Who will get your money?

My mother started giving money to her children while she was still around to enjoy it. She wanted to help us with things we might not be able to afford, such as vacations or renovating our homes. For the three years before her death last March, she arranged for regular distributions of cash to her four kids. She had more than enough money for herself and took pleasure in giving it away.

There’s no tax to pay on gifts of cash in Canada, nor is there any limit to how much you can give away in a year. So you can save taxes by getting assets into your children’s hands while you’re alive and keeping it out of your estate. You would do that because everything in your estate is considered sold when you die and attracts tax at a high marginal rate.

Transfers during your lifetime “can help you achieve your estate planning goals and give you a warm, generous feeling, especially if you can afford to continue your lifestyle without the money,” says Ed Olkovich, a Toronto lawyer specializing in estates and trust law. You don’t have to wait till your death to help family members. You can have that pleasure now.

However, you could have a tax bill in the year you give an assetway. Selling stocks to generate cash for your heirs could result in capital gains tax. Giving appreciated shares to your kids — without selling them — leaves you no further ahead.

“When you give something away, you’re deemed to have sold it at its fair market value at the time you make the gift,” says chartered accountant Tim Cestnick in his book, Winning the Tax Game 2005 (Wiley, $26.99). “If the asset has gone up in value, you might trigger a taxable capital gain when giving it away.”

The problem with a deemed disposition is you’re not actually selling anything. There are no sale proceeds with which to pay the tax bill. However, proper tax planning can minimize the tax burden, such as using capital losses to offset gains.

If you’re giving away assets that will lead to a tax bill, Cestnick advises doing it slowly over a number of years. That way, you won’t have to pay a huge tax bill in a single year. You don’t want to be pushed into a higher marginal tax bracket.

The gradual approach may be less popular with children hoping for a lump-sum amount. But it’s better for you. The inescapable reality is life is uncertain, and you never know what the future will bring. Money, once gone, cannot be reclaimed.

“If the gift will be large, my philosophy is never to give something away that you might need back. Just don’t do it,” says lawyer Wendy Templeton, who is responsible for the BMO Nesbitt Burns estate planning service.

Giving away assets makes sense in some cases, she says. “If you’re retired, in your 70s or 80s, with a $1 million estate, it’s not a big concern if you give $10,000 to your children. You’re not transferring a significant part of your wealth.”

Templeton’s father-in-law turned 102 this year. Average life expectancy is going up, she emphasizes, and you need to hold onto enough assets to cover extended health care and living costs. You don’t know how long you’ll be around. “Parents often say, ‘I trust my children.’ But what if you fall on hard times and your children have spent the money? What if a child dies or has marriage problems? That’s the worst of both worlds.”

She has seen people come under pressure from adult children to hand over money. Later, the children move away and leave elderly parents stranded in a nursing home.

“You don’t want to put your children into the position that they’re responsible for you,” she says. It’s important to get legal advice if your kids are pushing you to make large gifts. It’s important to understand the tax and financial implications.

Consider joint ownership
What about transferring the family home into joint ownership with children? “The kids are going to get it eventually,” some parents reason. “We’ll just start the process now.” Assets that are jointly owned with family members pass along to them automatically, even without a will. Still, problems can arise.

If you’re going to give away your principal residence, be sure to get legal advice first. There are some potentially harmful side effects, says Cestnick, since you may lose control over the property and expose it to a child’s creditors or a disgruntled spouse.

Olkovich talks about the Five Terrible Ds — death, divorce, debts, disasters and disposition — when explaining the dangers of joint ownership with children. He gives the example of a client named Karl, whose wife has just died and who wants to register all his assets jointly with his only child, Andrea.

Death If Andrea and Karl die together, joint ownership doesn’t avoid probate. Besides, Andrea’s estate would also be responsible for any capital gains on her share of the home. They could turn out to be more than the probate costs.

Divorce If Andrea gets married and her marriage breaks down, her spouse could make a claim to her share of the assets. Such a claim could force Karl to sell or put a mortgage on the home.

Debts Andrea could go bankrupt, and creditors could seize her portion of Karl’s assets, including the home. If she doesn’t pay her income tax, the government could seize her interest in the property for tax arrears.

Disasters People change. What if Karl has a falling out with Andrea and she gets greedy? She could force him to sell the home and divide the proceeds with her. This could be a disaster if Karl is relying on the home to finance his retirement. There’s no law that says Andrea has to follow her father’s wishes.

Disposition The cost of registering the deed into joint ownership could be higher than the probate taxes saved. And if they jointly own a second property, not a principal residence, Karl will have to pay income tax on any capital gains on his share, as well as lawyers’ fees and perhaps provincial tax on the land transfer.

Holding joint bank accounts with children can also cause problems, Olkovich says in Estate Planning in Six Simple Steps (ECW Press, $19.95). Claudio, for example, opened a joint account with his mother. But Claudio reported all the interest from the account on his own tax return. By doing so, he effectively eliminated any paper trail to his mother’s money, which he then moved into an account in his own name. All traces of Mom’s money disappeared. He felt he deserved it for all the care he gave her.

When she died after seven years, her other son Tony was surprised that the bank account only had enough in it to pay for her funeral. Tony hired an estate lawyer and found that Claudio was hiding the money in the other account. Angered, Tony went to court, so a judge would punish his brother appropriately and make him suffer for his dishonesty.

Dividing your assets
This brings up the question of how to divide your assets among your children. What happens if you decide not to treat everyone equally? Will there be repercussions if you leave different amounts for different children? That’s a concern for many parents, who worry about fights after they’ve gone – and possible legal battles.

Lawyers often advise leaving the same amount for each child. It’s easier to understand and less likely to be challenged.

“I encourage people to give equally,” says Olkovich. “How do you explain that some kids get a smaller share? You’re leaving them a lifetime of regret.”

Parents often treat children unequally while they’re alive. You may pay $100,000 for one child’s post-secondary education and nothing for another who stopped after high school. But you can find ways to compensate the child who received less — such as helping with a house down payment or covering the cost of kids’ summer camps or hockey equipment.

You shouldn’t try to make up for past injustices in your will, Olkovich says. The cost is too high in terms of family acrimony.

“Fights over estates are more likely to rip a family apart than any other event — and almost every such fight is based on a perception that the division was not fair,” says Arthur Drache, a tax lawyer in Ottawa.

The irony is that equal shares may also create problems. If one child has devoted years to caring for her parents while others just show up for the odd birthday and holiday, treating the siblings equally can cause deep resentment.

“There is no right or wrong answer,” he says. “Every parent must make his or her own determination.”

He suggests bringing up the subject as dinner table conversation with either one child or several of them. Raise the hypothetical question of whether to do an equal division or division based on need and see what happens.

A few years ago, Drache broached the subject to his own four children. “The result produced strong reactions that surprised me,” he says. “Although all four were in significantly different economic circumstances, they were unanimously in favour of equal treatment, which forced me to revisit my own inclinations.”

With important decisions like this to make, it’s no wonder that people procrastinate about preparing a will. In the long run, the estate will be divided. But if you don’t write a will, someone else will make the crucial decisions.

Templeton has a solution for parents who provide substantial assistance to some children and not others during their lifetime. They can put an adjustment clause into their will. This is known as a “hotchpot,” an old English term that means putting together, blending or mixing properties in order to achieve equal division among beneficiaries or heirs.

Suppose you have three children. You leave your cottage to the child who lives nearby, knowing the other two who live far away are not interested. In your will, you say you’re dividing your estate equally among the three kids, taking into hotchpot the value of the cottage property received by the one child.

Most parents have a hard time reducing a child’s share of the estate, Templeton says. Even if they made a loan to a child that hasn’t been repaid, they hesitate to cut the inheritance by that outstanding amount.

“When there’s an unequal distribution, you usually see it when one child is disabled or worse off – for example, making a poor choice of partner and supporting a big family. Families are comfortable giving more to benefit the one who’s more needy.”

If you decide not to give the same amount to everyone, “it’s nice for your children not to be surprised,” Templeton says. You may not feel comfortable talking to them about it, but you should talk to your executor. You can also set out your reasons in a private letter that the kids can understand.

What about disinheritance? Can your will be challenged if you cut off a child altogether? You may do so to express your disapproval of children who have lost contact with you or who have made irresponsible lifestyle decisions.

Only in British Columbia is there a law that restricts parents’ rights to dispose of property as they wish. It allows a spouse or child to apply to the courts to have the will varied if it doesn’t adequately provide for support.

Financial need is not the only factor a court will consider in varying a will. A recent Supreme Court case affirmed that a parent also has a legal and moral obligation toward an adult child.

“In B.C., the door is much wider open. If you cut out somebody, the law permits courts to substitute what they think is appropriate,” Templeton says.

In other provinces, the law is less clear. The only basis for challenging disinheritance is if the children are dependents and receiving support from the parents.

Some parents don’t want to leave everything they own to their children. Billionaire Warren Buffett has said he intends to leave most of his wealth to charity. Microsoft founder Bill Gates also plans to give his multibillion-dollar fortune to charity, while distributing $10 million (US) each to his kids.

“People worry that a large inheritance may affect a child’s work ethic and make them slack off,” Templeton explains. “On the other hand, others think that if you don’t give your kids money to play with, how will they learn to manage it?”

Giving to charity
If you’re planning to leave assets to charity, you have a number of ways to do it. You can name a charity directly as the beneficiary of an RRSP or RRIF. This means you’ll get a tax credit to offset some or all of the taxes owing on the disposition of these assets. And the proceeds won’t be subject to probate fees or to claims by creditors.

You can also name a charity as the beneficiary of a life insurance policy. “The donor can do this without it being public knowledge,” says insurance broker Jean-Pierre Ricard. This may avoid delays in settling an estate because of disgruntled heirs contesting a charitable bequest made in a will.

Leaving money to charities in your will “gives tremendous flexibility in the type of gifts you can make,” Olkovich says. Bequests can be of specific assets, such as a piece of art or real estate. You can also leave a gift of all or part of the “residue” of your estate, what’s left after taxes and expenses have been paid and other gifts have been distributed. The remainder has to go to someone. If it’s not, the same rules apply as if you had died without a will.

Making gifts through a will has its advantages — you can change your mind and your will. Nothing is irrevocable. Wills, however, don’t bypass the probate process. Creditors, spouses or others can challenge your will, possibly affecting your estate distribution and the bequest to a charity.

“You may wish to explain your charitable intentions with a side letter to your beneficiaries,” Olkovich says. “Although not legally binding, it may be comforting in explaining your reasons.”

You can donate publicly traded stocks to charity, especially those with a large built-up capital gain. The taxable portion of the gain is limited to 25 per cent (instead of the normal 50 per cent). You save taxes and you’re eliminating the executor, probate and legal costs to process the gift through your estate.

If you’re over 70, consider a charitable annuity. You deposit capital with a charity in return for a steady stream of income. Part of the payment is tax-free, since it’s made up of principal and interest. You get a charitable tax receipt, based on your age and the amount used to set up the annuity.

Charitable remainder trusts are more complex.  You transfer property into a trust during your lifetime, so you can enjoy income and tax benefits. On your death, the remainder of the trust’s assets goes to charity. There are costs involved in setting up the trust and administering it every year, so you need professional advice. And a trust is irrevocable. Once it’s in place, there’s no turning back.

Consider a foundation or endowment fund
Setting up a family foundation is another way to leave a legacy when you die. There are about 2,300 active foundations in Canada, dispensing about $1 billion a year in grants. You can count on spending $5,000 to $25,000 in start-up costs, according to Philanthropic Foundations Canada (www.pfc.ca).

If you want to save on administration costs, you can set up an endowment fund with a community foundation. There are 140 community foundations in Canada, which require minimum donations of $20,000 to $25,000. You need to dispense at least 3.5 per cent of the invested assets each year.

Some banks, such as TD Canada Trust, have set up foundations for private giving, with a requirement of only $10,000 in cash or securities to start an endowment fund. You can use the money to support any registered charities in Canada, as well as qualified universities outside the country.

What’s the appeal of an endowment fund? It lets you make a significant and sustained gift that will benefit others. As a long-term donor, you can be engaged in choosing the projects and people you give to, leading to a great sense of accomplishment and satisfaction.

A foundation or endowment fund can be a rallying point for family members to bring together shared interests for a common cause. It can teach younger generations the value of philanthropy and other important skills, such as investment management, resource allocation, project evaluation and assessment of impact. And it can live on after you die, creating an enduring legacy.

I’ve given some of my inheritance to charity. It seemed a fitting way to honour my parents’ lives and their devotion to making a difference in their community. And with governments cutting back on funding, charitable organizations need all the help they can get.

Ellen Roseman is a business columnist for the Toronto Star and financial author. She hosts It’s Your Money on the iChannel network. Reach her at [email protected]