As Benjamin Franklin famously put it in a Constitution Center letter from 1789: “In this world nothing can be said to be certain, except death and taxes,” these two things, death and taxes, are certainties in life. Oddly enough, most of us do not like to discuss death. We try to ignore and put off anything death-related for as long as we can. As a result, estate planning is often not something people actively think about. Combined with the fact that there’s no estate or inheritance tax here in Canada, many people believe they can completely ignore estate planning.
While there’s no “death tax” here in Canada, there are a lot of intricacies when it comes to what happens to your assets after you pass. You can’t just assume that your kids will automatically inherit your and your spouse’s investment portfolio, real estate, and other assets completely intact.
Consider this: you and your spouse have been building your investment portfolio for decades. Eventually, you can retire and live off your investment portfolio. Wouldn’t it be a shame to do all that work and then hand a needlessly large chunk of it to the government simply because you never bothered to do the unglamorous paperwork and plan what happens to your investments when you’re gone?
This is the part that people don’t like to think about or talk about, but I truly believe it’s just as important as planning how you invest your money. How do you pass down as much of your investments as you intended to the people you intended?
A quick disclaimer, I’m neither a lawyer nor an accountant. This is general information based on my own research. It is not personal advice. Estate planning is complicated and I’d highly recommend consulting with a specialist.
Is there really no death tax in Canada?
Yes, Canada indeed has no formal estate or inheritance tax, unlike many countries.
However, we do have something that feels like one and it’s called the deemed disposition.
Here’s how deemed disposition works: upon death, an individual is deemed to have disposed of all their capital property at its fair market value immediately before they die. Basically, the government pretends that you sold everything you own at its current fair market value. It doesn’t matter if you actually sold it or not; the government just treats it as if you did. This “pretend” sale, or deemed disposition, triggers a tax bill, often a hefty one, if you didn’t plan accordingly during your lifetime.
One classic example is the family lake cottage. Say your parents bought the place decades ago for $100,000 and now it’s worth $2 million. There’s no plan to sell it upon the death of your parents, as the plan is to pass it down to the family members.
But this doesn’t matter. In the government’s eyes, the CRA treats the lake cottage as if it were sold for $2 million. This means a 1.9 million capital gain. This $1.9 million is then taxed at the deceased person’s marginal tax rate (In BC, this would mean 53.5% top bracket rate, 33% from federal, 20.5% from BC). The same logic applies to holdings in your non-registered accounts and your rental properties (For now, let’s ignore RRSP, RRIF, and TFSA, I’ll get into them later).
Simply put, the deemed disposition rule triggers a pretend “sale” event and the deceased person must pay taxes on their last tax return. The remaining amount can then be passed down accordingly.
The second death that matters the most
If you are married or in a common-law relationship, you need to consider two separate moments with estate planning: the first death, then the second.
The first death: when one spouse dies and leaves everything to the other, almost everything can be transferred over with no immediate tax implications. This is called the spousal rollover. Essentially, all of your investments pass to your spouse at their original cost base (ACB) and the deemed disposition is deferred.
This is true for assets in non-registered accounts, rental properties, and also registered accounts (as long as the correct successor/beneficiary destinations are made). Now, the tax bill doesn’t just magically disappear. The tax bill simply gets deferred until the surviving spouse passes.
The second death: when the surviving spouse passes away, this is where the math can get complicated and the tax bill starts to pile up.
Because there’s no longer a partner to roll things over to, the deemed disposition rule applies to all the assets and everything lands on one final tax return. And because we are talking about combined assets for both spouses, getting taxed under one person, more often than not, this means getting taxed at the highest marginal tax rate. This is when the family regrets not doing estate planning to minimize taxes.
So if you are married or in a common-law relationship, estate planning is really not just planning for two separate deaths; the focus needs to be on the second death, because that’s where the tax bill is the highest.
Rules for the different accounts
If you have been following Canadian personal finance for a while, you know there are three different types of accounts – non-registered, RRSP/ RRIF, and TFSA. The rules are different for each of these accounts upon the holder’s death, so it’s worthwhile to go over the details.
The non-registered account: capital gain hit
For the non-registered accounts, everything inside will get the deemed disposition treatment upon death. Everything is treated as sold the moment before death, and the capital gains become taxable on your final tax return. If you hold rental or investment properties, the same rule applies; these properties are deemed dispositions immediately at death at their fair market value.
The good news with non-registered assets is that only half of the capital gain is taxable (i.e. the 50% inclusion rate), so the overall tax hit is gentler. Having said that, if your non-registered assets have grown a lot over the years, the 50% capital gain at your marginal tax rate can still add up fast. For example, if your adjusted cost basis (ACB) is $100,000 but the asset has grown to $1 million, you’re paying taxes on the $450k taxable income. This would trigger around $189k worth of taxes (~$120k federal and ~$69k for BC).
RRSP & RRIF: the potential tax bomb
Many people get surprised by the RRSP and RRIF tax implications when their loved ones die. When someone dies, the entire value of their RRSP or RRIF is added to their income in the year they die. Yup, the entire amount, so can result in a significant tax bill if someone ends up with a large RRSP or RRIF when they die.
There are a few things one can do to defer this hefty tax:
- If the person has a spouse or common-law partner, the RRSP/RRIF amount can be rolled over to the spouse or common-law partner. This is the cleanest solution for couples and this is why it’s so critical to name your spouse or partner as the beneficiary of your RRSP/RRIF because you can avoid the immediate income tax upon death. That tax is postponed until the second death.
- If there’s a financially dependent child or grandchild, the RRSP/RRIF can be rolled over to their account. However, this only applies to a child or grandchild who genuinely depends on you financially. This usually means their income is way below the basic personal amount or they have a disability.
As expected, a lot of taxation happens upon second death. For example, say the second spouse dies with a RRSP or RRIF of $1M, the entire amount is counted as income. This would trigger around $302k federal tax and around $181k BC tax for a total of $483k in combined taxes!
That’s a lot of money!
Therefore, you want to avoid dying with a large amount of money in your RRSP/RRIF. It makes a lot of sense to strategically withdraw from these accounts in retirement. In some cases, it may make sense to completely collapse these accounts. (This is also why the RRIF mandatory withdrawal rate increases significantly as you get older.
TFSA: successor vs. beneficiary
One of the most common TFSA mistakes people make is naming their spouse as the TFSA beneficiary rather than the successor.
Why does it matter? Let me explain.
If you name your spouse as the successor holder of your TFSA, the process is simple when you pass away. Your entire TFSA simply becomes your spouse’s. This includes every dollar of growth and stays tax-free forever. Naming your spouse as the successor holder also means no effect to your spouse’s TFSA contribution room.
If you name your spouse as the beneficiary instead, this is a messier process. In this scenario, the value of the TFSA at the date of the death is still tax-free. However, any growth after the date of death becomes taxable. If the estate takes time to settle and the TFSA value rises during that time, the growth is taxed.
Since you can only name your spouse or common-law partner as the TFSA successor, once only one of you is left, you do have to name someone as the beneficiary. As mentioned, the growth of the TFSA during the estate settlement window is taxed on your final tax return. The nice thing about naming someone as the TFSA beneficiary is that the funds skip your estate and avoid probate fees and delays and in fact, are passed “in-kind.”
Primary residence: The easy part
In Canada, our primary residence is increasingly one of our largest assets (especially after the mortgage is paid off). Fortunately, when it comes to primary residence, the principal residence exemption means any gain on your primary residence is not taxed.
Hopefully, the government doesn’t change this rule as a way to get more tax revenues from Canadians. Because if they do, this will complicate estate planning significantly.
Probate: something to consider
One important thing to consider in estate planning is probate, also known as the probate fee or estate administration tax. (And in reality, this is the Canadian version of an ‘inheritance tax”). Probate can be considered as the court’s stamp of approval, confirming your will is valid and giving your executor the legal authority to distribute your assets. Banks and land registry usually don’t act without this step.
Here in BC, probate is not cheap when your estate is large: there’s no fee on the first $25k, 0.6% between $25k and $50k, then 1.4% on everything above $50k, plus a small court filing fee. This may not sound much until you calculate the numbers. On an estate worth $1M, you’re looking at $13,450 plus a $200 court filing fee.
If you name a beneficiary or a surviving joint owner on your assets (typically registered), you can reduce the estate value and avoid the large probate fee.
Useful tools for estate planning
For estate planning, here are some very useful tools to utilize.
Get a will and name an executor
It’s extremely important to have a will and an executor. If you don’t have a will, it means the province decides who gets what. Not only that, it guarantees an extremely slow, expensive, and painful process for people you love. Make sure you have a will so you get to decide what happens to your assets (In terms of your executor, choose someone who is both competent and willing, as the process can be highly complicated. Also, ask that person, usually better to have a single person, if he/she is willing to do it.
Check for beneficiary/successor designation
For your registered accounts and life insurance, make sure you name the beneficiary or successor accordingly. This will avoid probate and allow money in registered accounts and life insurance payouts to get into your loved ones’ hands faster.
Remember, name your spouse or common-law partner as the successor for your TFSA. Name your spouse or common-law partner as the beneficiary on your RRSP/RRIF.
Another important thing to note is that if you switch brokers, you must update these designations.
Consider life insurance for liquidity
Since estate distribution can take a bit of time to finalize, it may make sense to have a life insurance policy so your loved ones can get a tax-free lump sum quickly when they need the money.
Joint ownership
I mentioned the surviving joint owner earlier. This is something you can do to reduce the tax consequences upon death. You can put an adult child on the title of your home or account as a joint owner to avoid probate (note, you can also name multiple joint owners). Since your adult child is a joint owner of your assets, when you pass, the assets are passed to them automatically by the “right of survivorship.”
While joint ownership is useful, there are some risks involved. These assets can be exposed to your child’s creditors and must be considered in asset division in a divorce. As a result, you may lose control of these assets. If you only name only one child as a joint owner and leave other children out, this could potentially create disputes in the family. If you’re considering joint ownership to avoid probate, definitely discuss this option among all family members and consult with a lawyer.
Take advantage of gifting
Since there’s no gift tax in Canada, you can gift money to your children or their spouses without anyone needing to pay taxes. When you do that, your children and their spouses can use the money however they want.
If you choose this option, there are a few important things to avoid attribution rules:
- Make sure you transfer the money directly to the intended recipient(s).
- Ensure the money is not deposited into a joint bank account before being invested.
For example, if you intend the money to go to your child’s spouse for investment, do not gift the money to the child, then have the child gift the money to their spouse. This will trigger attribution.
Generally speaking, gifting money is a good idea to avoid the big tax hit when you’re gone. Spread out the tax hit over time and gift the money rather than taking a big tax hit when you pass.
Note, there are other strategies and tools like Alter Ego Trust, charitable gifting, etc., but they are a bit complicated and probably deserve separate articles.
Final thoughts
It’s not fun to think about death, but it doesn’t mean you should ignore estate planning. Estate planning is a critical part of your wealth planning. Without having one, you can create a lot of headaches for your loved ones when you are no longer in this world.
I mean, the last thing you want to do is have your loved ones grieving, drowning in paperwork, fighting over an unclear will, paying tax bills, and waiting months for probate and estate to settle. There are so many ways to avoid this if you take time and plan for your estate.
Have you done any estate planning? Do you have a will? I’d love to hear from you on this touchy topic.
