Ensuring Financial Stability After Death: The Critical Role of Estate Cash Flow Planning

Estate Planning – Cash Flow After Death

There is significant emphasis placed on cash flow planning during a client’s lifetime but what is often overlooked is planning for cash flow after death.

Because death triggers a series of tax implications that can significantly impact estate value, planning for proper estate distribution is important to safeguard the financial well-being of the estate and heirs to make sure that there is enough cash to cover tax owing as well as distribute assets to beneficiaries.

To effectively plan for cash flow, as Investment Advisors we need to understand the estate’s assets, liabilities and distribution of assets per a client’s Will. This is an integral part of Estate planning. In rare cases where we don't oversee all of our clients' assets, we at the very least need to have a very clear understanding of what makes up the total estate so we can plan and organize accordingly.

Let’s review an example of a factitious client scenario where proper cashflow planning was not considered for a client.

Sarah was the sole beneficiary of her deceased mother’s RRIF. Because a registered account falls outside of the Will, the account is left directly to the beneficiary. The account was valued at over $500,000. Sarah’s mother owned a cottage joint with her sister Emily – Sarah’s aunt. That asset also bypassed the Will and Emily became the sole owner of the property upon her sister’s death. Sara’s mother had a bank account with roughly $10,000 in cash, this was the only asset the Will addressed. Sara received the proceeds directly from the institution where it was invested and used the funds to pay off all her debt and contribute to her own RRSP.

14 months later, the executor settling her mother’s estate advised Sarah that she will need to pay back some of the RRIF funds because the estate had insufficient cash to pay its sizable tax liability from the RRIF account. Remember upon a taxpayer’s death, any registered accounts owned are deemed to be deregistered, and the value of any assets held within those accounts is included in income for that year. With a RRIF account valued at over $500,000, the tax bill in Ontario would be around half.

Sarah asks her own advisor at this point if her mother’s executor has made a mistake, how could this could be possible.

Under Subsection 160.2(2) of the Income Tax Act, a taxpayer who receives a benefit from an RRIF as a consequence of the annuitant’s death is jointly and severally liable with the annuitant for the income tax on the benefit arising at death.

In this case, Sarah is liable. She’ll have to take funds from her RRSP to pay the estate’s tax liability, resulting in a personal tax liability.

Failure to plan

The advisor was involved in probate planning, as a beneficiary designation for the registered account was a specified individual. But the mother’s cash flow plan stopped at death. Often times, people are more concerned about probate than proper planning.

Estate planning extends beyond distributing assets to beneficiaries and ensuring taxes are considered. It involves strategic distribution plans in concert with the estate project and administration plan. This could involve the management of outstanding debts, payments to preferred creditors, staggered distributions, charitable donations and bequests, and funding to testamentary trusts. Ensuring adequate liquidity is essential.

Also essential is regularly reviewing beneficiary designations. Outdated or incorrect designations can lead to complications and disputes during estate settlement. Possibly at one point in her lifetime there was enough cash to cover tax in her estate, but that wasn’t the case when she passed. Regular reviews are necessary to ensure the Will and estate is consistent with today’s assets, ensuring there is no concerns for an illiquid estate with a tax liability, like is Sarah’s mom’s case.

As Investment Advisors we traditionally focus on guiding clients through their financial journeys in life, extending professional guidance into the realm of cash flow planning at death is equally essential. Embracing this holistic approach ensures that the true value of financial advice continues to resonate long after a client’s passing.