Taxes Upon Death
How are your assets taxed when you die?
Understanding how things are taxed upon death is really important to understand when planning your estate. With proper planning, this bill can be reduced, but today I am just going to discuss how different assets are taxed.
The first thing to understand is that all of your assets can be transferred to your spouse completely tax-free. However, if you have named someone other than your spouse as the direct beneficiary of a taxable asset, there will be taxes owing at that point. This example will be one that discusses when the 2nd spouse dies.
Let's look at an example...
I am going to take a look at a person who has fairly substantial assets at death and owns a whole bunch of different things to see how each asset is going to be taxed.
You will see that I have lumped the assets into 3 colours to separate the tax implications of each asset. I have only specified what the Adjusted Cost Base is for the three assets where it actually matters.
As soon as you die, it is considered that every single thing you own is sold.
Now we'll talk about each of the three sections. First is the green section and everything in the green section is completely tax-free. Your principal residence can always be sold tax-free. Cash has already had tax paid on it, so that's tax free. Life Insurance proceeds are tax-free and lastly the TFSA is always tax free.
Right there, the estate has $1,050,000 value that's free of tax.
Now let's look at the blue, which has the RRSP. As I said, it's like the RRSP is all sold on the day you pass away and all of that is treated as fully-taxable income, so now there is $500,000 worth of income to the estate.
In an ideal world, you would know exactly how long you're going to live and take out of your RRSP over time so that it is close to $0 upon death.
One idea however, is that if you knew you had a shortened life expectancy, you could take out half of the value the year before to decrease the bill by a little bit.
Now let's look at the orange. All of these assets have increased in value over time and will be taxed as Capital Gains.
The non-registered portfolio has $300,000 worth of Capital Gains.
The Cottage/Cabin has $400,000 worth of Capital Gains. This can be a huge issue for a lot of families as there's going to be a large tax bill associated with a lot of family owned properties. If you're wanting to keep the property in the family, you'll need to plan around the tax implications.
The rental property has a Capital Gain of $100,000.
The total gains are $800,000, so this estate will owe tax on $400,000 income here, because the Capital Gains inclusion rate is 50%, meaning only 50% of the growth is taxed.
This estate will have a taxable income of $900,000 ($500,000 from the RRSP and $400,000 from the properties and stocks).
If we are looking at this person and assume they died in Alberta in 2017, they would owe an average tax rate of 44.37% on an income of $900,000.
$900,000 * 44.37% = $399,330
Their estate is worth $2,350,670 AFTER-TAX.
Something to consider...
Different provinces have different tax treatment on Estates, which is called Probate. In Alberta, probate isn't much of an issue, because the maximum amount you will owe is $400, no matter how large your estate is.
However, provinces like BC and Ontario have pretty significant probate fees. BC residents owe 1.4% on everything over $50,000 and Ontario residents owe 1.5% on everything over $50,000, plus $250, plus 0.5% on everything under $50,000.
So, if this person was a resident of Ontario, they would owe $41,000 worth of Probate Fees, which is quite significant.
It would be worth their time to do a little bit of planning for this bill and the easiest way to do this is to name a direct beneficiary on their assets that allow this.
They could name beneficiaries on the RRSP, TFSA and Life Insurance, which would allow those proceeds to flow outside of the estate. This WILL NOT reduce the taxes owing, but will reduce the value of the Estate by $850,000.
This would save $12,750 in Probate Fees.
There are also some things you'd want to discuss with an accountant as you can manipulate the ownership of properties and it is possible to reduce the taxable gain on the cottage by claiming it as your principal residence for a certain period of time. These are not good strategies for all situations.
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