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In the next decade alone, $1207 billion will flow to the next generation, paying $78b in taxes.
Intergenerational wealth transfer is a task to undertake with due diligence.
Regrettably, eighty percent of businesses fail to reach the second generation, often due to the dire consequences of inadequate intergenerational planning. It underscores the importance of acting now.
Similarly, families unnecessarily pay billions, if not trillions, in taxes through probate taxes and estate fees.
The following guide provides empowering strategies to effectively enact an intergenerational wealth transfer, potentially securing a brighter financial future for your family.
Why is Adequate Planning Important for Intergenerational Wealth Transfer?
The most prominent reason is: Why should you pay more in taxes when you are entitled to pay less? Know that it is your right to pay less.
Here are some reasons why intergenerational wealth planning is essential:
- Significantly reduces taxes.
- Promotes family harmony.
- Protects your beneficiaries.
- Provides the maximum benefit to heirs.
Exclusive Strategies for Intergenerational Wealth Transfer
Following are some time-tested strategies for Wealth Transfer:
- Estate Freeze
An Estate Freeze means the value of the assets owned by an estate remains fixed at its current market value. To illustrate, a private company owner exchanges his common shares for preferred shares with a fixed value.
A freeze means the value of the shares he procures will remain fixed. Therefore, at the owner’s death, the asset’s value will not have increased; hence, no capital gains tax will be payable.
Later, the children will inherit preferable shares with minimal taxes and buy common shares for a nominal value of around $100.
Following are some of the benefits of an Estate Freeze:
- Diverts the dividends from the parent to the heirs, tax-free.
- No Estate Taxes
- The parent can redeem the preferred shares during his life whenever needed
- Transfer of shares within a company
- If you are a shareholder or a company director, you can nominate your heirs as your beneficiary through a separate will.
- The family members will naturally not disagree with such a setting.
- The shares will then roll over to the next generation without a probate.
- Parallel Company Method
Also known as the pipeline method, it is an effective means of intergenerational wealth transfer.
Following is a step-by-step process:
- In this strategy, the Estate creates a new private company to which the older company, previously owned by the deceased, sells its shares.
- In return for those shares, the latter company mentioned company receives a promissory note.
- After a year of parallel work, both companies undergo amalgamation.
- The Estate then redeems the promissory note.
- In this way, wealth is transferred from generation to generation.
- A Charitable Remainder Trust (CRT)
As apparent from the terminology, a charitable remainder trust is an irrevocable trust to which a person can transfer some assets and draw a regular income. On his death, the remainder goes to the Charity nominated.
A charitable remainder trust is particularly effective when you have a highly appreciated asset because such an asset is likely to incur a hefty capital gains tax and affect the estate adversely.
Following is how a CRT works
- A person (Settlor) owning highly appreciated assets transfers them to a CRT.
- He draws an annual or biannual income.
- The asset may be sold or resold at a high price without incurring taxes.
- At his death, the remainder of the asset goes to the Charity.
Benefits of a CRT
- You can sell the asset at a high value and reinvest the proceeds.
- Sizable income tax reduction on drawing profits from the trust
- Elimination of most of the immediate taxes
- Increase in disposable income
- Creation of a charitable gift
- Avoid probate and maximize beneficiaries' receipts
- Why a CRT gives you a net benefit
- The income beneficiaries (you and your family members) can draw an income for their lifetime or a specified number of years (usually 20).
- Because the CRT pays no income taxes, it can sell an appreciated asset without recognizing a gain.
- Selling without recognizing gains allows the trustee to reinvest the whole proceeds amount and generate even larger revenues for you and your family.
Wealth replacement trust
You can use some of the proceeds from the CRT to pay life insurance premiums so that your heirs(additionally) receive a sum equal to or greater than what they would have received from the appreciated asset.
Such a trust is called a wealth replacement trust. This method leads to more wealth receipts than family members might have obtained without a CRT.
- Trusts
Trusts are an effective vehicle for saving estate taxes, probate fees, and estate administration toils.
How do Trusts save estate taxes?
In Canada, death taxes apply not to inheritance but to the deceased himself. All the assets that he possessed before his death are subject to deemed disposition.
While the assets that he does not own are not subject to tax, this is precisely how a trust works.
After transferring assets to the trust, the settlor is no longer the property owner; now, the trustee is the owner.
Therefore, at the settlor’s death, the assets belonging to the trust are not taxed.
Similarly, if the parent has already divided the assets, they can go to the beneficiaries without probate.
Benefits of creating a trust
- Wealth protection Those who have their assets in their own name are not protected against liabilities, claims, or creditors. We are more vulnerable to lawsuits than we think.
More than one lawsuit is filed every minute in Canada.
Whereas, in the case of a trust, mainly if it is an irrevocable trust, tremendous protection against judgment holders, creditors, and other legal predicaments is available.
- Save Probate Fee Probate fees, also called estate administration tax, are levied in proportion to the size of an estate. They can be as high as 1.5% of the total value of the estate. Having a trust reduces these fees considerably.
- A trust Allows You to See Your Will in Action As opposed to a will, in the case of a trust, the parents can see with their own eyes how the distribution of assets that they make unfolds and where there is any need for correction.
- Transfer Wealth and Reduce Income Tax in Life If you divide the trust income among your family members, they will be charged tax on their hands.
Given that every Canadian has a personal text credit on any sum below $15000 in income, you will save a lot of money in income tax.
- Extend loans and give away gifts.
Loans and gifts are eligible for certain tax waivers. For example, there is no annual tax liability for a gift below $18,000. Therefore, you can extend money to your loved ones as gifts, but keep in mind the yearly limit.
Similarly, you can extend loans to them and remit them before death.
- Caution: If you do not charge your beneficiary interest on the loan, attribution laws may apply. So, it would help if you charged your family members interest at the market rate.
Loans and gifts are a reliable means to save taxes on wealth transfers and allow you to see your loved ones enjoying the benefit of the money you give them in your life.
Bottomline
Intergenerational wealth transfer can incur substantial tax liabilities if done without proper planning. To ensure that you leave the maximum possible sum to your heirs, take appropriate advice from experts and make time to do effective wealth transfer planning while you still have time.