When it comes to the intergenerational transfer of wealth, clients are often conflicted about whether they should gift their assets to family members while still alive or transfer their assets through their wills. The complexity of this decision is such that your expert advice may be relied upon.

In either case, there are tax implications. For some clients, gifting while alive provides psychological satisfaction. These clients will know that the intended recipient has received the gift, and that squabbles after their death have been avoided, says Elaine Wilson, vice president, personal trust services, Fiduciary Trust Co. of Canada in Toronto.

However, she cautions, “Once property is gifted, you can’t take it back.” As a result, she adds, “Individuals need to weigh the value of gifts against future need.”

What clients want to do is avoid depleting their assets through gifts to the point that they do not have enough for their own future needs — especially during retirement.

On the other hand, as Kathy Munro, tax services partner with PricewaterhouseCoopers LLP in Toronto, points out: “[Some] people don’t want to give during their lifetime because they want to maintain control over their assets.”

Concerns often arise in two areas, she says: children who are married can lose what was gifted to them in a divorce (unless they have a written marriage contract); and gifts can be subject to seizure by creditors. Clients with these concerns would normally use their will to direct the orderly distribution of their assets in a way that minimizes taxes to the beneficiaries and the estate. The will identifies the proportion of assets each beneficiary will receive and when they will receive such assets — either immediately or through a trust over a period of time.

GREATER FLEXIBILITY

Dean Paley, senior financial planning specialist and certified general accountant with responsibility for tax and estate planning with Edward Jones in Mississauga, Ont., believes that gifting through a will “provides a lot more flexibility” because the capital gains on any gifts will not be realized while the giftor is alive. In effect, he adds, “You are deferring any taxes on capital gains [until death].”

Arguably, using a will not only allows your clients to determine the beneficiaries, it also gives clients the ability to implement strategies that will minimize or defer taxes once they have passed away.

While still alive, a client can give cash to a child without triggering any significant tax consequences. If an adult recipient invests the cash, any resulting income or capital gains would be taxed in their hands. If the recipient is a minor child, the income earned by the investment — but not any capital gains — would be attributed to the giftor. If the cash is invested in a non-taxable product such as an RRSP, the recipient will benefit from the tax-deferred growth of the cash. On the other hand, the giftor can also benefit by saving taxes if the cash that was gifted had been earning taxable interest income prior to the gift being given.@page_break@If your clients choose to give their adult children the family cottage or other marketable securities, investments or property, it is assumed that they have sold those assets at fair market value. This results in taxable capital gains, which are the responsibility of the giftor — if the value of the assets at the time of making the gift is greater than the initial cost of acquisition.

However, any future interest, dividends or capital gains upon disposition is taxable in the hands of the recipient. One positive thing, says Munro, is that the recipient can benefit from holding an asset with an increasing value.

In the case of income-bearing gifts being made to a minor child, the giftor is responsible for the taxes on interest and dividend income, but not capital gains. If a similar gift is made to a spouse, the interest and dividend income is attributed to the giftor for tax purposes. The transfer of property to a spouse is generally deemed to occur at the giftor’s original cost base, with no immediate capital gains until the spouse disposes of the property.

REDUCING ESTATE TAXES

A key benefit of gifting to family members during the client’s lifetime is the reduction of probate taxes, which are based on the value of the estate, says Munro. Probate fees vary by province and can be a significant cost to the estate. In Ontario, for instance, probate fees are $5 per $1,000 on the first $50,000 — and $15 per $1,000 thereafter, with no maximum. In Alberta, probate fees are $25 on the first $10,000, increasing to a maximum of $6,000 for estates in excess of $1 million. By gifting while alive, the value of the estate is lowered. As well, gifts outside of a will are private and do not come under the same scrutiny as those given through a probated will.

When making bequests to family members through a will, the underlying question is whether the estate’s assets should be distributed immediately to the designated beneficiaries or whether all or part of the assets should be held in trust. In reality, an estate cannot be settled until all taxes have been paid and the Canada Revenue Agency issues a tax clearance certificate. “When someone dies,” says Wilson, “there is a deemed disposition of all assets, and capital gains are crystallized and taken into income. The estate is responsible for all liabilities, including taxes.”

There are tax advantages to creating, through a will, a testamentary and spousal trust that holds the beneficiary’s assets. The testamentary trust defers immediate crystallization of any capital gains.

With a testamentary trust, says Munro, income earned by the trust is taxed separately, at the same marginal tax rate as that of the beneficiary; it is not added to the beneficiary’s personal income. This can result in significant income tax savings if the income would have otherwise been taxed at the beneficiary’s highest marginal tax rate on their personal income tax return.

Effectively, says Paley, the trust is a “control mechanism” that facilitates income-splitting.

Several testamentary trusts can be created, each for a different purpose — for example, to provide education funds for children or grandchildren or to preserve the estate for the children. Each trust is taxed individually, potentially saving more taxes. IE