MONTREAL -- Many Canadians live frugally for years in the hope of leaving large legacies to their children, but without proper estate planning those legacies can be fraught with complications.
Taxes, real estate passed down and now shared by siblings, and questions about how to best manage a sizeable inheritance can leave people facing issues they've never encountered and are ill-prepared to handle.
It's an issue that's attracting increased attention as Canada's population ages and an estimated $1 trillion is passed along in inheritances.
While beneficiaries don't pay inheritance taxes, settling estates can be daunting tasks for children who are named executors and have to determine how much income taxes and probate fees are owed.
For instance, years of pinching pennies, even by those who survive the poverty line in their later years, can amass sizeable enough portfolios to push them into the highest income tax bracket after death.
"That happens all the time if you've got a $100,000 or more RRSP and you're not leaving it to a spouse,'' says Christine Van Cauwenberghe, assistant vice-president tax and estate planning at Investors Group.
A person's estate not only includes their annual income, but also unsheltered investments, registered investments and secondary properties.
"That's why you need to do tax planning because there could be a major tax bill in the year of death.''
Determining what to do with inheritances can pose its own challenges, especially if they are of a magnitude that can be life-altering.
"The first thing we tell clients when they receive a large sum of money is just to take a deep breath and not do anything rash,'' Van Cauwenberghe said from Winnipeg.
Some people are not used to dealing with large sums of money or haven't been successful in managing their own finances.
The tendency is for these people to quickly make large purchases, undermining the ability for the inheritance to generate a higher standard of living or allow the recipients to fulfil their dreams.
Van Cauwenberghe recommends that people put the money in some sort of short-term liquid fund like a GIC or money market for up to several months while they develop a plan that will incorporate the newly acquired money into their own financial plan.
"When money comes in you may want to just park it, it's the same advice we give lottery winners,'' adds Jamie Golombek, managing director tax and estate planning at CIBC Private Wealth Management.
Ultimately, the plan may be as simple as paying down debt including a mortgage, buying RESPs, topping up RRSPs and buying a tax-free savings account.
But it becomes more complicated with real estate. Do you sell or rent the family home or cottage? Can you get agreement from siblings who may have a different point of view?
Inheriting stocks can pose their own challenges if the recipient already has a large concentration in the same companies.
The key is to have a good financial plan, he said.
"If a sudden inheritance comes in it will be much more obvious where that money should be allocated and whether or not you should be liquidating stocks, real estate, etc.''
Proper planning is also required for those in shaky relationships. Inheritances typically aren't split upon a couple's divorce, but the exemption can be lost if the money is used to pay down the mortgage of the matrimonial home or put into a joint account.
Some of these people are even loathe to end their relationships until they receive the financial security that accompanies an inheritance, Van Cauwenberghe added.
Anecdotally, she said those who make the most of their inheritances tend to have a financial planning ethic ingrained in the family.
"If you've been good with managing money before, chances are you will be good with managing money after, perhaps there's just an extra zero or two at the end.''
Inheriting money can also prompt beneficiaries into finalizing their own inheritance plans and wills, especially since insurance can make even a young family worth more dead than alive, she added.
A recent CIBC survey found that almost half of respondents had not created a will and nearly half of those people thought they were too young or didn't have enough assets. This included almost one-third of Baby Boomers aged 45 to 64 and 10 per cent of seniors.
Failure to have a will forces a situation in which an estate is administered in accordance with provincial law, which could reduce entitlements to a surviving spouse in favour of children.
A will could also establish trusts for minors and young adults that stagger inheritance payments to later in life instead of giving a lump sum at the age of majority when rash decisions are more likely to occur.
Proper estate planning could also reduce probate taxes -- 1.5 per cent of an estate value in Nova Scotia, Ontario and B.C. -- by rolling over RRSPs to qualified beneficiaries, and deferring income taxes by taking advantage of a spousal rollover.
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The Volunteer Firefighter's Tax Credit
If you performed at least 200 hours of service as a volunteer firefighter in 2011, you can see your tax bill reduced by up to $450 - another new non-refundable tax credit introduced in last year's federal budget. That's the net effect of a 15 per cent tax credit on the $3,000 volunteer firefighters' amount. The 200 hours doesn't have to be entirely spent fighting fires. Attending required meetings and training also qualify. Be aware that there's a big wrinkle in this tax credit for those who get an honorarium for their volunteer efforts. Currently, the first $1,000 of that honorarium is exempt from tax. But if you claim that income exemption, you won't be eligible for the volunteer firefighter's tax credit. No documents need to be filed, but the CRA says it may require claimants to provide certified proof that they actually do qualify.
Family Caregiver Tax Credit
This measure doesn't actually take effect until the 2012 tax year, so you won't benefit from it when filing this year. But people who will eventually benefit can file a new TD1 Personal Tax Credits Return with their employers now to reduce their withholding tax for the remainder of 2012. This credit amounts to an increase of $2,000 in the claim when a taxpayer's dependent is physically or mentally infirm. So the spouse, common-law partner or other eligible dependent claim becomes $12,780 instead of $10,780. Similarly, the claim for a disabled child becomes $4,191 rather than $2,191. The caregiver amount claim for looking after an infirm relative also goes up by $2,000.
Tax-free savings accounts were first unveiled in the 2008 federal budget and have continued to grow in popularity - in part because Canadians can put more money into them each year. If you haven't yet contributed to a "Tiff-sa," the available contribution room rose by $5,000 on Jan. 1, 2012 and now stands at $20,000. TFSA contributions can go into GICs, mutual funds, bonds, stocks or savings accounts and earn profit tax-free, but keep in mind they don't work like a bank account with a maximum balance. When you withdraw funds in one year, TFSA rules don't let you redeposit that amount until the next. In 2009, about 70,000 people withdrew money from one of their TFSA accounts and then redeposited it the same year, so the Canada Revenue Agency levied penalties of one per cent per month on redeposits that were classed as excess contributions. The government eventually relented because of the widespread confusion, and rescinded the penalties in 2010 for people who accidentally put too much into their accounts during the TFSA's debut year. The amnesty is over now, however, and savers can't expect that kind of pity from the tax collector anymore. If you want to move your money from one account or institution to another within the same calendar year, you have to use a formal transfer process that requires filling out forms and, with most banks, paying a fee.
Changes That Affect Students
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Medical Expenses And An RDSP Change
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Changes To Federal Tax Brackets And Credits
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