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Posts from the ‘Legal’ Category

Warming Hearts Through Estate Freezes

Imagine ordering a large drink late in a steamy August afternoon after just completing a day’s toil in the sun. After several thirsty minutes waiting, watch in rapturous delight as the waitress finally brings over a tall, frosted glass, beaded with moisture . . . only to discover that it’s mostly ice. For lawyers and financial planners like me, that’s what I see when calculating actual size of the estate many of my clients will leave to their heirs after paying taxes. Although there are many ways to cut down on the ice quotient, the one I want to talk about today is called the “estate freeze.”

In simple terms, a freeze operates to cap or “freeze” the amount of unrealized capital gains on company assets that is taxed on when the grim reaper comes calling for that freezing shareholder. The freezer swaps the common shares that have grown in value for one or more classes of fixed value preferred shares that maintain control over the company but won’t participate in future growth. Instead, the company issues new common shares that are currently without value to the next generation or to a trust that the freezer controls and, when a holding company’s portfolio skyrockets higher or an active business’ widget sales go through the roof, those new common shares soak up all the new growth. Although the freezer will still need to pay tax on any unrealized gains on the preferred shares (s)he owns after their last gasp, (s)he will have at least minimized the tax (although not emotional) pain for those left behind.

Obviously, timing when to do the freeze makes a profound difference to the tax savings the freezer’s estate will eventually enjoy. If the company doesn’t continue to grow in the future or if the freezer dies within a year or two of implementing the freeze and the new common shares haven’t yet had a chance to significantly increase in value, then the whole exercise was likely a waste of time. On the other hand, for a company that doubles in value over 5 years, the savings to the deceased’s estate can be over $250,000 on every million dollars of gains that would have otherwise been taxed in their hands at this point. If amount of capital gains that are included in income and are taxed increases in the future, as many worry, the savings could be even more. For example, if the inclusion rate for capital gains increases from 50% to 75%, a properly done freeze could save the estate $375,000 per million dollars of capital gains avoided.

When to Consider Getting Chilly

Whether a freeze is worth considering depends on a host of factors. Perhaps the biggest are how much have your company shares already increased in value and how much will they continue to grow before your death if you leave well enough alone, as noted earlier. As a friend of mine once said, ask yourself if the juice (i.e., the benefit) is worth the squeeze (the cost and effort involved in extracting the relevant breakfast beverage.) The best candidates for a freeze own active businesses that they are looking to either pass down to the next generation or sell to an outsider. In the first case, minimizing the tax bill at death may make the difference between a business staying in the family poised for continued success or either a forced sale to pay the taxes owing at death or hamstringing heirs with large bank loans in order to pay that bill.

If the goal is instead to minimize taxes on an eventual sale, capping the original shareholders’ share value and transferring future gains to other shareholders allows more family members to claim the lifetime capital gains exemption on their shares upon sale. Every shareholder can avoid most of the tax on almost $900,000 in increases to the value of their shares at this point (the exempted amount increases yearly due to inflation) if they and the business satisfy certain criteria. By doing a freeze to transfer future growth to spouses and children, etc. after your own shares have unrealized gains of about $900,000 can mean hundreds of thousands of dollars in savings in some cases. For example, someone doing a freeze when her shares have grown by $900,000 in value in favour of her husband and 3 children in the expectation that the company would be worth $4,500,000 upon sale may be able to avoid capital gains tax entirely at that time. In that example, the new common shares owned in a family trust would be worth and could be apportioned equally amongst her hubby and children so each could shelter $900,000 of growth, with mom using up her exemption on the $900,000 in shares she retained after the freeze.

By contrast, if she does nothing, remains the sole shareholder and owns $4,500,000 worth of shares at sale, the tax bill could easily exceed $900,000 at today’s levels and far more if the inclusion rate for capital gains climbs in the future. As an added bonus, in some cases, a freeze might help a family save tax along the way by allowing them to sprinkle dividends to qualifying adult family members who actively work in the business but whose salaries aren’t enough to optimize the family’s annual tax savings.

On a related note, a freeze requires an accountant or business valuator to put a value on the company at the time of the freeze. Businesses hit hard by Covid may be able to turn this to their benefit if they are confident that the blip in value is short-lived by doing the freeze based on the current Covid-influenced levels so the new common shares can reap the rewards when the economy and business value both improve.

On the other hand, freezes are not just for active businesses. Doing a freeze for your holding company can still save your family a host of potential taxes on your eventual passing, particularly if combined with some of the other options I talk about in my next article on “wasting freezes” and share redemptions on death using life insurance. As I will also discuss, investors with large non-registered portfolios or perhaps rental properties might even consider setting up a new holding company, then rolling those assets into the company on a tax deferred basis (but do watch out for property transfer tax) to cap the future tax bill owing at death. This strategy works best if the plan is for the children to keep the assets, such as a real estate portfolio, for the long term after your death but can even mean huge savings if that isn’t the plan in some cases. If nothing else, it may provide your heirs with the flexibility to wait a few years after your death for the real estate or stock market to improve rather than forcing them to sell as soon as you’re in the ground in order to cover your final tax bill.

Reasons for Giving Freezes the Cold Shoulder

Admittedly, freezes are not for everyone. Besides taking into account the cost of doing the freeze and any additional annual expenses that might result, particularly if creating a family trust to hold the new common shares or setting up a new holding company, I suggest taking the following into account:

• A freeze may only delay the day of reckoning. Although shifting part of the potential tax bill from one generation of taxpayers to another is often great tax planning, it might not be so beneficial if the kids will need to wind up the company in short order anyway. It still may be worth proceeding if the freeze provides the heirs with some discretion regarding when to sell assets like real estate or if there are still tax savings to be had despite the desire to wind thing up shortly after your death.

• A freeze only works if the company continues to grow or you use the aftermath of the freeze to decrease the value of the freeze shares. If you plan to draw down the value of any company during retirement and suspect that it will eventually be worth less than it is now, then a freeze is not for you. The only exceptions may be if you also do a “wasting freeze” during retirement, as I discuss in my next article, to more actively transfer some of the capital gain tax bill to the next generation.

• Are you too young? If doing a freeze using a family trust, realize that the trust has an effective lifespan of 21 years in this situation, as all unrealized gains inside the trust are taxed on its 21st anniversary. Although the shares can be transferred out of the trust on a tax-free rollover basis at any time prior to then, some parents may not be keen to gift the shares directly to the children at that point, particularly children with rocky marriages, financial issues or similar problems. On the other hand, 21 years is a long time for children to get their act together and the parents can always just allocate the common shares to back themselves if that has not happened. This would undo the benefits of the freeze but it is always good to have this option if life does not turn out as expected.

• How much does control matter? How solid are your children’s lives? Practically speaking, doing a freeze doesn’t mean having to give up control of the company if the freezers retain all of the voting shares and control the family trust that also owns the new common shares. This allows them to continue with business as usual inside the company and to continue to pay themselves as many dividends and as much salary as their hearts desire and the Income Tax Act allows. If shares are gifted to the children directly, there is less control, which increases the chances of problems if a child is divorced or has creditor issues. Even if the shares are held in a trust, there are at least theoretically potential problems if one of your children divorces. One way of minimizing that risk is making it a precondition of the freeze than any married children get prenuptial or marriage agreements excluding the value of any shares from any divorce settlement.

• Are there other tax fighting weapons in the armoury? A freeze can be a silver bullet in the right circumstances but a empty shell in others compared to some of the other tax minimizing options available. Corporate life insurance can help minimize, reduce or pay the final tax bill, particularly if there is a big tax-free payout on the first death. Loaning money to a family trust (assuming most of your capital gain assets are outside of a company) at 1% so you can actually sprinkle income to your descendants now can be a really effective strategy in many situations. Even if you have to pay more tax now to get a critical mass of assets into the trust, it might be a blessing in disguise if the taxable amount of capital gains increases in the future anyway. Unfortunately, the trust idea may not be a particularly useful one if most of your assets are held corporately.

Conclusion

The tax bill faced by many estates on their corporate assets or non-registered holdings often takes a very big gulp out of what taxpayers want to pass along to their heirs, but proper estate planning can often reduce that large gulp into a small sip. Implementing an estate freeze many years prior your final passing may be one way of making that happen. In my next article, I’ll discuss some ways to supercharge the benefits of a freeze to hopefully make that final sip of taxes into a mere moistening of the lips.

Should I Stay or Should I Go Now – Whether or Not to Refinance Your Mortgage and How To Ease The Pain

Covid 19 is the sort of financial tsunami that bowls over and swamps all but the most conservative of financial projections. As we slowly begin to pick ourselves up, dry out our wet clothes and figure what comes next, I am suggesting to many of my homeowner clients with fixed rate mortgages to look at their existing mortgages to see if there are any opportunities to turn at least some of the lemon that is Covid into perhaps a shot glass full of lemonade.

When diving down into the rabbit hole of mortgage refinancing calculations, many surprises may await. Accordingly, I strongly suggest that you arm yourself with the expertise of an experienced mortgage broker like my friend and fellow Moneysaver contributor Russ Morrison that has been around the block at least twice to help you maximize savings and minimize unnecessary bank penalties.  And, after crunching the numbers, if you believe that it does make sense to pay whatever penalties come with paying up your current mortgage, it’s just as important to ensure that your shiny new replacement mortgage provides you with as much flexibility and as many features as possible in order to hopefully help you continue to save for many years to come. Don’t worry – I’ll save that next topic for another article.

How it Works

Trying to understand the ins and outs of whether or not it makes sense to pay down your existing mortgage ahead of schedule is a lot like trying to read a book in a foreign language upside while not wearing your glasses – extremely frustrating, confusing and open to misinterpretation. I’ll talk about the details of how this is calculated in a second, but at the end of the day, these calculations determine whether the savings you’d reap under the new mortgage would be enough if you continued your current payments going forward to pay down the mortgage penalty that you’d be adding to your new mortgage by the time your old mortgage expired. Put another way, if your mortgage balance would be $500,000 after taking advantage of all the prepayment options I’ll discuss later to lower your penalty, with 3 years until renewal, and your monthly payments are $3,500, would a new mortgage for $515,000 (current balance plus an arbitrary $15,000 penalty) and $3,500 in monthly payments leave you with a smaller mortgage balance 3 years from now than would be the case if you just kept paying down your current mortgage? If so, and the hassle factor and any associated costs from making the change aren’t too significant, then you’d want to look at making that change. I highly suggest getting your broker to spell out any additional costs or other downsides in advance so that you’re not surprised later. For example, will there be any legal or appraisal costs and, if so, how much?

Furthermore, if you want access to a new secured home equity line of credit (“HELOC”) from your new lender, how do those rates compare to what you currently have? HELOCs are usually variable and are also based around the bank’s prime lending rate. It is quite possible that in these days of Covid that your new HELOC rate might not be as attractive as your old one. You’ll need to take the extra interest you might be paying on the HELOC in the future into account before making your final decision if you’re planning on using your HELOC extensively going forward.

If your new mortgage is fixed term, then the calculations to determine whether you’re better off refinancing your mortgage are relatively straight forward. If you opt to go variable, however, then these calculations will need to take into account how your variable rate might change over the remaining balance of your current mortgage.  Although in these days of Covid, it is hard to imagine when rates might start to climb again, I still suggest taking this into consideration and crunching the numbers to include at least a rate increase or two at different points of time during the period in question. Taking on a variable mortgage does mean taking on more risk.  Factoring in what things look like if rates do climb, however how unlikely that may currently seem, forces you to see what could happen if life throws us yet another curveball. If you’re still ahead of the game despite these more pessimistic estimates, then you can proceed with more confidence and certainty. If the numbers no longer work, you can either stay with the status quo or, if the savings if rates don’t change are too much to pass up on, then at least you’ll have made an educated decision with a better idea of the downside if things don’t go entirely your way.

Calculating Your Prepayment Penalty

If you pay down a typical fixed rate mortgage ahead of schedule, it’s going to cost you. The penalty is generally whatever is higher – the interest you would have paid on the remaining balance of the mortgage over the next three months, or what they call the “interest rate differential” or (“IRD”), which is allegedly based on the difference between what you would have paid in interest over the remaining term of your existing mortgage vs. what you would have paid in interest over this same period on a fixed term mortgage at current rates for the remaining mortgage term. For example,  if you had 36 months left on your existing mortgage, the IRD would look at the interest you would have paid over those three years under the status quo minus the interest the bank can get now lending out your current mortgage balance to someone else based on their current posted 3-year mortgage rate. In theory, you are compensating the bank for not being able to get as much interest on the money you’re returning to them ahead of schedule when they have to lend it out to someone else now at lower rates.

There is one very important exception to the IRD calculations just discussed. Banks are only allowed to charge an IRD penalty during the first 5 years of your mortgage. After that point, they can only charge three months’ interest. Although longer term mortgages (i.e. like 10 years) are not particularly common (they are generally priced higher than 5-year mortgages for several reasons, one of which is to compensate them for lost IRD payments if the borrowers do cancel beyond the 5 year mark), if you’re the exception to the rule and already beyond the 5 year mark, you should have your mortgage broker on speed dial. You’ll be able to avoid the sticker shock that I’ll be taking about in the ensuing paragraphs if you do refinance.

Calculating a typical IRD penalty sounds pretty straight forward, but all lenders are not created equal and the devil is in the details.  For the naive, if your current 5-year mortgage rate was 3.39% and the posted rate for a three-year fixed rate mortgage today was 2.39% on a remaining mortgage balance of $300,000, you’d expect that the interest rate used to calculate your penalty would be 1%. Not so fast. Your original 3.39% rate was very likely not the “posted rate” advertised to the masses but a discounted rate that is referred to as the “bank rate” or the “discounted rate.” That is also true for the 2.39% rate currently posted – it’s likely that because the bank truly loves you and values your business that they would be willing to go a little lower than the posted rate, but only just for you, of course. As a result, the rate some banks use to calculate the IRD is the difference not between the actual 3.39% 5-year mortgage rate that you are currently paying and that 3-year posted rate of 2.39%, but the posted rate when you took out your mortgage two years ago and that 3 year posted rate. The difference between the posted rate and the bank rate on your original 5-year mortgage may actually be 2% or more higher in some cases! Thus, instead of using 1% (3.39% – 2.39%) to calculate your IRD, some banks might use 3% or more using this example (5.39% – 2.39%). Alternatively, they might get to the same 3% result by subtracting the 2% discount you received 2 years ago from the current 2.39% posted three-rate. Never mind that shorter term mortgages don’t get discounted nearly as much as 5-year fixed mortgages, nor that banks aren’t discounting their rates nearly as much these days in these times of Covid. Put another way, how many lenders out there do you think would be willing to discount their posted 3-year rate of 2.39% by 2% to 0.39%? In the end, there are currently a lot of horror stories regarding some potential prepayment penalties, particularly for those poor souls who aren’t refinancing in order save money under new rates but who might be losing their homes due to the financial crisis or are forced to refinance purely for cash flow reasons.

It’s important to note that banks aren’t the only way to get a mortgage in Canada. In addition to banks, or private mortgages, your choices include monoline lenders (lenders who only do mortgages rather than the whole array of products banks offer) and credit unions.  Generally, banks charge the highest penalties on fixed mortgages, although it really varies from lender. Bottom line: it’s vital to do your research prior to entering into your next mortgage to determine how lenders calculate their IRD penalties, as well as other key considerations like portability (the ability to transfer your old mortgage to your new home) and penalty- free prepayment privileges that can reduce any penalty if you do need to get out of your mortgage at a later date.

In the end, as Russ Morrison, licensed mortgage god, advises, picking the right mortgage is a lot more than just comparing interest rates. That’s why I suggest working with a mortgage broker rather than going it on your own. It’s free, you get to shop the entire mortgage market and you also get lenders’ best rates up front rather than only after you’ve found a lower rate elsewhere.  Perhaps most importantly, however, a good broker will walk you through the other considerations I’ve just discussed so the mortgage you pick fits you like a glove and you know how to optimize its features.

If it still makes sense to prepay your mortgage, there are a few things that might minimize the pain:

  • Be strategic when picking the time to pay down your mortgage. Get your broker to calculate both the savings and penalty happen to be if you pay down at different points in time. One of the big things to keep in mind, however, is that you won’t know for sure what the posted rate for the period closest to your remaining mortgage term will be in advance, nor the rate that you’d be able to get on the new mortgage that you will actually take on. If you try to get too cute, you may not be able to get the same mortgage rate offered today, which could more than offset any reduction to your mortgage penalty you might get by waiting. As well, using our previous example, if you wait until there are only 2 years left in your current mortgage, the IRD would look at the 2-year posted rate rather than the 3-year one. It could well be that the 2-year rate is lower than the 3-year posted rate, which means that, although the calculations would only look at 2 rather than 3 years of lost interest for the bank, the rate used to calculate that penalty may actually be higher: for reducing the IRD, you usually want the posted rate offered for the remaining term of your current mortgage to be high, not low so that the difference between the two rates (and thus, the rate used to calculate your penalty), is as low as possible.
  • Prepay the pain away.  When calculating the best time to pay down, it’s vital to remember that the penalty is only applied against the outstanding balance at the time of paydown.  Thus, the less you then owe, the smaller the penalty you’ll incur when repaying the bank’s dough. This will occur naturally over the lifespan of any mortgage, although if you’re still 25 to 30 years before it’s scheduled to be paid down completely, each payment at this stage is likely mostly interest anyway. There are steps you can take, however, to hammer down your mortgage balance before you pay it out and, as a result, significantly reduce any mortgage penalty. Most mortgages allow you to pay a set percentage of the original balance loan (a range of 10 to 20% is pretty common) each year in one or more lump sum payments. You may also be allowed to increase your regular payments by that same percentage, too, often without this affecting how much you’re able to prepay in lump sum payments. I’ll dive into the ins and outs of prepayment rules in a separate article but here are the basic things to keep in mind when looking at these options:
  • The early bird gets the worm. The earlier you start prepaying, the smaller your mortgage balance when it’s time to calculate the penalty.  Each prepayment means that every regular payment you make thereafter will be directing more money towards the mortgage balance rather than in interest payments. Just like when looking at investment returns over the long term, the magic of compounding also casts its financial spell when trying to reduce your mortgage balance by making extra payments as soon as possible.
  • Read the fine print and use it against them. Different lenders offer different prepayment percentages and features. Some allow you to make as many lump sum payments each year over a small minimum payment amount as your heart desires, while others aren’t as generous. Others may even restrict when you make your annual prepayments to a set date, such as each year’s mortgage anniversary! Since you’re stuck with these rules and limitations, it’s essential know the hand you’ve been dealt so you can employ these rules to your best advantage. For example, are the prepayment periods based on your mortgage anniversary or the calendar year? If you’re planning to pay down your mortgage, you could save you a lot of penalty dollars if you diarize the earliest date you can make your next lump sum prepayment and time your mortgage paydown for after you’ve done just that. If you have a 20% yearly prepayment privilege, getting to make an extra 20% prepayment reduces your mortgage penalty by that same 20%!
  • Let your HELOC lend a hand. Although taking advantage of the prepayment privileges propounded in the preview paragraph may sound promising on paper, it might be another thing entirely coming up with the money to make this happen in the real world. That’s where your existing HELOC comes in.  If you use your existing HELOC or even arrange a new one in anticipation of paying out your mortgage early to fund lump sum prepayments or also free up the cash to also increase your regular payments as well, this can take a huge bite out of that future mortgage prepayment penalty. And, when it’s time to take out that cheaper, lower rate mortgage, you can borrow enough to pay down the balance of the HELOC. Even better, since the prime lending rate has fallen so fast so soon, the interest you’re paying on it in the meantime may actually be significantly lower than the rate that you’re paying on your current fixed rate mortgage anyway.  Not only will you be reducing the penalty you’ll pay the bank down the road – you’re doubling down your savings by reducing the rate of interest you’ll be paying along the way as well!
  •  Consider using your TFSAs to turn the tide. If you’ve got a lot of money already tucked away in your TFSAs and you’re still struggling to come up with your prepayment, consider dipping into your TFSAs to come up with a bit more cash.  You can always borrow back the money to fill up your TFSAs as part of your new mortgage, although you will have to wait until the next January before you can replace the money you’ve withdrawn. This option works best for investors who don’t expect a lot of growth or income from their TFSAs between now and then, as the opportunity cost for reducing the prepayment penalty using your TFSA loot is the tax-free income and growth you would have received had you stayed invested. If you’re one of those people who have calendar prepayment privileges and want to make that final penalty-free prepayment in January before refinancing your mortgage, consider pulling your TFSA money out in late December if you want to minimize potential lost investment growth. Your new mortgage can include enough money to restock your TFSAs and you can start earning tax-free TFSA dollars once again with minimal opportunity cost. Just don’t try to claim a tax deduction on the money used for TFSA purposes, as that’s not allowed.
  • Cash in your cash accounts. Another potentially useful way to prepay that mortgage is to sell existing non-registered investments to raise the cash. There will be a tax bill to pay on any capital gains, so you’ll need to take this into account before making this decision. If you were going to be selling some of the investments anyway within the next couple years and are worried about having to pay more tax on capital gains in the future like I am, this might be something you could consider doing anyway. Want to stay invested? Perhaps you can use your HELOC to buy back those investments. Not only will this reduce your eventual prepayment penalty and perhaps even lower your combined interest rate if your HELOC interest is lower than your fixed rate mortgage, you can now write off the interest on the money you’ve used to repurchase those investments! If selling investments at a loss, however, be sure not to repurchase the exact same ones or wait for at least 30 days after selling to do so or you won’t be able to claim that loss for tax purposes. When eventually getting your new mortgage, you’ll likely need to pay down the existing HELOC, which might mean having to sell your investments again, but you can take out a new HELOC at that point with whoever is issuing your new mortgage or even look at carving out a separate mortgage just for investment purposes if that gives you access to a lower interest rate.Either way, try to keep the investment loan portion of your mortgage or any HELOC as a separate mortgage or portion of any HELOC for tax purposes. Not only will this make your accountant far happier, it will also likely save you a bunch of tax dollars going forward. If the debts are kept separate, you can arrange your finances so that you pay as little as possible towards your deductible debts and direct more towards your non-deductible ones. As a result, more of your debt and more of your interest will be tax-deductible, which can result in significant tax savings.

Final Considerations

When refinancing your mortgage, there may also be some opportunities to reduce your current expenses if times are tight. Although the break-even calculations assume that you’d continue your normal payments under the new mortgage and keep your amortization period (i.e. the number of years before your home is completely mortgage-free) the same, you don’t have to do either of these things.  Under your new lower rate mortgage, your minimum regular payments will probably be lower despite adding the interest penalty to the balance. If your focus at this point is on keeping your monthly costs lower, you could likely reduce those payments slightly and still have the penalty paid down by the time your current mortgage would have expired. Or, if cashflow is particularly tight, you might decide to decrease your payments and increase your amortization period which could significantly reduce your regular payment costs to make ends meet until your finances improve. At that time, when funds permit, you could look at increasing your regular payments under the prepayment privileges provided under your new mortgage in order to get things back on track. For some of us, the decision to pay down our current mortgage may even be based purely on reducing our regular costs even if the size of the penalty doesn’t otherwise justify making the change. If you’re in that boat, you’ll just have to make sure that you still qualify for a mortgage or to see if you have any relatives willing to act as guarantors.

Conclusion

Although 2020 has caused many financial problems for far too many Canadians, there may at least be a few ways of easing the sting and helping us get our houses back in order. For some of us, paying down our mortgage early might be one such opportunity.

Free Online Presentation November 6, 12:15 pm

Once more the World Money Show and Canadian Money Saver Magazine have generously invited meme to be part of their 3 day Extravaganza of investing and financial planning running from November 4 to 6.

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To register and find out more, please click on the following link:Registration Link: https://online.moneyshow.com/2020/november/canada-virtual-expo/speakers/ffvcms0311172/colin-ritchie/?scode=051449

Even More Wills, Chills and Thrills – A Few More Things to Consider When Drafting a Will

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During these times of turmoil and Covidic confusion, many of my clients have had Wills on the brain. Although many Wills do a good job covering off the basics, I still often finish reviewing my new clients’ old Wills with a vaguely uneasy feeling that there are a few too many “what ifs” left floating in the wind for my liking. And when I also reviewing their beneficiary designations, I really start to get fidgety. Thus, in effort to stop my squirming, I am inflicting this article upon you today.

In law school, I was trained imagine the worst and to make you think about things that you don’t like talking about at cocktail parties. Fortunately, my job is also to provide you with safety valves and solutions to protect you and yours if the worst actually does come to pass. Admittedly, in many cases, this extra worrying will be unnecessary and any extra issues, tension and confusion left unresolved will eventually work itself out with few permanent scars. On the other hand, if life does come up snake eyes, a little extra planning can easily pay for itself many, many times over in terms of problems avoided, relationships preserved, and dollars saved. In my view, when you’re talking about the transfer of a lifetime’s worth of hard work, sacrifice and saving to the people and causes you love most in amounts that can profoundly their futures, this is one of those times when it’s worth sweating the small stuff. 

Noting all of this, here are a few of the extra things I suggest considering before you sign your Will’s back page:

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  • Not being able or getting around to update your Will and beneficiary designations on insurance or registered plans in the future. I am particularly thinking of clients who lose their capacity to make legal decisions due to disease or injury but may linger for many years after diagnosis or mishap.  Most people assume that they can just make changes to their plans if someone dies in the wrong order or life throws a curveball, but this isn’t always possible. To counter this contingency, I like to include:
  • Backup guardians and trustees and perhaps secondary backups.
  • Indexing cash gifts to inflation or making them a percentage of the estate instead so that they keep up with inflation or grow/ shrink with the size of your estate if it is larger or much smaller than anticipated.
  • Distributing assets like accounts, real estate and company shares as part of an heir’s share of the estate rather than a stand-alone gift. In other words, if the goal is to equally divide an estate amongst your 3 children but for your youngest son is to get the cabin, divide your estate evenly but specify that your son’s share includes the fair market of the cabin at death net of taxes. In that way, regardless of what the cabin is worth in the future, your boy still gets his mancave but the estate is divided equally. Worried about the cabin being worth more than his fair share? Either he can get a mortgage to buy out his sibs at death or you can provide other options in your Will like him paying out his siblings over time at an interest rate that is based on the market rate at that time.
  • Contingency planning for life insurance and registered plans if leaving these assets jointly to your children with descendants of their own or who might have them in the future. Without this planning, if a child with descendants predeceases you, it is very likely that your other children would just get a larger piece of the pie and the children of the deceased would both go hungry and might even be stuck indirectly paying for some of the taxes on some registered plans they never received. Although many clients accurately assume that children who receive this extra share would do right by their nieces and nephews:
  • Some of your kids may honestly believe that they are just following your wishes when keeping the extra share or may never understand that there has been an injustice in the first place;
  • If the recipient children have creditor issues or incapacitated, they might not be able to set things right even if they want to; and
  • If the grandchildren are still minors or even young adults, it could be messy and complicated to determine how to get the money back to the children, avoid unnecessary taxation and determine who is to manage the money in the meantime.
  • Including provisions to hold an inheritance in trust if your now-healthy heirs are incapacitated at the time they inherit or perhaps beset by other problems, like creditor issues or addictions. Why take the chance that an inheritance might end up managed by the government, squandered, used to feed an addiction or handed over to creditors rather than your kith and kin?
  • Flexibility to move any trusts created in your Wills to other jurisdictions if your children or other heirs end up living abroad. It’s also really important to get good advice if you have heirs with U.S. citizenship or living in the U.S to avoid your heirs pay far more taxes than necessary.
  • Contemplating potential money issues and uncertainties might arise amongst your beneficiaries and trying to head off as many at the pass in advance. Along those lines, I suggest dealing with the following:
  • Stipulating executor fees and ongoing fees for trustees managing trusts for your heirs directly in the Will. Although courts generally award fees based on a percentage of your estate and you can do the same in your Wills, this can cause problems. Either the person doing the work doesn’t want to rock the boat and claim a fair (or any) executor fee or perhaps they does claim a fee and the rest of your heirs feel (perhaps with justification) that it is more than you would have wanted, particularly if the executor is also an heir and doing some of the work for their own benefit. The size of the estate doesn’t often match its complexity so naming a percentage in your Will might over or undercompensate your executor. Ultimately, although this is not a perfect solution, I have landed on picking a flat fee and indexing it to inflation or, if using a percentage, including a minimum or maximum value that is also inflation indexed. I also suggest doing the same thing for trustee fees as well in order to ensure that they also get paid yearly if required to manage trust funds for some of your heirs in an amount that is fair, transparent and not open to creative interpretation.
  • Including a memo that distributes your personal effects and then stipulating a way to divide the remainder, with provisions for compensation payments if there is a significant disparity in the value of the assets distributed. Some people fight more about the picture albums and artwork than the bank accounts. Trying to head this off at the pass in advance or even sitting down with your children to get clarity who gets what and agreeing upon a process for divvying up your “stuff” can go a long way to eliminating sour faces at future family picnics. Some people even put masking tape labels on the back of contentious possessions with the name of the future heir on the back! Others have an auction between heirs to buy your velvet Elvis print and bobblehead collection, although others think starting a bidding war over the family heirlooms and assets is just a recipe for disaster.
  • Providing guidance or perhaps including even a guardian fee for the people caring for your children. It is often exceedingly difficult to quantify the extra costs your guardians might incur raising your children and it can be an awkward conversation if the person managing their money and the person managing your children are not the same. Providing a statement of general principals to your trustee, such as to take a liberal and expansive view of expenses and to clarify things like including your guardian’s vacation costs when travelling, or to with your children might make your guardian and trustee’s relationship far more comfortable and productive. It is also a great idea to provide guidance on the sort of lifestyle you wish to provide your children. See my earlier articles on “Voices from Beyond the Grave” that discusses this and other related issues in more detail on either my or the Canadian Moneysaver websites for more details.
  • Considering whether the same person should be trustee and guardian. This is often done without incident, but there is a significant conflict of interest if the person deciding how much of the guardian’s mortgage, cable bills and property tax should be paid from the a child’s trust fund is the same person incurring these expenses. Every now and then, we lawyers hear cautionary tales about guardians who may have dipped into their charges’ trust funds a little too liberally, perhaps so that the children can’t afford to attend university or don’t have that down payment for their first home that mom and dad anticipated would be there.  This may be due to fraud or overly generous accounting, but it also might due to picking people to raise your children who are not also good at managing an investment portfolio or budgeting for the future. Moreover, both jobs require significant time commitments. Perhaps picking different people to watch your money than those you’ve picked to watch your kids is actually doing your guardians a rather large favour.
  • Not automatically picking children or spouses as executors or trustees. Being an executor is a generally thankless task and it takes longer to wind up many estates that most people expect. Although it can be expensive and not without problems, picking a professional trustee or at least someone who isn’t one of your heirs to do the job might sometimes be the best solution. Do consider the following before naming family as your executors:
  • Do your children get along and work well together if you pick them to act as a team? Do you want to include tie-breaker provisions in case they can’t agree? Does it make sense to name children who now live in distant lands or to require that they also sign off on every decision?
  • Will any children feel excluded if their siblings are picked as executors and they are not? As well, siblings not chosen may have unrealistic expectations regarding how long an estate should take to settle and have been noted to unfairly hound executors for their piece of the pie far sooner than is reasonable. The excluded siblings may also often feel without justification that the chosen child has not done a good job at maximizing the value of an estate or overpaid everyone involved, from the estate lawyer down to the woman hired to clean out your refrigerator after you’re gone.
  • Does your new spouse really want to be executor if it means your old kids are breathing down her neck? Conversely, how would your children from prior relationships feel if the new spouse is your sole executor or perhaps managing trust funds for them or their children? How do they feel about your spouse even managing his own trust fund if whatever is left at his goes to them,  particularly if that spouse has unlimited spending powers?  Likewise, if the children are managing your spouse’s trust fund and deciding both how much to pay out each month and how to invest the cash, how would your spouse feel about that?  If the kids are to get what’s left down the road, there is also a real temptation for them to both be cheap when budgeting money to your spouse while also picking riskier investments that focus more on growing their own future inheritance than the more conservative income-focused portfolio that better ensures your spouse will never run out of cash. The expression “conflict of interest” was perhaps invented with these situations in mind. The expression “family squabble” certainly was.
  • Is there even the slightest chance of a Will challenge, particularly if you have a blended family or you don’t treat your children equally in some provinces? An inheritance is a once in a lifetime windfall and no matter how people get along until that point, big money can still lead to big problems, particularly if you are not around to make sure that everyone plays nice. Moreover, if your children are forced to wait until your new spouse dies before getting their inheritance, they may actually get legal advice telling them to challenge your Will since they will have little chance of challenging their stepparent’s Will at a later date, assuming that there is anything left to challenge by that point anyway.
  • Is there a reasonable chance that anyone acting as trustees of any ongoing trusts will have to act as “bad cops” to their siblings, nieces or nephews and thus wreck Christmas dinners for decades to come or who will ultimately cave to pressure in order save future Christmases? This is another great reason to consider a professional trustee, particularly if dealing with heirs with potential addiction issues, creditor problems or a money management handicap.
  • Determining whether it makes sense to pass on or sell family assets like businesses and cabins. Will passing along these assets in kind to your family mean starting a new family feud rather than continuing a family legacy. Issues include:
  • Treating children with sweat equity in the business or farm fairly while also providing for your other children.
  • Balancing your business children’s desire to potentially run and grow the business vs. non-business children’s desire for cash flow and safety.
  • Do your children have the experience to run your business and to work together? Is this a recipe for success or the ingredients for creating a family disaster?
  • Who gets to make business decisions? Equal voices can mean gridlock or non-business children having too much say in matters they don’t understand but providing control to one can cause resentment or to make unfair or unpopular decisions. Who sets salaries for the business children? Are profits to be reinvested or a set percentage paid out each year? What if the child you pick isn’t up to the task and ultimately squanders not only his inheritance but his siblings’ as well by running the business into the ground?
  • What if any of the children wants to sell their share of the business or cabin and the others can’t or won’t buy them out?
  • Are your children able and willing to pay ongoing property expenses and do their share of the maintenance for family cabins and cottages?  If one child really doesn’t use the place as much, should they be paying the same portion of costs? Does that child really want the place?
  • Balancing financial autonomy with financial prudence.  Except for smaller gifts, I generally recommend holding a youngster’s share of an estate in trust until they are at least 25 years of age and often suggest handing over the inheritance to those children in stages so that they can learn and make mistakes with only a small portion of the inheritance before being entrusted with the big bucks later. Some of my Wills even require the children to co-manage their trusts with the original trustee for a while so that they get on-the-job experience managing investments, budgeting and taxes before getting to call their own shots. Although there are horror stories about younger heirs burning through their legacies and many years of their lives when trusted with too much too soon, I worry almost as much about responsible, well-intentioned kids hiring the wrong financial advisors or trying to do too much on their own with insufficient experience. On the other hand, in Wills that hold a child’s share of the estate until they are in their mid-30’s or so on, I usually draft the trusts in such a way that the money can be handed over ahead of schedule if the child has proven themselves along the way if the trust is no longer worth the expense. For trusts with a larger dollar value or time line, also consider appointing a “protector”. This gives your heirs someone to notify if the trustee is not up to scratch and the protector can swoop in, fire the incumbent and appoint a new trustee if appropriate. Otherwise, getting rid of a bad trustee is as hard and frustrating as getting ink stains out of your favourite shirt and far, far, far more expensive.
  • Decoupling family finances. While money is probably not the root of all evils, I do see it as a major cause of many family spitting matches. Accordingly, I ask my clients to carefully consider whether or not to leave assets like private companies and real estate jointly to multiple family members for the reasons expressed previously. In situations where it is the right decision or the only practical choice, I encourage clients to take additional steps, like signing agreements or at having family discussions in advance to set up ground rules, particularly to cover what would happen if one of the children later wanted out, such as a buyout procedure, valuation formula and the appropriate timeframe for payouts. Do investigate life insurance in these situations as well in the hopes of paying some of the children out in cash rather than making them get shares in the family business instead. You might even make the children to get the business or cabin pay for this insurance in the first place!
  • Providing surety in blended family situations. Decoupling finances can be even more important for blended families. For first marriages, it is common for the surviving spouse to inherit all or most of the family assets and that usually makes sense. In second marriages, however a lot can go wrong if the children from your first kick at the can are forced to wait to inherit until your second dearly beloved is no more. This can poison relationships, result in those Will challenges I mentioned earlier in places like B.C. and might even result in your children missing out on any part of your estate if your new spouse outlives them, remarries, goes on a decade long spending spree or ultimately leaves  their inheritance to their favourite charity, the pool boy or their own children instead of yours.  If it isn’t possible to provide for your children while also protecting the surviving spouse (again, more life insurance might be a solution in some cases), many families leave the survivor’s share in a trust that ensures that the remainder flows to the children or their descendants eventually. While this situation isn’t ideal, picking the right trustee and providing sufficient guidelines in the trust can at least go a long way to minimizing family tension, particularly if the children at least receive something at the first passing, perhaps when they need a financial leg up the most.
  • Equalizing inheritances for children with large age gaps. If you’ve already put some of your older children through school, covered their spring break adventures, paid for 10 years of interpretative dance or tuba lessons, funded a closet full of must-have jeans,  two decades worth of pizza and so on, is it fair to leave your estate equally to all your children when the younger ones never received such benefits? In situations like this, I often use a general education and maintenance trust to cover all expenses for anyone in school or under a set age, with the remainder divided equally amongst all of your children, regardless of age, when the last of them no longer qualifies for payments. This might comprise 40% of the estate if no surviving spouse and is designed to provide the younger children with the support and extras that their older siblings received during your lifetime. The remaining 60% would be equally divided amongst all the children, with older children receiving their portion of the 60% immediately. When the dust settles, all the children have been provided with the same leg up and luxuries prior to get their university diplomas or reach adulthood but your older children are not forced to wait until their youngest sibling gets a diploma before having the cash to buy their first home.
  • Including provisions to gift over an inheritance on a child’s death.  Although most Wills contemplate what happens if a child predeceases you, most don’t deal with what happens if a child inherits but passes on while leaving behind a spouse. In most cases, your son or daughter-in-law would likely inherit and your grandchildren would only what’s left after (s)he is also deceased. If that spouse remarries, has additional children in the future or squanders the cash, then your grandchildren may end up with nothing, less than you would like or perhaps inherit it far later in life than you would have wanted. Leaving the money in a trust that names your child and their own descendants as beneficiaries can ensure that your grandchildren get what’s left on your child’s passing or can even gift over to your other children instead at that time if none of these grandchildren exist and you really don’t like your son /daughter-in-law. As an added bonus, this type of trust structure can actually save your child a lot of money along the way in taxes avoided by allowing gains and income to be taxed in your grandchildren’s hands at their rates, making any inheritance go a lot further. You might even name your child to be their own trustee in some cases in order to maximize flexibility and decrease both complexity and costs of running the trust.

Conclusion

My job as a lawyer is to find the dark cloud hidden inside the silver lining, no matter how small and unlikely.  Although many of the extra provisions I’ve just enumerated in copious detail may be ultimately be unnecessary in many cases, the downside is generally just a few extra dollars and hours “wasted.”  On the other hand, taking a bit more time now to think and plan for the unpleasant and unthinkable might be a game changer.