Let’s say you have a $1 million estate that has $200,000 of stocks in a non-registered account, a $300,000 Registered Retirement Income Fund (RRIF) and vacation property valued at $500,000.
Your heirs would not be getting the whole $1 million because there’s a $100,000 capital gain on the stocks and a $300,000 capital gain on the vacation property. At a 50% marginal tax rate, tax payable is $25,000 on the stocks, $75,000 on the vacation property and $150,000 on the RRIF. Total tax bill: $250,000.
Now the question is how it’ll be paid.
Managing the tax liability
If there’s enough liquidity in the estate, then the estate assets can simply cover the tax. But that’s not always the case. To pay the tax bill, vacation property or another cherished asset may need to be sold. Or investment holdings must be redeemed – not ideal if markets are down when tax is due. If your heirs don’t wish to sell assets, they could borrow money to pay the tax, but that method can prove costly.
Another option, if you plan early, is to establish a fund designed to cover taxes payable by your estate. A Tax-Free Savings Account (TFSA) can be ideal, supplemented by non-registered investments if needed. This method of providing an estate with liquidity takes great discipline – the funds may face competing interests over the years, like buying property in Florida.
Life insurance – a possible solution?
In certain situations, life insurance can be a cost-effective way to leave more of your estate value to your heirs. The strategy involves estimating the future tax payable by the estate, then purchasing a permanent life insurance policy with an insurance benefit that offsets the tax liability.
This solution offers several benefits. The cost of premiums, when this solution suits your situation, compares favourably with other funding methods involving conservative investments. The final payout amount is guaranteed, arrives when needed, and is tax-free. From the day the first premium is paid, the tax liability is covered – a benefit unique to this strategy. The executor doesn’t need to liquidate estate assets to pay taxes owing.
If you have a spouse, you may plan to roll over or transfer assets to him or her on a tax-deferred basis, but your spouse may eventually face a large tax liability on estate assets. A solution is to purchase one life insurance policy on both of your lives, a joint last-to-die policy. This policy only pays the insurance benefit upon the passing of the second spouse. This way, the tax liability on estate assets is sure to be covered no matter when it becomes payable.
Contact your advisor if you would like to investigate strategies that help manage taxation on estate assets.