Creating a succession plan
Lawyer Peter Lillico's six-point plan
Families should try to seek a tentative consensus before sitting down with a lawyer or tax accountant, who will charge, typically, $250 an hour to fine-tune the details.
The key to creating a solid plan is sitting down as a family with all the information and following a decision tree like the one outlined by Peterborough, Ont., estate-planning lawyer Peter Lillico on his law firm’s website. Lillico, senior partner at Lillico Bazuk Kent Galloway, boils down the process into six steps:
1. estimating the capital gains tax due upon transfer;
2. reducing the tax bite by possibly designating the cottage as your principal residence;
3. funding the tax liability;
4. deciding when to give the cottage to the children and whether it should be by gift or sale;
5. preparing a co-ownership agreement for the children to sign in the event that you give it to more than one child;
6. establishing a testamentary trust with a fund to pay for a portion of the operating costs if there are significant inequalities between the kids’ financial circumstances that could lead to disharmony, or if some siblings use it significantly more than others.
“The fight we’ve frequently seen between siblings is when one lives farther away and can’t use it as often, and pays a smaller portion of a big cottage roof repair, then the next year moves back to the area and uses it much more,” says Virginia McKenna, a tax partner at PricewaterhouseCoopers in Hamilton, Ont. Let it be known that I paid $350 as my quarter share of the chimney repair last year, even though I only used the cottage for two days in the summer.
Generally, you will need the advice of more than just an estate-planning lawyer.
In fact, your lawyer will probably recommend consulting a tax accountant and perhaps a financial planner as well because each has a different focus. Accountants may be most concerned with helping you avoid capital gains tax. Financial planners may be more focused on selling you insurance to help fund the capital gains tax liability. Lawyers may want you to concentrate on drafting a co-ownership agreement between the children and on avoiding probate fees. Pursuing a trust or a corporation structure may involve trust officials at financial institutions and corporate lawyers. Luckily, you can do much of the groundwork yourself on the internet.
Before consulting the various experts, though, Lillico and other estate-planning lawyers recommend that the parents talk to the children about their future interest in the cottage. “It’s best to say to the children, ‘You have to hammer it out while I’m alive or we will sell the cottage,’” says Lillico. “While the parents are alive, they have moral authority. If the children can’t get it together to sign a co-ownership agreement, then the parents know it’s going to sink like the Titanic after they die.”
Moreover, some children may say that they have no interest in the cottage or that they would prefer a life interest in the cottage, rather than an ownership stake, and would be happy instead with an equivalent share of the estate’s liquid assets. Most important, in my mind, is that children should ask their parents to speak frankly about their own desires and needs in old age. Perhaps the parents want to use the capital from the cottage to fund potential nursing home stays or other long-term care or travel, but for selfless reasons are once again putting their children first. Or perhaps they would like to continue using the cottage themselves but can’t afford to and would really like some financial assistance from the children to cover the fixed costs. As a close friend of mine said to her father, “Our wish is for you to make the most of your remaining years and not think about providing for us.”
Families should try to seek a tentative consensus before sitting down with a lawyer or tax accountant, who will charge, typically, $250 an hour to fine-tune the details. But consulting a lawyer briefly up front with a few key questions will also help family members structure their initial deliberations. For example, estate experts will advise that if the children are interested in occupying severed lots on the cottage property, do the severing now because executors should not be expected to carry out something that elaborate.
Those whose children are still undecided might follow the example of one Toronto-based couple, who own a four-acre island in Lake Muskoka. They undertook a severance for their three children in advance of a municipal zoning change that increased the minimum requirement for severed waterfront parcels from one acre to two acres. The parents, who are in their 60s, first asked the children to indicate their long-term interest in the island and its 1891 six-bedroom cottage. They learned that one son might prefer a wilder, more remote canoe lake and that their daughter in Ottawa might not be able to use it as frequently because of the five-hour cross-Ontario trek to get there. Since the children were of the age that their lives and views might evolve down the road, and since the onerous carrying costs of the property ($12,000 annually for taxes and insurance alone) would make it a major financial responsibility for the eventual owner, the couple have set up a simple method in their wills for their children to choose the part of the estate (which also includes insurance and investments) they might wish. “If they cannot sort out the island ownership on their own, then we’ve said that they must put three pieces of paper into a hat,” explains the father. “The person who draws the paper marked ‘First’ has the right to choose first and say which lot on the island he or she would like or whether they are not interested. The person who draws the paper marked ‘Second’ then states whether he or she would like one of the remaining lots or not. The process continues in rotation until all the island lots are spoken for. For example, if one child passes during the first rotation, the person with the paper marked ‘First’ has first dibs on the unclaimed third lot. The executor would sell any lots that all the children have rejected and the proceeds would form part of the estate. It could end up that one child owns the entire island or two-thirds of it or that they all opt out. But looking at the totality of the estate, each child takes his or her equal share in any combination of real estate and other assets.” In other words, any child who passes on a share of the cottage property would receive a larger portion of the rest of the estate.
What if only one of your darling offspring wants the cottage and yet it represents the lion’s share of the estate?
The question arises, of course, what if only one of your darling offspring wants the cottage and yet it represents the lion’s share of the estate? Financial planners may suggest that cottage owners buy life insurance that will pay out a tax-free lump sum to the remaining siblings and help equalize the estate assets. But this can be prohibitive for an elderly couple on a fixed income. Kevin Wark, president and CEO of Equinox Financial Group in Toronto, says that a joint second-to-die term-to-100 life insurance policy for $1 million for a 65-year-old woman and her 67-year-old husband, if both were non-smokers, would cost them $15,000 in premiums each year. And at that price, it begs the question: Why should the parents go to such lengths to inflate their estate in order to be fair? Wark suggests that another option is for the child who gets the cottage to be required to take out a mortgage on the property and use the mortgage funds that the bank advances to pay the other siblings their share.
This article was originally published on May 17, 2004