ALISON MACALPINE
Feb. 28, 2022
Money is on the move from one generation to the next with almost $700-billion in financial assets set to transfer by 2026, according to J.D. Power’s 2021 Canada Full-Service Investor Satisfaction Study. Without appropriate planning, just imagine the tax bill.
“No one really wants to pay more taxes than they have to, and I think most advisors are thinking about that on a regular basis,” says Damian McGrath, senior trust advisor with Raymond James Trust (Canada) in Saskatoon. “But thinking about estate planning and tax efficiency is probably one of the areas that many advisors are not considering enough.”
Conversations around strategies have to start with an understanding of what assets clients have, how they’re held, and what their ultimate wishes are, he says.
“It’s not just about taxes. In fact, it’s probably less about tax but more about what clients want their legacy to be.”
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That said, there are many strategies that can help minimize taxes due when wealth transfers.
For business owners, an estate freeze can be tax-effective, although it does require legal, accounting, and valuation expertise with their associated costs, says John Waters, vice-president and head of tax and estate planning at BMO Nesbitt Burns Inc. in Toronto.
“Typically, the parent would freeze the value of their existing common shares and exchange those for fixed-value preferred shares at the current value of the company,” he explains. “Then, the child would typically subscribe for new common shares so that the future growth in the company would accrue to them.”
Basically, you’re freezing out the owner at the current value and the future growth accrues to the next generation, he says.
A freeze can result in a significant tax deferral, enable income splitting among family members, and provide access to the capital gains exemption on the eventual sale of the children’s shares, Mr. Waters says. There’s also the option to trigger taxes at the time of the freeze to take advantage of the business owner’s capital gains exemption.
Depending on the situation, advisors can then layer in a family trust to own and control the child’s shares legally. That has the effect of separating the legal and beneficial ownership of the shares, with the child entitled to any income or growth.
“It adds an element of control and protection for parents, particularly if they’re concerned about giving too much wealth too soon to a younger individual, or if [an adult child] could be unduly influenced by others, or if there are creditor concerns,” Mr. Waters says.
How to utilize life insurance
Another option is a permanent tax-exempt life insurance policy that can also help with the tax-efficient transfer of wealth, says Mark Halpern, chief executive officer of Wealthinsurance.com Inc. in Markham, Ont.
A parent or grandparent can start out owning the policy and, at some point in the future, transfer it to children or grandchildren with no deemed disposition and benefits that go beyond the policy’s insurance component.
“Now, the child [or grandchild] owns the policy and the cash surrender value, or the equity that’s in that policy, can actually be accessed by that child for emergencies and opportunities like to buy a house, fund their education, or start a business,” he says. “It would be taxed at their rates as opposed to at rates of the senior parent or grandparent.”
The original policy can also be set up with the children or grandchildren as successor owners, so the policy transfers seamlessly to them upon death.
Mr. Halpern emphasizes that every client can choose two out of three possible beneficiaries for their estate – the government, family and charity. Most people pick the last two.
However, he says that philanthropy “is a very big part of the planning that often gets overlooked, and it’s huge because you can convert taxes into charity – or minimize taxes on the sale of a business or the sale of some real estate and create charity instead.”
That’s a very important part of the conversation to have, he adds.
How to incorporate philanthropy
Mr. McGrath points out that Canada probably has one of the most tax-friendly regimes with respect to charitable giving.
“It starts from the wish and the desire to have a charitable program and then saying, ‘Okay, now, how do we maximize all the tax benefits that are available?’” he says.
Options include establishing a foundation or creating a donor-advised fund within an existing foundation. These result in immediate tax savings rather than waiting until assets pass to charities through a will. It also makes it easier to update the list of charities as each change doesn’t require a new will.
“You can get the double tax effect,” Mr. McGrath adds. “You get the tax credit for what you put in, and if you transfer securities in kind that have an inherent capital growth in them, you can also wipe out [the taxation of] that capital growth.”
Overall, Mr. McGrath says advisors have an opportunity to strengthen long-term relationships by helping clients implement tax-efficient estate plans.
Addressing this need can also help advisors get to know the next generation. That’s critical because the moment of wealth transfer is a precarious time when money in motion may very well move to a different advisor.
“The idea of an advisor is [evolving]. You can’t just manage money anymore,” he says. “You have to be able to pull in estate planning concepts, know about business planning and know about insurance planning because you are really at the centre to pull those things together.”
