Many clients have seemingly simple instructions for their wills.   Gifting specific assets to certain beneficiaries are logical and straightforward for many testators.  “I want to give my investment account to John”.    Such simple instructions give rise to many dramatic consequences that should raise red flags for the advisor.   Leaving aside drafting concerns, the client should be asked to consider the following major issues:

1. Ademption and Tracing

Wills work wonderfully because of the concept that they govern what you own when you die.  Residue clauses, by definition, do not depend on what particular assets the testator owns.   Rather, the Will simply divided up the value of whatever assets are owned at death regardless of whether they were owned when the Will was made or purchased between the making of the Will and death or changed from one type of asset to another.

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Gifting specific assets always raise the possibility that the particular asset will be sold, gifted away, converted into another asset, destroyed or otherwise disposed of before death.   

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Question 1: What would the client want to happen to that gift in that event- should it be replaced by cash or traced into another asset?   

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2. Equalization values

Clients often think of the value of certain assets as static.  Naturally, assets often change value.  Sometimes, the client’s intention is to treat two beneficiaries equally by gifting two similarly valued assets to two individuals.   That may be fine, absent a change in their relative value, a change that is almost guaranteed to occur.

Question 2: Is the overall intention to treat different beneficiaries relatively equally with gifts of specific assets?

3. Income Tax

Canada has a simple income tax regime on death.   Accrued capital gains on any assets are triggered and income tax must be paid.   The issue arises because, in the normal course, the income tax on all assets is paid from the residue of the estate. Thus, the beneficiary of the specific asset receives it at its full after-tax value, while the residuary beneficiaries bear the tax burden associated with that asset.   This is especially pronounced where the gift is of a registered investment such as an RRSP.  In that case, the residuary beneficiaries may pay more than 50% of the value of the RRSP in tax while the RRSP beneficiary receives the entire gross value (See my article in Lawyer's Daily on this issue).

This issue may arise whenever a specific asset is gifted to a beneficiary who is not the sole beneficiary of the estate.   Since the value of any specifically gifted asset can increase or decrease between the Will and death, it may not be easy to properly estimate the tax consequences at the time of death.

Question 3: Who should bear the income tax consequences of the specifically gifted asset?

4. Associated Debts

Some assets have “associated debts” such as a mortgage on real property or a margin account on an investment portfolio.   A gift of a specific asset gives rise to the question of how those associated debts should be dealt with.  In some cases, the default is that the property is gifted subject to the debts, such as with a devise of real property.  In others, those debts may be payable from the rest of the estate, subject to any specific provision in the Will.

Question 4: How should the Associated Debts be dealt with?

5. Transactional Costs

There are often transactional costs whenever assets are gifted by Will.  Like income tax, those transactional costs are usually paid out of the estate to the detriment of the residuary beneficiaries. 

Some of them may be minor, such as the cost of shipping a specific asset to the beneficiaries.  Others may be more substantial.   There may be Estate Administration Tax on the value of the asset at 1.5%, executors’ compensation of up to 5% and legal fees in transferring title to the beneficiaries. 

Question 5: Who should bear the Transactional Costs related to the specifically gifted asset?

These are the kinds of issues that should be raised with clients who think that they have a “simple” plan for their wills.

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This blog was first published in The Lawyer's Daily Monday, February 05, 2018