Planning Ahead: Six Ways to Minimize Taxes on Your Estate
It is tax season once again. While many of us focus on reducing this year’s tax bill, it’s also a good time to consider how to manage future tax obligations. After all, as the old saying goes, “nothing is certain but death and taxes.” Planning ahead can help preserve more of your hard-earned wealth for your heirs, rather than the tax authorities.
In Canada, unlike the U.S., there is no estate tax in the traditional sense. Instead, you are deemed to have disposed of your assets at fair market value at death, and your estate is subject to tax on any accrued gains. For many estates, the greatest tax exposure comes from registered accounts such as Registered Retirement Savings Plans (RRSPs) or Registered Retirement Income Funds (RRIFs), capital gains in non-registered accounts and appreciated assets like vacation properties or other real estate.
Here are six ways to help minimize taxes on your estate:
1. Defer Taxes — In some cases, the tax liability on appreciated assets can be so significant that estates are forced to liquidate assets, such as a business or family cottage. Deferring taxes can help avoid this. A spousal rollover allows assets to transfer to a surviving spouse, spousal trust or certain eligible beneficiaries (i.e., disabled child, financially dependent child) on a tax-deferred basis, with the associated tax liabilities being deferred until your spouse dies or assets are sold.
2. Use Exemptions — Tax exemptions can provide meaningful savings.
For example:
- Principal Residence Exemption (PRE): If you own more than one property over time, careful planning around which property is designated as your principal residence, and for which years, can help reduce overall capital gains tax.
- Lifetime Capital Gains Exemption (LCGE): Business owners may be able to shelter gains on qualified business shares or certain farm or fishing property.
3. Don’t Overlook Foreign Estate Taxes — If you own assets outside Canada, or if your beneficiaries live in a country with an estate tax, planning is important. Many Canadians own U.S. assets. U.S. “situs” property, which includes U.S. real estate and shares in U.S. corporations, may be subject to the U.S. estate tax. (For dual citizens, U.S. citizens residing in Canada or Canadian citizens considered residents of the U.S., U.S. estate tax may apply to worldwide assets.)
There may be strategies to minimize potential U.S. estate tax, including disposing of U.S. situs assets before death, using joint ownership for U.S. property (which may help defer or reduce exposure, depending on ownership structure) or using a Canadian holding company, trust or partnership to own the U.S. situs assets. It’s also important to note that tax law can change (see inset for recent changes to the U.S. estate tax law).
4. Freeze Taxes — Business owners may choose to freeze the value of their business for tax purposes today, while transferring future growth to the next generation. By using an estate freeze, you can continue to control the business and lock in your future tax obligations, while the other party benefits from any increases in the value of the business (but is also liable for the future taxes on the growth).
5. Plan on Giving — Leaving a legacy through charitable donations can create a lasting impact while reducing taxes. Properly structured gifts may significantly reduce tax in the year of death and the preceding year. In the year of death, the maximum donation amount increases to 100 percent of net income (up from the 75 percent limit in a normal year). Gifts made during your lifetime, such as contributions to family members or charitable causes, can also reduce the size of your taxable estate while providing immediate benefits.
6. Use an RRSP/RRIF Drawdown Strategy — Registered retirement accounts often represent one of the largest tax liabilities at death. A proactive drawdown strategy may help reduce this exposure. Instead of withdrawing only the required minimum amounts, some retirees choose to gradually withdraw additional funds during lower-income years, smoothing income over time and potentially paying tax at lower marginal rates. This approach can also allow assets to be reinvested in more tax-efficient vehicles, such as a Tax-Free Savings Account (TFSA), or support gifting strategies. However, be aware that higher withdrawal amounts may have other consequences, such as potentially triggering the OAS claw back.
Plan Ahead
Estate tax planning can significantly affect what you leave behind. Professional advice can help ensure your strategy is structured properly, allowing you to preserve more of your estate for the people and the causes you care about.
Note: Tax minimization is only part of the planning equation. There may be planning techniques, including the use of insurance, to help fund estate taxes and avoid the forced sale of assets. For a deeper discussion, please call.
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