Let’s imagine that you have a net worth of several million dollars at the end of your life. How much do you think will be left to your heirs after taxes are paid?
While there is no inheritance tax in Canada, taxes can still diminish your legacy and leave your loved ones with far less than you expect. Mostly, these taxes arise from the “deemed disposition” of property as well as provincial or territorial probate taxes (which we won’t cover here). Canadian tax rules generally stipulate that when you die, you are considered to have disposed of all your assets at their fair market value.
Fortunately, a good estate plan can reduce or defer the taxes your estate must pay. The starting point is understanding the tax consequences that apply to the types of assets you own. The next step is using strategies to mitigate the potential tax impacts.
Understanding which assets are taxable and where taxes can be deferred
The income tax bill your estate might need to plan for is based on whether you have a spouse or common-law partner who survives you, the type of assets you own, and whether you have a professional corporation.
We’ve provided a quick primer below.
Examples where assets may not be taxed immediately on your death:
- An RRSP or RRIF that you can “roll over.” If you have a spouse or common-law partner, or a child or grandchild who is your financial dependant and who is physically or mentally disabled, your registered retirement savings plan (RRSP) or registered retirement income fund (RRIF) can “roll over” to them with no immediate tax consequences if you designate them as the beneficiary in your registered account form. (In Quebec, you need to make such a designation in your will, instead.)
- An annuity purchased with RRSP or RRIF funds. If you have a “qualified survivor,” such as a financially dependent child or grandchild, your RRSP or RRIF can be used to purchase an annuity for them that will be paid to, and taxed in the hands of, the child until they are 18 years of age.
- A TFSA. The amount held in a tax-free savings account (TFSA) is never taxable (but TFSA earnings from the date of your death to the time when the estate is settled could be taxable, unless the TFSA is left to your spouse or common-law partner as a “successor holder”).
- Principal residence. The property you own and ordinarily occupy is not taxable, thanks to the principal residence exemption.
- Life insurance. Death benefits from a life insurance policy are paid tax-free to the named beneficiaries.
Examples where assets may be taxable on your final income tax return:
- An RRSP or RRIF that you can’t roll over. Your RRSP or RRIF becomes de-registered and is fully taxable in your year of death if you have no spouse, common-law partner or qualified survivor to inherit the funds (or if that person declines to accept the rollover).
- Non-registered investment accounts in your name. Assets in non-registered investment accounts are taxable as if you sold them at fair market value just before your death — but due to the tax treatment of capital gains, they are taxed at a lower rate than assets in your RRSP or RRIF are.
- Other real estate. Capital gains on real estate that doesn’t qualify as your principal residence are taxable.
- Corporate shares. Capital gains on the shares you own in the corporation are taxable.
- Personal use property. Capital gains on any personal use property with a fair market value of $1,000 or more are taxable. Examples of such property are a boat, coin collection, art collection or cars.
Strategies to help minimize taxes
If you are concerned about the amount of income tax your estate might face when you die, there are estate planning strategies you can implement to help reduce the potential impact:
- Optimum withdrawal order. When you reach retirement, consider drawing funds from your registered accounts (RRSP or RRIF) first, before withdrawing from your TFSA or non-registered investment accounts.
- Property occupancy. If you own and regularly occupy more than one property, at your death, your executor may be able to select which property is eligible for the principal residence exemption, thus reducing the capital gains tax bill on your estate.
- Your corporation. Remember that your corporation (whether it’s a medical professional corporation or a holding company) doesn’t die when you do, and a variety of planning techniques involving your corporation can help mitigate the effects of income tax. Examples are a charitable bequest, an estate freeze or permanent life insurance.
- Permanent life insurance. A permanent life insurance policy can help reduce taxable income during your lifetime and create a tax-efficient payout at death.
Putting your tax-efficient estate plan together
If you don’t plan your estate with tax efficiencies in mind, the impact of income taxes upon your death can be considerable. Especially if you are an incorporated physician, expert advice may be required to help you understand your options and structure tax-efficient plans. By taking time now to learn about the available strategies, you can put a plan in place today that will reduce your taxes tomorrow.
Talk to an MD Advisor* to help you make the right short- and long-term decisions for you and your family.
* MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec), or an MD Private Investment Counsel Portfolio Manager.