Mid-life Concern

Harry Hendrickson and his wife Jane had made a list of their assets and liabilities in preparation for writing their wills.

“Our plan was that our wills would mirror each other,” Harry told me. “All my assets would be left to Jane, and vice versa. If both of us are gone, our estates will go to our two children. Then the lawyer mentioned the use of a spouse trust. He said I might want to talk to you about it.”

“I notice that your assets are not equal in value,” I said looking down the list. “Jane owns the house, worth about $400,000. You have a stock portfolio valued at $800,000. Did the lawyer tell you about the tax rule that triggers a capital gain on your death?”

“He did mention it,” Harry said. “He told us that the gain on the house was tax free and that no gain was realized on assets that passed between married couples.”

“That’s right. When you die, you are deemed to dispose of all your assets. Since gains on a principal residence are exempt, no tax is payable on that asset. If you transfer your non-RRSP (registered retirement savings plan) stock portfolio to your wife, no tax is payable on those gains either. Your wife will inherit the assets at your cost basis, which means that when she sells the stocks herself, she will pay tax on the gain based on your original purchase price.”

“What about the RRSP?”

“A similar rule applies. If your wife inherits your RRSP, no tax is payable until she begins to withdraw funds. Then she pays tax as though the RRSP was always hers. The purpose of these rules is to apply tax on assets when they pass to your children’s generation — and not to tax assets that remain with the marriage partners.”

“Fine. So our original plan seems to work well. That brings me back to my question. What is a spouse trust and why would I want to use one?”

“A spouse trust is a special type of trust that enjoys similar tax deferral benefits to leaving assets directly to your spouse. For example, if you transferred your non-RRSP stock portfolio to a spouse trust, you would defer capital gains taxation at death. Gains would be taxed only when shares were actually sold, just as they would if Jane inherited them. To qualify for this beneficial tax treatment, the trust is subject to very restrictive rules. Only the spouse is entitled to the income or capital of the trust during her lifetime. That means nothing can be paid from the trust to your children or anyone else. However, Jane can make personal gifts to the children from funds that have been allocated to her.”

“Why would my lawyer suggest the use of a spouse trust?”

“There are two main reasons. The first is to protect Jane from making mistakes. Many husbands in the past felt that their wives were not capable of managing the family assets. They put assets in trust so that a trustee would make investment decisions.”

“That can be pretty expensive, can’t it?”

“Yes, and there are problems if Jane and the trustee don’t see eye-to-eye. Also there’s no guarantee that the trustee will make anything other than safe, mediocre decisions.”

“I think I would rather have Jane control her own destiny. She’s smart enough to seek professional advice if she needs it.”

“The other reason for the spouse trust is that it puts limits on Jane’s behaviour and gives you a say in who inherits the assets after she is gone. For example, she could marry again and her new husband might be entitled to a share of her estate. Or she could become involved with a charity or a religious group and choose to leave the bulk of her money to them instead of to your children. Remember, Jane will have control of her assets forever. She may become a different person in her old age due to disease, chemical changes or emotional trauma.”

“It’s demeaning to say that a person I have trusted and loved all my life shouldn’t have control of our money. But you’re right, Jane and I may be different people when we’re 90 years old than we are today. Maybe some financial controls should be discussed before we finalize our wills.”

“It’s something both of you should consider. You might want to make your adult children part of the discussion as well. Making a will often seems like a simple thing, but there are problems to be acknowledged that are quite out of the ordinary.”

HANK T. BULMASH, MBA, C.A.

BULLMASH CULLEMORE

CHARTERED ACCOUNTANTS, TORONTO.