Estate planning isn’t just about what you leave but who gets it first.GETTY IMAGES
Are Canadians ready for the first phase of the great wealth transfer? Before wealth is transferred to the next generation, it usually moves within the same generation to the surviving spouse. Yet, many couples overlook this crucial part of their estate plan.
Advisors play a key role in ensuring that horizontal transfers don’t go sideways, including potential pitfalls such as a lack of financial literacy and the complications of blended families.
Most Canadians don’t give their estate enough thought, according to a recent IG Wealth Management study, which found that 54 per cent of survey participants don’t even have a plan. Fifty-five per cent of those surveyed don’t understand the tax implications, and 47 per cent don’t grasp why having a will is important.
Even for those who have planned, it’s understandable that many don’t focus heavily on the first step in typical estate plans. At first glance, the decision is relatively straightforward, says Christine Van Cauwenberghe, head of financial planning at IG Wealth Management in Winnipeg. “In a traditional relationship situation, it may make sense to leave the entire estate to the surviving spouse.”
Still, the horizontal transfer requires careful planning and education for clients, says Lydia Potocnik, regional director of estate and trust services at BMO Private Wealth in Toronto.
That should involve more than meetings about portfolio performance. Discussions should ensure spouses understand their wealth, how retirement income will be generated to meet their needs, and how much might be left in the estate when both partners are deceased.
In many relationships, partners assume distinct roles in attending to financial needs or have different levels of financial savviness. “That’s why advisors need to make sure both spouses are coming to meetings,” Ms. Potocnik says.
That helps avoid situations in which a surviving spouse is scrambling to manage the money without insight. The right discussions and planning can also help circumvent risks such as insufficient liquidity in the estate once taxes and debts are settled.
“Very often, the surviving spouse will be faced with a higher tax burden,” says Leanna Wachniak, wealth advisor with CIBC Wood Gundy in Calgary.
For clients facing this risk, advisors can recommend strategies such as permanent life insurance, funded by non-registered investments. The obvious upside of this approach is its tax-free death benefit to support the surviving spouse. But whole and universal life insurance also provide tax efficiency during life, as taxable wealth is transferred from a non-registered account to the tax-sheltered insurance policy.
This strategy is often also used for blended families. Many clients today have children from different marriages. Advisors can add value by offering strategies such as creating a different structure for their wills.
Most Canadians use a mirror will – essentially the same document for both spouses, only with the deceased and surviving spouse reversed depending on who dies first. It can include instructions to pass more wealth onto children from a first marriage, for example, and less to stepchildren from a second, who may have assets from another parent to inherit.
However, a mirror will includes no protections to prevent the surviving spouse from changing their will. Ms. Potocnik explains that a mutual will can include these protections, which are generally considered legally binding.
Decisions around will structure, and why one may be better than the other, highlight how even the most basic step in an estate plan shouldn’t be taken for granted, Ms. Van Cauwenberghe says.
“Most people want to leave something for their surviving spouse, but they also want to leave something to their children from a previous relationship,” she says. “If they don’t, there’s no guarantee it will happen when the survivor dies.”
Even if families aren’t blended, a far-seeing estate plan should consider that the surviving spouse can remarry. With a mirror will, the surviving spouse could change the estate plan, affecting the original beneficiaries.
The worst case is Cinderella-like. The new spouse convinces the survivor to change the will to favour division of wealth for their benefit and not the original beneficiaries. That can lead to an outcome that would have the deceased spouse spinning in their grave.