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Keeping more family money

An increasing amount of money is changing hands between generations. Here’s how to make it stay within the family.


Date: August 17,2015

You might say that we’re living in an age of inheritance, where elderly parents are passing away and leaving their money to their boomer children, many of whom are now entering retirement.

While that money might be needed to fund someone’s post-working lifestyle, it could also be passed down to yet another generation in the future.

For advisors, this poses some interesting challenges: How does an inheritance mesh with someone’s financial plan, and how can it be maximized so that every generation benefits?

As with most financial matters, there is no clear-cut answer.

“Every single estate-planning situation is different,” says Peter Bowen, Fidelity Investments Canada’s vice-president of tax research and solutions.

However, there are two universal ways to keep more of that inheritance money in a client’s bank account: Minimize taxes and avoid probate fees.

Here’s how to do that.

Trying out trusts

Many advisors have been making use of trusts for years, especially with high-net-worth clients. And for good reason – they offer multiple tax benefits.

For example, with trusts it is possible to split income with lower-earning beneficiaries by allocating some of that trust income to offspring who have a lower tax rate, however consideration should be given to the attrition rules to ensure such strategies are effective.

Trusts also help avoid probate fees. Any assets held in a trust are not included as part of an estate, so no probate fees apply.

Another advantage to a trust is asset management, says Warren MacKenzie, principal at HighView Financial Group. Beneficiaries may be too young to manage the assets themselves, so the settlor can dictate how assets in the trust are distributed.

However, Mr. MacKenzie warns that changes to federal legislation taking effect January 1 of next year could impact how advisors utilize trusts. For example, under the new legislation, testamentary trusts, which have been taxed more favourably in the past, will pay tax at the top federal rate of 29 percent.

Advisors should get comfortable with the new legislation. But “trusts are still useful,” says Mr. MacKenzie. “Advisors should simply consider the changes when estate planning.”

Life insurance

Life insurance is often used to build inheritances. Why? Because it’s not taxed when it’s paid out.

There are many life-insurance options on the market, but Mr. MacKenzie prefers whole life policies because they’re so simple. The policyholder pays a premium for a certain amount of time, and from there the money is managed by fiduciaries.

“The fiduciaries are experienced money managers,” says Mr. MacKenzie. “From what I’ve seen, they often outperform most balanced investment portfolios.”

That money is also growing on a tax-sheltered basis inside the policy, often for decades. This results in a much larger estate value, and it can even triple the amount that could be achieved in a non-tax-sheltered investment with comparable risk, he says.

Give while living

One way to make sure that money stays in family hands is to advise clients to give to children or grandchildren before they pass away.

That way, the dollars won’t go through probate and, since the money won’t be part of the estate anymore, it won’t be subject to creditors.

Consider paying for a grandchild’s education or helping out with a home or a wedding — things that will allow offspring to invest, rather than spend, their own money, says Grant Smith, a partner at Clearline Chartered Accountants.

“Cash while you’re alive has no tax implication because the individual has already paid tax on it,” he says.

To lower the overall tax burden, Mr. Bowen suggests that any charitable donations given, either while living or at time of death, be made “in-kind”.

Help the family communicate

Parents should talk to their kids about their estates, but that often doesn’t happen, says Mr. Bowen. If parents and children talk, then they can start deciding what to do with that inheritance now, before it’s too late, or before any family drama complicates matters.

Talking, ultimately, will help keep more money within the family. Advisors can play an integral role in this process, especially when it comes to family communication. For example, if the client is nervous about discussing inheritance, the advisor can step in and organize a family meeting.

Talking is also critical, because a lot of parents are worried that their children won’t be responsible with the money they receive, says Mr. MacKenzie.

He uses lottery winners as an example, with 70 per cent of them claiming bankruptcy within seven years of winning and then living with regrets for the rest of their lives. “I’d say that happens in about half of large inheritance cases,” he says.

The advisor and the client have a shared mutual responsibility to ensure that the beneficiaries are going to be able to manage and use the inheritance wisely.

“Because when it’s not done properly,” says Mr. Bowen, “it can get ugly.”

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