When our mortality finally catches up with us, we are subject to two possible taxes: provincial probate and income tax. Many Canadians go to great lengths to avoid the first.

In some cases, however, planning to avoid probate can be so zealous that the estate has no money available to pay income tax or other estate-related costs. Such planning not only potentially contradicts the testamentary wishes of the deceased, but can also overemphasize the income tax burden.

To create an effective estate plan, it’s important to understand the costs of both taxes and the planning options available to reduce them, as well as how that planning can affect estate distribution goals.

Provincial probate

Provincial probate costs vary greatly across Canada—from nothing in Quebec to as high as 1.7% of estates over $100,000 in Nova Scotia. The fee structure varies as well. In some provinces, probate is charged as a percentage of estate assets, with the percentage increasing as the value of the estate increases. In other provinces, and in the territories, probate is a flat fee based on the estate value and is capped at a maximum dollar value (see Table 1).

Table 1: Probate rates/fees by province

Province Top probate rate/fee
British Columbia $150 + $14 per $1,000 in excess of $50,000
Alberta $525 on estates greater than $250,000
Saskatchewan $7 per $1,000
Manitoba $70 + $7 per $1,000 on estates greater than $10,000
Ontario $250 + $15 per $1,000 in excess of $50,000
Quebec No fee
New Brunswick $5 per $1,000 on estates greater than $20,000
Prince Edward Island $400 + $4 per $1,000 in excess of $100,000
Nova Scotia $1,002.65 + $16.95 per $1,000 in excess of $100,000
Newfoundland $60 + $6 per $1,000 in excess of $1,000
Northwest Territories $400 on estates greater than $250,000
Yukon $140 on estates greater than $25,000
Nunavut $400 on estates greater than $250,000

Naturally, probate planning is most actively pursued in provinces where the cost is highest. Along with Nova Scotia, the costliest provinces are Ontario (1.5% of estates over $50,000) and B.C. (1.4% of estates over $50,000). Note, however, that while probate costs are high in these provinces, they pale in comparison to income taxes.

Income tax

Income tax rates vary even more than probate rates across Canada (see Table 2). They’re also much higher, as they’re based on a percentage of income and not assets. On regular income, for example, rates are as low as 44.5% in Nunavut and as high as 54% in Nova Scotia.

Table 2: Top tax rates by province (2017)

Province Regular income Capital gains Eligible Canadian dividends Ineligible Canadian dividends
British Columbia 47.70% 23.85% 31.30% 40.95%
Alberta 48.00% 24.00% 31.71% 41.29%
Saskatchewan 47.75% 23.88% 30.33% 39.62%
Manitoba 50.40% 25.20% 37.78% 45.74%
Ontario 53.53% 26.76% 39.34% 45.30%
Quebec 53.31% 26.65% 39.83% 43.84%
New Brunswick 53.30% 26.65% 33.51% 46.25%
Prince Edward Island 51.37% 25.69% 34.22% 43.87%
Nova Scotia 54.00% 27.00% 41.58% 46.97%
Newfoundland 51.30% 25.65% 42.61% 43.62%
Northwest Territories 47.05% 23.53% 28.33% 35.72%
Yukon 48.00% 24.00% 24.81% 40.17%
Nunavut 44.50% 22.25% 33.08% 36.35%

At death you’re deemed to have sold or redeemed all assets, which can create taxable income above and beyond your typical income sources for a year. Such income may be taxed as capital gains (half of which is taxable) or fully taxable income in the case of registered accounts, such as RRSPs and RRIFs. As a result, income in the year of death may far exceed typical annual income, significantly increasing income tax costs.

Covering the rest

When all tax costs associated with dying can’t be eliminated, speak to clients about how they’ll be covered. Should these costs be paid out of estate proceeds? If so, will the estate’s distribution still align with the original objective? If not, how will these costs be paid? Where appropriate, life insurance can be used. Alternatively, for philanthropically inclined individuals, testamentary donations could reduce or eliminate income tax at death.

When people think about the costs of dying, they tend to focus on avoiding probate costs more than income tax, despite the latter likely being higher. When reviewing clients’ estate plans, first help clients articulate desired beneficiaries. Next, project future income tax and probate costs. Finally, determine which strategies provide the most savings without disrupting the desired distribution. Don’t let clients get distracted by the relatively small cost of probate when their estate values could better be preserved by reducing income tax.

Case study

Consider this fictional scenario: Wilma is 78 years old. Walter, her husband of 53 years, is 79. Both are retired, reside in Kamloops, B.C., and have two adult children, Robert and Lisa. Wilma and Walter meet with their advisor to review their estate plan. They approach the review as follows:

  1. Determine desired estate distribution.
  2. Estimate income tax and probate costs, assuming no planning is done.
  3. Review options available to reduce the estimated costs.

Wilma’s income and assets are as follows:

Wilma’s income and assets

Income Assets
CPP $7,727 Asset Adjusted cost base Fair market value
OAS $7,005 RRIF $345,857 $554,528
RRIF minimum $35,268 TFSA $36,743 $55,534
Total $50,000 Home $225,000 $750,000
Cottage $30,000 $300,000
Non-registered $124,846 $276,686
Total $762,446 $1,936,748

The couple is debt-free and expects to be so at death. Wilma and Walter would like each other to be the sole beneficiary of their respective estates. If they die within 30 days of each other, they would like their estate to be evenly distributed between their two children.

For simplicity, we’ll calculate the income tax and probate costs for Wilma only. We’ll project both costs assuming she were to die today, receive her full annual income and own all non-registered assets in her name alone. (We’ll also assume she has no estate plan in place.) For income tax purposes, Wilma will use the principal residence exemption for the home, but the deemed disposition of the cottage would be included in taxable income:

Wilma’s terminal tax and probate results

Income source Taxable income Income tax Probate fee
Total pension income $50,000 $7,045 $0
TFSA $0 $0 $770
Home $0 $0 $9,950
Non-registered $75,920 $30,752 $3,878
Cottage $135,000 $60,336 $4,200
RRIF $554,528 $264,510 $7,770
Total $808,443* $362,643 $26,568
* Net of $7,005 OAS clawback

Assumptions: We use 2017 federal and B.C. tax rates.
Pension income is taxed first; then we added income from smallest to largest.
For probate, assets were from smallest to largest for calculation purposes.

Wilma’s estimated income tax bill is 13.65 times higher than her estimated probate fees, despite the fact that B.C. has one of the country’s lowest top marginal tax rates and one of the highest probate tax rates. Clearly, her planning should prioritize reducing income tax over probate costs while adhering to her estate distribution goal.

Strategies and cost savings

Wilma could reduce income tax or probate fees at her death using one or more of the following strategies.

Beneficiary designation—By naming Walter as beneficiary or successor annuitant on her RRIF, Wilma would reduce her income tax by $264,510 and her probate by $7,770. By naming him as beneficiary or successor annuitant on her TFSA, her income tax would be unchanged (since the TFSA is tax-free), but her probate would fall by $770. While naming any beneficiary allows registered assets to bypass probate, you can only do a tax-free rollover of such assets to qualified beneficiaries, such as spouses and financially dependent children or grandchildren. For non-registered portfolios, segregated funds can provide this option where other investment options can’t, but you’d need to compare the benefits to the costs associated with selling the portfolio and repurchasing the new vehicles.

Joint ownership—By making the home, cottage and non-registered investments joint with Walter, Wilma would lower her income tax bill by $91,088 and be left with the estimated tax owing on her current annual income. Attribution would still apply on the non-registered portfolio, but probate would be significantly reduced.

Trusts—Where joint ownership could be problematic, trusts could be used instead to meet the same objectives. An alter ego or joint partner trust can be especially effective since there’s no deemed disposition on assets used to settle them. The costs of setting up and maintaining a trust should be weighed against the benefits they provide in deferring income tax and reducing probate costs.

Gifting assets—While gifts are deemed to be given at fair market value, the income tax associated with the gift might be lower now than the income tax at death. This might be a viable consideration where gifting won’t impact Walter and Wilma’s ongoing income needs, or when assets (e.g., the cottage) are no longer being used.

Selling assets—Where non-income-generating assets are no longer used, needed or wanted by intended beneficiaries, selling them for cash may be appropriate. This could lead to a candid discussion among family members about the cottage, and allow for additional tax planning regarding the principal residence exemption to help reduce the associated tax bill.

Curtis Davis, FMA, CIM, RRC, CFP, is senior consultant, Tax, Retirement & Estate Planning Services, Retail Markets at Manulife. Reach him at Curtis_Davis@manulife.com

Originally published in Advisor's Edge Report

See all comments Recent Comments

CJ

In the “joint ownership” strategy; if she made her non registered portfolio and cottage joint, would that not trigger a deemed disposition for 50% of the assets being transferred to Walter? Meaning tax owing on the transaction. And why would there be a need to transfer ownership of the home? The home would not be taxable under the principle residence deduction anyway?

Wednesday, Dec 13, 2017 at 9:52 am Reply

Curtis Davis

Hi CJ. Thanks for the comment. There is no deemed disposition when assets are made joint by spouses (including common-law spouses). The change in ownership is done at the adjusted cost base of the asset (unless the spouses elect to do so at fair market value, in which case it would be a deemed disposition). The principal residence exemption (PRE) can only be applied to one property when multiple properties are owned during the same time period. Before the income tax and probate calculations, I indicated that “for income tax purposes, Wilma will use the principal residence exemption for the home, but the deemed disposition of the cottage would be included in taxable income.” The PRE could have been applied to the cottage, but then the deemed disposition on the home would trigger a taxable capital gain (and a larger one than the cottage at that).

Thursday, Jan 4, 2018 at 2:27 pm

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