The costly act of dying
Death can be one of the most expensive events of your life. But you can plan ahead. By determining what your estate will likely cost your family to settle, you can review your asset structure to determine if there are ways to minimize those costs and to ensure sufficient funds will be available to cover those costs. The following expenses are often incurred at death. However, the level of each cost is dependent upon your financial affairs and the ownership structure of your estate.
Upon your death, your estate is required to file a special income tax return, called a “terminal return”. All income earned by you from employment, investment and pensions that year up to your date of death must be reported on this return, and the resultant tax paid by the estate. A second separate return can be filed called a “rights and things return” for income earned but not received until after death. For example, commission income, unpaid bonuses and dividends declared but unpaid all qualify. As outlined below, there are additional amounts that may need to be reported on the terminal return.
When you die, all tangible assets — suchs investment assets, real estate (except your principal residence), art and collections — are considered disposed of at their fair market value. The difference between the fair market value and their original cost is called a capital gain (assuming the fair market value is greater than the cost). This capital gain is subject to both provincial and federal income taxes. However, if assets held are left to your surviving spouse, no taxable capital gain will result. Any asset left to a surviving spouse will be transferred to that spouse at their original cost and no tax will be paid until that asset is either sold or the surviving spouse dies. At that point, the fair market value at that time is what affects the calculation.
Registered Retirement Savings Plans and Registered Retirement Income Funds can be left to your spouse tax free as long as your spouse transfers them into another RRSP or RRIF. If they’re bequested to anyone other than dependent children or grandchildren, the full cash value must be included in your estate and reported on your terminal income tax return. u.s. estate taxes If you own property in the U.S., upon death you may be subject to U.S. estate taxes. The rules are very complicated for non-U.S. citizens. If this applies to you, a U.S. tax specialist should be consulted to determine the impact these taxes may have on your estate.
Probate fees are provincial fees charged by the government declaring you have a valid will. Each province regulates these fees and, in most cases, they’ve been based upon the value of your estate. Governments are reviewing the issue, following a Supreme Court of Canada ruling in October 1998 that questioned the legitimacy of the fees.
Legal and Executor fees
This is a fee paid to your executors for settling your estate and ensuring your possessions pass smoothly to your beneficiaries. While a spouse or family member does not have to be paid such a fee, your estate will have to pay an executor’s fee if the duties are performed by a professional. Fees may be charged on an hourly basis or as a percentage of the estate. In most cases, you can discuss these terms in advance, which will enable you to approximate the amount to be paid.
Statistics show pre-planned funerals have increased in popularity over the last few years, and the trend is expected to continue. With pre-planning, you have the opportunity to discuss your wishes in advance with a funeral director and arrangements can be made in an unhurried manner. You can determine the costs associated with burial or cremation and have the choice of pre-paying for these services or budgeting to cover them in the future.
How to reduce these costs?
Review your financial affairs to see what can be done to minimize these costs. Here are some strategies to consider:
1. Transfer assets to a trust
You’ve decided you want to leave certain assets to a beneficiary when you die, but you don’t want to give up control now. By transferring assets to a trust and naming your intended beneficiary as the beneficiary of the trust, you remove that asset from your estate. In effect, you no longer own the asset. However, this asset is also not owned by the beneficiary. The trust is the owner and as the settlor of the trust you retain control over the asset. Unless the terms of the trust state otherwise, you can leave this situation in place until you die — at which point the beneficiary can take over control. Since you don’t own the asset, it doesn’t form part of your estate for either income tax purposes or probate fees. However, you should be aware that transferring assets to a trust is considered a disposition for income tax purposes and you’ll have to report the disposition on your tax return and pay any resultant tax in the year the trust is established.
2. Spousal Rollovers
By detailing in your will assets to be left to your spouse, you can eliminate any capital gains tax on your death on those assets. No tax will be paid until your spouse sells these assets or dies, whichever occurs first. Although you are only delaying the tax, it’s better to leave your spouse the full value of the asset with a deferred tax liability than for your estate to pay tax now and your family to receive only the net proceeds.
3. Estate Freeze
The best way to avoid estate tax is to give your heirs the belongings you want them to have before you die. Any subsequent increases in value and eventual capital gains are their responsibility, not yours. In most cases, the eventual tax will be lower, as presumably they’re not in the same bracket as you and at least you have delayed the payment of tax. However, the down side is you give up control over the asset and you’ll be subject to tax on the accrued gains earned up to date.
4. Life Insurance
Many individuals choose to purchase life insurance to cover the tax liability estimated when selling their estate.