Taxation of an estate when a person dies can be significant. In some cases, the amount of tax owed can be so severe that part or even all of an estate must be liquidated in order to pay the taxes owing.
One way to minimize estate taxes is to leverage life insurance.
The following describes several methods of doing this.
Charitable Donations
Charities can be named as the beneficiary of a life insurance policy. When a person passes away and a charitable donation is made the entire donation is a tax credit.
This also applies to the inheritance of shares in some companies, which involve capital gains taxes. These capital gains taxes can be reduced by the tax credit from the donation to charity.
100% of a person’s net income can be used as a charitable donation in the year of death, and any excess can be rolled over into the next year.
Note that to qualify the charity has to be registered as such with the CRA (Canada Revenue Agency), and a donation receipt must be provided.
Life Insurance to Cover Taxes Owed
Another option is very simple: purchase a life insurance policy and use it to cover the estate taxes. Of course, this does mean that there will be the cost of premiums. Still, this solution makes sure that the estate does not need to be liquidated. This scenario is often used to cover the capital gains tax portion of a cottage (or other secondary residence) that is willed to children.
Term life insurance is the cheapest alternative. However, whole life insurance, while a bit more expensive, offers numerous financial options (and also accumulates a cash benefit).
When using this method be sure to talk to an estate planning expert so that you have an accurate figure for the taxes that will be owed on the estate. Then shop around, and make sure you get just enough coverage for the estate taxes.
Spousal Rollover
Joint and last to die life insurance policies only pay when both spouses have passed away, thereby deferring the estate taxes owed when the first spouse dies. This is ideal for people that are especially concerned with a surviving spouse being stuck with a large tax bill.
In addition, joint and last to die policies tend to be cheaper than single-person policies, since the risk involves two people and not one person.
Conclusion
The most important point of this article is this: make sure that there are sufficient funds to cover the estate taxes; otherwise the estate must be at least partially liquefied in order to cover those costs.
Tax credits can be obtained via charity donations, and a life insurance policy can also provide the capital needed to meet the estate’s obligations!
