Financial Literacy

Living inheritances are more popular than ever. Here’s how they work

By: Vin Heney on October 25, 2018
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Inheritance is no small business. It’s estimated that Canadian baby boomers stand to inherit roughly $750 billion over the next decade, representing the largest wealth transfer between generations in Canadian history.

But the unprecedented asset transfer isn’t the only thing about inheritance that’s changing. More and more, aging Canadians are opting to pass along a portion of their net worth to their children or grandchildren while they’re still alive. According to a survey done by RBC, 61% of boomers plan on passing along money during their lifetime.

A “living inheritance” allows older generations to see their contributions in action, such as heirs using it to buy a home, funding an education or even just saving it to ensure financial security. It’s also a recognition of the unique financial difficulties faced by younger generations. And, importantly, there are tax benefits to passing along a “gift” while living versus providing heirs with a traditional inheritance once deceased.

The times they are a-changin’, and it’s no surprise that inheritance is, too. Find out how, as we break down this shift that’s happening in Canada.

The sooner, the better

Generally speaking, the older people get, the more financially self-sufficient they become. So by the time people receive a traditional style inheritance — following the death of a parent or grandparent — they usually need it less than they would have when they were younger. As the population ages, it’s the boomers who typically stand to receive traditional inheritances, despite being a financially well-positioned generation. The reality, however, is that it’s the boomers’ children — the grandchildren of the inheritance givers — who have the biggest financial need.

Therein lies the challenge with traditional inheritances: by adhering to tradition, the needs of the living often get overlooked. The idea of a living inheritance, therefore, is a recognition that the status quo was in need of a shake up.

In the early years of adulting, it can take a while to pay off student loans or tackle consumer debt. This can mean delayed savings for a down payment or a retirement fund sans pension plan. So getting help sooner rather than later can mean a world of difference for younger Canadians looking to get a financial foothold in an unforgiving economy.

Joe Barbieri, a fee-only financial advisor to a growing number of young Canadians, agrees. “Nowadays, even if you have a work ethic, you still might not be going anywhere, because the job market is hard, the waging has hardly gone up, and millennials are finding it’s hard to get started.”

Sharing is caring

Another major advantage of a living inheritance is that it allows the giver to be an active participant. Rather than taking the traditional route — and missing out entirely on your heirs’ use of your generosity — many would rather share in the experience. Helping a child or grandchild find their first home or buy a car can be a source of joy for a parent or grandparent.

Moreover, living inheritances allow older generations to pass along their knowledge, not just their wealth. By being involved in the financial decisions that follow, the givers can ensure their gift is being used wisely. Because this approach is gaining popularity, estate planning is evolving to reflect it. It’s becoming common for givers to provide a small amount — instead of a lump sum — and see how the beneficiary handles it.

Other givers are setting up what’s called an incentive trust. This method rewards beneficiaries with set amounts once certain milestones are achieved. Achievements could include graduating from school, hitting professional targets, or meeting personal goals. The objective here is to use inheritance as a tool to motivate performance and reward positive behaviour.

Still, others opt for testamentary trusts. These are amounts of inheritance that are gifted once beneficiaries hit certain ages, commonly in their 30s and 40s, when career paths are more established and large financial decisions are on the horizon.

Life and taxes

Of all of the reasons that parents and grandparents decide to pass along assets while they’re still alive, perhaps the most overlooked is tax benefits. Simply put, Canada has no gift tax. This means you could give your child $500,000 in cash tomorrow, and it’s not reportable, it’s not considered income, and it doesn’t show up on their tax returns.

With traditional inheritance, on the other hand, it’s generally agreed upon that the deceased person’s estate pays tax because of the capital gains on assets. Although there’s technically no inheritance tax in Canada, once the giver is deceased, the assets passed to the estate are considered “sold,” and taxes are owed on the gains. This gets much more complicated, and varies depending on the type of account that’s inherited.

“RRSPs and [Locked-In Retirement Accounts] would be taxed like income, cash accounts would not (because they’ve already been taxed), the capital gains get taxed on stock holdings, and a house is tax-free (providing the beneficiary is living in it),” explains Barbieri.

But generally speaking, significant taxes can be avoided by gifting assets (living inheritance) versus setting up an estate (traditional inheritance).

“If you have a child who’s working hard and went to school and is doing all these part-time jobs and is very responsible, but he just can’t start up the way we did in the ‘60s and the ‘70s, and we’ve just got this money sitting here, and the government’s just gonna take it all, well hey, let’s win-win it by giving it to them,” says Barbieri. “And sometimes they [the givers] live through their inheritance through their children. They say ‘Ah, I gave them one hundred grand and I’m proud of them and they’re getting ahead because of my help.’ There’s a source of pride in it.”