Life Insurance and Estate Planning

Estate planning, which deals with the transfer of assets after death, has seen increased application in recent years. A Will is one of the fundamentals of the estate planning process, as a document that highlights how assets should be distributed while listing relevant beneficiaries. When an individual passes away, certain financial obligations need to be addressed. Generally these are probate taxes, income taxes, as well as any outstanding liabilities. This makes it imperative that the estate has enough liquidity at the time of death in order to settle these expenses. A lack of liquidity could result in assets from the estate being liquidated (often below fair market value) in order to settle accounts. This could jeopardize the original terms of the investor’s Will. We discuss the expenses faced by the estate below.

The executor of the estate pays probate tax at the time of death. This tax is levied on assets contained in the estate, including property, registered and non-registered investments, bank accounts, pension assets, businesses owned and personal assets. Note that property owned outside Ontario and joint assets, insurance policies, RRSPs and RRIFs with designated beneficiaries are not included in the probate tax calculation.

The calculation of the tax is as follows: for the first $50,000 in total assets, the fee is $5 per $1,000. The additional value of assets exceeding $50,000 is $15 per $1,000. For example, consider an estate with a total value of $500,000. The probate tax would be $250 for the first $50,000 ($5 times 50) and $6,750 for the additional $450,000 ($15 times 450), totaling $7,000 in total probate tax.

Financial liabilities must also be paid at the time of death. Included are items like mortgages, credit cards, personal obligations as well as all other forms of debt. Once these liabilities have been settled, the terminal tax return is filed. There is a section of the Income Tax Act that states that all assets at the time of death are deemed to be sold. The assets are not actually sold; however, the ITA states that they are sold at fair market value. For example, a cottage purchased thirty years ago for $50,000 could now be “deemed” to be sold at a fair market value of $500,000. The tax on this accrued gain could be in the range of $100,000. In addition, all Rsp’s are collapsed upon death and included in the terminal (final) tax return (upon death of the final spouse). This could lead to a huge tax liability. For example, a $400,000 Rsp could result in approximately a $200,000 tax bill.

Investors often overlook financial obligations arising at the time of death, with most of the attention to planning ending at retirement. With the expenses that arise at death, investors must ensure their estates possess adequate liquidity. One of the most effective ways to do this is through a life insurance policy. Under the policy, when the insured passes away, a death benefit is paid out to a beneficiary. The proceeds are tax-free, and an excellent way to ensure that the estate is preserved without having to liquidate assets such as businesses assets, stock portfolios and real estate at fire sale prices. If the tax bill is not paid with the final tax return penalties and interest will accrue. Penalties on overdue tax bills are 1% a month to a maximum of 17%, in most situations. If you owe $300,000, and fail to pay the tax bill for a year after it is due, the penalty would be approximately $50,000!!

Life insurance policies also provide tremendous flexibility to the estate planning process. Besides providing the funds to pay off taxes and debts, life insurance proceeds can be used to set up annuities for beneficiaries, be placed in a testamentary trust that heirs can access after turning a certain age, or be donated to charities. The certainty of payment – the insurance company is obligated to pay out the death benefit as per the contract – adds peace of mind that unexpected surprises can be handled financially. As long as the life insurance contract lists a spouse, child (in trust), grandchild, or parent as beneficiary it will provide a tax-free lump sum payment that is protected from the claims of creditors, making it a vital tool to any estate plan.

Final Thoughts

The estate planning process is an elaborate and precise method to transfer assets after death. All estate plans should start with a Will, and call on the expertise of financial planners, accountants and lawyers. The estate has a need for liquidity at the time of death in order to pay taxes and debts.

One of the best ways to provide liquidity to the estate is through a life insurance policy. Life insurance proceeds are tax-free, and would make the expense covering process much easier. This would keep assets intact and allow beneficiaries to receive their inheritance without any hassles or delays. Life insurance is dynamic enough to offer additional benefits. If the estate already has enough liquidity to pay off expenses, life insurance proceeds can establish trusts, education funds, and charitable donations among a plethora of other options.

The financial advisors at GTA Wealth Management Inc. specialize in estate planning, and can work with you to identify your estate planning goals, the preparation of your Will and the life insurance policy that best suits your needs.

Contact or call GTA Wealth Management toll free 1 855 GTA WLTH (855 482 9584) to accelerate your ride to financial independence. A professional wealth management financial advisor is ready to serve your wealth management, tax return and planning needs. GTA Wealth Management Inc.has three convenient locations in Mississauga, Toronto and Markham to serve you.

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