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 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|
|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 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|
|Prince Edward Island||51.37%||25.69%||34.22%||43.87%|
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.
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:
- Determine desired estate distribution.
- Estimate income tax and probate costs, assuming no planning is done.
- Review options available to reduce the estimated costs.
Wilma’s income and assets are as follows:
Wilma’s income and assets
|Asset||Adjusted cost base||Fair market value|
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|
|* Net of $7,005 OAS clawback|
Assumptions: We use 2017 federal and B.C. tax rates.
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.