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Advisors be warned: diligent estate planning is required for common-law couples due to the complexity of their situations.
Estate planning often goes awry as some common-law partners “fall into the arrangement” and aren’t sure how things will ultimately work out with the relationship, says Kevin Wark, managing partner of Integrated Estate Solutions in Toronto and the author of The Essential Canadian Guide to Estate Planning – 2nd Edition. Suddenly it’s five or 10 years later and no planning has taken place as the relationship has evolved to a permanent arrangement.
Although the federal Income Tax Act generally treats married and common-law spouses similarly for tax purposes, that’s not necessarily the case with respect to the division of property on separation or death under provincial family law legislation, Mr. Wark says.
“For example, in Ontario, there’s no automatic entitlement of splitting family assets on separation or death for common-law partners, even though they may have been living together for 20-plus years,” he says.
Below are three key issues advisors and financial planners should keep in mind for their affected clients.
1. Dying without a will or power of attorney
Having updated will and power of attorney documents is paramount for common-law partners who, otherwise, could find themselves disinherited without these legally bound documents.
Many common-law partners assume when their partner passes away, they, as the surviving partner, will inherit the assets automatically under intestacy rules – a provincially defined calculation that determines who will receive the deceased’s assets when there’s no will. But in some provinces, married couples and common-law couples are not seen as synonymous, which would leave common-law partners with nothing, says Wilmot George, vice-president of tax, retirement and estate planning at CI Global Asset Management in Toronto.
“Having a will is important if you want to provide for that common-law partner after death,” he says. “Married spouses and children often inherit under intestacy rules but, depending on the province, common-law partners might not.”
Furthermore, unfavourable tax implications could also result. For example, because a common-law partner is not considered next of kin for intestacy purposes in some provinces, there may be cases in which a child or another family member of the deceased inherits the estate, creating a potential tax issue.
When married or common-law partner spouses inherit directly, assets can roll over to the surviving spouse or partner tax-free, but that’s not generally the case with children or family members, Mr. George explains. The end result is the estate facing an immediate tax liability, he adds.
Who manages the deceased common-law partner’s estate in the absence of a will is another issue.
As common-law partners might not be deemed next of kin, Mr. George notes that courts might not appoint the surviving common-law spouse as the estate administrator. Having a completed will reduce this risk as well as the risk of estate challenges from other family members, he adds.
Without completed powers of attorney documents, another family member could be appointed to make financial and health care decisions, Mr. George says.
2. Division of property
If a common-law couple wants to own property, such as a house, it may make sense for them to own it jointly.
“If it’s a long-term relationship and it’s clear they’re going to stay together, joint ownership would allow the property to pass to the surviving common-law partner automatically,” Mr. Wark says.
Holding the asset jointly also bypasses the estate and if it’s a principal residence, passes to the common-law partner tax-free.
Cohabitation agreements or up-to-date wills are other options that would allow the couple to address property division issues on separation or death, which could be helpful where one partner owns the house or has significantly more financial resources than the other partner.
3. Beneficiary designations
Mr. George advises that common-law partners ensure their beneficiary designations are up-to-date for their registered accounts such as their tax-free savings account, registered retirement savings plan (RRSP) or registered retirement income fund (RRIF). When doing so, assets would normally go directly to the beneficiary.
But in the case of separated common-law partners who purposely continue to be beneficiaries, unintended tax consequences can arise. Unlike married separated people, there is no tax-deferred rollover opportunity for separated common-law partners. So, a tax bill for RRSPs and RRIFs would flow to the deceased’s estate.
Mr. Wark also recommends naming a common-law partner as the beneficiary on any life insurance policy owned by the other partner, as that money pays out tax-free to the beneficiary immediately upon death. He adds the insurance beneficiary designation could be done irrevocably to protect the surviving common-law partner further.
Additional complications can arise if one or both partners may have been divorced or widowed previously and have children from the first marriage. There may be financial obligations to the ex-spouse or children that also need to be factored into the planning arrangements involving the new partner.
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