The article “For Common-Law Couples, Estate Planning Is Full Of Pitfalls. Here’s How To Avoid Some Of Them” was originally published on Financial Post on April 16, 2019.
Couples who are common-law can have a unique set of financial planning challenges that differ from their longtime, first-marriage counterparts.
Statistics show that more Canadians are divorcing, remarrying and living common-law than in the past. Couples in second marriages or who are common-law can have a unique set of financial planning challenges that differ from their longtime, first-marriage counterparts. Perhaps the most difficult issue is the one that nobody likes to talk about — estate planning.
Polls suggest about half of Canadians have no will. Talking about dying and proactively planning for it can be difficult, but it is easier for married couples who started with nothing and built their nest egg together.
Common-law couples and those who remarry may manage their financial affairs separately. They may bring uneven assets or incomes into their relationship. They may have uneven expenses for their children, an uneven number of children, or ongoing support obligations for a former spouse.
Here are some of the most common estate planning mistakes made by these couples and how to avoid them.
Joint ownership of real estate
It is not uncommon for common-law spouses and couples in second marriages to hold real estate as tenants in common, particularly if they have children from other relationships. This differs from the typical joint ownership structure called joint tenancy, whereby a survivor becomes the sole owner of an asset upon the death of the other owner. As tenants in common, both parties can own a separate interest in a home, the ownership of which can be transferred by an individual to whomever they wish.
As an example, a couple might each own half of a home as tenants in common, and both might leave their 50 per cent share to their children in their wills. Upon the death of the first partner, their children might end up as co-owners of a home with their step-parent. In the absence of a provision in a will, this could present an awkward situation for the survivor and the children of the deceased.
One solution may be to include a clause in a will permitting a surviving partner to stay in the home for a predetermined time afterwards, so they are not forced to sell their home and move while mourning a loss. It is important to include conditions in a will about who is responsible for the ongoing expenses in the interim, and how the value is to be determined if the survivor decides to purchase half of the home from the children of the deceased.
One valuation option may be to obtain two independent appraisals, with the purchase price being the midpoint of the two. A notional real estate commission based on the customary rate in the province of residence could also potentially be included in this calculation.
Leaving too much or too little to the survivor
The Goldilocks principle often applies to estate planning for couples who each have their own children. They must find the right mix of beneficiary designations so that neither too much, nor too little, but just the right amount of inheritance is left to all parties. This really is more art than science, as the only allocations that may be somewhat predetermined relate to potential family law requirements and minimum inheritances that may apply between spouses in certain provinces.
There are real and perceived risks of leaving everything to a surviving spouse or common-law partner who is a step-parent to your children. In the absence of establishing a trust in your will, or preparing mutual wills, there may be nothing stopping a survivor from gifting assets during their life or upon their death in such a way that you may not have anticipated. They may even get into a new relationship after your death that significantly changes how their assets are ultimately expended or distributed.
There is also the risk of how your children could perceive your partner if they inherit everything, at the expense of your kids, even if your children may someday inherit from them.
At the other extreme, if you do not provide sufficiently for your partner in your will, they could be in an unfortunate financial position as a result of your death. If a couple has one partner with less assets as retirement approaches, they may feel compelled to work longer than they would otherwise if they had more confidence in their financial security in the event the other partner died. Or they may compromise their spending in retirement in order to preserve their assets, to the detriment of a mutually happy retirement.
As a result, it can be vitally important to think about and talk about how assets will be distributed upon death in order to find a happy medium.
Leaving the wrong assets to the survivor
Certain types of assets can pass more efficiently to a surviving spouse or common-law partner than to children. Registered Retirement Savings Plan (RRSPs) and Registered Retirement Income Funds (RRIFs) can be transferred on a tax-deferred basis to a spouse or common-law partner upon death. If these accounts are instead payable to children, they become fully taxable upon death, unless an account is left to a financially dependent child or grandchild who lived with the deceased and whose income was below certain thresholds.
Tax Free Savings Accounts (TFSAs) can also be transferred into a surviving spouse or common-law partner’s TFSA without affecting their TFSA room, creating more tax-free investment opportunities for them. A TFSA left to a non-spouse beneficiary is no longer tax-free for the beneficiaries.
RRSPs, RRIFs and TFSAs should not necessarily be left to a surviving partner simply to save tax. However, considering which assets to leave to whom when there is a desire and a choice is an important estate planning exercise.
This is hardly an exhaustive discussion of the estate planning challenges or opportunities for those in a second marriage or common-law relationship. It is important to appreciate the unique circumstances facing these couples. Avoiding talking about or not planning for death will not make us immortal. And not addressing these issues while you are alive can lead to problems for those you love most after you are gone.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.