A testamentary trust is established using a will when someone dies, including the following types which direct a named trustee to manage and distribute assets and income to named beneficiaries of the trust.
You can designate the number of years it will survive, within permissible, legal limits. The trust becomes effective at the time the will is probated. The assets undergo the probate process and are therefore, exposed to creditors’ claims. Note: If your intent is to avoid probate, a living trust would be a more suitable alternative especially adapting the use of life insurance. However the potentially lower marginal tax rates allowed with the testamentary trust, needs to be weighed against potentially higher future income tax payable. When using a testamentary trust (versus an inter vivos trust) make sure your beneficiaries are properly specified to work according to your trust directives. A qualified tax advisor should assist you as you make these decisions.
Individuals commonly choose between two types of trusts: family and spousal.
Family trusts
Minor Trust This trust protects the interests of underage children.
Protective Trust This trust protects any family member with special needs such as:
• Safeguards adult children’s assets from creditors or divorce settlements.
• Manages funds for spendthrift adult children.
• Minimizes disclosure of small business assets that could be susceptible to lawsuits or creditors.
Spousal trusts are established to provide your spouse with funds.
• Protects the testator’s children’s assets should your spouse remarry or can assure the inheritance of children from a previous marriage.
• Reduces income tax through income splitting.
How are trusts funded?
If an estate will have significant capital gains tax due and/or debts, consider using life insurance to cover all liabilities. You can also increase the death benefit to pay off business agreement liabilities (if any) and provide specific trusts with the necessary cash.
You establish a testamentary trust in a Will. It directs a named trustee to manage and distribute assets and income to designated beneficiaries of the trust.
You can designate the number of years it will survive, within permissible, legal limits. The trust becomes active at the time the will enters probate. The assets undergo the probate process and are, therefore, exposed to creditors’ claims. If you intend to avoid probate, a living trust would be a more suitable alternative. Individuals commonly choose between two types of trusts: family and spousal.
Trusts re carefully designed estate planning tools and will need the guidance of a good tax lawyer.
The purpose of a Family Trust is to:
• Protect the interests of underage children and any family member with special needs • Safeguard adult children’s assets from creditors or divorce settlements • Manage funds for spendthrift adult children • Minimize disclosure of small business assets that could be susceptible to lawsuits or creditors
Spousal Trusts are established to provide your spouse with funds. These trusts also:
• Protect your children’s assets should your spouse remarry. It can assure the inheritance of children from a previous marriage • Reduce income tax through income splitting
Funding trusts
If an estate will have significant capital gains tax due and/or debts, consider using life insurance to cover all liabilities. You can also increase the death benefit to pay off business agreement liabilities (if any) and provide specific trusts with the necessary cash.
Life Insurance Plans for Individuals Life insurance is a type of coverage that pays benefits upon a person’s death to designated beneficiaries. A small premium gives you immediate coverage and provides for a significant death benefit payable upon the insured’s death to provide capitalization to pay an income for dependents. In some cases, there may be a maturity date where the insured, if still living, can receive the proceeds.
Tax deferral is allowed with some types of life insurance to offer insurance with an investment component, allowing increased funds to pass to heirs. Tax specialists can maximize an estate’s value while using life insurance. And the investment after achieving growth can enhance retirement income.
Types of Life Insurance
Life insurance has two primary classes:
1. Term Life Insurance Term Life is less expensive, but most term periods are generally temporary. Many people choose term life insurance (or term rider on a permanent plan) when beginning a family, as they try to keep costs lower while covering many liabilities.
Term Life Insurance plans include: The death benefit coverage continues for temporary terms set in 5, 10, or 20 years; or a lifetime level term to age 100.
Other periods can run to age 65, 75.
The premium remains constant for these terms.
The low cost of insurance for a certain level of death benefit is the essence of this plan, generally with less emphasis on a cash value.
You can buy more term coverage for less premium, which does increase upon each term period renewal (for example, a five-year term rises in cost in the sixth and eleventh year and so on).
Term insurance can generally be converted to Permanent Life Insurance coverage without medical underwriting, but check with your advisor about renewal and conversion options when you plan to buy a policy.
2. Permanent Life insurance The coverage continues to the time of the decease of the insured or pay one a level or an increasing lump sum at a certain age of maturity (usually age 100), or offers cash value or premium pre-payment incentives. Where there are cash values associated with a Permanent plan, the insurance cost can be lowered as the increasing cash funds accumulating in the program replace the level of insurance needed.
Permanent Life Insurance plans include:
Whole Life, can offer a level premium and a cash value table in the policy in some cases, guaranteed by the insurer;
Limited Premium Payment, is a policy that can be paid up fully in a specific period of time (such as over 10 or 20 years; or paid up at age 65).
Endowment Life is where the cash value grows to a level equal to the insurance coverage.
Life insurance premiums vary according to the policy type. In some cases, paying a little more premium offers enhanced benefits. Tax-deferral strategies may change due to legislation.
Segregated fund policies are unique insurance-related products with some guaranteed investment features that can benefit both your capital and income for years.
· Premiums are paid to the insurer for an insurance policy. These monies are allocated to segregated fund investment options.
· An investment manager then invests these premiums in the segregated fund. He invests in stocks, bonds or other assets, according to the fund’s stated investment objectives.
· Through the insurance policy, you can take advantage of unique benefits that can bring more certainty and flexibility to your financial strategies.
· Where a segregated fund invests in aggressive growth equities, there are some unique provisions that risk-averse investors may prefer. Often a portion of the capital invested may carry an agreement to be returned after the timing of maturity. Check the contract provisions which often include reinvesting options at certain junctures of time which also should be understood.
Guaranteed retirement capital and income
· Lifetime guarantee on your income Some policies offer some control over your retirement income by providing you an income for life. With a lifetime income benefit option, your income may not decrease regardless of how the segregated fund performs unless excess withdrawals are taken. This may give some protection against the risk of outliving your money, market volatility and inflation.
· Maturity guarantee on your capital Segregated fund policies provide some certainties to return a percentage of the premiums paid into the segregated fund (less a proportional amount of redemptions), depending on the product selected.
Make sure that you pay careful attention to the contract terms and time periods relating to any mention of a certainty regarding the return of a percentage of premiums paid. Go over this carefully with your advisor.
Too much debt can threaten your future and destroy your peace of mind. Here are five warning signs to watch for:
You are spending more than 20% of your after-tax earnings on debt. Total up all you owe, excluding your mortgage, e.g. student loans, car payments, and credit card bills. Now total up how much of your after-tax income is dedicated to servicing this debt.
You are paying for daily essentials with credit instead of cash. Consequently, you are close to the credit limits on your cards. Credit cards charge notoriously high interest rates, which is exasperated by compounding when credit cards are not paid off monthly. This can also increase your actual gross cost of goods purchased.
You are deferring important expenditures. You may need maintenance work (on your car, your home, and your teeth) as you struggle to get by.
You seem to spend your paycheque the day you get it. This may be a sign that you’re also over spending, an activity that leads to debt.
You are not differentiating between ‘good’ versus ‘bad’ debt. Good debt is money borrowed for productive purposes to help generate wealth over time (such as an education, build a small business, or purchase real estate). Fancy cars, expensive vacations, restaurant meals, and over-indulgent gift giving may indicate a lifestyle that for many do not justify the average household’s paycheque.
If you are in serious debt, consult a debt counselor who will arrange a repayment schedule with your creditors.
More than three million Canadian couples will pass on an average of one-quarter million dollars to the next generation over the next 30 years. Consider that 50 percent of all personal assets are owned by people of age 50 or more. A question they will ask themselves is how to transfer this wealth to their families?
Transferring property to your children. Your children will be faced with a host of new responsibilities when they inherit your wealth. They will have to ask themselves: should we sell the house; what assets should we keep or place in storage; which assets should we share and which should we sell? Canadians who own a cottage or second residence used for vacations may require special tax planning because a cottage or vacation condo is considered to be a secondary residence for tax purposes. There may be family quarrels over who will pay for a cottage’s or vacation property’s upkeep and use, once you die. Consider your estate-planning directives before you pass on. This preparation will help to prevent confusion and potential family conflicts.
Utilize legal and/or accounting help. If your estate requires special consideration, discussing estate issues with professionals will provide options and guidance for simple-to-complex estates. If you have a cottage or another secondary residence, be sure to include this in your discussions.
Consider these alternatives:
• Plan to have the cottage/second residence held in a testamentary trust after you die. A trust is a legal document that allows you to determine what property will be provided for specific beneficiaries upon your passing. You may also set certain conditions to the use of the assets by the beneficiaries.
• Maintain control. Set up a living trust, so that the property won’t form part of your estate at death. A living trust is created while you are alive, and your beneficiaries can benefit from your wishes during your lifetime.
• Or, if the children want the cottage/second residence, give or sell the real estate to them while you are alive.
Understand the result – deemed disposition. When the ownership of a cottage/second residence goes directly to beneficiaries or into a trust, a deemed disposition takes place. This means that if the value of the cottage has increased, capital gains tax may have to be paid.
Consult an accountant to help you determine what tax will have to be paid upon the disposition of the cottage. Typically, the fair market value of the property, less its total costs, will result in a capital gain (only half of the gain becomes taxable). However, this gain may result in substantial costs because you could be faced with a higher marginal tax bracket. Tax planning with your accountant is essential.
Advanced estate planning can cover your second residence’s estate tax liability.
So you may ask, how can you pass on the cottage/second residence to your children without a large tax liability? Personal life insurance, purchased with your after-tax dollars, can provide a non-taxable death benefit to pay this tax. For a minimal monthly premium payment, your potential capital gains tax liability on a family cottage/second residence can immediately be covered.
In addition, your life insurance can also pay off any unpaid portion of the mortgage. This can help equalize the estate with other siblings. The person holding the mortgage would be the beneficiary for tax reasons. A joint last-to-die life insurance policy may be the least costly method to resolve the estate inequity. Note: A capital gain is only triggered upon the death of the last spouse, or upon the disposition of the property.
Estate equalization maneuver. In some families, not all children may wish to share in the family cottage/second residence. Where there is one child, who – to the exclusion of others – will receive your cottage/second residence, an inequity may occur. Your estate will pay the applicable capital gains tax on your cottage/second residence, thus lowering the remaining assets in your estate for equal distribution among the other children. Therefore, you may want to plan for estate equalization to the other heirs using an increased amount of life insurance proceeds.
Note: Prior to February 28, 2000, the inclusion rate for tax on capital gains was 75 per cent. From February 28, 2000, to October 17, 2000, the inclusion rate was 66 2/3 per cent. Currently, and as of October 18, 2000, the inclusion rate was further reduced to 50 per cent. You may need to treat your capital gains or losses separately, on the basis of these periods and inclusion rates, relative to the time that you realized your capital gains or losses. Consider consulting an accountant when evaluating your final estate tax liability.
Determining, how much life insurance is necessary for your family’s financial security will require an objective viewpoint as you assess the following:
Evaluate the death benefit that you need.
Your advisor can assess the death benefit you need, by using a mathematical calculation that is referred to as a “capital needs analysis”. You may want to have enough capital to pay for your funeral, final taxes in your estate, outstanding loans or a remaining mortgage, and/or your credit card debt.
If you earn an income and support dependents, you may need to provide a significant amount of money to invest, from which your family can earn an investment income to provide a quality lifestyle. Life insurance can also provide enough money to cover a child’s education or top up the potential retirement income needs of a spouse if a breadwinner dies.
Where there are two spouses providing an income for the family, many couples purchase enough life insurance to reciprocally protect the potential income loss of one or both income sources, by covering both spouses appropriately.
Business Owners have special insurance needs
In many families, one spouse is employed, and another is self-employed. If one spouse owns a sole proprietorship business, he or she may need to consider income replacement insurance which can create a replacement paycheck in case you become disabled. There may be business-related debts and expenses, which if not paid, can create liabilities for the family.
If you are in a business partnership, you may want to look at establishing a buy-sell agreement, and/or succession planning facilitated by life insurance capital if you or a partner die; or income replacement insurance if you or a partner are disabled and can no longer work at your business.
Critical Illness Insurance
Many are also using Critical Illness insurance for personal or business planning, which can offer capital solutions if one becomes critically disabled. Once you are certain how much you need, your advisor can offer quotes and several plans most suited to your circumstance.
Succession planning allows you to transfer your wealth creating potential.
Many who own family businesses, will move into retirement over the next two decades. A delicate process referred to as “succession” or “business continuity” planning can lead to relinquishing leadership roles while transferring their businesses to the next generation.
By developing a succession strategy you can fairly distribute business assets; transfer the power and authority associated with leadership from the senior to next generation; and cultivate family harmony. The successor then becomes the new steward of the family legacy.
An excellent plan will establish the best possible tax planning to limit liabilities that can occur.
Segregated funds from insurers offer you an insurance policy contract.
The value of your interest in a seg fund is equal to your share of the securities owned by the seg fund. This is credited in terms of the number of units an investor owns of a seg fund. With seg fund policies, you own an interest in an investment portfolio as stated in an insurance policy contract.
You pay premiums that “deposit” money into a seg fund policy that further invests in the seg fund.
Look through a wider lens to see life insurance at work. Life insurance protects you against income loss and the adverse effect that less income can have on your family if one were to die or have a disability.
As you build on that foundation by creating your assets and net worth, you may need to reassess your level of coverage. Caring for others is at the root of life insurance planning.
You have family responsibilities. Adequate coverage allows a surviving spouse and surviving family to maintain their current lifestyle.
You can support a stay-at-home parent caring for your children. If one parent’s income is currently relied on to provide all living expenses, the death of that individual may cause financial insecurity for all family members, particularly when there will be a stay-at-home parent caring for the children.
Life insurance protects children. The coverage needed will be affected by:
the number of children and their ages
educational expenses of the children
the current value of your assets
your current income
debt accumulation
your future employment goals versus stay-at-home parenting
your overall financial goals
You can place young children as secondary or contingent beneficiaries; thus allowing them to receive the death benefit if your spouse if the primary beneficiary predeceases them. A trust can manage funds on behalf of the children. It can direct investing the proceeds of the death benefit to create guardian income for loved ones.
Continue coverage throughout college or university. When children go to college, many of us tap into our savings to help meet their tuition and housing expenses. We may purchase a child’s first car, or pay him/her income for one or more years. If you die without providing continuing support, your young adult child may need to quit seeking a higher education due to a shortage of funds.
Protect your income in case of a disability. Have you thought about how becoming ill or injured could affect your children’s financial security? Would your income be reduced, placing them under duress? Disability insurance is designed to replace approximately 70% of your pre-disability income and is especially necessary for the self-employed.
You can designate the number of years it will survive, within permissible, legal limits. The trust becomes effective at the time the will is probated. The assets undergo the probate process and are therefore, exposed to creditors’ claims. Note: If your intent is to avoid probate, a living trust would be a more suitable alternative especially adapting the use of life insurance. However the potentially lower marginal tax rates allowed with the testamentary trust, needs to be weighed against potentially higher future income tax payable. When using a testamentary trust (versus an inter vivos trust) make sure your beneficiaries are properly specified to work according to your trust directives. A qualified tax advisor should assist you as you make these decisions.
Too much debt can threaten your future and destroy your peace of mind. Here are five warning signs to watch for:
Many who own family businesses, will move into retirement over the next two decades. A delicate process referred to as “succession” or “business continuity” planning can lead to relinquishing leadership roles while transferring their businesses to the next generation.
