4 Tips for A Better Will
Further to requests following my webinar for Canadian Moneysaver magazine last October, I’m going to write a number of articles designed to help you understand the estate planning process, detail your choices, and assist you in increasing the chances of the right people getting the right assets at the right time — and with as little hassle, tax or expense as possible. If I can make you laugh or at least tweak the corners of your mouth from time to time along the way, I’ll consider that an added bonus.
To get the ball rolling, I want to talk a little bit about Wills today. I’ve already written about why almost every adult needs one (check out my blog at www.colinsritchie.com), so today’s article isn’t about why you need a Will. To cut to the chase, I want to talk about four potential problems that can arise when deciding how to dole out the loot, and offer a few possible solutions.
When the Generation Gap is Between Siblings Rather Than You and Your Kids
Most parents (at least on good days) want to treat all of their children fairly. If your kids were born within a few years of each other or are already independent adults by the time you’ve gone up to see the spirit in the sky, it usually means bequeathing them equal shares. Unfortunately, in this brave new world of test tube babies and blended families, it’s not uncommon for parents to have some children that are already working stiffs and others that are still awaiting puberty. In cases like this, dividing the pot equally might leave your younger offspring clamouring for more, and your older children feeling a little guilty. For instance, if you paid for the older children’s braces, tennis lessons, university education and spring breaks down south, along with their basic room and board until they were old enough to spread their own wings, your younger children might feel shortchanged if this is not taken into account when dividing up your estate. Moreover, the courts recognize that parents have a stronger obligation to their minor children than to those who have already flown the coop.
If you think I’m on to something, there are a couple of solutions to provide for all of your children in situations where equality doesn’t equal fairness. The most common technique I’ve seen is for mom and dad to put their estate into a trust for their children, with instructions to their trustee to focus on using it for education and maintenance of the younger children until the youngest reaches a set age or educational milestone. Following that, the remainder is divided equally between all of the children. What this results in is a trust that covers the expenses generated by the younger children — the ones mom and dad paid on behalf of their older brothers and sisters during their lives — until the youngest is self-sufficient, after which, whatever is left is divided equally between the children, regardless of age.
My major problem with this strategy is that this may leave the older children waiting, conceivably, for decades before getting their pie of the pie. Rather than making them wait until their younger siblings are finished school before everyone gets paid out equal shares of the remaining estate, I like the idea of carving out a separate pot for the younger children’s expenses and dividing the remainder equally among all of the children. For example, perhaps 40% might go into the trust earmarked for educational expenses and maintenance until adulthood (note: the portion allocated to this trust should be large enough to ensure that funds never run short) and, if you had three children, each of them would receive an additional 20% immediately, or, in the case of the younger one(s), the 20% could be placed in a separate trust for each child exclusively. Dividing the excess immediately in this way gives your older children the money they may need to buy homes or perhaps start funding their own children’s educations, while still ensuring that younger ones aren’t inadvertently shortchanged. Further, if there is anything left in the education fund once the younger children have been “all learned up,” that remaining balance can then be paid out equally — including to the older children who, up to that point, will not have received any payments out of that particular trust.
Deciding When Your Kids are Old Enough to Make Their Own Bad Decisions
Perhaps the toughest decision parents face after deciding who gets what is when to give it to them. At law, children are not allowed to manage their own money until they reach the age of majority in their province of residence. Before then, unless your Will appoints someone to call the shots, a government entity takes on this role. For example, in B.C., the Public Trustee is in charge of investing minors’ assets and deciding whether it is reasonable to spend part of the inheritance on a new sports car (or, alternatively, if that’s just a really bad idea).
I generally suggest waiting until a child is at least 25 before giving him or her free rein, although my personal preference is that they wait until they are 30 to receive a substantial portion of any significant inheritance. I further suggest distributing the inheritance in stages so that they can (with any luck) make their mistakes with a smaller portion of their fortune before getting the really big bucks. For example, they might get 10% of the balance at 25, 30% of the remaining balance at 30, and the rest when they turn 35. Here’s another type of planning that I’ve only seen in one other lawyer’s Wills but that I really like to include: language that will delay any distribution if the child is going through a life event, e.g., illness, addiction issues, divorce or creditor problems. While this extra step might cause complications in some cases, most people seem to think it’s worth the hassle.
Drafting a Great Will But Rolling the Dice with Life Insurance
If you most of what you’re leaving behind at this point will be paid by a life insurance company, I suggest you drink another cup of coffee and pay particular attention to this section. If you’re like 99.8% of us, you’ve merely relied on the basic insurance form provided by your insurance advisor, ticked off the appropriate boxes, and penciled in a few names. Of course, things may and often do) turn out all right if everyone dies in the right order and is old enough to handle money wisely when they inherit. It’s also true that you can update your beneficiary designations along the way if necessary. Unfortunately, this can’t be guaranteed, and, if things go wrong, the problems can be significant.
Some of the problems include the following:
- Unintentionally disinheriting descendants such as grandchildren if their parent dies before you and your life insurance named all of your children as joint beneficiaries — a circumstance that would result in the surviving children dividing the spoils;
- Children making their own money decisions as soon as they turn 19 even if you indicated that someone else would hold the money “in trust” until then; and
- You inadvertently providing for disagreeable sons/daughters-in-law. Assuming your child died very shortly after you, his or her portion of the proceeds would be paid to their estate, and the spouse would get at least 50% of the balance — even if you would have preferred it all to go to your grandkids (if any) or your other children.
Although it is probably ideal to have a separate, standalone document called a “life insurance trust” that your lawyer files with the life insurance company, it’s also possible to solve the same problem within the Will. While the cheapest solution is to simply pay the proceeds into your estate so that the Will governs its distribution, this causes a lot of other problems, e.g., probate and trustee fees, credit issues, delays and Will challenge exposure, that are best avoided. Accordingly, I suggest paying for a slightly more expensive Will that is able to properly distribute your insurance proceeds while avoiding the issues that can come from either using the basic insurance form or paying the money directly into your estate. If you believe enough in the benefits of life insurance to cough up premiums each month, I suggest coughing up just a little more to ensure that the insurance proceeds accomplish what you actually intend. As a final point, it is vital you file a copy of the Will with your insurer and update the beneficiary designation in your Will every time you prepare a new one, updating your Will means revoking previous Wills, including the insurance instructions contained in it.
Own RRSPs, RRIFs, TFSAs and the like? In some provinces, such as B.C., you can now do the same sort of planning inside your Will. (In other provinces, it is likely necessary to prepare a separate trust document that gets filed with your investment company — something known as a “secret trust” — to avoid the same problems mentioned with life insurance (not to mention some additional tax consequences that can further penalize anyone unintentionally disinherited from a slice of the registered-fund pie.)
High Tax Bills Watering Down the Benefits of an Inheritance
First, let me be clear that there is no such thing as estate tax in Canada; the tax bills I’m talking about arise either if your heirs are already in a high tax bracket or if the investment gain from their inheritance puts them there. With proper planning, it’s possible to reduce the yearly tax bill by tens of thousands in some cases, i.e., if the inheritance is left in a trust not only for your child but which also names low-income dependents (such as your grandchildren) as beneficiaries. Furthermore, a lot of these savings will remain available despite the changes to how these trusts (including those created using life insurance or RRSPs) are taxed in 2016. In a nutshell, any income generated by the trust paid out to or for the benefit of these low-incomers can be reported on that person’s tax return and taxed using their rates. Barring this, it would be taxed at the higher rates of the person who would otherwise have inherited it directly. Worried about trustee fees or leaving decisions to this middleman? Make the target heir the trustee of the trust, allow him complete discretion about how the money gets distributed, and indicate that he can theoretically spend every last cent for his own intense enjoyment so that no one can quibble with his decisions. It is also easy to set up the trust so that it can be unwound at any point if it is no longer serving its purpose. As an added benefit, this trust can stipulate who inherits at the target beneficiary’s death; this could be a wonderful thing if the situation includes providing for a new spouse in a blended family, i.e., if you want to ensure it stays with your bloodline on a child’s death.
If you’ve made it this far and have been even mildly entertained or educated, excellent: there is more to come. While a good Will is a cornerstone to most estate plans, there are many other documents and planning strategies that serve as the bricks and mortar of the whole process. In fact — particularly for older clients, those with larger estates, or those worried about either creditor or Will challenges — the Will might be little more than an afterthought! To learn more, stay tuned.