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How to Smooth the Wealth Transfer From Parents to Children

A successful estate distribution is one in which the family receives as much (and the taxman as little) as possible and the family is still able get together for the holidays without too much drama. Take steps to make this outcome likely by initiating a family discussion today.
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Many retirees are in an enviable financial position: They have worked hard, invested wisely and spent prudently, leaving more than enough to fund their retirement. They won't outlive their assets. This will leave an often sizeable inheritance for their children. However, there is more to consider than just determining who gets what.

While you are able to defer most taxes when you leave your estate to a spouse, this does not apply when willing assets to children or grandchildren. Any tax-sheltered or tax-deferred assets are deemed to have been sold on the date of death and the tax is payable.

To optimize the wealth transfer, here are some points to consider:

Tips for Parents:

• First and foremost, involve your adult children in your plans. You may want to enlist your advisor as the facilitator.

• Divide equitably. If you have more than one child, avoid future resentment by trying to keep your estate distribution as equal as possible. If there is a reason for not doing so, have this discussion with your children to explain why so there aren't any surprises. A phrase that is used in Financial Planning is "fair is not always equal". When considering estate distribution, parents should be fair to all beneficiaries, but this does not always mean equal. For example, one child inheriting a business/farm with a substantial value and the majority of their net worth is attributed to that farm/business. Life insurance can be used to equalize the inheritance.

• Decide, as a family, what happens to the lake cottage. Your natural inclination may be to leave it jointly to multiple family members but is this the most practical solution? I have seen clients forced to sell a beloved family cottage because one person didn't use it anymore and wanted their share of the value in cash.

• Understand that not all assets are equal - at least not in the eyes of the taxman. For example, you may think you are being fair and equitable leaving your $500,000 house to your daughter and your $500,000 RRIF to your son. And you may also feel that you are being prudent by naming your daughter sole executor because she has always been good with money. Oops. The house goes tax-free to your daughter but the RRIF is fully taxable to your Estate. Worse yet, the financial institution doesn't withhold the tax but sends your son a cheque for the full $500,000. Your estate (and your daughter as executor) is responsible for the tax (approx. $200,000). If there isn't sufficient surplus cash or life insurance proceeds in the estate to pay this tax, where does it come from?

• Prepare your children for reality. Sadly, many adults are relying upon an inheritance or a lottery win to fund their retirement. In reality, this will happen for very few. By having a family discussion surrounding your estate plans and desires, children will have more realistic expectations. Plus, you can feel comfortable that they understand your wishes.

• Protect your estate in the event of costly long-term care. This expense of having one spouse in the home and another in a care facility can quickly erode any estate plans you may have. According to the 2014 Sun Life Canadian Unretirement Index, 29% of those surveyed are not confident that they will be able to take care of medical expenses in retirement. Talk to your advisor about Long-Term Care Insurance to determine if this product works for you.

• Consider the gift of life insurance. This is likely the most tax-efficient way to leave a legacy to your children. All life insurance proceeds are received, tax free, by the beneficiary. Life insurance is especially effective in equalizing estates where only one child gets the farm or business.

• Consider bypassing your wealthy children and leaving money to your grandchildren via a trust.

• Why wait? Consider gifting now. There may be no financial advantage to waiting until you die to leave money to your children. Depending on the size of your estate and the types of assets, it may be possible (and advantageous) to gift money to your children now. If you are sitting on a sizeable non-registered investment which is earmarked for your children while they, at the same time, are struggling under a hefty mortgage, consider gifting them some money now. Both benefit. You are no longer saddled with the taxes each year and they have reduced their debt and stress load. Plus, you are around to see them enjoy the gift. Care should be taken when distributing assets prior to death as there may be unintended tax consequences.

Tips for Children - Before

• You don't want to come off as greedy so how do you start the conversation with your parents about their estate plans? Start by involving them in your own financial plans. By opening up to them about your plans for your own financial future, they may feel more comfortable in sharing their own plans.

• Expect nothing and avoid being disappointed. Carry on with your own financial plans as if you will inherit nothing from your parents. This is both practical and likely. If you do inherit something, it's a bonus.

Tips for Children - After

• A sudden influx of cash should prompt a meeting with your advisor. Though you may be tempted to put the entire amount against your mortgage, your advisor may be able to help you use the funds to satisfy several financial goals.

• Keep to your original plan. Continue to save for your financial goals. This inheritance, unless very substantial, will allow you to supplement your goals but not necessarily fully fund them.

• If you splurge, keep it within reason. For example, you could top up your RRSP and then do something fun with the tax savings or refund.

• Don't let this tear apart your family. Even if the estate distribution wasn't ideal, try to work things out. I have been witness to too many situations where family members are no longer on speaking terms with each other. Try to keep in mind what your parents had intended and respect their wishes.

A successful estate distribution is one in which the family receives as much (and the taxman as little) as possible and the family is still able get together for the holidays without too much drama. Take steps to make this outcome likely by initiating a family discussion today.

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