the capital gain ($50,000) as well as 3 months of rental income, for January to March.

Cases with a surviving spouse

Where there is a surviving spouse or common-law partner, a non-registered capital property can be transferred to them, without a capital gain having to be reported as income. Eventually, when the spouse passes away, the property will be disposed in their name, and the capital gain reported at that time.

With respect to RRSP and RRIF investments, if an eligible person has been named as a beneficiary, then the income from the investment does not have to be reported, and any tax is deferred. Eligible beneficiaries include a spouse or common-law partner, a financially dependent child or grandchild (under 18 years of age), or a mentally or physically disabled child or grandchild of any age.



Cases with no surviving spouse

With no surviving spouse, common-law partner, or other eligible beneficiary, all estate assets are deemed to have been sold at fair market value immediately at the time of death. For real estate properties, a capital gain will have to be reported at 50%. The same goes for any non-registered investment, where the capital gain will be the difference in the market value when the investment was purchased, and the value at the time of death. All registered investments, such as RRSPs and RRIFs, are deemed sold at their full market value upon death. The full balance of the RRSP or RRIF will need to be reported as income on the final tax return.

8. How do I avoid estate tax in Canada?

While there is no estate tax in Canada, it is important to plan carefully so that your heirs do not have to pay a large tax bill prior to receiving their inheritance.

For example, as noted above a vacation home such as a cottage may be subject to capital gains tax upon death. This can be challenging to the heirs as they may have to sell the cottage to pay the taxes owing. Therefore, people who own a family cottage may wish to “gift” it to their children while they are still alive. This allows them to transfer ownership without paying tax. A lawyer can assist you with the documentation to make sure that you stay within the tax rules.

Here are some ways to minimize taxes at death in Canada:

·       Plan your withdrawals: During retirement, take money from your RRSP/RRIF first. Dip into your TFSA only when needed. Your investments accumulate tax-free in your TFSA so if you die your estate will not owe any taxes on any gains you have made.

·       Choose your principal residence: If you own more than one home, you can make the more valuable dwelling your principal residence. Any capital gains on this home will be tax exempt.

·       If you have a corporation, plan for what happens next: Corporations don’t die when you do. So, make sure there is a plan for the shares and assets of the company. There may be ways to reduce your taxes by holding funds in the corporation rather than personally.

·       Consider permanent life insurance: Life insurance is a way ensure that your taxes are paid upon your death. The insurance payout can be set up to cover the taxes owing. In that way, your heirs do not have to sell investments and property in order to meet the tax bill.

9. How are capital gains on investments treated?

As I illustrated in the example above, if the deceased had non-registered investments at the time of death, they would be considered to have been sold at that time. Any income generated by the investment would need to be reported on the deceased tax return. In the case of capital gains, 50% would be considered taxable and added to the estate income.

10. What is probate?

Often, an estate must go through a legal process referred to as probate. The first requirement of probate is to determine that the will is valid and authentic. Probate also involves the overall administration of a person's will. In situations where a person died without a will, the overall estate. As I mentioned earlier, there is no tax on estate assets, however, provinces do charge probate fees before estate assets are transferred to the beneficiaries.

11. How do probate fees work?

Probate fees can be complicated, and they vary from province to province. Certain assets in an estate can bypass probate, reducing the final probate cost. An example would be assets with a designated beneficiary, such as a life insurance policy, or most registered investment products, such as RRSPs and TFSAs.

Here's a tip. If you haven't named a beneficiary on your RRSP or TFSA, make sure that you do, if you want to avoid those monies being subject to probate. In lieu of a beneficiary, the funds will be transferred into your estate, and be included in the probate for the calculation of fees. In most cases, joint assets are also excluded from probate, as the joint owner assumes full ownership of the asset. This is most often the case where there is a surviving spouse.

12. If I am a beneficiary, do I have to pay taxes on my inheritance?

As you are now aware, a Canada inheritance tax does not exist. Instead, the deceased's estate representative must file a tax return for the estate before disbursing funds to the beneficiaries. As a beneficiary, this means that once you've received your inheritance, it's yours to keep.