Easy Tax Savings – Inheritance

Many parents make the common mistake of leaving their children with way too much inheritance all at once. Many children will spend their inheritance unwisely because they haven’t learned how to handle such a large windfall. What parents should do instead is pass down the inheritance gradually throughout the later years of their lives to minimize taxation, and maximize economic utility.

This is a bigger deal than most people realize. A study from MIT looked at U.S. senior citizens and discovered that unmarried older individuals had a median net worth of $165,000 a year before they died. And for continuously married seniors it was $600,000 before they died. This means that the majority of elderly people die with some amount of inheritance to pass on. The median inheritance in Canada most people can expect is usually over $200,000.

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Estate tax rates in the U.S. vary depending on location and inheritance amount as there could be a maximum exemption threshold. In Canada, we don’t have an inheritance tax 😀 but we do have to pay taxes on a deemed disposition. Some provinces also charge probate fees of as much as 1.5% on the value of the estate. Here are some reasons why gradually passing down an inheritance earlier may be better.

  • Kids can use some of the inheritance money today to pay off their debts. The effective rate of return to the family’s cumulative wealth can be dramatic since paying down a 7% car loan is like a pre-tax return of 10%. Time is money 🙂 Why wait when money could be put to proper use now?
  • There will be less financial stress related to taxes and fees because the investments would already be owned by the kids so there wouldn’t be any transferring of assets when the elderly pass away 😀
  • Most people reach their highest earning potential in their 50s or 60s, which in Ontario could mean a marginal tax rate of 46%, yikes! But if our children is over the age of 18 we can give them the money and advise them on how to invest in stocks, bonds, etc because the investment income they make will probably be taxed at a much lower rate. It is a great way to teach your kids about the capital markets 🙂 The entire family as a unit will save huge amounts of taxes over decades by using this tax loophole efficient strategy 😉
  • By giving their adult children money in stages parents can witness how their kids spend that money, and offer them financial guidance if necessary, so their children may understand how to handle future inheritances responsibly.

If you are approaching your senior years and know that you can’t spend all your money before you die, then you can help fund your grandchildren’s RESPs (or 529 plans) so their parents can contribute more to their own savings like a TFSA (or Roth IRA) for tax free investing, and once again, the whole family benefits 🙂

If you’re expecting to receive an inheritance then talk to your folks about giving you some of it now. But don’t be like “Hey Ma, can I have some of your retirement savings?” You have to be tactical and mature about it 😉 Explain to them how it will benefit the whole family 😀

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The pre-requisite to attempt any of the suggestions above is trust. If you don’t trust your kids (or parents in the case of reverse inheritance) with your money, do not give it to them! Also, make sure you don’t give away so much that you run out of money during your own lifetime lol. Lastly, only do this for genuinely real inheritances. For example, don’t trade stocks in an account opened using your kid’s name and then keep the profits and tax savings for yourself. That’s tax avoidance and can get you in trouble with the CRA/IRS, and it’s also poor parenting quite frankly 😐

We often consider our pensions when creating a financial plan. But only 35% of workers have a workplace pension plan 😕 Yet more than 50% of married U.S. seniors leave behind $600,000 or more, and Canadians are apparently even wealthier than Americans, so the majority of us will receive free financial assets, but hardly anyone talks about it 🙁 Why not? I think we ought to take inheritances more seriously and integrate it into our retirement plans better 😉

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03/17/2014 9:45 am

My parents did this, sort of (too long to explain). I think sometimes it can majorly backfire due to not knowing what the heck you’re doing financially in your early to mid twenties. The other thing to keep in mind is that as the person giving an inheritance is that you don’t short-change yourself, so you need a very nice buffer in your retirement plan.

Pauline @ Reach Financial Independence

We have a tax free inheritance allowance of around $50,000 every 5 years, my mother already gave my sister and I a little bit but when we tried to have my grandparents do the same it looked like we were pushing them to the grave. They are worried about medical bills when they get too old so want to keep all their cash for now, which means a 30-40% tax rate when they pass. If I have kids I will optimize taxes for sure, 40% is too painful.

03/18/2014 9:31 pm

Great tips for Tax saving. I like it.

Debu Shah
Debu Shah
03/20/2014 1:03 am

When you have money circulating in family.Our parents always want us to be safe from wasting money.End of the day it is a hardworking money.Taxes are weapon of government to take out money from our pocket.In my country it has become burden on us.Your tips are useful somehow for us too.