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 In Value For Money Investing

Well most of tax season is behind me and now back to a kinder and gentler world. One thing that sticks in my mind so clearly is that my financial planning clients experienced much less tax than they would have without prior planning. Tax planning can be both very simple and very complex at the same time. With luck and good planning, it is hopefully simple for you and complex for the tax specialist and your planner. The terminology can be confusing, so in the following text, I will continue to use the common term “probate”, instead of the correct terms: certificate of appointment of estate trustee with a will and estate administration tax. You should also be forewarned that I am not a lawyer, but a financial planner and a chartered accountant. The focus of the column is income taxes and financial planning. You should contact a lawyer for the legal points.

It is spousal trusts that come foremost to mind after this tax season. They are very simple arrangements that can save significant taxes after the demise of the first spouse. Most seniors are now quite aware of the advantage of splitting income with a spouse. The introduction of the pension splitting rules a few years ago highlighted this advantage even more by substantially changing the total tax bill for many couples with pensions. With the progressive tax system (the paying of a higher rate of tax as you make more), being able to spread your income among two individuals is very fruitful. Unless both spouses are at the highest tax rate, there will be some savings. A spousal trust is an easy way to continue to have two tax payers after the death of the first. The surviving spouse is one and the estate is another.

The “simple for you” part is that it often only requires the change of a couple of words in your Will. Instead of saying “I leave everything to my spouse”, say “I leave everything to my spouse, IN TRUST”. Of course your lawyer will want to add a few more words to make sure the trustees clearly understand the terms, but this is really quite routine. If it has been more than 10 years since you did your Will or your financial planner was not involved, you probably do not have a spousal trust provision. I remember clearly, what I call the early years, when estate lawyers told me, you cannot do that. It does not work. Well no laws have recently changed in this area yet estate lawyers are now frequently including this structure in the Will.

The cost of all this is obviously an issue. If you add these changes at a time of doing an update to your Will the extra legal fees will be negligible. The annual cost can be as little as the few hundred dollars to file the spousal trust return. Remember, the deceased spouse would have also been required to file a tax return, so the incremental cost is again negligible. For our financial planning clients this adds less than a couple hundred dollars.

So what are the savings? Well, essentially it is going to be about 13 to 26 percent of investment income earned by the assets in the spousal trust. If you are expected to be at the lowest rate of tax even after the death of your spouse, we would not suggest a spousal trust for tax reasons alone.

A common problem in all of this is the holding of joint assets between spouses. For many years, the lawyers were concentrated on probate fees and how to avoid them, which was their area of expertise. Unfortunately, what was good for avoidance of probate was terrible for income taxes. This joint status makes the establishment of a spousal trust very problematic. At death there is no estate to put in trust because it has already flowed to the surviving spouse. If you do the math, you come to realize that the use of joint assets often only delays, not avoids, probate until the second death. The establishment of a spousal trust will usually trigger a need for probate, but the income taxes saved can be far in excess of the cost of an early probate. Discuss this frankly with your lawyer. I know of many lawyers that prepare Wills that do so without even knowing about the who, what and where of the assets owned. The point here is not that lawyers are incompetent, lack knowledge or are careless. It simply means that they are not experts at every aspect of your estate and the inclusion of a knowledgeable financial planner and/or a tax expert is essential. I accompany most of my clients when they go to get their Wills completed. It makes for great team work and a very successful Will.

On a related topic, if you have made a provision for a trust for a disabled child, do not make the mistake of adding one of their siblings to your account to avoid probate. There will be no estate and thus no trust effectively established. This seems a bit farfetched. Well, I have seen it twice. Great Will written by lawyer and assets put in wrong ownership by client.

While on the topic of trusts and probates, let’s discuss Alter Ego trusts. I get asked often about their use and they do have some advantages for sure. However, they are a good example of something used to avoid probate that can have a substantial tax downside at death. You could well be exchanging probate for a much higher rate of tax on your first $125,000 in income in the year of death. If probate avoidance is the reason, you must be sure that you are already going to be in the highest tax bracket before incurring the additional taxes on the capital gains that may occur at death. Again, a caution that trying to avoid probate can cost you more.

Value For Money Investing means we wish to allocate and use our hard-earned resources in order to improve investment outcomes in a continuous and sustainable way at a fair and equitable price. In other words, achieve good investment returns AND receive fair value for the services provided. Costs do matter!

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