March 2009

What happens when we die?

What happens when we die is a highly philosophical question but, for our heirs, it can become a very real headache.

For most people, the main reason for setting up a financial plan is to make sure they can retire comfortably. That’s quite normal. But there are other aspects to consider – and estate planning should also be high up on the list.

Because if you don’t plan for your estate, the taxman will do it for you.

Death = sale

In Canada, there is no estate tax: the beneficiaries’ inheritance is transferred to them without they themselves being taxed. However, all of the deceased’s taxes must to be paid before the transfer is made.

It’s really quite simple: in practice, when you die, the tax authorities assume that you have disposed of your assets and that the related income taxes have to be paid. If you have arranged to transfer your assets to your spouse, part or all of the tax bill will be deferred until your spouse dies. But at that point, the whole thing will come due.

Let’s see what all this means.

RRSPs, RIFFs and other tax-deferred plans
The entire value of such a plan is taxable at the individual’s marginal tax rate. In the end, the heirs may very well be left with barely half the value of the plan!

Unregistered investments
Capital gains and investment income are taxable at the time of death. Where capital gains are concerned, 50% of the value is taxed at the deceased’s marginal tax rate, but all investment  income is taxable (after adjustment, in the case of dividends).

Income property
Half of the capital gain from an income property is taxable at the deceased person’s marginal tax rate.

U.S. investments
If the deceased had investments in the United States (for example, a condo), an income tax report has to be filed in the U.S. and the related taxes paid. But the U.S. and Canada
do have certain tax treaties in this regard, which is why it is important to talk with an advisor.

Second home
A second home is considered as sold and the capital gain is taxable. If the remainder of the estate cannot cover the taxes, the heirs may be forced to sell the house or borrow money to pay them.

Main residence
You can breathe a sigh of relief:  capital gains on the main residence are not taxed.

What to do?

There are several ways to lessen this tax impact:

  • take out a life insurance policy that will pay the taxes when you die;
  • if your second home has appreciated more than your main residence, it should be designated as the main residence;
  • hold your U.S. investments through a Canadian company (for example, choose U.S. funds
    from a Canadian investment fund company);
  • leave part of your holdings to a charity, which will trigger special tax treatment;
  • encourage your heirs to take steps on your behalf that will result in lower taxes (for example, contributing to your RRSP for the year of your death).

But, above all, talk with an estate planning expert who can help you to structure your estate plan and write your will in detail so that your heirs won’t be in for any surprises. In cooperation with your financial security advisor, the estate planner can make a huge difference – for you and for your loved ones.

Breaking news

Thanks to the most recent federal budget, losses in an RRSP or RRIF between the time of a taxpayer’s death and the time his/her assets are distributed are now deductible. Previously, any increase in the value of such a plan was taxable after death, but there was no provision for a loss. This is a very welcome change in a bear market like the one we are currently experiencing.