Part of the financial estate planning process is proper planning of liquidity in an estate. Liquid cashable assets can be required in an estate to cover obligations at death, special payments and charitable gifts.
It should be noted that we do not have “estate tax” in Canada. The deceased however is considered to have disposed of all their assets at the time of death. This may trigger income tax dues, including capital gains from all types of assets. It is the duty of the executor of the estate to manage the tax filing and pay any taxes owing, in some cases as soon as within six months from the date of death.
For example, Carl, in setting up his estate, is planning to divide it equally between his two sons, John and Peter. Carl designates John as the beneficiary of his RRIF (Registered Retirement Income Fund) of $400,000 while leaving $250,000 of GIC funds to Peter through his will. At time of death, the income taxes on the $400,000 RRIF are estimated at $150,000.
Did Carl achieve his goal?
On the surface, the RRIF after tax should be at $250,000, equating it with the GIC fund value. However, a closer look at how the taxes are paid gives us a different picture:
John, as the beneficiary of the RRIF would get $400,000 outside the estate, directly from the financial institution handling the account.
The taxes on RRIF income are payable by the estate through the final tax return.
After paying the income taxes the estate has only $100,000 available for the other son, Peter.
Assets passed outside the estate can affect the liquidity needed to cover the estate obligations. If the executor does not have enough liquidity in the estate, they may be forced to sell assets to cover such liability within a short period of time:
As another example, Mary is enjoying her retirement years due to a generous pension. Currently her only assets are her home and a cottage that she willed to her daughter Cathy, to keep it in the family. The cottage was bought 20 years ago for $200,000 and is valued today at $900,000.
At time of death, Mary’s home is not subject to capital gain taxes. Her cottage, however, will be subject to capital gain taxes of about $150,000. To pay the taxes due in time, the executor may be forced to sell the home or the cottage to raise the tax payable and, in the process, lose an asset of considerable value.
With proper planning, the above two situations can be avoided:
Carl’s example can create a rift in the family that Carl did not intend. A better way to deal with this situation was to appoint both sons as beneficiaries of the RRIF and the GIC.
Mary’s situation needed longer term planning. Setting up life insurance anticipating the taxes due on the capital gains would be the preferred way to deal with the lack of liquidity in the estate. This is due to the tax exempt status of the proceeds of life insurance in Canada.
A will is a key component in estate planning. However, without the proper financial planning, a will may lead to unintended consequences. Therefore, it is advisable to deal with both the legal and financial aspects at the same time, ideally with your lawyer and financial planner working in harmony to achieve your goals.
Joe A Salib, CFP®
Joe Salib is a Certified Financial Planner (CFP®) with Sun Life Financial in Unionville, Ontario. His more than 30 years of business experience has helped him assist professionals, business owners and families to create their own successful financial plans.
Joe is a long-time volunteer in the community and is currently the Treasurer of the Markham Board of Trade. Joe conducts financial literacy sessions at local organizations and is a CARP recommended advisor, active in retirement and estate planning.