As a parent, you would never pick favourites among your children. This is also true when you pass away. You would never want your child to feel inferior to his or her siblings.
It is not always easy to divide an estate equally among multiple heirs (estate equalization). This is especially important if you want to leave a specific asset to a specific person, such as a business. It may be difficult to pass on an equivalent amount of assets to other heirs due to a lack of liquidity.
A life insurance policy can be useful in these situations. It can assist you in striking the right balance in estate distribution so that each beneficiary receives an equitable share.
What is an estate?
Your estate at death is your net worth.
Net worth = (Total value of all your assets) - (Total value of your debts)
A word about debts: Not all debts are passed on to your estate after you pass away. For example, federal student loans are forgiven when the borrower dies. So if you pass away without repaying a federal student loan, your estate will not owe that amount. A mortgage loan, however, is another thing. Any balance on the mortgage loan must be paid from your estate.
When calculating a person’s estate, only those debts that become the estate’s liabilities are taken into account.
Your estate's assets include everything you own, such as:
- Your house and other real estate properties
- Bank accounts
- Your car
- Stocks, bonds, mutual funds, etc.
- Life insurance
- Personal belongings, like jewelry
What is estate planning?
You cannot take your estate with you when you pass away. But you can decide what happens to it after you are gone.
Estate planning is the process of creating legally-binding instructions regarding how your estate is to be distributed among your heirs. That said, a comprehensive estate plan also includes:
- Primary and secondary guardians for minor children
- The name of the person who will make financial decisions on your behalf if you are unable to do so because of aging or poor health
- The name of the person who will make personal care decisions on your behalf if you become incapacitated
- A plan for offering financial help to a disabled family member without affecting the latter’s ability to receive public benefits
- Protects your assets in the event of divorce or from creditors
- A plan for minimizing tax at death
- A plan for avoiding or reducing probate fees
Who is estate planning for?
Almost everyone should plan their estate. Unless your estate is very small, you should have an estate plan in place to ensure that your assets are dispersed in the manner you choose.
If you die without an estate plan, the provincial court will develop one for you, which may or may not include what you had in mind.
What is estate equalization?
Estate equalization is the process of dividing your wealth fairly among your heirs. When the estate is composed of easily divided assets, it is simple to ensure that each heir receives an equal share.
However, if you want to leave a specific asset to a specific individual but do not have enough assets to achieve an equitable distribution of the estate, things may become complicated. In this case, an estate planning tool, such as a life insurance policy, will be required to ensure that all heirs are properly cared for.
You can leave a specific asset, such as a family business, to one person while distributing the remainder of your estate, which normally includes life insurance proceeds, to other heirs. This method assures that the correct person leads your firm when you are gone, while also ensuring that no family member feels unfairly treated.
How does estate equalization with life insurance work?
Life insurance provides the liquidity required to ensure each heir receives an equal inheritance. Family members who want to inherit the family business get it, while the remaining heirs receive the life insurance payout and other non-business assets.
For example, Miles owns a family business that is valued at $5 million, while the total value of his entire estate is $10 million. He has three children: Rob, Sara, and Tina; and:
- Only Tina is actively involved in the company
- Sara and Rob do not want to run the family business
- Miles want Tina to inherit the company after his death, but he also wants to split an equal inheritance to the three heirs
Clearly, Miles has a problem. If he leaves the company to Tina, the other two children receive a smaller share (Tina gets 50%, while Sara and Rob each receive 25%). And if he doesn’t create an estate plan, each child will get equal ownership in the business. But splitting the family business is something that neither Mile nor his heirs want.
In this scenario, taking out a life insurance policy can help. Miles can buy a $5 million policy and names Sara and Rob as the beneficiaries. This way, each of his three children will receive an equal inheritance after you are gone.
Life insurance can also be used with other assets, such as family property. Say you have a cottage on Vancouver Island, which accounts for the lion’s share of your estate. You want to pass the cottage on to the youngest child, as your other two children are settled abroad. By purchasing a life insurance policy, you can balance your estate among the heirs so that each receives the same proportion of the assets after your death.
Types of life insurance in estate planning
There’s no denying that life insurance is an important estate planning tool. But the question is: Which type of life insurance should you use?
Life insurance policies come in two flavors: term and permanent. For estate planning, permanent life insurance policies are a better option.
A permanent life insurance policy stays in force as long as you live, provided the premiums are paid. Because of its permanence, you can rest assured that your policy will eventually pay out the cash benefit to your beneficiaries. Term life insurance, while less expensive, does not provide such a guarantee. It is only valid for a limited time, which means that the insurer will only pay while the policy is active. If you outlive your term life policy, your payout is forfeited.
How else can I use insurance for other aspects of estate planning?
You can use life insurance in estate planning for multiple purposes. Apart from ensuring your beneficiaries inherit the same amount of money, life insurance can help you with:
- Estate preservation: Tax liabilities at death, probate fees, executor fees, other legal fees, and funeral costs can all eat into the inheritance you want to leave behind. Life insurance proceeds can help offset these costs and ensure your heirs receive the exact amount of money you wanted them to have.
- Estate creation: The life insurance payout is passed directly to your beneficiaries upon your death. In doing so, it creates an immediate estate for your loved ones.
Keep in mind that estate planning is not just about taking care of your dependents after you are gone. A good estate plan should also cover unfortunate circumstances like incapacitation or disability.
Ask yourself: If you were to fall critically ill or become disabled, would your family be able to still live comfortably? If not, you may need critical illness and disability insurance protection as well.
Critical illness insurance provides a one-time payment if you develop a serious illness. Most insurance companies cover heart attacks, strokes, cancer, and multiple sclerosis, but the list varies from company to company.
Like critical illness insurance, disability insurance provides benefits for the living. It pays a specific amount of money on a regular basis for a fixed period if you are unable to work due to illness or injury.
Estate liabilities after death
Your estate has certain liabilities when you pass away. Knowing them and planning for them in advance can help preserve your assets for your beneficiaries.
When you pass away, the executor must file your final tax return on any income you earned up until the date of your death. Any money owed to the CRA is paid from your estate before the funds can be distributed among your heirs.
All of your assets will be considered to have been sold at fair market value at the time of your death. Real estate, businesses, investments, and RRSPs are examples of them. Various assets do not create the same amount of income and, as a result, are taxed differently.
If you leave behind a spouse or common-law partner, he or she can inherit your capital assets and RRSPs tax-free. However, taxes cannot be deferred forever. The CRA will eventually send a tax bill when your spouse passes.
A life insurance policy can help cover taxes after death. If you are married or have a common-law partner, you may want to consider a joint last-to-die policy instead of a single life plan. Joint last-to-die life insurance covers two people but pays the death benefit once, when the second insured dies. This arrangement works well for married couples because tax on any registered plan income and capital gains is deferred until both of them die.
Probate is the legal process through which a person’s will is authenticated. Your estate executor can start the process of settling the estate only after the court issues a grant of probate.
This legal document validates your will and comes at a cost. The responsibility of paying the probate fee lies with your estate. The fee is based on the value of the estate (like 1.4% for estates worth more than $50,000) and can vary from one province to the next.
Since larger estates pay higher probate fees, reducing the size of the estate can help save money. Here are some tips to help you reduce the probate fee or avoid it altogether:
- Name someone other than your estate the beneficiary of your life insurance policy. Insurance proceeds can bypass probate, provided the estate is not the beneficiary
- Name someone other than your estate the beneficiary of your registered retirement savings plan (RRSP). Like the life insurance payout, RRSP funds don’t have to go through probate
- Set up an irrevocable trust and transfer some of your assets into it. Since assets placed in an irrevocable trust are no long considered part of your estate, this strategy can help minimize probate fees. An irrevocable trust is a trust where the grantor cannot change the terms or end the trust after its creation.
An estate executor is the person who administers the deceased’s estate, according to the instructions outlined in the last will and testament.
Many people choose to name a family member or a close friend as the executor. But since acting as executor can be time-consuming, they may expect to be compensated for the services they provide. For a large, complex estate, it is best to appoint a professional, like an estate lawyer, who will definitely charge a fee.
Typically, executor fees range from 4% to 5% of the estate’s value. Ensuring your life insurance policy and RRSP have a beneficiary reduces the estate’s value and, by extension, executor fees.
Accounting and legal costs
The executor of your estate is responsible for filing your final tax return, for which he or she may need to hire an accountant. Your executor may also need an estate lawyer to get your will probated. Your estate will cover all these expenses, which can be quite substantial.
When you pass away, your executor is responsible for arranging the funeral and paying for it from your estate. The funeral costs depend on many factors, like the type of service you want. On average, a funeral in Canada costs anywhere between $5,000 and $10,000.
Is Estate Equalization Right For Me?
The goal of estate equalization is to distribute your assets equitably among multiple heirs. If the estate is large or complex, doing so without life insurance can be difficult. In addition to assisting in the equalisation of your estate, the payout from your life insurance policy can help to preserve the value of your estate by offsetting the costs that are due when you die.
Permanent life insurance is a better fit for estate planning than term life insurance. Dundas Life works with some of Canada's top life insurers and can help you find the right policy at an affordable price. For more information contact our team.
Frequently Asked Questions
Why use life insurance for estate planning?
Life insurance can be an important cog in estate planning. You can use it for balancing the estate among multiple heirs, preserving the value of the estate, and even creating an immediate estate for your beneficiaries.
Could you use term life insurance as an estate planning tool?
Term life insurance is the purest form of life insurance and so much more affordable than permanent life insurance. But the downside is that it comes with an end date. Since there is no guarantee that your beneficiary will receive the death benefit, term life insurance is not a good option for estate planning. Instead of it, consider a whole-life policy.
Is estate planning and the last will and testament the same thing?
No, they are not.
The last will allows you to leave instructions regarding the distribution of your assets after your death. You can also use it to name a guardian for your minor children. Estate planning, however, covers other things as well. For instance, it can include a plan for reducing your tax liabilities upon death. The will is just one tool used in estate planning; other common tools include life insurance, trusts, and powers of attorney.