Bulletproof your beneficiaries

Just how do you write a will so that everyone will be happy? When it comes to leaving your estate to a blended family, this task becomes especially tricky.

In a blended family situation, you or your new spouse may have children from a previous marriage. You may have children together. And for some families, both situations might be true a few times over!

So how do you prepare an estate plan that will treat everyone fairly, while ensuring your estate eventually passes to those you most want to benefit?

This may involve leaving a certain percentage or dollar value to your new surviving spouse, your separated spouse (to help raise your children) or directly to your children. The possibilities are endless. To take advantage though, you need to ensure your will is up to date and that other estate plan components are properly structured.

Wherever possible, work to minimize the chances of disagreement or litigation—such things are expensive, the dissention hurts families and, unfortunately, it happens a lot when people die.

All of this is a very real concern. It’s difficult to put an exact number on it, but we often see, and need to correct, a lot of blended-family issues when reviewing cases for our advisor base.

The problems caused are rarely intentional. They stem from a lack of coordinated attention on the part of the legal, tax and investment advisors.

Problems also stem from a lack of education. There are, in fact, a few common misconceptions that many clients have when we first start to work with them.

When beneficiaries lose

The most obvious consequence of a poor estate plan comes when the client dies and children from a previous marriage are left with nothing because their estate is automatically and unintentionally passed on to the new spouse. We previously saw this mainly with registered asset designations, but we’re starting to see more situations where non-registered assets held jointly are also automatically passing to the surviving spouse instead of beneficiaries named in the client’s will.

It is often thought an estate will be distributed according to instructions laid out in a will. In truth, this might not occur. But it often depends more on a combination of how the assets are owned, what beneficiary designations (if applicable) have been made, than on any instructions made in a will.

A solely owned asset will generally be disbursed according to your will. High probate fees, however, particularly in Ontario, have a number of people making joint ownership with right of survivorship (JTWROS) arrangements for their significant assets. This happens frequently with the matrimonial house but is more of a concern when it happens with large investment accounts or rental real estate. Instead of passing according to your will, the asset passes to the surviving joint owner(s).

We see situations where proper planning and well-drafted wills exist but clients have followed “advice” on probate tax avoidance in newspapers and other publications, and place the assets in JTWROS with their spouse or children. They do this without realizing the assets will no longer be theirs on death, to be distributed according to their wishes.

Simply, it’s a lack of education that leads to these problems. When it comes to probate fees, even the most rational person who hasn’t been educated about the matter may balk and be driven to action after reading the wrong article. Most of us have grown accustomed to paying taxes on our income, but learning probate fees alone will eat 1.5% of your estate is a difficult, more offensive pill to swallow.

Another way to own an asset and have it pass according to your will is to own the asset as “tenants in common,” which allows two individuals to own an asset together.

Upon death, however, you can direct how your ownership in that asset is distributed. This can happen with cottages (although if this is the case, a buy-sell arrangement should probably be put in place) but more frequently it’s also happening with large investment accounts that have been pooled to gain access to certain investment products, private equity investments or preferential fee pricing. Similar to solely owning an asset, the tenant’s ownership percentage in the asset will generally be subject to probate fees.

While probate fee planning may be appropriate for some clients, others (primarily High Net Worth clients and blended-family situations) could benefit from using a spousal trust. These allow assets to roll over tax-free on death, the way they would if they were going directly to the surviving spouse, but the assets are instead put into a trust for the spouse’s benefit during his or her lifetime.

To ensure a tax-free rollover, the spouse must be entitled to all of the income generated during his or her lifetime, while nobody else is able to access the capital. Once that person dies, the assets are then distributed according to the will writer’s original wishes.

This is especially important in blended-family situations where you may want to take care of your new spouse but also leave the assets to your children from a previous marriage.

One added bonus: once created, the trust is taxed using its own set of graduated tax rates. The surviving spouse may save more than $10,000 a year in taxes than a beneficiary who had received the inheritance directly.

Other considerations

In addition to ownership concerns, estate planning often doesn’t keep pace with life changes. At the very least, we like clients to look at their situations every three to five years.

New legislation gets passed, court cases may alter certain estate planning strategies, financial and family situations change and planning strategies evolve as the kids grow more independent.

Planning for a couple where both are working and their kids are young is quite different from the planning needed once they’ve reached their 60s and the kids are out of the house.

Overall, I’d say half of the time clients are missing out on tax or estate planning opportunities specific to their situations but otherwise have very good advice and planning in place.

Others, though, need a complete overhaul of their plans. This often occurs in cases where one advisor was not speaking to the next and inadvertently changed the client’s estate plan.

Finally, we’ve noticed a number of our clients simply do not understand the magnitude of their wealth. Once you include RRSPs, the value of their homes, cottages and businesses in the equation, it turns out there are a lot of wealthy people out there who don’t realize how significant their estates (and estate taxes) will be.

It’s necessary to have real access to a coordinated team that can identify any pitfalls, provide comprehensive analysis and logically explain the situation – right down to what will happen to assets, both during clients’ lifetimes and when they pass away.

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Mike George is director, wealth and estate planning, Richardson GMP Limited .

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Mike George