Tax Planning and Wills Go Together

Virtually everyone appreciates the importance of having an up-to-date Will. However, very few people understand that your Will can also be structured to take advantage of valuable tax planning opportunities.
 
Although we dont like to think about dying, our ultimate demise is inevitable and unfortunately is often sudden. Having a Will is very important to make sure your property and assets go where you want them to go. It also makes it easier for the family members who survive you to administer your estate.
 
Dying without a Will is referred to as dying intestate. Anyone who has had to deal with the affairs of a relative or loved one who has died intestate understands the administrative headaches and other hardships that can arise when there is not a Will. When someone dies without a Will, their decisions are made for them by a set of arbitrary rules set out in the Estate Administration Act. Rarely does this coincide with what the deceased would have done if he or she had prepared a Will.
 
Fortunately, most people have Wills. However, very few people do more than prepare a simple or basic Will. This may result in missing valuable tax planning opportunities that can only be accessed through your Will.
 
Our life expectancies have increased such that it's not unusual for parents to pass away leaving children in their 50s or 60s. In many cases, these 50 year old children are quite well off financially and have reached the stage in their life where they are in a "saving mode" (as opposed to being in a "spending mode" in their 20s and 30s). It is not unusual for me to meet with older clients to discuss tax and estate planning and hear that their children all have incomes in the highest tax bracket and have paid off their home mortgages and other debts.
 
This creates an interesting tax planning opportunity. If these 50 year old children inherit a share of their parent's estate, what will they do with it? In most cases, the inheritance consists of cash or property which is sold. Typically, the recipients inheriting such funds spend a little but, by and large, invest the bulk of it for their own retirement.
 
The problem is that this investment income on their inheritance money is taxed at the highest rate of tax in British Columbia (over 54% in 1996). For example, if the inheritance totaled $200,000, and that generated $15,000 of investment income per year, over $8,000 of that would be paid in personal income taxes.
 
If on the other hand, the inheritance money was held in a discretionary testamentary trust in favour of the 50 year old child and perhaps his or her own children, those funds could instead be invested by the testamentary trust and taxed at a far lower rate. If we used the same example as above, the testamentary trust would instead pay income tax of less than $4,000, a savings of over $4,000 per year. This savings can continue year after year.
 
Although the testamentary trust must keep proper records and must file an annual trust tax return with Revenue Canada, this may be a small inconvenience when compared to the ongoing income tax savings.
 
Although the parent who passes away does not derive any direct benefit from such a plan, it is usually greatly appreciated by the children and grandchildren.
 
Such a structure provides a number of other advantages as well. For example, if the beneficiaries named in the testamentary trust include the grandchildren, the 50 year old child can use the trust to facilitate his or her own estate planning objectives by having the trust funds ultimately paid out to their own children thus avoiding probate fees and other hassles on their death. As well, if the testamentary trust is properly structured, it can provide a fair measure of protection from creditors while the fund is held in trust.
 
This type of trust can also be drafted to provide flexibility. Suppose that the 50 year old child's income position changes so that they are no longer in the top tax bracket or suppose something happens so that they need the full amount of their inheritance. The testamentary trust can be drafted so that it may be collapsed and the entire amount of the inheritance held in the trust can be distributed tax free to the beneficiaries. The trust can also be structured so that each year a certain amount of the capital is paid out (tax free) to the beneficiaries should they require more than just the annual income earned.
 
As you can see, it creates a "winwin" situation. If your children wish to take advantage of the tax planning opportunities they can do so. If it is to much of a hassle or they need money, they can simply collapse the trust.
 
Everyone should have a Will. But don't miss the opportunity to take advantage of the income tax rules. The next time you review your Will, have it looked at by a tax professional to make sure that you have a tax-planned Will.

This article is not legal advice and a lawyer should be consulted on any specific case.