HFI Financial

Keith L. Hatton, CFP, CLU, ChFC, TEP

Will Planning Techniques

The will is one of the most notorious testaments, embracing all
the elements of money, power, passion, insurance, life and death.
It provides a fascinating source of material for stories, both real
and fictional, of murder, forgery, romance, inheritance, drama and
even comedy, be it Howard Hughes or Agatha Christie.

Cloaked by all the mystique and sometimes overlooked is the
mundane fact that the will is a key element of estate planning. For
most people it is the cornerstone document of their estate plan
and for some the only estate and succession planning they will
ever need to do. The will, more than any other planning tool,
reflects and achieves the essence of estate planning, namely the
transfer of property from one generation to the next in accordance
with the wishes of the testator, while at the same time minimizing
the amount of tax and probate fees payable.

"Death and taxes are inevitable" is a phrase that is frequently
uttered. Unfortunately, in Canada the two often occur at the same
time due to our system of deeming the disposition of all capital
property on death, at fair market value, with the exception of
capital property to a spouse or spousal trust and the exemption
which applies to a principal residence.

Will planning increases in importance because it is not only the
size of estate, but also the kinds of property owned by the
testator at the time of death that determines the tax
consequences in the terminal year. Also, the Income Tax Act
(ITA) provides exceptions to the rules for realizing income in the
terminal year as well as a number of elections that permit
personal representatives and trustees to affect the taxation of the
deceased, the estate, any testamentary trusts created in the will
and the beneficiaries of the trust.

Consequently, tax-oriented will planning involves the use of
various legitimate techniques, not confined to those incorporated
in the will document itself, but extends to estate planning
techniques adopted in anticipation of death and taxes (including
probate fees) as well as techniques applied by executors and
administrators after the death of the testator. The three
inter-related components that comprise will planning are
commonly referred to as: Probate Planning, Will Drafting and
Post-mortem Planning.

Perhaps the best way of demonstrating the importance and value
of this strategic planning is to select a few examples, from the
multifarious techniques that are available, in each of these three
areas.


Probate Planning

This component of will planning is designed principally to avoid or
reduce the probate fees and to minimize the effect of capital gains
taxes on death.

Inter Vivos Dispositions

Obviously, the less property that belongs to the testator at the
time of death the less the probate fees and taxes that will be
payable. The testators can dispose of their property inter vivos by
the way of gift or for consideration and either absolutely or by
means of trusts with certain reservations or obligations.

If there is no indication of imminent death then the question of the
tax consequences of the disposition becomes important as the
prepayment of income tax might well offset any probate fee
saving. However, if there are little or no accrued gains or if the
gains are exempted, this technique is often worthwhile. Before
embarking on a gifting program, testators must consider other
means of support and income.

If there is a need for support for the donor, assets can be settled
in a remainder trust, reserving the right to the donor to receive
lifetime income and a power of encroachment, with the remainder
interest passing on death to the intended beneficiaries.

A hybrid gift-sale is sometimes used to transfer property and still
provide for the donor. It involves the absolute transfer of the
property subject to an agreement by the donee to provide support,
use, occupation or maintenance by or for the donor for life. The
obligation can be collaterally secured by a pledge of the property
transferred.

Utilization of Exclusions

The provisions of the ITA and the Estates Act contain a limited
number of exclusions which allow property to pass outside the will
with the result that the excluded property will not be subject to
probate. Specifically these are:
encumbrance on real property,
life insurance and annuity proceeds to a named
beneficiary,
jointly owned property which passes by survivorship, e.g.
real property and bank accounts.

Transfer to a Corporation

In determining value of the estate for probate purposes, there is no
deduction of debts except encumbrances on real property.
Therefore, a person holding personal property subject to debt
should consider transferring the property to a corporation in return
for shares since the value of the shares will be net of the
liabilities.

If the assets are of sufficient value, they could be transferred to a
corporation in return for shares and debt, which become the
estate assets. Directors of the company are usually prepared to
effect the transfer of shares and debt on death, without probate. In
situations where probate is required, the corporation would be
incorporated in a jurisdiction that had the lowest probate fees.

Powers of Attorney

While not a technique per se, having a continuing general power
of attorney can enable the attorney, on notice of impending death
of the donor, to take steps to realize and transfer assets out of
the name of the donor to another person as trustee. This avoids
the necessity for probate. Such a transfer will preserve the assets
for purposes of estate distribution.

Will Drafting

The terms of a will have a significant effect on both the taxation of
the testator in his or her terminal year and the taxation of the
estate and its beneficiaries. Where there are alternative methods
by which the testator's dispositive wishes can be implemented,
the method which produces the least amount of tax should be
chosen. Further, where certain options or elections are available,
the draftsman must ensure that the will is sufficiently flexible to
take advantage of all benefits. The impact of matrimonial property
regimes in force in different jurisdictions must also be kept in
mind.

A classic example of the options available to the personal
representative when filing a final income tax return is that relating
to "rights & things."

Rights & Things

Significant possibilities for saving tax in the terminal year are
provided by the rules relating to "rights & things" which generally
include income items that are amounts receivable at death as
opposed to received, that would normally be included in income
only when received. A "right or thing" includes any of the following
items:
Uncashed bond coupons,
Unpaid dividends receivable,
Unpaid salary or share of profits accrued prior to death, but
not received,
Unpaid commissions receivable including insurance
agents' renewal commissions.

The legal representative may elect to exclude any right or thing
from the regular terminal tax return and file a separate return
which includes all such items. Alternatively, the representative
could choose to transfer certain items to one or more
beneficiaries or allow the value to be included in the deceased's
terminal return. Considerable tax savings are achieved because
effectively two sets of marginal rates and personal credits are
used.

Spousal Deferrals

The ability to defer tax by interspousal transfers of property is well
recognized, especially on death. A spousal deferral is available
with respect to non-depreciable capital property, depreciable
capital property of a prescribed class, land, resource properties,
reserves and refunds of premiums under RRSPs and RRIFs.

Charitable Donations

In 1996 the tax credit for charitable donations was raised from
20% to 100% in the year of death, with any unused credits being
allowed to be carried back to the prior year. The change meant
that the previous bias against testamentary gifts as opposed to
inter vivos gifts disappeared with the pendulum actually shifting
towards bequests. It is now more attractive also to have the death
benefit of an insurance policy paid to the estate and then
bequeathed to a charity than was previously the case.

A large percentage of older Canadians have unused RRSP and
RRIF funds which they will now be willing to leave to charity, since
the income inclusion of funds in the year of death will be offset by
the gift. All that is needed is a revision of the potential donor's will
to direct the donation of the RRSP/RRIF funds to a charity of
choice, to meet the statutory requirements.

Indeed, the transfer of capital assets which trigger a deemed
realization at death by will may not only ameliorate the tax bite in
the year of death, it may also produce a bonus for the year
preceding the gift. For example, a potential donor owns a family
cottage with a cost base of $100,000 and a fair market value of
$400,000. If, in the year of death, the cottage is donated to a
charity (which presumably would sell it), the gift would be worth
$400,000, but the taxable amount included in income would only
be $200,000 (three quarters of $300,000). The gift would not only
cover off the tax associated with the deemed realization but would
offset $175,000 of other income in that year. Moreover, if there
was no other income in the year of death, up to $175,000 can be
carried back to the prior year to offset income in that year which
should result in a windfall tax refund to the estate in respect to the
previous year.


Post-Mortem Planning

The estate planning that occurs after death is to a large extent
dependent on the inter vivos planning already completed and, of
course, on the provisions of the will. This area of planning relates
mainly to the allocation of assets to beneficiaries, minimizing tax
on income of the estate and, where possible, rectifying planning
omissions.

Allocation of Assets

In general, where there is a surviving spouse, it is beneficial to
defer the capital gains tax. However, there are situations where
this is not always the most suitable strategy.

Consider, for example, where the taxpayer owned shares in a
private company which qualify for the $500,000 capital gains
exemption and which were directed to be left to a spousal trust. In
these circumstances, it might be beneficial instead to cause
these shares to be held in a non-qualifying or tainted spousal trust
and subject the deceased to a taxable capital gain at fair market
value. The shares, held in a tainted spousal trust, would not be
the subject of a further deemed disposition. Provided that the
shares are disposed of within 21 years of the death of the
deceased, they could be transferred on a tax-free basis to
beneficiaries.

Similarly, assets in the estate which have no inherent capital
gains such as cash on deposit, treasury bills and life insurance
proceeds, if transferred to a spouse or spousal trust can give rise
to tax consequences in the future, without achieving any benefit at
the time of death. The assets could for example be invested in
stock or mutual funds with potential large capital gains for the
surviving spouse.

If, on the other hand, these assets were directed to a tainted
spousal trust, there would be no tax consequences on the
spouse's death because the tainted trust would still exist, or
could be dissolved on a rollover basis.

Where the will confers flexibility to allocate assets among different
beneficiaries, significant tax benefits can be achieved by making
an appropriate allocation. The ITA helps because, in order to
obtain the spousal rollover, the assets must vest in the spouse or
spousal trust within 36 months of death. Not only does this allow
for flexibility in tax planning, it allows also for essential retroactive
tax planning in that the determination can be made with the
benefit of hindsight.

The executors could implement a post-mortem estate freeze in
favour of the surviving spouse's beneficiaries or a trust for them. In
this way, if the spouse survives the deceased for a considerable
period of time, the deemed disposition on the spouse's death will
be at the value of the asset at the time of the freeze, rather than
on death, which could be considerably higher.

Income Splitting

Testamentary trusts are given the graduated rates applicable to
individuals. If a trust has earned income of $60,000, the tax on
this income would be $19,130 (in Ontario). On the other hand, if
the same income were realized by an individual taxpayer in the
top tax bracket, the tax would be $31,750. Consequently, there is
a tax savings of $12,620 from having income retained and taxed in
a testamentary trust. To the extent that a testator creates
multiple testamentary trusts by virtue of the will, the benefits can
be multiplied.

Where a trust holds shares that qualify for the $500,000 capital
gains exemption, there is also fertile ground for income splitting. If
a capital gain is created in an estate from either a designation or
a crystallization, an actual payment to beneficiaries will be
required. It may be possible to make the payment in the form of
shares of the corporation.

Life Insurance

Life insurance has traditionally played a significant role in will and
estate planning, primarily by ensuring that the estate has
sufficient liquidity to provide income to dependents and to fund tax
liabilities. The role of the life agent and estate planner is to identify
the tax liabilities that arise on death and to advise on the estate
planning strategies to defer and minimize the impact of taxation. If
the life insurance policy is issued appropriately as to ownership
and beneficiary designations, the proceeds on death can be tax
effective in a number of scenarios, such as:

When the proceeds are payable to a named beneficiary,
rather than to the estate, they are excluded from the value
of the estate and probate fees are avoided. In Ontario, for
example, for every $1 million of life insurance proceeds so
designated $1,500.00 of probate fees is saved.

If a corporation is the beneficiary of life insurance proceeds used
to redeem shares (grandfathered from the stop-loss rules) from an
estate, every $1 million of insurance received by the estate as a
capital dividend means a saving of approximately $290,000 in tax
on the capital gains to the estate.

If the estate is the beneficiary of life insurance proceeds which are
used to pay a charitable bequest, the estate is entitled to a 100%
tax credit for the donation. On the other hand, if the charity is
designated as the beneficiary of the life insurance, there is no tax
benefit to the estate.

Conclusion

Will planning is a continuous process of estate and tax planning
which does not refer only to the drafting and execution of the will
testament. Nor does it just take place in advance of death and
end at death, but continues through the life of the estate to the
ultimate disposition of the deceased's assets. Too often this
consummate nature of will planning is overlooked which means
that many of the valuable tools and techniques available to
minimize tax are not even considered, let alone used. As is often
the case, life insurance plays a key role in this planning process.

Statistics reveal that only 50% of all adults in Canada have a will
and that many of these are incomplete, out of date or inefficient
from a tax planning perspective. Nobody likes to think about death
or taxes but there are encouraging signs of a growing awareness
that both are facts of life which are best confronted by skilful will
planning.

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Last modified: December 14, 2008