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What options does Buy-Sell Insurance give business owners?

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When a co-owner/partner dies, the surviving business owners usually have five options in dealing with the deceased owner’s business interest:

1.   Buy-out the heirs of the partner with Life Insurance proceeds: This is usually the most preferred option. After all, the surviving owners/partners know how to run their business. It usually makes sense to buy out the heirs who are not engaged in or lack expertise in the business and carry on business from there.

2.  Keep the heirs in the business.  This would only be advisable if the heir was actually involved in the business for some time, or has skills that can advance the cause and profitability of the business.

3.  Take on an outsider who purchases the deceased’s business interest. A good buy-sell agreement can circumvent the need to have an outsider buy into your business if that arrangement would harm the current business partnership or the business. In some cases an outsider may already have an investment in, have expertise in, or a common business goal with your company that would mutually benefit everyone in the business. In this case, advance planning could allow such an individual to be part of buying side of the buy-sell agreement. The same individual may need to be a beneficiary on the insured lives of all the partners, in tandem with being written into the agreement.

4.  Selling to the heirs may be an option. This may be an option when some of the heirs are involved and successful in the same line of business with primary senior family members of the earlier generation who began your business. In this case the considered heirs, should receive funding from the proceeds of a well-planned fund to cover capital gains taxes, and fund operations, and pay for the owners shares.

5.  Liquidate the business or sell it to a third party. If this is the main goal, it is wise to involve discussions with the potential buyer long before one dies. If the business is large you may need to hire a firm that specializes in valuing and selling businesses. It is wise to estimate your capital gains exposure and cover any tax liabilities, as well as redeem business debts with the proceeds of life insurance which can be paid out tax-free.

In most cases, option #1 offers the business owners the best choice, with a small expenditure to buy life insurance that makes a payment to heirs with the use of a buy-sell agreement.

Is probating an estate expensive?

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It is a significant job for the executor to probate a will. The original will must be submitted with an inventory listing the estate’s assets recorded at their fair market value to the court in the jurisdiction where the deceased last lived. There may be increased fees if a lawyer is retained to cross-examine the asset list or if the executor charges a percentage of the asset base to do the work.

Probate fees are paid from an estate to the provincial court. These fees are approximately .5% to 1.5% of the estate’s assets, depending on the size of the estate and the province. Provincial lawyers complete the necessary ‘letters of probate’ or ‘grant of probate document.’ In Ontario, they are now referred to as ‘the certificate of appointment of estate trustee with a will.’

Because probate is calculated on assets, regardless of liabilities, an estate with assets of $1 million and liabilities of $200,000 would pay probate on the entire million. In addition, if these same assets are transferred to your spouse, probate fees may be due again the second time around when these assets are transferred through his or her will. These fees are paid with after-tax dollars, as they are not deductible on the final income tax return. There is no law stating that a simple will and estate needs probating.

How can I minimize the need for estate probate?

There are a few tactics whereby you can reduce the need for an estate to be probated by the government:

Defer possible probate by holding assets jointly. Probate fees may be charged when that asset is transferred later through the will of the second spouse.

  • Establish a person as a beneficiary on your life insurance policies independent of the estate. This way, all monies pass to the heirs tax-free. If the estate needs probating, this portion of the assets will not be included in the estate, as the death benefit will flow directly to the heirs circumventing scrutiny. Life insurance strategies are excellent financial tools to circumvent probate on larger wealth transfers to heirs. Family wealth can be positioned to pass through life insurance policies, delivering tax-free benefits without probate. This method has frequently been used to transfer inter- generational estate wealth in the millions.
  • Name your beneficiaries on your RRSPs and RRIFs. Insurance companies’ products will allow you to sidestep probate in this way. To protect themselves, banks and trust companies will probably require probate or a letter of indemnity from the estate’s lawyer if the assets are significant. If your spouse is your beneficiary, consider a secondary beneficiary should your spouse die at the same time you do.
  • Consider setting up a spousal testamentary trust in your will to avoid double probate. When the second spouse dies, the assets can be distributed via the trust directives as opposed to a will.
  • With your spouse, set up mutually owned property as ‘joint tenants with rights of survivorship to transfer these assets automatically outside of the will.

Once the will has been probated (if necessary) and the executor confirmed, he or she could start transferring assets as directed by the will. Some assets can be transferred easily within a short period of time. Others have to wait until the estate expenses have been paid, including any final income taxes due to Canada Revenue Agency (CRA), after which they will issue a tax clearance certificate.

Note: The Estate Administration Tax (ETA) in Ontario, will replace some of the previous probate processes, and may add more complexity to the above scenarios. If your estate is large, it would be wise to seek the advice of a good tax accountant.