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In estate planning, Canadians don’t have to contend with an estate tax the way U.S. citizens do. However, what many people don’t realize is that a “deemed disposition tax” applies when you pass away. In this article, we’ll provide tips on minimizing your estate’s exposure to this tax and structuring your estate plan to ensure your beneficiaries get the assets you intend for them.
Key Takeaways
- Canada’s deemed disposition tax, which is similar to the estate tax in the U.S., is deferred when assets are transferred to or held in a spousal trust for a surviving spouse.
- Creating a trust allows you to transfer assets while you are still alive, which avoids probate costs when you die.
- If you die without making a will, the Canadian province in which you lived decides how your assets will be distributed.
Taxation and Estate Planning
The deemed disposition tax is so named because your investments are deemed to be sold at death. Any capital gains triggered by their sale are included in a final income tax return filed in the year of your demise. A final tax return also includes the value of any retirement accounts and income received from stocks, bonds, real estate investments, and even life insurance proceeds in the year of death, from Jan. 1 up to the date of death.
With Canadian federal income tax rates of up to 33% in 2022, this final taxation can be substantial. Provincial taxes and probate fees also apply. (Skipping out on probate costs is possible, though, with proper advance planning.)
The good news is that the tax is deferred if the assets are transferred to a surviving spouse, rather than sold or otherwise left unclaimed. Taxes are deferred even if the assets are held in a spousal trust, which provides income to the surviving spouse. However, if the spouse sells the assets, the tax applies. When the spouse dies, and the assets are passed on to other heirs, 50% of the capital gains of any stocks, bonds, real estate investments, and other assets are taxable at the personal income tax rate.
The government of Canada also has special rules that apply to depreciable property, depending on its proceeds or deemed proceeds of disposition at the time of the individual’s death, if it is not left to a spouse.
Why It’s Important to Make a Will
“Nothing is certain but death and taxes,” the old saying goes (attributed to American Benjamin Franklin). While you can’t control either of these two inevitable events, you can make a will to ensure that your financial affairs are managed according to your wishes once you’re no longer able to do so due to incapacity or death.
Without a valid will, you are considered to have died intestate. When that happens in Canada, the province you lived in decides how your assets are distributed, without regard to your wishes. Following the laws of intestacy, the province typically distributes the first $50,000 of value to a surviving spouse, then divvies up the rest between the spouse and children. If you don’t have a surviving spouse or children, your parents are next in line to receive your assets, followed by any siblings.
Dying without a will also leads to delays and extra expenses. The court appoints a bonded administrator to serve as an executor of the estate. In addition, any assets distributed to children under age 19 must be passed along to a bonded guardian or to the Public Trustee. The process of appointing these administrators is both expensive and time-consuming.
Last Will and Testament
The purpose of the last will is to give instructions to a person you choose as an executor on how you want your assets distributed after your death. It typically doesn’t give directions on your funeral or burial, as it usually won’t be opened until after the funeral, when the heirs come together for the reading of the will.
Power of Attorney
Power of attorney gives the person of your choice the power to manage your financial affairs if you become incapable of managing them yourself. It gives this person, designated as your agent or attorney-in-fact, the power to handle such day-to-day tasks as:
- Paying bills
- Filing tax returns
- Opening mail
- Banking
- Talking with accountants and lawyers
- Looking after pets
- Voting on your behalf
Without a power of attorney, your spouse has no legal authority to perform a variety of important tasks for you if you become disabled.
Living Will
A living will gives healthcare/mental power of attorney to a person of your choice. It gives this person, acting as your agent or attorney-in-fact, the power to implement the medical treatment you wish to receive if you become unable to express your wishes. The document tells doctors, family members, and the courts your wishes for life-support and other medical procedures if you were to become brain dead, unconscious, terminally ill, or otherwise unable to communicate.
A living will essentially gives your chosen agent the power to choose whether or not to “pull the plug” or to decide your fate for you, but its value is debatable. Euthanasia isn’t legal under section 215 of Canada’s Criminal Code, and the living will has no legal status. However, Canada’s Charter of Rights throws the constitutionality of this section of the Criminal Code into question by giving everyone the right to “security of the person and the right not to be deprived thereof.
How a Trust Simplifies Estate Planning
A will ensures that your heirs get exactly what you want them to get, but a trust can simplify the process of transferring these assets to your heirs. The main difference between the two is that the trust will let you transfer assets to beneficiaries when you’re still alive, while a will transfers your assets when you die.
A trust is a legal entity that owns some or all of your assets, such as bank accounts, real estate, stocks, bonds, mutual fund units, and private businesses. The terms of a trust are more legally binding than those of an ordinary will, which can be challenged in a court of law as to whether it fulfills the deceased’s “moral obligation.” A trust also allows you to avoid the probate process, where the contents of your will are made publicly available.
Types of Trusts
The main type of trust in estate planning is a revocable living trust, so-called because you can change or revoke the terms of the trust at any time while you’re alive. The trust instructs the trustees on how to distribute your assets to beneficiaries while you’re alive, after death, or if you become incapable of doing so.
Both you and your spouse can be trustees and manage the trust’s assets. This feature of a living trust may be important, for example, if a family business is placed in a trust and you want to continue to have some control over its operations. When one spouse dies, the surviving spouse continues as trustee, but the trust becomes irrevocable in that only limited changes can be made to its terms.
As the income from trust-held assets is taxable at Canadian trust tax rates, living trusts are not as popular in Canada as they are in the U.S., where the income is taxed at your personal income tax rate. A living trust established after June 17, 1971, is subject to tax on all income at the highest marginal rate of tax in the province of residence. In contrast, a testamentary trust, which operates only after death, is taxed at the personal provincial tax rate.
In addition, assets that are transferred into or out of a Canadian trust are generally treated as if they have been sold, and they are taxed on any increase in value (appreciation) from the purchase date. However, two relatively recent trust structures, the alter-ego trust, and joint-spousal trust allow you to avoid capital gains taxation.
The Bottom Line
In sum, to ensure that your assets are distributed the way you want them to be, you will need a last will and testament, and you also may want to consider a living will, a power of attorney, and a trust.