Back in the day, there was a simple model for family inheritances. On the death of a spouse, the family assets were transferred on a tax-free basis to the surviving spouse. Upon the death of the second spouse, the assets were equally split between the children. There have been changes in the traditional model based upon a number of factors, including:
• Divorces and second marriage have changed the dynamics of asset distributions. Many individuals place a greater emphasis on the needs of their children, as compared to step-children. For example, if a man had two children from his first marriage and the second marriage brought three stepchildren into the family, he may prioritize the children of his first family from an inheritance perspective. In many cases, children from the first marriage may be ranked higher than the new spouse. Such issues can be managed with a spousal trust, but that is a topic for another day.
• Parents are challenging the assumption that all children should receive an equal inheritance. Perhaps one child married a surgeon while the other is a struggling single mother and therefore their financial needs are very different. Should a parent split the inheritance equally or provide additional assistance to the child with the greatest needs? If the struggling child receives a larger inheritance based on her needs, are the parents punishing success?
• Many retired families have sufficient resources to fund their remaining years and are prepared to distribute the children’s inheritance before they die. If a family waits until the last spouse dies, the children may be retired before they received their inheritance. The children could best utilize their inheritance when they were struggling with a mortgage, raising a family and paying for their children’s education.
In addition to the financial advantages that will accrue to the children, the parents will also receive certain benefits. It will result in a tax reduction for the parents as their investment income will decline with a prepayment. A smaller estate will result in lower probate fees if the family has not implemented a strategy to reduce or eliminate provincial probate fees. Perhaps the great joy of this strategy is the satisfaction gained by watching their children and grandchildren enjoy the money.
If a family decides to prepay their children’s inheritance, what options are available? The easiest strategy is an outright gift that lets the children decide how the funds should be spent. If the parents are concerned about their children getting divorced and the inheritance going to a son or daughter in law, the gift can be structured to avoid this possibility. Other options include eliminating their children’s mortgage, or the payment of an amount equal to the available contribution room in the children’s Tax Free Savings Account or Registered Retirement Savings Plan. Another option is to establish a Registered Educational Savings Account for the grandchildren with a lump sum payment.
Two possible complications for parents prepaying an inheritance are the unequal needs of their children or concerns with the financial immaturity of one child. One technique to resolve these issues has been called the “godfather” approach to inheritances. The parents have four children who have unique financial needs and levels of maturity. They advised their children they will distribute cash to the children as they need it. However, every cent that has been transferred will be considered as a loan. On the assumption the children do nothing to annoy the parents, the loans will be forgiven. A ledge is kept of all money forwarded and the parents intend to even out the payments in the final distribution of their estate.
The prepayment of an inheritance can be a godsend for children. However, as parents age, they may be less inclined to adopt this strategy. The prepayment strategy is an excellent discussion point for parents as they update their estate planning strategy.