Table of contents
This is the complete guide to estate planning using life insurance.
In this post, you will learn:
- What estate planning is
- How much tax, probate fees, and other costs your estate has to pay
- How life insurance is a cost-effective way to cover these expenses, preserving your estate for your loved ones
So if you’ve ever wondered how life insurance fits into your estate plan, you’re in the right place.
What Is Estate Planning?
Estate planning is the process of arranging and managing your assets for if you become incapacitated and after death. The purpose is to preserve your assets and make sure they go to who you want them to go to when you’re not around to make the decisions.
For incapacitation, you’ll want to draft a power of attorney document. This lets you name a trusted person to make financial decisions on your behalf if you’re unable to manage your own affairs.
For death, you’ll need a will to direct how you want your assets distributed. Besides that, you can also name an executor to administer your estate. Among other things, the executor handles paying debts and distributing the assets from your estate.
Who is estate planning for?
It goes without saying that everybody needs to do some form of estate planning. But if the following apply, then estate planning with life insurance is especially suitable for you.
- You are in good health
- You are interested in estate planning
- You are open to long-term strategies to achieve your estate planning goals
- You want to maximize the value of your estate for your beneficiaries
- You and your partner are on the same page with regards to your estate plans
- You own capital property like mutual funds, stocks, rental properties, seasonal properties, and shares of a private company with large accrued capital gains
- You have an RRSP/RRIF
Estate Liabilities After Death
When you’re doing estate planning, you need to know the liabilities that your estate has when you die.
Why? Because then you’ll know how much of your assets your family will actually get. (Hint: it’s a lot less than you think.) Then you can plan ahead to reduce these liabilities to maximize the value of your estate.
Let’s take a look at some of the debts your estate has to pay starting with the largest one and the one CRA is most interested in: taxes.
Taxes
Who’s one of the largest beneficiaries of your estate? If you answered the government, you’d be correct, unfortunately.
When you own capital property where the fair market value is greater than the adjusted cost base, there’s a capital gain when you dispose of the asset. The taxable portion is half of the capital gain. At death, you’re deemed to have disposed of your capital property, resulting in a taxable gain that you have to report on your final tax return.
On top of that, you also have to add the fair market value of your RRSP or RRIF to your income when you pass away, resulting in an even higher tax bill.
In BC in 2023, the highest marginal tax bracket is for income above $240,716. At this level of income, your tax rate is 53.5%!
Fortunately, the spousal rollover lets you transfer both your capital property and RRSP/RRIF to your spouse on a tax-free basis at death. But you can’t defer taxes forever. CRA will get its share when your spouse also passes away.
Assets that accrues a large capital gain include investments such as:
- Stocks
- Mutual funds
- Rental properties
- Family cottage
- Shares of a small business
As a tax relief, you might be able to claim an exemption on the capital gain of your small business shares up to $971,190 in 2023.
Also, the family home is not included in the calculation. That’s because, under the principal residence exemption, the capital gain on a family home is exempt from taxes.
Probate fee
Before the executor can start administering the estate, he/she has to obtain a grant of probate from the courts. This officially proves the validity of the will and gives the executor the power to deal with the assets in the estate.
In BC, before the grant of probate can be issued, the estate needs to pay a fee to the Supreme Court of British Columbia. This is called the probate fee and is based on the value of your estate.
In BC, the probate fee is:
Gross estate value | Fee |
|---|---|
Under $25,000 | No fee |
$25,000 to $50,000 | 0.6% |
Over $50,000 | 1.4% |
Because the probate fee is only charged on the value of your estate, if you reduce the assets that fall into the estate, you reduce the probate fee you have to pay.
One of the ways you can do this is by naming a beneficiary in your life insurance policies and RRSP/RRIF. In doing so, the funds bypass your estate and you avoid paying probate fees.
You can also transfer your assets while you’re alive or hold them jointly with your beneficiaries. Upon your death, the asset avoids your estate and goes directly to the joint owner. Before you transfer, make sure you’re aware of the unintended consequences of doing so. You may:
- Trigger a capital gain if the fair market value is higher than the adjusted cost base
- Give up control of the asset
- Expose the asset to potential creditors or a family law claim of the joint owner
Reducing probate fees is important but it shouldn’t come at the expense of other parts of your financial plan.
Executor fee
If you name a loved one or trusted friend to be your executor, you typically don’t need to compensate them. However, they can charge your estate a fee.
Since the tasks of an executor are complex and time-consuming, you might want to take the burden off your family member by designating a professional like a law firm to administer the estate. The executor can also seek professional help after your death. Either way, your estate will have to pay for the services.
In BC, the executor can receive up to:
- 5% of the total value of your estate
- 5% of income earned during the administration of your estate
- An annual fee of 0.4% of the market value of the assets
Legal and accounting costs
Your executor will need the services of a lawyer to probate the will, assist in administering the estate, and deal with the sale of real estate. He/she will also need the services of an accountant to file your final tax return.
Legal fees for an application for probate starts at around $2,500. Accounting fees for preparing a final tax return may start at $1,000. Your estate will be responsible for paying these fees. You’ll want to allocate around $5,000 for legal and accounting fees in total. However, the more complex your estate, the higher these costs.
Funeral costs
The cost of a funeral depends on the type of service you want (eg cremation, burial). A traditional funeral including the casket, burial, and cemetery plot will cost more than a basic cremation. On average, a funeral costs between $5,000 to $15,000.
Estate Planning Strategies Using Life Insurance
Now that you know the costs to your estate, it becomes clear the role life insurance plays in estate planning. Although you can do estate planning just fine without using life insurance, you can accomplish so much more if you have it.
To determine if you need insurance, you need to ask yourself what your estate planning goals are. Here are some of the more common goals people try to achieve.
Estate preservation
One of the main goals of estate planning is to preserve your estate so that you maximize its value for your beneficiaries.
You might have a large number of assets now, but as you see above, a lot of different parties will end up taking a piece of the pie. What you have left over to pass to your loved ones might be worth half of what you own right now.
Life insurance provides two major advantages for estate preservation:
- It provides liquidity to pay the debts so that your estate doesn’t have to sell off the assets for cash.
- It provides cost-effective funding today for an expected capital need at death.
- It replaces the portion of your estate lost to taxes, probate, and more.
Effective planning for estate preservation involves calculating your total liabilities at death based on the list above: taxes, probate fees, executor fees, legal and accounting costs, and funeral costs. By doing so, you know how much life insurance you should get to cover these liabilities.
Check out the case study further down which gives you tips on how to calculate these costs.
Estate equalization
Estate equalization means balancing your estate among your beneficiaries so that each of them gets the same amount. While this isn’t too difficult if your assets are easily divisible (eg RRIF, principal home), it can get complicated when you want to give one child a specific asset.
Consider this: you have a business that one child is actively involved in. He worked hard to help grow the company so you want him to inherit the shares. To equalize your estate, you might need to bequest an equivalent value of a life insurance policy to your other child.
The same goes for a cottage that only one child uses. If you want to bequest it to that child and don’t have many assets to give to your other child, you can use a life insurance policy to balance things out.
One thing you want to avoid is mistakenly leaving your RRIF to one child and your home of equal value to another, thinking you’ve equalized your estate. Even if they have the same value, one will end up inheriting a lot more than the other.
How? The child receiving the RRIF will get it tax-free without having it go through your estate. However, the child receiving the home will first have it go through your estate. If you don’t have enough liquidity, your executor will have to sell or mortgage your home to provide the funds to pay the tax stemming from the RRIF. In the end, the child will receive a lot less than the value of the home.
Charitable giving
A goal for many philanthropists is to give not only while they’re alive, but after death as well. While you can leave a bequest to your favourite charity in your will, using life insurance often results in a larger donation.
Another benefit is that by naming the charity as the beneficiary of the insurance policy, you can bypass your estate and save on probate fees.
With a charitable donation at death, you receive a tax credit. You can claim this credit in any year of the estate and the last two years of your life up to 100% of your net income.
Create a legacy
What if one of your goals is to leave money for your children but you don’t have many assets? Life insurance is a powerful way to create an instant legacy. With a stroke of a pen, you can double or triple the legacy you leave to your children and grandchildren.
Case Study
Let’s take a look at a case study that brings everything together.
In this example, the goal of the couple is to preserve their estate for their children. They will have tax, probate fees, executor fees, legal and accounting fees, and funeral costs at death. In order to maximize their estate, they decide to buy a life insurance policy to cover these expenses.
Here are the facts:
- John, a 60-year-old non-smoker with a life expectancy of 85
- Jill, a 60-year-old non-smoker with a life expectancy of 86
- Home currently valued at $500,000 and growing at 3%
- Rental property currently valued at $500,000 and growing at 3% with an adjusted cost base of $100,000
- RRSP currently valued at $500,000 growing at 6%
- Will convert RRSP to RRIF at age 71 and start taking minimum RRIF withdrawals the next year
- Tax rate of 45% at death
- RRIF will have a named beneficiary to avoid probate and executor fees
- Probate fees of $150 plus 1.4% for the value of the estate above $50,000
- Executor fees of 5% of the total estate value
- Legal and accounting fees of $5,000 increasing by 3% each year
- Funeral cost of $15,000 increasing by 3% each year
As you can see, the total liabilities climb steadily until they start taking the RRIF minimum. Then it plateaus at around $750,000.
If they want to preserve their estate, they can buy a permanent life insurance policy. In this case, since the majority of the liability is from taxes which isn’t owed until the second spouse dies, a joint last-to-die policy is a better fit. It pays out on the second death and is less expensive than a single life policy.
The cost of a $750,000 joint last-to-die policy for a 60-year-old non-smoking couple is $356.55/month in the first year. If they end up living until life expectancy, they will pay $377,178 in premiums in total to get a tax-free $750,000 death benefit. That’s exceptional value even after taking the time value of money into account.
Frequently Asked Questions
What type of life insurance is best for estate planning?
Permanent life insurance, like whole life and universal life, are the best types of insurance to use for estate planning. That’s because they last a lifetime so you can rely on a payout upon death.
Why use insurance for estate planning?
Life insurance creates a cash injection to your estate that it can use to offset taxes, probate, and other fees. It’s also the most cost-effective compared to other methods of funding your estate.
Is life insurance part of an estate in Canada?
Although you can name your estate as the beneficiary for the proceeds of your life insurance policy, it may not be the most efficient. Doing so will subject it to probate fees and creditor claims.
What Are Your Estate Planning Goals?
Now you know estate planning isn’t as simple as getting your power of attorney and will done.
If you want to preserve your estate for your beneficiaries, it’s worth going through the exercise of calculating the expenses your estate will have.
Contact us at info@briansoinsurance.com or 604-928-1628 to find out how we guide your through the steps and recommend a suitable insurance policy to help you achieve your estate planning goals.
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