The Best of The Blunt Bean Counter - Taking it to the Grave or Leaving it all to your Kids?

This summer I am posting the "best of" The Blunt Bean Counter blog while I work on my golf game. Today, I am re-posting a July 2011 post (originally written as a guest post for The Canadian Capitalist) on estate planning and the four groups (at the risk of stereotyping) that people seem to fall into, when dealing with their estate.

Next week I will have a re-post of  a blog on accessing the capital dividend account for those of you that have private corporations and then a three-part series on a true summer topic - the tax issues surrounding the sale and/or transfer of your cottage.

Taking it to the Grave or Leaving it all to your Kids?

I am often engaged to provide estate planning. Many "older" Canadians have amassed great wealth (some just through the sale of their home and/or cottage). A 2006 Decima Research study estimated that over one trillion dollars in wealth could be transferred between 2006-2026. After twenty-five years of discussions regarding the distribution of wealth, where an estate will clearly have excess funds when the parents pass away (to be clear, this post is only discussing situations where you are very certain you have more funds than you need to live, not situations where you may have excess funds when you pass away, but are not secure enough to distribute while alive) it is my opinion that the parents should consider partial gifts during their lifetime.

It is my observation from the 25 years of meetings that people form four distinct groups when it comes to distributing their excess wealth:

1. Those that will take their wealth to their grave (or leave it to their pet Chihuahua)
2. Those that will distribute their wealth only upon their death
3. Those that may not be able to afford their grave (as they give and give to their children)
4. The most common, the middle ground of the extremes, those who are willing to distribute their wealth, but in many cases harbour concerns their wealth will be “blown” or lead to unmotivated children.

In this blog, understanding my opinions may be diametrically opposed to some readers, I will talk about these varied groups.

Taking it to the Grave and Leaving Nada to Your Family

For those who wish to take their wealth to the grave, there may be an altruistic or philosophical reason. However, there is more often than not, a deep rooted family issue, and the chill in the room makes it very clear that advisors should stay clear of delving into these family issues (when I initially wrote this post, I was criticized by a reader for saying the advisor should stay clear in these cases. I now think they were correct. I can think of a specific case since I wrote this post in 2011 where I challenged a client on this and they made a change to their will not because they really wanted to, but because the change could possibly help avoid litigation down the road, despite it being distasteful to them). 

Distributing your Wealth upon your Death

In the case of those who wish to distribute their wealth upon their death, the issue is typically philosophical. That is, one or both of the parents feel that their children need to make their own way in the world and that leaving them money during their lifetime will do their children a disservice or destroy their moral compass. This is a touchy area, but I often suggest that if the parents feel their children are well-adjusted, they should consider providing partial inheritances. A partial inheritance can facilitate a child’s dream, such as climbing Mt. Kilimanjaro while the child is physically able, or assist with the down payment on a cottage. The selling point on partial distributions is that the parents can share vicariously in the joy of the experience they facilitate.

Giving your Kids too Much while Alive

In the third situation, the parents spend every spare nickel on their children’s private school, dance lessons, hockey teams, etc., while younger and then assist in buying houses, cars, etc., when their children are older. In these cases I suggest the parents pare back the funds they spend on their children and/or make the children contribute to their own activities. It is imperative the parents impart upon their children that they are not an ATM and that there are family budgetary limits to be adhered to, often easier said than done.

The Balanced Approach

The majority of families fall into the last category. They are willing to distribute their “excess” wealth while alive, but in many cases harbour concerns their wealth will be “blown” or lead to unmotivated children. Dr. Lee Hausner, an advisor to some of the wealthiest families in the United States, suggests in various articles of hers that I have read, that parents do not transfer money during career-building years so the children learn to be productive members of society. Children should be taught they have choices to make (ie: distribute money for one thing they want but not three things they want) and they should learn to be philanthropic amongst other things. I think this advice stands on its own whether you are one of the wealthiest families in the United States or just a family that has been lucky enough to accumulate more assets then you will ever require.

How one distributes their wealth is an extremely private issue and each individual has their own thoughts and reasons for their actions. However, in my opinion, where you have the financial wherewithal, you should consider making at least partial gifts during your lifetime.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.

Holy Hotchpot—Equalizing Uneven Advances to Children in your Will

Many parents stress unnecessarily, over how thy will equalize their wills, where they have made unequal gifts to their children during their lifetime. Don't fret; today I will discuss a simple "hotchpot clause" that can alleviate your concerns.

Families with the financial wherewithal often advance funds to their “financially dependent” children to fund their living expenses or help with the purchase of a house, to the exclusion of their financially "independent children". In many cases, parents assisting financially dependent children, have the expectation that when they pass away, the funds they have advanced during their lifetime to financially dependent children will be considered advanced on account of those children’s inheritances, not separate gifts above and beyond their inheritances.

I have clearly stated in two of my most read blogs, “Is it Morbid or Realistic to Plan for an Inheritance?” and “A Family Vacation – A Memory worth not Dying for" that where parents have the financial means, it is my opinion that they should consider making partial advances on account of an inheritance while alive. Some readers have stated that they do not agree with my views. However, for today, let’s suspend the debate on whether parents should or should not provide partial advances to their children and assume a situation where a parent has made unequal advances to their children during their lifetime and they want to equalize these advances in their will.

Over the years, a legal concept now commonly known as a “hotchpot clause” has evolved to deal with the equalization of the beneficiaries of an estate, where one or more of the beneficiaries have already received money during their parent’s lifetime. When a hotchpot clause is inserted in a will, the clause will prevent a beneficiary (typically a son or daughter) from “double dipping” where the parent intended any money advanced during their lifetime to be considered a pre-payment of an inheritance, rather than an advance over and above an intended inheritance.

This concept is best illustrated by an example.

Richie and Betty Rich have three children; RJ, Archie and Veronica. Richie and Betty have an estate of $1,000,000. Their son RJ runs a successful comic book store and makes a good living, but is by no means wealthy. Archie, the youngest, suffers from an entitlement issue and has never finished school nor held a full-time job. However, he has always been the apple of Betty’s eye and can do no wrong in his mothers' eyes. Veronica gave up a promising blogging career when she married, but unfortunately her marriage fell apart and her husband left her with two young children.

Over the past few years, Betty has advanced Archie over $100,000 to fund his snowboarding lifestyle. Furthermore, Richie and Betty both have felt the need to advance $200,000 to Veronica to fund the private school education of her children.

It is Richie and Betty’s intention to have their $1,000,000 estate split equally when they pass away, however, they want the funds previously advanced to Archie and Veronica to be accounted for, such that RJ gets 1/3 of their estate, including amounts previously advanced to Archie and Veronica.

If Richie and Betty were to die in a car accident today, their current will stipulates that their estate is to split equally amongst RJ, Archie and Veronica, such that each child would be entitled to $333,333 each ($1,000,000/3), which is not the intention of Richie and Betty.

However, if Richie and Betty had met with their lawyer before they died in the car accident, their lawyer could have inserted a hotchpot clause, such that their estate would be considered to have been $1,300,000 ($1,000,000 plus $100,000 advanced to Archie and $200,000 advanced to Veronica). Thus, when the estate was settled, RJ would receive $433,333 ($1,300,000/3), Archie would receive $333,333 ($433,333-$100,000) and Veronica would receive $233,333 ($433,333-$200,000).

To view an example of what a hotchpot clause may look like, please follow this link. A word of caution; you should always engage a lawyer to draft the clause, as a hotchpot clause must mesh with the rest of your will. 

“From the basis of equitable treatment between beneficiaries, a hotchpot clause is a useful tool” comments Albert Luk, a lawyer at Devry Smith Frank LLP and past contributor to my blog. “However, one must always be aware that a hotchpot clause requires evidence of provable advances to the beneficiaries. Bad (or no) book-keeping may render a hotchpot clause ineffective. The key is to keep good records.”

There is obviously no requirement for parents to be equal and fair to their beneficiaries. However, where parents intend to split their estate equally amongst their children/beneficiaries and yet, have made loans, advanced funds for house down payments or just advanced funds to their children in unequal amounts while alive, their estate planning must include the consideration of those gifts and loans (with proper evidence as noted by Albert Luk above) and they should ensure their lawyer has drafted a hotchpot clause.

Bloggers Note: If you are interested in delving deeper into this topic, Corina Weigl of Fasken Martineau DuMoulin LLP wrote a great paper on this topic in 2001.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.