DOELL OSMAK

Lawton Partners Financial Planning

Keeping the cottage in the family: Create a lasting legacy with a smooth transfer of ownership

by

A family cottage is a place of cherished memories, where children, and maybe even grandchildren, have grown, swum and played under the stars. As owners grow older, they may begin to think about handing it down to their loved ones. Early planning can help avoid conflict, reduce taxes and ensure the cottage remains in the family for the next generation – and possibly for generations to come.

Begin the dialogue

There’s a special kind of lifestyle that goes with owning a cottage. S’mores, swimming and lounging on the deck go hand in hand with bugs, mice and never-ending repairs. There are costs for maintenance and taxes, and family schedules to consider. You might assume that your children would love to take over the cottage one day, but it’s important to ensure they actually do. If you have more than one child, would they all want to share it? And if so, can they get along and handle the joint responsibility? These questions should all be raised early on, before any assets change hands.

The capital gains issue

Over the years, many cottages and vacation homes have increased significantly in value and are now worth substantially more than their purchase price. At death, 50 per cent of this increase in value, minus the cost of improvements (such as additions or decks) is subject to tax if the cottage is transferred to anyone other than your spouse – this is capital gains tax. An asset like a house qualifies as a principal residence and is exempt from this tax, but generally cottages are not. If your estate does not have enough funds, it may be forced to sell the cottage to pay the tax.

EXAMPLE:

Sara and Charlie purchased a cottage in 1975 for $60,000. Over the years, they invested $100,000 in improvements to the property. Today the cottage is worth $500,000. Charlie passed away last year, leaving Sara the sole owner of the property. She wants to pass on the cottage to her two children after she dies. Assuming the cottage is not her principal residence, the transfer will result in a capital gain of $340,000, of which $170,000 is taxable at Sara’s marginal tax rate.

  • Original cost $60,000
  • Capital improvements $100,000
  • Total investment $160,000
  • Market value today $500,000
  • Capital gain ($500,000 – $160,000) $340,000
  • 50% of capital gain taxable $170,000

For illustration purposes only.

There are several strategies to consider that can help reduce taxes and support a smooth cottage transfer.

Sell the cottage to the kids now

By selling the cottage to your children today instead of transferring it at death, you can limit the tax liability and pass the responsibility for any future capital gains on to your children. In addition, because the cottage is transferred outside of your estate, the time and costs associated with settling the estate are reduced, and the cottage is protected against potential claims from creditors or other parties.

If you decide to go this route, set the sale price at least equal to the fair market value of your cottage, not a reduced or nominal price. The Canada Revenue Agency will consider the cottage to have sold at the fair market value, so reducing the price will not reduce the capital gains tax. Also, when your children eventually sell or pass on the cottage, they will be required to report the reduced purchase price as their cost base, resulting in double taxation.

The sale will trigger a capital gain tax liability, but you can structure the sale and the tax payment over five years if you take a mortgage back from your kids. You may also consider forgiving the mortgage in your will so that your kids will receive the cottage free of any debt.

Selling the cottage today can also provide you with a source of income. You’ll want to ensure the additional yearly income doesn’t push you into a higher tax bracket and reduce any government benefits such as Old Age Security.

One possible drawback to consider with this solution is that the children become the owners of the cottage. They could sell it, or it could become an asset at risk in the event of a marriage breakdown.

 Leave the cottage for children in the will

If you choose to pass on the property after your death, there are two ways to do it: you can name the heirs in your will and they will become co-owners of the cottage, or you can create a trust that owns the cottage and give each heir a portion of the trust.

A trust allows you more control over what happens to the cottage. You can allocate funds for maintenance, taxes and bills. A trust also protects against marriage breakdown or bankruptcy. Keep in mind that trusts cost money – a fee of about one or two per cent of the cottage’s value every year.

 Use life insurance to cover capital gains

Life insurance can be a cost-effective way to help pay capital gains tax. Consider purchasing a policy that pays out after both you and your spouse pass on. You can also choose a plan where the death benefit increases over time to match the growing tax liability. If cost is an issue, your children could pay a share of the premiums.

Sell the cottage and pass the proceeds to your children

You may opt to put the cottage on the market now or specify that it be sold after your death. After paying taxes and transaction costs, any remaining proceeds will pass to your kids. They can then use the money however they want, including buying their own cottage. The downside to this option is that the cottage doesn’t remain in the family, but it may be a reasonable solution to avoid potential conflict.

Get professional advice

However you decide to transfer ownership of your cottage, proper planning can help ease the way and reduce the tax burden for you and your loved ones. Speak to your advisor and a legal and tax professional to determine your best course of action.

COTTAGE‑SHARING AGREEMENT 

A cottage-sharing agreement can help co-owners manage expectations and avoid conflict around many issues. Some things that should be discussed and put into writing include:

  • Maintaining a cottage budget, including paying for utilities, taxes and insurance
  • Retaining the cottage ownership within the group
  • Opening and closing the cottage, cleaning, and performing maintenance and repairs
  • Deciding on large renovations and purchases and how these should be financed
  • Rules around pets, guests and renting out the cottage
  • Schedule for usage

Keep your receipts

You can reduce taxable capital gains by keeping financial records for any improvements you make to the property – for example, additions, bunkies, decks, landscaping, septic systems and boathouses.

 Did you know?

Capital gains tax came into effect December 31, 1971. Even if you owned the cottage before that date, you need to calculate the increase in value only since then.

© 2020 Manulife.

Forward thinking: Estate planning essentials to ensure your wishes are carried out as intended

by

You know you should do it, but it’s a tough reality to face. Estate planning is a process that many people put off, and you’re certainly not alone if you have yet to begin.

WATCH: We have to talk, a video about talking to your family about estate planning.

Just over half of Canadians (51 per cent) do not have a will, and a further 15 per cent have a will that is not up to date. [1] Those are surprising numbers when you consider just how much is at stake. When someone dies without a will, they get no say in who receives their assets. Guardians for minor children are chosen by the courts. And in the worst instances, families can be torn apart over inheritance disagreements.

These are not pleasant situations, yet they happen more often than you might think. The good news is, creating a plan ahead of time can ensure your assets are passed on as you wish, your family is cared for and the stress over handling your affairs is reduced during an already difficult time.

The elements of a simple estate plan include:

  • Will – tells the executor (liquidator in Quebec) who should receive assets; may also name guardians for children and establish a trust to hold assets for them[2]
  • Power of attorney for property – appoints someone to make financial decisions on your behalf if you are living but incapacitated
  • Power of attorney for personal care – appoints someone to make health care decisions on your behalf if you are living but incapacitated
  • Beneficiary designations – naming beneficiaries directly, particularly on life insurance policies, registered plans and non-registered segregated fund contracts, can simplify and speed up the distribution of assets

The very process of developing an estate plan also often reveals opportunities to implement strategies that can maximize the amounts beneficiaries receive by reducing taxes and/or probate fees. To illustrate this, let’s explore four scenarios focused on people of different ages with different priorities – none of whom currently have an estate plan.[3]

What are probate fees?

When the executor of an estate applies for a will to be probated (approved by the courts), the courts assess fees based on the value of the estate. Probate fees[4] vary across Canada – in some provinces (such as Alberta) they are relatively low, but in other provinces (such as Ontario, British Columbia and Nova Scotia) they can amount to thousands of dollars. Certain assets, such as segregated fund contracts and life insurance policies when there is a named beneficiary, are paid directly to that beneficiary without passing through the estate, so they are not included in the calculation of probate fees.

Meet Sana and Graham

  • Married couple, age 30 and 35
  • Three children, age 7, 5 and 3
  • $20,000 in Sana’s TFSA and $12,000 in Graham’s TFSA
  • $10,000 in a family RESP with Sana and Graham as joint subscribers
  • $15,000 in a non-registered account

Items to address:

  • Name guardian for children in will – someone trusted who shares their parenting style
  • Arrange for assets to be managed on behalf of children – for example, in a trust by a trustee
  • Consider naming a successor subscriber for the RESP to take over management of the account if both Sana and Graham die
  • Consider life insurance for Sana and Graham to protect the family’s standard of living and help pay for the children’s care and education

At first glance, Sana and Graham have few assets and may not think it’s necessary to create an estate plan just yet – but with three children who are not allowed to manage their own assets until they reach age 18, it’s essential they put strategies in place now. In addition, partly because they have few assets to fall back on, insurance makes sense to provide tax-free money the family can use if either Sana or Graham unexpectedly pass away. Life insurance also offers the option to pay out the proceeds to an insurance trust to provide for minor children. With an insurance trust, it’s possible to control what children receive when and, because the money does not pass through the estate, it avoids probate fees and creditor claims.

Meet Irina

  • Never married, age 50
  • No children
  • $1.3 million home with $300,000 mortgage
  • $700,000 in an RRSP
  • $60,000 in a TFSA
  • $250,000 in a non-registered account

Items to address:

  • Decide who should inherit assets – perhaps a mix of family members and charities – and create a will
  • Establish a power of attorney for property and for personal care
  • Consider life insurance to cover the taxes due on the estate, which will be substantial without the option of a tax-free rollover to a spouse
  • Consider life insurance to fund a charitable gift, with tax-deductible premiums and the opportunity for a donation that doesn’t flow through the taxable estate first

Irina needs to think of people she can trust to be an executor and power of attorney and take the time to write the three basic estate planning documents (will, power of attorney for property and power of attorney for personal care). She may have relatives or friends to whom she would like to leave her significant assets – but, if she doesn’t, she can make a very meaningful charitable gift. In that case, life insurance is one of the most effective ways to achieve this, because it has the potential to deliver the certainty of a large, tax-free lump sum that will make a big difference to the causes she supports.

Meet Mateo

  • Widower, age 60
  • Two children, age 25 (with a disability) and 23 (not responsible with money)
  • $900,000 home with no mortgage
  • $700,000 in an RRSP
  • $50,000 in a non-registered account
  • $250,000 life insurance policy

Items to address:

  • Set up a Registered Disability Savings Plan (RDSP) to accumulate savings for the 25-year-old child; the child may be eligible for RDSP grants and bonds from the government as well
  • Plan carefully for the transfer of the home and financial assets, keeping in mind that an RRSP can roll over tax-free to a dependent disabled child
  • Consider establishing an absolute discretionary trust (known as a Henson trust) to avoid the direct transfer of assets to the 25-year-old and protect provincial disability benefits he may be receiving
  • Consider adding an annuity settlement option to the life insurance policy; cheaper than a trust, this allows money to be paid out to the 23-year-old as a stream of income instead of a lump sum

Mateo has significant opportunities to help his children through appropriate estate planning. With the right structures in place, the 25-year-old with a disability can continue to enjoy valuable provincial benefits and access programs and services that significantly improve his quality of life. Meanwhile, the 23-year-old can receive smaller payments over time rather than an overwhelming lump  sum, reducing the risk that she will spend all of her inheritance unwisely.

Meet Wei

  • Married, age 71
  • Two children from previous marriage, age 36 and 34
  • $750,000 home with no mortgage, jointly owned with husband
  • $500,000 in a RRIF
  • $50,000 in a non-registered account

Planning opportunities:

  • Consider investing RRIF assets in a segregated fund contract with Wei as the owner and annuitant, her husband as the successor annuitant, and her children as irrevocable beneficiaries
  • Note that a testamentary spousal trust set up in Wei’s will can accomplish similar goals, but may be a significantly more costly solution
  • Consider life insurance to pay the tax liability on the RRIF when it transfers to the children

Blended families need to build estate plans with care to avoid unintentionally disinheriting anyone. In this case, Wei wants to provide income to her husband during his lifetime, but give what’s left at the time of his death to her children. By investing her RRIF assets in a segregated fund contract, as described above, Wei can allow the RRIF to transfer to her husband on a tax-deferred basis, but at the same time ensure that her children will have a say in the management of the assets that will ultimately pass to them. Specifically, her husband will need the consent of the irrevocable beneficiaries to increase his income stream from the RRIF or to cash out the entire RRIF.

Speak with your advisor

Whether or not you see your own situation reflected in these examples, if you don’t yet have a comprehensive estate plan in place, speak with your advisor. Request referrals to legal and accounting professionals, as required. Also ask about strategies that are appropriate for your specific circumstances and that may help you save taxes, avoid probate fees, speed up the delivery of bequests and protect vulnerable beneficiaries. Finally, be sure to revisit your plan regularly to ensure it remains up to date and continues to reflect your wishes.

DON’T FORGET DIGITAL ASSETS

Digital assets deserve estate planning attention, too. It’s important to grant a trusted person the power to access and handle your hardware, data (including music, photos, videos and e-books), email, websites and social media accounts. Digital currency such as PayPal and Bitcoin, as well as gift cards, loyalty points, cash-back rewards and even video games can have significant monetary value. And then there are business-related digital assets, including data, patents and other intellectual property.

The first step to getting your digital estate in order is to take inventory. List all your digital assets and how to access them: the physical location or website associated with them, any account numbers or usernames, and your passwords. Next, figure out what you want done with your digital assets – what accounts should be disabled and what assets should be passed on to loved ones or business partners – and include your instructions in your will.

Note that passwords should not be included as part of your will because, if probated, they become public; make sure, however, that you store passwords in a secure place that your executor can ultimately access, such as a lock box or safety deposit box, or with your lawyer.

© 2020 Manulife.  

[1]  http://angusreid.org/will-and-testament

[2] In all provinces except Quebec, guardian appointments in a will are temporary. Guardians must apply to the courts to make these appointments permanent.

[3] Each example is fictional and for illustrative purposes only.

[4] Probate does not apply in Quebec.

Inheritance strategies

by

Whether you pay off debt or invest, some strategic planning can help newly inherited money go a long way.

When a loved one passes away and leaves a bequest to you, you may be filled with a range of emotions from grief to relief – while you are saddened by your loss, an inheritance can be an excellent opportunity to improve your financial well-being.

An inheritance is a gift that needs to be treated with special care. If you find yourself the recipient of one, here are some ideas to consider.

Take your time

It’s a good idea not to make any major decisions about your inheritance too quickly. Carefully think about your options and how they might relate to your financial goals. Consider placing the assets in a high interest savings account until you are ready to make decisions.

Pay off consumer debt

Consumer debt (which includes credit cards, loans and lines of credit) often comes with a higher interest rate than a mortgage, so that’s a good place to start. Canadians were carrying an average of $23,496 in non-mortgage debt in early 2019.[1]

Identify your highest-interest debt and consider applying a substantial amount of your extra money towards that balance. Paying off a $3,000 credit card balance charging 19.99 per cent interest, for example, can save you nearly $560 in the first year. By contrast, if you continued making only minimum payments, it would take more than 17 years to pay off the balance and cost close to $3,500 in interest.[2]

Pay down your mortgage

The biggest debt for many is often a mortgage. Across Canada, the average mortgage balance is about $210,000.[3] If your mortgage allows lump-sum prepayments, consider allocating the extra funds towards the principal. You could save hundreds or even thousands in interest and be a step closer to paying off your mortgage.

Boost your retirement savings

Money can grow quickly inside a Registered Retirement Savings Plan (RRSP), because you don’t have to pay any tax on investment growth until you make withdrawals. 

Assuming you have contribution room available, $5,000 invested in an RRSP today, earning an average rate of return of six per cent and compounded annually, will grow to almost $29,000 in 30 years. That’s a tidy sum to put towards your retirement lifestyle. Don’t forget you also get a tax deduction based on your RRSP contribution, which may mean a refund the next time you file your taxes.

Save for a short-term goal

Many of us have a mix of short-term goals. You may be saving for a down payment on a home, a new car or a dream vacation. Or you may want to build up an emergency fund. 

Consider stashing extra cash in a Tax-Free Savings Account (TFSA) for these types of goals. Any investment growth accumulates tax-free, and the money can also be withdrawn tax-free. One of the best features of a TFSA is that you can take out money to finance a short-term goal and then recontribute the same amount in the following calendar year. In other words, you don’t lose your contribution room when you withdraw.

Save for education

If you’re saving for a child’s post-secondary education, you can get a head start by investing in a Registered Education Savings Plan (RESP). An RESP offers an incentive to save for a child’s education in the form of Canada Education Savings Grants (CESGs) for eligible beneficiaries and contributions. CESGs match 20 per cent of up to $2,500 in contributions each year, up to a maximum lifetime limit of $7,200. 

If you didn’t contribute last year, and you contribute $5,000 this year, you could receive $1,000 in CESGs. Over 10 years, earning an average rate of return of five per cent and compounded annually, that $6,000 could grow to over $9,700.

Make sure your own estate plan is up to date

Just as important as creating an estate plan is periodically reviewing and updating it, especially after you experience significant changes such as receiving a large inheritance.  Keep in mind that upon your death, the residual beneficiary of your will could be the sole beneficiary of your increased wealth – and this may not be your intention. 

We want to hear “Your Story.” By considering these tips and working closely with us to put a plan in place, you can ensure that your inheritance is used effectively – just as your benefactor would want it to be.

Source:  manulifesolutions.ca 

[1] www.consumer.equifax.ca/about-equifax/press-releases/-/blogs/canadian-consumers-piled-on-their-winter-cred-2

[2] For illustration purposes only. Assumes minimum payments are made (the greater of $10 or three per cent of the balance monthly).

[3] www.cmhc-schl.gc.ca/en/data-and-research/publications-and-reports/mortgage-and-consumer-credit-trends

Client Login

Follow this link to sign in to your account using the LP Financial Planning Services client site portal.

Login

Get in touch