Category: GlobalTV MoneyWise

EstateWISE – Education planning trust

An elderly grandmother wishes to provide that an inheritance to a newborn grandson be used for post-secondary education.  How can she be sure that the money is not instead frittered away? 

Why can’t this grandmother simply pay for the grandson’s education directly? 

  • If she is alive at the time, then that’s exactly what she would do
  • However, if she has died before the child begins (or finishes) schooling then she can use a testamentary trust in her Will to dictate how his inheritance will be managed 

How far can she go to control how the money is dispensed to the child?

  • As long as the terms of the trust are not illegal or immoral — and we are talking about education here — then she has great latitude in how the trust will be managed
  • In the absence of detailed trust terms, a beneficiary who is mentally capable and is of the age of majority is entitled to an inheritance
  • In this case, the terms of the trust would state that the entitlement to capital would be delayed until one or more distribution dates after the age of majority

How does the child then get access to the money for his/her education?

  • Grandmother will have empowered the trustee — likely the child’s own parent — with discretion to encroach on that capital prior to those dates if it would be in the best interests of the child
  • The trustee would be able to pay the money directly to the institution, just to make sure it doesn’t get diverted into a less education-related purpose — like a sports car — on the way to the registrar

What if the grandson does not enter or continue in school?

  • If grandmother is adamant that the funds be used for education and nothing else, she could put that in the trust terms, and then have another beneficiary for the remaining funds
  • More likely, the distribution will simply be delayed until one or more later dates as mentioned, when hopefully the child is more mature and is in a stable work environment
  • This alone would be an incentive, or you can get even more strategic about the terms so that the ultimate distribution is that much more delayed if school is not completed

Is there a way to dovetail the inheritance with the child’s other funding sources?

  • Grandmother could get creative in the trust terms to explicitly have a formula, or use a reward system to accelerate the inheritance 
  • Usually though, it would simply be left in the discretion of a responsible trustee

EstateWISE – The estate freeze

Along the lines of “a penny saved is a penny earned”, a guiding principle in estate planning is that “tax delayed is money earned”.  A prime application of this principle is an estate freeze.

What exactly is being frozen in an estate freeze?

  • Taxes — If you could pay today’s taxes at your death, you and your family will presumably have more to work with while you are living
  • While these taxes may not be entirely avoidable, it may be possible to put a freeze on some of them
  • In a sense, an estate freeze allows an individual to tell the government how much tax that person will pay, and when the person intends to pay the tax

Who might be interested in an estate freeze?

  • Likely it is someone who has accumulated a fair amount of wealth, but not necessarily — it may simply be someone who is expecting growth 
  • Some examples may be a cottage, an investment portfolio, or a small business corporation
  • The focus is on isolating the capital gains tax liability that a person has presently, and shifting the future tax liability to others — ideally one or two generations out in time

What does an estate freeze look like?

  • There are innumerable variations on how an estate freeze might be carried out
  •  It may involve trusts, corporations, existing share re-structuring, sales or a combination of these 
  • The common characteristic is that beneficial ownership is being rearranged so that asset growth is being shifted to be taxed in later generations
  • As well, usually life insurance is put in place to pay the frozen tax at the benefactor’s death

Are there any drawbacks to an estate freeze?

  • If the values do not increase, or in fact go down, the exercise will have been a waste of time or may even cause more cost than if it had all been left alone
  • As well, the transactions in the strategy have to be bona fides, which means that the property owner has to give up a degree of control — sometimes complete ownership transfer

What if a person changes his/her mind in future?

  • A well-structured freeze will have exit strategies which also have cutesy names like “thaw”, “gel”, “unfreeze”, “re-freeze” — but nothing is foolproof
  • Obviously, professional advice is a must before undertaking any estate freeze steps

EstateWISE – Joint ownership of the cottage with adult children?

Joint ownership is a common ownership arrangement that assures that a property remains within an ownership group, like a family — but what are the drawbacks when a cottage is owned this way?

Can we re-cap how joint ownership works for estate planning purposes?

  • Under joint ownership, when one joint owner dies, the surviving joint owners continue on as owners and the deceased owner has no further claim on the property
  • For estate planning purposes then, joint ownership provides the benefit of allowing the cottage to devolve outside of the estate, and thereby avoid probate tax

So, let’s say mom and dad want to add their adult son as a joint owner, what happens?

  • Whenever there is a change of ownership, there is a disposition for tax purposes
  • In this case, mom and dad will be deemed to dispose of a proportionate one-third interest in the cottage to son, and they will have to pay tax on that portion of the gain since the last disposition

So now that son is a joint owner, has our family ‘paid all their dues’ or is there more to come?

  • Unfortunately, as each death occurs there will be a disposition of a proportionate interest in the property, and tax will have to be paid by the deceased’s estate
  • Had things been left alone, it would only be upon the second death of mom and dad that capital gains tax would have been payable
  • It’s not necessarily a matter of paying more tax, but rather paying it sooner than otherwise required 

Other than this tax complication, is this a sound estate planning strategy?

  • If it was a last surviving parent adding on an only child late in life (perhaps nearing death), then this step may simplify the ultimate estate distribution, and any immediate tax consequences are of little concern because they would be coming up shortly anyway
  • Primarily you will be avoiding probate tax, but there are other legal issues to consider … 
    • There are legal fees and government filing charges to be paid each time there is a change
    • If the son uses the cottage as a matrimonial home with his spouse then has a marriage breakdown, his interest in the cottage may be included in determining any equalization payment
    • If the son has creditor problems, there could potentially be a forced sale of the property
    • Finally, if the son dies before the last parent then property will revert back to the parent, and all the out-of-pocket costs and pre-paid taxes will be for naught
  • These are the most common concerns, but there can be other issues depending on the personal circumstances — the bottom line is to get professional advice in order to make an informed decision