Make the wrong decisions and an inheritance can become the cause of many regrets
By Olev Edur
Canada’s retirees are in the midst of the biggest intergenerational transfer of wealth ever. By 2030 or so, an estimated $1 trillion will have changed hands in this country, as the now-retiring baby boomers inherit the fruits of their parents’ lifelong labours.
A testament to our dramatically improved lifespans and to the diligence of recent generations, this state of affairs undoubtedly comes as a great relief to many hard-pressed and debt-saddled boomers—but hazards await the unwary.
For starters, it may be tempting to spend some of the windfall now—prematurely—and worry about the details later. But Christine Van Cauwenberghe, assistant vice-president of tax and estate planning at Investors Group in Winnipeg, cautions against making any assumptions.
“You need to see the actual terms of the inheritance before making any plans or taking any action,” Van Cauwenberghe says. “People have expectations, but you may not receive as much as you expect, when you expect it.”
Indeed, a 2012 survey conducted by Investors Group found that among people who expected an inheritance and believed they knew how much they’d be getting, 57 per cent guessed they’d be getting more than $100,000. Yet of those who received inheritances, only about 20 per cent got that much, while 25 per cent got less than $5,000.
Similar study findings are cited in a BMO Wealth Institute report entitled “Passing it on: What will future inheritances look like?” According to the report, “about 1.5 million Canadians [in 2006] were relying on their inheritance as the primary source of capital to fund their retirement,” and, “on average, Canadians expected to receive a total of $150,600 in cash or cash equivalents, and $151,200 in non-cash inheritance. But in reality, inheritance sums received were significantly less—the average inheritance received that year was $56,000.”
Such diminished returns can result from a variety of causes. The BMO report points to tax liabilities, probate and legal fees, possibly sizable charitable donations, and, quite often, poor planning: “Particularly with the older generation, discussions of their death and the transfer of their estate, including writing a will, may be considered ‘taboo.’ The lack of candid conversation between generations appears to be a major contributing factor to poor retirement and estate planning. Moreover, the problem with this lack of dialogue is that it often leads to misgivings and financial insecurity in retirement for boomers and seniors.”
Les Kotzer, a will/estate lawyer with Fish & Associates in Thornhill, ON, agrees that a wall of silence often surrounds the issue of money and inheritances, often to the detriment of all concerned. “One client told me the whole family is fighting terribly over inheritances, and it’s because no one talked about it beforehand,” he says.
“She said, ‘We weren’t the Partridge Family—we were the ‘ostrich’ family because we never talked; we just hid our heads in the sand,’” Kotzer recalls. “It turned out that the father wasn’t as well off as everyone thought—his properties were all mortgaged, and now everyone is fighting, but there’s not much of the inheritance money left.”
“There are lots of reasons inheritances can be less than expected,” Van Cauwenberghe says. “It may be due to bad planning, or it may be intentional. Or the parents may have needed that money for their own care. You never know when and what you are going to receive.”
Park the Money
Sometimes certain heirs may have a legitimate beef about their entitlement and can seek redress in the courts (see box, below), but assuming you accept your entitlement, further hazards may await.
YOUR RIGHTS AS AN HEIR What if you don’t get what you expect from an inheritance or feel you’ve been shortchanged? Unless you’re an immediate family member or a dependant, you’re out of luck. “In Canada, testators are free to give their estates to anyone they choose, but there are rules to protect certain individuals,” says Christine Van Cauwenberghe, assistant vice-president of tax and estate planning at Investors Group in Winnipeg. “This usually means spouses, who are entitled to receive as much as if they were separated or divorced. It wouldn’t be the entire amount of the estate, especially if the surviving spouse has lots of money, but they could make a claim against the estate if it’s left to someone else.” Similarly, when it comes to intestacy, spouses are first in line. “If there is no will, spouses get priority,” Van Cauwenberghe says. “Generally, a surviving spouse gets a preferred share, ranging from zero to $300,000, depending on jurisdiction [estate matters are provincially governed], plus a portion of the residue.” The definition of “spouse” varies by province, so your entitlement can depend on where you live. “In half our jurisdictions, ‘spouse’ includes common-law partners,” Van Cauwenberghe says. “This is the case mostly in the western provinces, but less so in the east.” Once the spouse has been adequately compensated, the remainder of the intestacy is shared among children of the deceased, although, Van Cauwenberghe notes, in Quebec the estate can be further extended. But there is no legal obligation for your estate to provide for children or other family members. “Non-spouses—usually meaning children—have fewer rights than spouses,” she says. Exceptions may apply to dependants of the deceased, who may be able to lay claims against the estate under provincial family laws even if they are not immediate family. Van Cauwenberghe points to Ontario’s “dependants’ relief” legislation, which encompasses spouses and kids, as well as parents, grandparents, and siblings. “British Columbia also has its wills variation legislation,” Van Cauwenberghe adds. “So if, for example, a spouse is left destitute because the estate was given to the kids, or because he or she is unable to maintain an established lifestyle, the courts could alter the will and allow him or her more. With the wills variation legislation, it’s harder to disinherit a child in BC than in other jurisdictions. “Of course, we advise all our clients to plan their estates properly so that they don’t leave their spouses destitute in the first place.”
“Grief counsellors often advise against making any quick decisions when you get an inheritance,” Van Cauwenberghe says. “Just park the money for a few months.
“It often takes a year or more to settle an estate, anyway. It’s not just probate: often executors need to figure out what’s in the estate and where it is; they may need to liquidate certain items, pay debts, file tax returns…it takes time to do all that.”
In some cases, there may be adverse tax considerations, so, again, it’s best to let it lie for a while.
While Canada no longer imposes any form of inheritance or estate tax, the departed are deemed to have sold all their worldly possessions at market value, and all their income and accumulated gains are taxed one final time before disbursement by the estate. As such, any bequests from an estate can be received tax-free. Similarly, life insurance proceeds are generally tax-free to the beneficiary.
In some cases, an inheritance may bypass the estate and revert directly—and immediately—to the intended recipient. That would be the case, for example, with jointly owned property, and with beneficiary designations on life insurance policies, RRSPs, RRIFs, and other registered accounts. When it comes to beneficiary designations in tax-sheltered RRSPs/RRIFs/etc., you may receive the full proceeds of the plan, but the estate is still going to get the full tax bill, and the entire amount must be added to the departed’s income that year. (An exception applies for surviving spouses, whereby the tax can be deferred through a spousal rollover.)
“Taxes can be a big problem if one child is a designated beneficiary and the other child is a beneficiary of the estate,” says Doug Carroll, vice-president of tax and estate planning at Invesco Canada in Toronto. “Generally, a designated beneficiary gets the gross amount of the RRIF, but the estate is responsible for paying the tax, so the other child’s entitlement is reduced.”
There’s no legal obligation for the designated child to pay the estate’s tax, although if the estate can’t pay the full bill, that child may also be on the hook. “If the estate is insolvent, Canada Revenue Agency may follow the money to the beneficiary and require him or her to pay the tax,” Carroll says. “So you need to be aware of the tax associated with money from registered plans.
“If, on the other hand, your benefits come from a registered pension plan [RPP], then the plan administrator will apply a withholding tax. That should cover most of the bill, but if it’s not enough, you’re responsible for the rest. You should be aware of this difference between RPPs and RRSPs or RRIFs.”
Preserving Your Bequest
Carroll points to another reason for cooling your heels a while before dipping into your new-found wealth, one which can relate to your marital circumstances.
“Generally, depending on province, your inheritance is treated as a gift that is not subject to division if you get a divorce,” he says. “That’s as long as you keep that money separate from your other assets.
“I don’t like to bring up the subject of divorce, but if you use that inheritance money to buy a matrimonial home or pay down the mortgage, it becomes a marital asset and can be subject to equalization. As a result, it’s best to set up a separate account for that money and keep it isolated.”
Van Cauwenberghe notes that marital changes can sometimes coincide with inheritances: “In some instances, heirs receive the inheritance and make a change in their relationship at the same time. So if you’re thinking about separation or divorce, keep the inheritance money very separate.”
Another hazard for the recently endowed: not only do people tend to overestimate what they’re going to be getting, but when they do get it, they tend to overestimate its worth.
“Sure, a hundred thousand dollars may seem like a huge amount, but it may need to be spread out over a long time, so it’s not really as much as it seems in a lump sum,” Van Cauwenberghe says. “We’ve all seen people who get a big lump sum—lottery winners, for example—and spend it very quickly. They make lifestyle changes such as buying a new home or a cottage—changes that they can’t afford.”
“Usually the people with these estates are depression-era parents, frugal savers who didn’t take any chances with their money,” Kotzer says. “But the boomers who are inheriting this wealth are much more willing to take risks. I’ve seen clients lose it all—maybe $500,000: they invest it all in some penny stock that they heard about. With the push of a button, they can lose everything that it took their parents a lifetime to accumulate. People need to be very careful; an inheritance may seem like a lot of money, but it can go very quickly.”
Plan for Your Future
Once you receive your benefit and have allowed due time for contemplation, you need to figure out what that new-found money really means for you.
“Once you’re over the grieving—it’s usually a close family member—you need to sit down and make up a new financial plan,” Van Cauwenberghe says. “Your priorities may change once you’ve received the money. You also need to incorporate that money into a new plan.”
“The first thing most people think is that if they haven’t paid off the mortgage, they should,” Carroll says. “This may be a good move from a financial or legal perspective, but does it make better sense to pay off a 2.7 per cent mortgage or to invest in stock or mutual funds that can earn, say, eight per cent? You need to strike a balance in order to make an informed decision as to whether you should pay off that non-deductible mortgage, versus investing in the market and earning taxable returns.”
The question of how to invest is complex, and the answers can depend on many personal, financial, and legal variables, so both Van Cauwenberghe and Carroll strongly suggest you get some professional advice.
“It’s really a matter of personal preference what you do afterwards, and there are many choices,” Carroll says. “But it’s best to leave the money alone in a separate account until you can get some financial and legal advice on the tax and legal implications of your good financial fortune.”
Unfortunately, many retirees don’t bother getting advice. A 2009 BMO study found that, of those aged 65 or older who had received an inheritance, more than three-quarters hadn’t spoken to a financial advisor about their windfall.
“Despite the positive outlook on inheritances, studies have shown that a significant proportion of boomers may not be properly prepared to manage this inflow of cash and may not have explored strategies to ensure that a legacy will be passed down to their children,” the BMO “Passing it on” report concludes.
Photos: iStock/StockstudioX (RRSP and RRIF). Fotolia/robyelo357 (woman); iStock/photoangelina (money).