Probate Fees vs. Income Tax

by Tax Guy - Burlington Accountant on March 9, 2011 Print This Post Print This Post

One of the benefits of an RRSP or RRIF is the ability to directly name a beneficiary and avoid probate fees (also referred to as probate taxes) on death.

While the direct beneficiary designation feature is an efficient method of passing your retirement plans to your loved ones after you die, it does not avoid the income tax bill!

Probate fees and income taxes are different and some special planning should be considered when making a beneficiary designation on an RRSP or RRIF.

What Is Probate?

Probate is a process of confirming that your Will is valid and is your last Will and protects the executor from personal liability. Although there is no need for your executor to obtain probate and incur those fees, many times probate is required to change the ownership and distribute certain assets (stocks, bank accounts, and in some cases real estate).

If probate is obtained, the fee in most provinces is based on the value of your estate. With certain exceptions such as direct beneficiary designations on RRSP’s, RRIF’s, TFSA, insurance and assets registered in joint ownership.

What If There Is No Will?

When you die, your assets do not automatically pass to your heirs! If you do not have a Will, a family member may have to go to court and request to be appointed as the personal representative. Your estate will then be distributed according to the provincial law (which may not be what you expected!). Probate fees will be paid according to the court schedule for the province based on the value of your estate.

What Is Income Tax?

Income Tax, as its name suggests, is a tax on the income you receive. Income tax is calculated annually and is based on things such as employment income, business income, dividends, interest, and the net capital gains from investing.

When you die, you are deemed to have sold all of your investments at fair market value and any net capital gains and other income will be included on your final income tax return.

Comparing Probate & Income Tax

The following table compares and contrasts the difference between probate fees imposed by the court and income taxes due at death.

Income TaxProbate
Tax/Fee Applied ToIncome To The
Date of Death
Value of Assets
At Date of Death
Direct Named RRSP's IncludedYes, unless a
spouse is beneficiary
No.
Direct Named RRIF's IncludedYes, unless a
spouse is beneficiary
No.
RRIF Successor AnnuitantNo.No.
TFSA Beneficary/SurvivorNo.No.
Insurance ProceedsNo.No.
Segregated FundsYes.No.
Joint OwnershipYes.No.

RRSP & RRIF Beneficiaries

Notice in the table that certain assets, such as your RRSP’s, are not subject to probate but are still included in your final tax bill on death.

This can sometimes create a problem if the estate has no other assets to pay the estate debts and final taxes because the bulk of the estate was passed to your heirs via direct beneficiary designations or joint ownership.

Estate Planning Tips

If you have significant investments inside of RRSP’s, RRIF’s, in segregated funds or held in joint ownership, there a couple of things to consider:

  1. Name your spouse as the beneficiary. For income tax purposes, your spouse can receive the assets on a tax-deferred basis.
  2. Avoid bankrupting your estate. Leave enough in your estate to pay the final expenses and taxes. If you do not, the CRA will hold anyone ho has received a payments from your registered accounts and segregated funds liable for a portion of your final tax bill.

You Can’t Take It With You

If you want to find out more about estate planning tips and pitfalls, I’d suggest picking up a copy of The 50 Biggest Estate Planning Mistakes…and How to Avoid Them by Jean Blacklock and Sarah Kruger. The book outlines the major mistakes people make in estate planning and their consequences in an entertaining way-and then proceeds to tell you exactly how to avoid these mistakes. The book is available at chapters.indigo.ca.

About The Tax Guy...

Dean Paley CGA CFP is a Burlington accountant and financial planner who services individuals and business owners locally, nationally and internationally. Dean has appeared in the National Post, Toronto Star and Metro News.

To find out more, visit Dean's website Dean Paley CGA CFP or connect via Twitter @DeanPaleyCGACFP.

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{ 4 comments }

drvajra March 29, 2011 at 11:30 am

Let’s say there is a family: Father, mother, and two young children. The bank accounts, and the brokerage accounts are in the husband’s and wife’s names (joint tenants). They have a rental property which is in both of their names (50% each). They have no other home (they live in part of the rental property) or cottages boats etc. .
When one of them dies, the other has full control of the bank and brokerage accounts and the rental property. The wife and husband trust each other, so there is no fear of divorce wranglings.

In this case there will be no probate necessary. There is even no need for a will. Am I correct?

drvaj

Tax Guy March 30, 2011 at 11:57 am

Given the facts, there is no probate required. However, a Will is always required, particularly to avoid any uncertainty.

If an objection is raised following the death of one spouse or there is something that is not considered in the overall plan, the Will is the deciding document. Also, if one spouse dies and the other remarries, upon their death the new spouses children may become entitled to your assets and may partial disinherit your own children.

A Will can be used to create a spousal trust whereby the marital assets pass to the trust for the benefit of your spouse. Upon their death the assets are distributed to your own children and no to the new spouse’s children. To create the trust, the Will would normally be probated and the cost well worth the future heart ache and head aches.

Probate avoidance is like tax avoidance. Both are legal but usually cause other problems that cost far more than the probate or tax that would have otherwise been paid. Another way to look at is this way: What do you want to achieve and who will get your assets? (note that tax and probate minimization is a consideration but must never be the objective!).

drvajra March 30, 2011 at 10:29 pm

Great info!

Is creating a spousal trust a difficult job? Can an individual do it or is a lawyer needed? How does one find the RIGHT lawyer other than looking into the yellow pages?

Tax Guy April 2, 2011 at 10:32 am

A spousal trust is not difficult but should involve a lawyer (avoid DIY wills!).

Any estate/wills lawyer will be trained to make them.

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