Given how much has changed during the COVID-19 pandemic, any approach to wealth planning needs to be multifaceted. People are considering, or potentially reconsidering, what values are attributed to the assets held in their families' portfolios and right now is the ideal time to step back and think about those plans for the future.
If you are a high-net-worth individual
(“HNWI”) in your 50s or 60s, you are
likely looking at the next phase of your life. Whether you are
operating a family business or are a sole operator, you may be
wondering what will happen to your business going forward. Will
there be an exit to an arm's-length party (i.e.: family
relationship, business relationship) via a future sale or is the
next generation going to take over the business? Now is the time to
start thinking about those big decisions if you have not already.
While many businesses are suffering as a result of the pandemic, it
is important to continue planning on building value going
1. Consider (or reconsider) an estate freeze.
One very simple way to preserve wealth for the next generation, as well as minimize your ultimate tax liability, is undertaking an estate freeze. Via a series of transactions, the current value of an individual's ownership in a business (or portfolio of assets) is “frozen” at the current value. There are several benefits to undertaking an estate freeze:
- The individual's tax liability in respect of the business (or other assets) on death is capped at today's value (any future appreciation in the value of the business/assets is passed on to the next generation and not subject to tax in the hands of the freezing individual).
- If the freeze is structured appropriately, where an active business is involved, you can access other family members' lifetime capital gains exemption on a future sale of the shares of the business, thereby minimizing the overall taxes paid on an ultimate sale.
- The “frozen” shares that the individual receives in the estate freeze can provide a source of annual income, while further minimizing tax on death.This is accomplished through annual redemptions of the frozen shares held by the freezor.
We have identified three categories of individuals that fall within the estate freeze planning spectrum:
- Those who have already implemented an estate freeze of their business/assets;
- Those who have been considering an estate freeze but have not yet implemented one; and
- Those who have not yet considered an estate freeze.
We have been faced with an unprecedented time in our lives with the COVID-19 pandemic. It is prudent, now more than ever, to consider the current value of your business and your plans for the future. If anything, this pandemic has made us reflect on our health and mortality, reminding us once again, of two fundamental truths – death and taxes.
Given the lockdowns around the world, business values, and asset values in general are likely significantly depressed at this time. Although you may see a decline in your business value as a negative aspect, it does present an ideal opportunity for tax planning. If you were putting off that estate freeze, now may be the best time to revisit and implement.
When you die, you are deemed to dispose of your assets at their fair market value. If you freeze at today's value, you are essentially capping the tax that will ultimately be paid on death. Assuming that values are significantly lower at this time, it may be prudent to undertake an estate freeze, thereby minimizing the amount of tax that your estate will pay on your death; therefore, preserving more wealth for the next generation. The economy will eventually improve, and values will inevitably increase in the future, so it makes sense to freeze now and take advantage of lower current values in meeting your estate and tax planning objectives.
Thawing and Refreezing Existing Estate Freezes
For those who have implemented an estate freeze in the past, now is a good time to revisit your business value. Has there been a meaningful decline in the value as compared to the freeze value? If the answer is yes, then you should consider whether it makes sense to "thaw" your existing freeze and refreeze at the lower valuation. If you do nothing, you will miss the opportunity to reduce the freeze value and your ultimate deemed disposition tax on death.
Three years ago, Mary implement an estate freeze of her business when the value was $5 million. Mary exchanged her common shares of the business for frozen preference shares with a fixed value of $5 million, and the new common shares were issued to a newly established family trust, the beneficiaries of which are her two adult children. Given the current circumstances, Mary's business value has dropped to $3 million. Mary should consider a thaw and refreeze of her business because of the drop in value. This refreeze may be undertaken relatively simply by reorganizing the preference shares of business owned by Mary. The refreeze would effectively have Mary exchanging her existing preference shares with a fixed value of $5 million to newly issued preference shares with a fixed value of $3 million. By refreezing, Mary reduces the face value of her shares by $2 million, which may directly translate to a deferral of deemed disposition tax of about $540,000 if the value of the business increases to $5 million or more by the time Mary passes. The $2 million of future appreciation has effectively been transferred from Mary to the family trust (and ultimately her two children).
Have You Been Considering a Freeze but Are Hesitating?
If you have been considering undertaking an estate freeze of your business, but have been putting if off for whatever reason, now is an ideal time to make it happen.As discussed above, given that business values have declined, implementing a freeze now will meet your estate planning objectives, while minimizing your estate taxes and preserving wealth for your family.
Take advantage of the current conditions with tax-saving measures to provide some financial security and future certainty for your family.
You've Never Considered an Estate Freeze - but Should You Be?
Perhaps you have never considered whether an estate freeze makes sense for you, because you are not ready to face those tough business succession questions and realities, or simply because dealing with your mortality is too difficult at this time. One thing that this pandemic has made us realize is that our health and lives are vulnerable. We all need to plan for the inevitable reality that is death. This is the perfect time to reflect and plan for the future, and with depressed valuations, “the ducks are in a row” and well positioned for an estate freeze.
2. Develop a meaningful philanthropic strategy.
COVID-19 is creating a new and increased need for charities and non-profits, while also adding enormous financial pressure to support their causes. Luckily, there are ways for HNWIs to donate that do not always involve an outflow of cash (and let's face it – right now, in many cases, cash flows may be lower than they would otherwise be in a non-pandemic situation). For example, a HNWI could consider donating shares of a public companyrather than cash to their charity of choice. There are tax benefits to this donation strategy. When you donate shares, the capital gains inclusion rate is zero, yet you still receive a full donation credit based on the fair market value of the shares.
Families can also consider establishing a charitable foundation or donor-advised funds that would give them the flexibility to make a contribution to the foundation or fund and get an immediate tax credit, and that foundation or fund will disperse the cash to various charities that you intend your donation to go to. There are ways to stagger donations to various charities, while receiving a donation tax credit up front and having that foundation or fund disperse the donation over a period of time.
3. Protect yourself and your assets through your power of attorney, will and life insurance policy.
Power of Attorney
This pandemic has reminded us that anything can happen in the blink of an eye and our good health is certainly not guaranteed. Needless to say, there is no time like the present to make sure our houses are in order. If you are a HNWI without proper wills and powers of attorney ("POA") in place, it is critical to get the process started. If you have these documents in place, it may be prudent to consider updating them. A POA gives a person of your choosing the power to act on your behalf when you are not able to do so yourself. POAs are beneficial from both a health and a financial perspective. If you are somehow incapacitated (i.e.: on a ventilator, intensive care unit, etc.) or cannot speak for yourself, you want someone that you trust to be your voice. If you found yourself in that situation without a POA, it would be extremely difficult for your beneficiaries and family members to access your financial assets and carry out your overall wishes.
A will is important because it is the document that dictates how your assets will be dealt with and distributed when you die. How do you want your wealth to be transferred? Your will is meant to dictate your exact wishes. Generally, a will for a HNWI is going to be a very detailed document that clearly spells out the executor(s) you have appointed to oversee your estate, how and when your assets will be distributed and to which beneficiaries when you die. It also dictates any bequests you want to make to certain individuals and charitable organizations. Without a will, you die intestate, which means that you left no instructions as to how your property is to be distributed. In these circumstances, the relevant provincial statute on succession will govern how your assets get distributed to surviving family members. Not having a will with your wishes clearly defined may lead to complications for your surviving beneficiaries and potential disagreements. It is important that the creation and revision of your will ties into your overall estate planning. You have likely worked your entire life to build a meaningful legacy, so it is crucial to ensure that you have a proper will and POA to preserve your wealth for future beneficiaries.
Life insurance can also be a very effective tool in estate planning. Generally, individuals look at purchasing life insurance policies to provide their estate with liquidity on their passing. Without life insurance, your estate may not have the funds to pay the deemed disposition tax on your passing. You may leave very valuable assets to your beneficiaries, but these assets may not be liquid. Life insurance can be implemented to deal with this situation, avoiding the forced sale of assets by your estate to cover the taxes. Life insurance is a good way to plan for this situation and should always be tied into your overall estate plan. If you are implementing an estate freeze now at lower values, then it is a perfect time to look at your life insurance needs as well. You will require a lower death benefit to fund your deemed disposition tax if you freeze at lower values today, potentially leading to reduced premium costs.
4. Work together with a professional.
Estate planning is complicated. If you are a HNWI with a portfolio of significant assets, there are going to be tax implications involved. Without a team of advisors with considerable experience and understanding of the complexity of this area, it is nearly impossible to navigate all of the opportunities available. You want to make sure that you are well represented from both a legal and financial perspective. Accountants and lawyers usually work together in formalizing estate plans, especially in respect to wills, power of attorneys and estate freezes. A poorly organized estate plan or lack of one all together, will cost you more in the long run, so it be prudent to invest in working with a professional now to preserve your wealth for the future.
Originally published 18 June, 2020
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.