Avoiding probate fees: Good, bad, ugly

In BC, probate fee avoidance can be a bit of an obsession. And like any obsession, sometimes the things people do cause a lot more problems than they solve.

What is probate, and what are probate fees?

Probate is the court order which legally confirms that a deceased person’s Will is their valid last Will, and that the executor named in that Will has the right to receive the assets of the person who died. It is what gives the Land Title Office, banks and other financial institutions the legal comfort that they are transferring a deceased person’s assets to the right executor. To get probate, a probate application is made to the BC Supreme Court, and this is usually done by filing a set of documents with the court.

Before the court will issue the probate grant, probate fees must be paid. Officially, probate fees are a sliding scale ($6 for each $1,000 or part of $1,000 of the value of the estate in excess of $25,000, up to $50,000, plus $14 for each $1,000 or part of $1,000 of the value of the estate in excess of $50,000) – but it is easier to think of it as approximately 1.4% of the value of the estate, although it is actually a little less.

What do probate fees apply to and not apply to?

Assuming the person was a BC resident at their death, probate fees apply to the gross value of the estate which passes to the executor under the Will, and normally includes things like home, other real estate, vehicles, furnishings and personal effects, bank accounts, investments. While a mortgage registered on property will reduce the value of the estate (because it attaches to the specific asset), general debts do not reduce probate fees. When I say ‘property’ in this blog post, I’m not just talking real estate – property (or assets) is anything a person owns.

Probate fees do not apply to assets that pass directly to someone ‘outside the will’ because there is a separate legal mechanism other than the Will which gets it to the person it is going to. This is the origin of tactics for reducing probate fees. For example:

  • Property that is owned jointly with another person, whether it is land owned as joint tenants, jointly owned cars, or joint bank and investment accounts. As a general rule, the property goes to the surviving joint owner (also called joint tenant) for them to keep. BUT, and this is a big but, not all jointly owned property actually goes to the surviving listed owner – sometimes it is actually held by that surviving listed owner on a “resulting trust” for the deceased person’s estate.
  • Life insurance with designated beneficiaries. As a general rule, this gets paid out to the person or people named as the beneficiary.
  • RRSPs, TFSAs, RRIFs with designated beneficiaries. As a general rule, these get paid out to the person or people named as beneficiary.
  • Property that is owned by a trust. If a person transferred their property to a trust during their lifetime, they don’t own it anymore so it is not a part of their estate. The trust deed or trust agreement will say how the property is to be used during the person’s lifetime, and how it will be distributed when they die.

Because of this, lots of people get the advice to put everything into joint names and designate beneficiaries on everything they possibly can. Sometimes this is great advice. Other time it opens the door to problems down the road, like lawsuits whose costs will quickly outweigh that 1.4% you were trying so hard to avoid.

A little more on joint ownership and beneficiary designations, keeping in mind there are lots of nuances that can’t be covered in a single blog post:

Joint ownership

More than any other probate fee reduction strategy, joint ownership is the one that most often makes me want to tear my hair out. Main things to keep in mind here: future expensive and stressful lawsuits, the risk of disinheriting people you actually care about, tax consequences, and claims from creditors and other people’s spouses.

When does joint ownership make sense? Joint ownership often makes sense for a couple who either don’t have children or who had all their children together (ie, first marriage, not a blended family), who plan to leave everything to each other in their Wills anyway, and who don’t really care where the money goes when the second person dies. This works because the law presumes that anything a person puts jointly with their spouse is intended as a gift to them, and the tax system is generally favourable to leaving property to a spouse. No one else is hurt by the spouse getting the property. Only real caveat is on the family law side – if the property is something a person inherited or received as a gift from family, then they put it into joint names with their spouse, if they separate they could lose ½ of the inheritance they would otherwise have kept to themselves.

When is it a bad idea – or at least something to really think through first – and why?

Situation number 1 – Blended families. If a person jointly owns property with a spouse in a blended family, the main risk is disinheriting children you actually want to take care of. If each person has children from a previous relationship, they may say to each other “I’ll leave everything to you, and we’ll promise to equally divide everything among all of the children when the last one of us dies.” Problem: the surviving spouse could change their Will at any time to remove the other’s children, and step-children have no rights to a step-parent’s estate. Also, if the surviving spouse remarries and puts a property into joint names with a future spouse, it’s gone. There are some good other options that an estate planning lawyer can work through with the couple to allow the surviving spouse use of the property/estate during their lifetime but then make sure that the children will truly inherit down the road. Or, maybe a certain property is left to a spouse in joint ownership, but other things are left to children.

Situation number 2 – Joint ownership (real estate, bank accounts, investment accounts) with adult children, other family members, the executor…This is where the tearing of hair really begins.

  • Lawsuits and hatred waiting to happen – the resulting trust issue. Say a parent has 3 adult children, and the parent makes their home or giant savings account joint with 1 of them (who didn’t contribute a cent to the property). Parent dies, and the joint owning child says “Mom wanted me to have this all to myself”. The other two children say “No way – mom did that for convenience so you could help with banking, or to save probate fees, but she definitely wanted you to share it with us when she died. It’s part of the estate.” The parent is no longer around to say what she really wanted. If there is not clear evidence about the parent’s intention, the law will presume that the child is owning it on a ‘resulting trust’ for the parent’s estate – meaning that even though it is technically in the child’s name, it is actually a part of the estate (and, by the way, probate fees should be paid on it). But the other children have to bring a lawsuit to deal with it. After a lot of legal fees, much costlier than probate fees, that lawsuit is likely to be settled with everyone hating each other forever. Much better to have paid the probate fees and left your children the legacy of a good sibling relationship. If it is really, truly meant as a gift, then it should be properly documented with a deed of gift drafted by a lawyer.
  • Control – once a parent transfers a home or account into joint names, it is not theirs alone. If the parent wants to sell, they will need the child to sign. If it is a joint account, the child will be able to withdraw funds from it.
  • Tax consequences – whenever a person transfers real estate or investments into joint names, they also need to watch out for tax consequences. Talk to a tax accountant beforehand. Changing ownership of property is like selling it, and any capital gain will need to be reported and tax paid. If it is the parent’s home, while they own it they have the benefit of the principal residence exemption on their portion, but not the child if it is not also their principal residence. Now that you have to report the sale or transfer of a principal residence to get the exemption, CRA is going to catch many more situations where capital gains should be paid.
  • Creditor and spousal claims – If a parent transfers a property into joint tenancy with an adult child, and that adult child goes bankrupt, the creditors can come after the property. If the child has a spouse and then separates, the child’s spouse could have a claim to a portion of the parent’s property.

If it’s a very valuable property (think many Vancouver detached homes), then doing a proper trust might be the answer if you really want to reduce probate fees. It costs more to do up front, needs to be thought through fully for tax and other issues, and has ongoing administration requirements, but trusts can solve problems of other strategies. They are especially useful for blended families where the couple are over 65 years of age. More on trusts in another blog post.

Beneficiary designations

Beneficiary designations can be a great tool, whether it is for life insurance, RRSP/RRIFs, or TFSAs. The main things to watch out for here for blended families, taxes on RRSP/RRIFs, as well as situations where children are still under 19 or not yet financially responsible, or beneficiaries are disabled.

When you have life insurance, RRSP/RRIF, or TFSA, you can name a beneficiary or beneficiaries (or successor subscriber for a TFSA) on forms provided by the company, or you can do a separate document with a lawyer. In most cases, the company forms are used.

Life insurance is the easiest. You can name your spouse as the beneficiary of your life insurance, with your adult children, other people or charity as the contingent beneficiary if your spouse isn’t living. Or, you could give percentages you choose to spouse, adult children, other people, charity – making sure everyone you want to take care of gets a portion directly. Life insurance has no tax consequences for the estate and is received by the beneficiaries tax free.

  • Blended families – I love life insurance as a tool for blended families. For example, if a person really wanted their spouse to get the home in joint tenancy to keep for themselves, they might make their life insurance go to their adult children instead. It’s a flexible tool. But keep in mind that any life insurance left to a spouse is for that spouse alone – when that spouse dies, you have no control over where those funds go.
  • Children under 19 (or not yet financially responsible) – for children under 19 years old it is not a great idea to designate them directly on the usual designation forms either as primary or contingent beneficiary – because a trustee is needed (if not named, or if the named person is deceased or unable to act, the Public Guardian and Trustee would manage the funds normally) and, even if a trustee is properly named, all funds would have to be paid out at age 19. Instead, the better options are to either let the funds flow through the estate under your Will (for non-blended families with young children, on the life insurance forms spouses would just designate each other with no contingent beneficiary) or to do a special Insurance Declaration through a lawyer.
  • Insurance Declarations – An Insurance Declaration is a fancy designation form written by a lawyer, and can look like your Will. Instead of an executor, it has an insurance trustee. The insurance trustee receives the life insurance, probate free, from the insurance company and then handles the funds as set out in the Insurance Declaration. The Insurance Declaration names alternate insurance trustee if the main one can’t act. For children and young adults, it includes trusts so that funds are available for children’s needs while they are growing up and then gets paid out to them when they are old enough to be financially responsible. Insurance Declarations are also a great tool for disabled beneficiaries, as it can include life long trusts for them. It is also a good tool where you want life insurance to be used for estate costs, and still reduce probate, because you can give the insurance trustee direction to pay those costs.
  • Grandchildren – If life insurance is left equally to children on the company forms, and one of the children dies before the parent, that child’s children will not inherit their share the way they normally would in a Will. You need an Insurance Declaration if you want that detail (or put the life insurance through your estate).

TFSAs are similar to life insurance in that it has no tax consequences for the estate and is initially received by the beneficiaries tax free. For a spouse, there is also the option to name the spouse as the successor holder (instead of beneficiary) so that the spouse can continue to have tax free growth in the TFSA. For a good article on this, see http://www.moneysense.ca/save/investing/tfsa/successor-holder-tfsa/. The same kind of things I said about life insurance apply to TFSAs. In BC, you can now do separate declarations like the Insurance Declaration for TFSAs and RRSPs, although many of the companies are not yet comfortable with this and want their own forms used only.

The main difference with RRSPs/RRIFs is on the tax side. Because RRSPs are tax deferred, at death it’s time to pay the piper. The whole amount of an RRSP is included in income in the year of death, which can make for a whopper of a tax bill. That tax bill is paid by the estate (CRA only goes after the beneficiaries if the estate can’t pay). If the RRSP is designated to a spouse, then the spouse can take it on a rollover basis, which means the tax only needs to be paid when the spouse dies down the road. So RRSPs to a spouse are very often a good idea (in a blended family you might leave RRSPs to spouse, and life insurance to children for example).

If the children are going to be named as contingent beneficiaries on the RRSP/RRIFs, you want to make sure there is enough other money in the estate itself to cover the tax bill. Also, watch creating an imbalance. If an RRSP is left to one beneficiary, but the estate goes to other people – the whole RRSP goes to its beneficiary, but the estate beneficiaries get the estate value less the tax paid for the RRSP.

And, in case this isn’t obvious from what I’ve said so far, beneficiary designations on company forms only work when you really want the person you’ve named to keep the money for themselves. If you expect them to share or pay the mortgage or estate expenses, you’re back into that resulting trust lawsuit territory. A lawyer drafted insurance or plan declaration is the better approach.

Final word: Probate fees are not evil. They are a cost of dealing with an estate. When working with a lawyer, you can discuss the good ways to reduce probate fees and ditch the rest.