Common wealth transfer mistakes

Each year in Canada, billions of assets are transferred at death. If you intend to transfer all or part of your assets to your heirs, you want to make sure that it goes to the people you selected and in the manner you intended.

Unfortunately, wealth transfer doesn’t always occur as planned. This article outlines some common mistakes that can occur when trying to transfer wealth.¹

Not having a will

A basic and all too common mistake is failing to have a will. A will communicates your intentions and allows you – and not the government – to determine how your assets will be distributed on your death. Having a will can make administration of your estate easier and can help you save taxes. It also allows you to choose the executor of your estate and the guardians of your children. For more information on wills, see Wills 101 (national edition)

Will drafting errors

Having a properly drafted will is important, to say the least. But there are a few things to consider that you might not be aware of.

If you’re thinking of using a handwritten will (also known as a holograph will) or a do-it-yourself will (also known as a stationary will), be wary. Often, there are problems with interpreting your instructions if they’re not clear, or they may not comply with provincial statutory requirements. Such issues may invalidate the will or add costs to the administration of the estate and delay distributions out of the estate. Having a will prepared by a lawyer is always preferable to both holograph and stationary wills.

In some provinces (e.g., Ontario), one strategy used to avoid probate fees is to have multiple wills, where one will is submitted for probate and another will (dealing with assets that don’t require probate) is not. Shares of a private corporation are a common example of an asset that may avoid probate fees through the use of multiple wills.

If your will leaves too much discretion to the executors in choosing the amount of a bequest to a charity, or in choosing the charity itself, beneficiaries may object to the donation, which can lead to tension between them and the executor. This could be especially true if the donation will reduce a beneficiary’s inheritance or there’s disagreement about the testator’s philanthropic intentions.

In most provinces, marriage revokes a will unless the will specifically contemplates the marriage and identifies the future spouse.

In many provinces, gifts or inheritances are excluded from equalization upon a marriage breakdown. In fact, in some provinces, the income from an inheritance or gift can also be excluded if the will expressly says so. If this is the case, make sure your will has the appropriate declarations. However, this may be jeopardized if a recipient uses the gift for the benefit of the family, contributes the money to a matrimonial home, or commingles the assets with other family assets so they can no longer be traced.

Treating equal beneficiaries unequally

Often when splitting assets, the intention is to split them equally between beneficiaries – for example, between three children. However, if you fail to consider the tax consequences, the wealth transfer may not be equal at all.

Take a simple example where you have three assets – a registered retirement savings plan (RRSP), a home, and a non-registered mutual fund portfolio – and each asset is worth $1 million. You name your first child as beneficiary of your RRSP, and in your will, you leave the house to your second child and the mutual funds to your third child. You think you’re leaving $1 million to all three, but the reality is that the child receiving the mutual funds under the will is going to have their share reduced by any tax your estate pays on the RRSP and the mutual funds.² Assuming a 40 per cent effective tax rate, your estate would pay $400,000 in taxes on the RRSP, in addition to any potential taxes on the deemed disposition of the mutual funds, which we’ll assume are $100,000. As a result, the third child would be left $500,000, significantly less than the $1 million the first and second child each received, and not what you’d intended.

Spousal issues

Another way people fail to consider the tax implications often involves second marriages or separated and estranged spouses. For example, let’s say you’ve named your new spouse as beneficiary of your RRSP or registered retirement income fund (RRIF) to provide for them after your death and named your children (perhaps from a previous marriage) as beneficiaries under your will to inherit the rest of your estate. You assume that your spouse will roll over your RRSP or RRIF to their RRSP or RRIF and pay tax on any withdrawal. But what if they don’t? Instead, your spouse just takes the cash. Well, your estate could be responsible for any taxes on the RRSP or RRIF, which effectively means it comes out of your children’s inheritance.

Under these circumstances, you can use two strategies to prevent this from happening:

• It’s possible for the legal representative (executor) of the estate to make a unilateral election to deduct the amount paid from the RRSP or RRIF in the estate. By doing so, this limits the tax burden in the estate and shifts the income inclusion to the surviving spouse.
• If you have a RRIF and the contract allows, consider naming your spouse as successor annuitant or Joint Life.³ On your death, the RRIF will automatically transfer to your spouse on a tax-deferred basis, making sure that your estate won’t have to pay the tax. For second marriage situations where you want to provide an income stream to your spouse but want to make sure that anything left in the RRIF on your spouse’s death goes to your children, see When to consider the RRIF successor annuitant or Joint Life option.

Failing to update beneficiary designations

When a life event such as a birth, death, marriage, separation, or divorce occurs, people often remember to review and update their will accordingly but may forget to review their beneficiary designations. You should review your will and any beneficiary designations to make sure that they still reflect your testamentary intentions. This is a common oversight and often results in the courts having to decide.

Minor beneficiaries

It’s important to consider the age of the individuals you name as beneficiaries. Remember that, generally, death benefits can’t be paid directly to minors and, therefore, will often have to be paid into the court or to the Public Trustee. In addition, after reaching the age of majority, the minor will be entitled to the funds without any restrictions.

Naming a minor as irrevocable beneficiary is even more problematic and should almost never be done. When an irrevocable beneficiary is named, their consent is required to deal with the contract. However, a minor can’t provide their consent until they reach the age of majority, which means the contract will effectively be frozen until that time. Furthermore, as explained earlier, a death benefit couldn’t be paid directly to the minor.

If you want the death benefit to be paid to a minor, it’s recommended that a trust be used to receive the funds on behalf of the minor. The terms of the trust can set out how you want the funds to be invested and when payments are to be made for the benefit of a minor. If the child is disabled, the trust could meet the requirements to be a qualified disability trust and benefit from being taxed at graduated tax rates. For more information on qualified disability trusts, see Considering insurance trusts and the annuity settlement option.

Lump sum to adult beneficiaries

Sometimes providing a lump-sum payment to adult beneficiaries isn’t wise. This could be the case if the beneficiary isn’t financially responsible and may spend the money frivolously, or perhaps is disabled and may lose their government disability benefits. For these individuals, an annuity settlement option or testamentary trust may be more appropriate. For more information, see Protecting your nest egg after you’re gone.

Failing to name a beneficiary or naming your estate as beneficiary

Unless there’s a specific reason for having assets flow through your estate, such as to use tax losses or deductions, or to apply any special instructions contained in the will, it may be a better idea to name a beneficiary directly on a contract, where possible. Having assets flow through your estate may subject them to claims by your estate creditors, as well as probate and administration fees. Furthermore, if your will is submitted for probate, it becomes a matter of public record, available for anyone to view.

When a beneficiary other than your estate is named in an insurance investment (such as a segregated fund contract), the death benefit bypasses your estate and, therefore, avoids probate fees (and potentially other estate administration fees). The proceeds are then paid directly to the beneficiary, usually within two weeks after receiving all necessary documents. By avoiding your estate, the death benefit may also avoid claims by creditors of the estate and challenges to the validity of the will, which can delay the distribution of your estate by weeks, months, or even years. Also, if a beneficiary of the family class⁴ is named or a beneficiary is named irrevocably, the insurance investment offers you the potential for creditor protection while alive.

Adding a joint owner other than your spouse

Placing non-registered assets into joint ownership with right of survivorship⁵ is one of the most common methods of avoiding probate. On the death of one joint owner, the asset transfers directly to the survivor, bypassing the deceased’s estate. However, there are some significant disadvantages with joint ownership, particularly when someone other than your spouse is added as joint owner.

As an example, let’s say you’re single with two adult children. Your daughter lives in town and your son lives on the other side of the country. Your health is failing and your daughter is caring for you. To help her to take care of you, you add your daughter as joint owner to your bank and investment accounts, which are your only assets. Your intention, as per your will, is to divide your estate equally between your kids. On your death, the accounts automatically transfer to your daughter. If your daughter is dishonest and doesn’t return the funds to your estate, there’s nothing left for your son, and this may result in a lawsuit. The court will try to determine your intention. Was this a gift to the daughter or merely an agency agreement? That’s why it’s so important that you document your intentions so the courts can administer your estate according to your wishes. Your other alternative is to make sure you have a properly executed Power of Attorney for property, which could allow your child to assist in administering your finances without having to add them as joint owner.

For more information on the risks of joint ownership, see Be careful with joint ownership.

Unused charitable donations

If you’re planning to make a significant charitable donation at death, steps should be taken to make sure that your estate will be able to use the entire donation receipt. While the limit for claiming donation receipts at death is 100% of net income in the year of death and the year prior to death, it’s still possible for there to be unused receipts. Individuals making extremely large donations, relative to their annual income, who die early in the calendar year or who name a charity as beneficiary of their non-registered investment or life insurance policy have a greater risk of having unused charitable tax credits. Naming a charity as beneficiary of an RRSP or RRIF is usually not a problem because charitable receipts can be used to offset the tax on the income from the RRSP or RRIF. If you have a spouse with sufficient income, your spouse could also claim any unused charitable receipts for the next five years.

If you‘re concerned that you may have unused charitable receipts at death, consider making some charitable donations while alive and reduce your taxes payable now.

Ideal candidates

Individuals who want to:

• transfer assets to their heirs
• make sure their assets are distributed according to their wishes
• avoid making one of the common mistakes outlined earlier

Take action

If this applies to you, then:04

• have a will prepared by your lawyer (if you don’t already have one)
• review your estate plan, including your will, beneficiary designations, and jointly held property, with your tax or legal advisor
• review your will and beneficiary designations regularly and after a life event to make sure they still reflect your wishes, and amend or update them as needed.

1 This Wealth Transfer Strategy applies to all provinces other than Quebec. For Quebec residents, refer to Common wealth transfer mistakes (Quebec edition). Many of the issues discussed will vary by province. You should consult with your legal advisor. 2 It’s assumed that the home can be transferred tax free as a result of the principal residence exemption. The general rule is that without a tax-deferred rollover, the fair market value of the RRSP must be included in the annuitant’s terminal return and taxed in the estate. See RRSPs and RRIFs on death for more information on the taxation of RRSPs and RRIFs at death. 3 The Income Tax Act doesn’t allow an RRSP to name a successor annuitant. 4 In provinces other than Quebec, a family class beneficiary is any of the spouse, child, grandchild, or parent of the annuitant. In Quebec, it’s any of the spouse, descendants, or ascendants of the owner. 5 All other references to joint ownership mean joint ownership with right of survivorship. Joint ownership doesn’t apply in Quebec.