Estate planning in Canada involves preparing for the management and distribution of a person's estate after their death. It ensures that the individual's wishes are honored, minimizes taxes, and provides for the needs of their beneficiaries.
Death and taxes are two certainties in life, and taxes are also a certainty in death.
But when it comes to estate planning, one common mistake you can make is not having an effective plan on how to manage the taxes. Failing to do so might cause a heavy tax burden for your family and beneficiaries, who may end up getting a smaller share once all the taxes are settled.
This article talks about some strategies you can use to decrease the taxes your estate will have to pay when you die, or at least postpone them. Some of these strategies might not apply to your situation! It can be a good idea to consult an accountant in Toronto to get advice on which are suitable for you.
Understanding Estate Tax Planning
You might be surprised to learn that you still have to pay taxes after you pass away before your beneficiaries receive their inheritance. This is known as filing your final tax return, which is done by your executor.
Estate planning can seem daunting and overwhelming, and while understanding the basics may not reduce all the stress involved, it does help.
Developing an effective strategy is not just limited to those deemed “wealthy” – regardless of where you fall on the money scale, an estate plan offers peace of mind. Such projects also look after loved ones and help minimize taxes
Some things that will be on your final tax return can include:
- Any outstanding income until the day of death
- Capital gains taxes on any assets you own. These are considered to be ‘sold’ on the day of your death.
- Capital gains on properties outside of your principal residence
Tax Implications After Death
Your estate will primarily incur two types of taxes after your demise: your final income tax return, and probate fees or estate administration taxes.
Final Income Tax Return
Your accountant can help with paying outstanding liabilities, which includes paying the final tax return with the Canada Revenue Agency (CRA). A final tax return is mandatory for any deceased person and must be filed in the year of death.
On this final tax return, the executor must report the income earned by the deceased person between the first day of the year and the date of death. Any income earned after the death of death must be reported on the Trust Income Tax and Information Return (T3).
Probate Fees or Administration Taxes
If your estate requires probate, the fees associated with probate are often known as administration tax. Probate fees are based on the size of your estate and vary depending on the province you are in.
For example, in Ontario, a new statute called the Estate Administration Tax Act (EATA) requires that you pay estate administration taxes on the value of the assets passing through the estate of the deceased, as part of the process of obtaining the certificate of appointment of estate trustee (the certificate that formally appoints the executor of an estate).
Like your final income tax return, your executor is also responsible for paying probate fees to the court alongside any application costs.
Estate and Tax Planning Strategies to Reduce Taxes After Death
If you want to leave more money in your beneficiaries’ pockets, there are also several ways you can minimize your estate administration taxes in advance through estate planning.
1) Creating a Will
A will is a legal document that outlines how a person's assets will be distributed after their death. It also allows for the appointment of an executor to manage the estate and guardians for any minor children.
2) Avoid Probate
Not all wills need to be probated in Canada. Your own will may not need to go through probate if you have a small estate, your financial institution(s) agree to waive a grant of probate, you are a First Nations member who is a resident of a reserve, or if you have multiple wills and another one of your wills does not require probate.
3) Joint Ownership of Assets
Placing assets in Joint Tenancy with Rights of Survivorship (JTWROS), where two or more people can hold assets together, can help reduce your estate fees after you pass. This can also help your property avoid capital gains tax.
This is because assets owned jointly pass to the other owner without entering the estate, though, of course, exceptions may exist.
Holding property jointly with rights of survivorship can allow assets to pass directly to the surviving owner without going through probate. This is common for real estate and bank accounts.
4) Beneficiary Designations
Naming beneficiaries on insurance policies, registered retirement savings plans (RRSPs), registered retirement income funds (RRIFs), and tax-free savings accounts (TFSAs) ensures these assets bypass probate and go directly to the named beneficiaries.
5) Leave Property to Your Spouse
If you leave property to your spouse, neither of you will have to pay taxes immediately on the capital gain. The taxable capital gain will be postponed until your spouse sells or gives the property to someone, or until he or she dies. This is called the “spousal rollover.”
This strategy is extremely useful for a property with a large capital gain (e.g., cottage, investment property, land, non-registered investment).
If you don’t leave your property to your spouse, the capital gains tax will be due when you die. This tax takes priority and is paid by the estate, which decreases the amount the heirs receive.
6) Leave your Registered Retirement Savings Plan (RRSP) to Your Spouse
If you leave your registered retirement savings plan (RRSP) or your registered retirement income fund (RRIF) to your spouse, he or she can transfer the funds to his or her own registered plan when you die. No taxes will be due if no funds are withdrawn.
7) Leave Your TFSA to Your Spouse
If you leave your tax-free savings account (TFSA) to your spouse, he or she can transfer all or part of the funds to his or her own TFSA before December 31 of the year following your death.
This will not affect your spouse’s own contribution limit. Your spouse must fill out a form called “Designation of an Exempt Contribution – Tax-Free Savings Account (TFSA).” However, the interest earned in your TFSA between the day of your death and the time of the transfer is taxable and must be declared by your spouse.
If you don’t leave your TFSA to your spouse, the income and capital gains from the TFSA will be taxable from the date of your death. However, anything accumulated in the TFSA before your death is not taxable.
8) Establishing Trusts
By creating a trust in your will, you can divide the income between the trust and the beneficiaries, who are considered separate taxpayers. This means the income of the trust and the income of the beneficiaries will be taxed separately.
Also, if the trust is created for your spouse only, taxes can be postponed until he or she dies, or until the trust transfers the property received under the will to another person.
- Living Trusts: These are created during an individual's lifetime to manage assets and can help avoid probate.
- Testamentary Trusts: These are established through a will and come into effect upon the individual's death. They can provide for minor children or other beneficiaries who may need financial oversight.
If you do not create a trust, the income from the property the estate receives is added to the income of the person receiving it, which increases the taxes due.
For example, you leave your rental property and stock portfolio to one of your children, but you decide not to use a trust.
Your child will have to pay taxes on his or her own income, in addition to the income produced by the property received from the estate. Since his or her income will be higher, the taxes owed will be higher too.
9) Inter Vivos Gifts
Inter vivos means between the living, so inter vivos gifts are gifts of assets you can make while you are alive. While these gifts can help reduce the tax value of your estate when you pass, they are also irrevocable.
10) Asset Relocation
Another option for reducing taxes after death is to move your assets into a jurisdiction outside your province.
11) Charitable Bequests
Incorporating charitable donations into your estate plan can reduce the taxable value of your estate through tax credits.
12) Power of Attorney
A power of attorney for property allows someone to manage your financial affairs if you become incapacitated. A power of attorney for personal care designates someone to make healthcare decisions on your behalf.
13) Advance Directives
These documents, such as a living will outline your wishes regarding medical treatment if you become unable to communicate your decisions.
How to Start Estate Planning
Effective estate planning in Canada involves a combination of legal documents, financial strategies, and regular reviews to ensure that your assets are distributed according to your wishes and that your beneficiaries are provided for efficiently.
Remember, you don’t need to have a vast estate to start planning because not having a large estate does not exempt you from paying taxes. As mentioned, tax rates may vary between provinces and territories, so check first with the CRA on the prevailing estate laws so you can plan effectively.
Which strategy do you think can benefit you the most? You can speak with your accountant about the best possible tax workaround that applies to your estate. Our expert team of accountants in Toronto can tailor an estate plan to your specific circumstances and ensure compliance with Canadian laws and regulations. Feel free to reach out to Filing Taxes at 416-479-8532. Schedule an NTR engagement appointment with us and take the first step toward proper management of your finances.
Frequently Asked Questions
When considering estate planning taxes and how to manage them, here are some other questions you may have.
How much can you inherit without paying taxes in Canada?
There is no inheritance tax in Canada, so theoretically, there is no limit to how much you can inherit without paying taxes for it. But final tax income returns and other estate settlement fees shouldn’t be ignored, as monies owing are deducted from the estate before funds are distributed to beneficiaries.
Is estate planning tax-deductible in Canada?
Estate planning is not tax-deductible in Canada, though the benefit of it to you and your loved ones, and the peace of mind it’ll give you, is worth it.
What is the best trust to avoid estate tax?
Any irrevocable trust, such as inter vivos trusts and many complex trusts, is shielded from estate taxes as the trust is no longer considered part of your estate.
Disclaimer: The information provided on this page is intended to provide general information. The information does not consider your personal situation and is not intended to be used without consultation from accounting and financial professionals. Salman Rundhawa and Filing Taxes will not be held liable for any problems that arise from the usage of the information provided on this page.