Managing estate holdbacks

The purpose of an estate holdback is straightforward: instead of distributing all assets to beneficiaries as soon as possible, the executor “holds back” funds to pay taxes, accounting and legal bills, as well as any other costs incurred during the estate’s administration.

But how much should executors hold back? And how should they tell beneficiaries about it?

Exercise caution

Fhara Pottinger, partner at Weiler, Maloney, Nelson in Thunder Bay, Ont., says executors should take a “better safe than sorry” approach to holdbacks. If an executor distributes the estate before taxes are paid, the executor may be required to pay the tax personally, so it makes sense to hold back more than may be needed.

“The executor is on the hook for the taxes, lawyers’ fees, accounting fees, etc.—basically, it becomes their bill,” she says. So the executor “may as well exercise caution from the beginning.”

How much should the holdback be? Pottinger says it can vary “radically” depending on the type of estate, and she doesn’t generally base it on a specific percentage.

If the estate is modest, she says a holdback of a few thousand dollars may be enough. On the other hand, with a substantial or complicated estate, it may be wise to hold back tens of thousands. And if the estate holds complicated assets (overseas real estate, for example, or a business), an executor should hold back even more.

Pottinger remembers one exceptionally complex estate in which the holdback was well over $1 million. Because the beneficiaries all lived in countries with complex inheritance and tax laws, Pottinger decided to wait until the estate received a clearance certificate from CRA before making a full distribution—a process that took 10 months.

Pottinger says family dynamics are another important factor: if an executor notices conflict early in the distribution process, it makes sense to hold back more in case of legal troubles.

“If you’re getting pushback on the interim distribution, or you’re getting a lot of letters and correspondence, and [the family] is fighting about teacups or whatever, then you should take a moment to [think about] holding back extra,” she says.

Above all, Pottinger encourages executors to consult an expert rather than making assumptions about tax liability.

“I don’t recommend relying on a ‘guesstimate,’” she says. “When it comes to taxes, people do not think of everything, unless they are fairly [knowledgeable] themselves. The accountant bill, at the end of the day, will save them a lot of headaches.”

What’s your comfort level?

Harmanjit Mavi, associate at MLT Aikins LLP in Winnipeg, says good communication can make estate distribution more comfortable for both executors and beneficiaries.

“My recommendation is, as soon as it’s feasible, to report to the beneficiaries where things stand,” Mavi says.

This can be an interim report outlining the estate’s assets, known and anticipated liabilities (e.g., taxes), and the holdback. Mavi says the report should be formally prepared by counsel, as incomplete information may cause confusion and aggravation later.

The report is usually provided to the beneficiaries at the same time as an interim distribution, he says.

In some cases, executors may want to invest a holdback to earn income for beneficiaries, Mavi says. But such a decision needs to be balanced against the cost of filing a T3 tax return for any income received by the estate over $500.

“It has to be worth the hassle,” he says. “Executors are still subject to the prudent investor rule, but I don’t see much of an issue if you’re just holding back $100,000 for a year, and you leave it in just cash, and it doesn’t generate much interest.”

“So, the difference between earning maybe 2% on that, and maybe having to file a tax return on that income—I don’t think there’s enough value there to justify the hassle,” Mavi says. “But it really depends on how much money there is.”

How much should you hold back? Five questions to ask.

Are there international assets?

International assets can lead to uncertainty, delay and legal fees. It’s wise to overestimate any potential cross-border tax bills in the holdback.

What about business assets?

There may be a significant delay in determining tax liability for a business. It’s a good idea to make a significant allowance for such liability in the holdback.

Is there litigation pending?

Any litigation against the deceased (or against their business) that could result in a significant payout and/or legal costs demand a larger holdback.

Are there any outstanding tax returns?

If you’re not sure, it makes sense to hold back more—at least until it’s clear taxes are up to date.

Is there family conflict?

Conflict among heirs or questions that foreshadow disputes or litigation may be a sign to hold back extra to account for legal fees.