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You and your heirs may think that all of your assets will pass over to them tax free. Let’s examine how estate taxation can erode the value of one’s property and cause business succession problems
The Family Business Many successful family businesses have accrued capital gains in the millions, from the time the owner started years ago. The tax payable is so high that the business cannot afford the liability once the owner dies, at least without liquidating. One way to cover the tax liability is to save for it. The problem arises if the owner dies too soon, or the money gets used for an emergency or a new opportunity; or if the savings goal is impossible for the company to achieve. A better method might be to simply buy life insurance to immediately cover the entire estimated liability risk, which is due at the same time the benefit is paid upon the owner’s death (or the death of a surviving spouse). A sole owner may buy enough life insurance to add additional capital to offer stability if the company were to be sold, or where a wife, son, or daughter wants to take it over.
Investments Any capital asset that has accrued value over the initial purchase price, will have capital gains (if yet unrealized) taxed in the estate. At that time if there is no surviving spouse or dependent, an RRSP will all be taxed fully as income. Again, life insurance allows the payment of any gains tax and/or a capital replacement of the estate’s lost RRSP value.
The Cottage Perhaps you acquired a cottage that has increased in value from next to nothing, over several years of inflation while people have sought after vacation properties. Just like the business, a cottage can have capital gains growth. Thus, that asset can also later present you with a tax liability. If you die, or sell it, capital gains tax will be triggered on the portion that exceeds the amount originally invested. Consider passing the cottage on to the children. Personal life insurance, purchased with after-tax dollars, can offer a non-taxable death benefit to pay the tax. You can buy additional life insurance for business needs, or create future income for a spouse, or dependent child, if necessary.
Does your family want to keep the cottage after your death? If so, would you want them to inherit the cottage together with a large income tax bill? Where the property passes to the deceased’s spouse, taxation of the capital gain may be deferred. Once it passes to the next generation, tax is finally due at once.
The most effective and least expensive way to cover any capital gains tax liability on a family cottage is to purchase a life insurance policy on the owner(s) for the projected amount due in the estate. Purchase a permanent life insurance plan. These plans often offer a competitive rate of return on your investment and the full amount is payable at death entirely tax-free. An additional benefit is that by virtue of the life insurance guarantee, the entire coverage needed is available after the payment of just one monthly premium. If you die, your beneficiaries will have the cash to pay the debt, rather than having to quickly sell the cottage to pay taxes due. Consider taking out a permanent policy on your life (or a joint policy that insures your spouse as well) that will increase in value to meet the tax on the rising capital gain on your cottage property.
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