How to Ensure a Smooth Transition of Real Estate to the Next Generation

Ensuring a Smooth Transition of Real Estate

Mr. and Mrs. Reynolds are a 60-year-old cou­ple who have saved, in­vested, and built a sig­nif­i­cant and di­ver­si­fied port­fo­lio of in­vest­ments for them­selves.

They’ve ac­cu­mu­lated a va­ri­ety of as­sets in­clud­ing stocks, cur­ren­cies, com­modi­ties, and of course a di­ver­si­fied port­fo­lio of real-es­tate.

THE PROB­LEM

The Reynolds have a com­plex es­tate with mul­ti­ple con­sid­er­a­tions that are be­yond the scope of this case study. However, they do have one is­sue that we will cover…

The fam­ily cot­tage was pur­chased 10 years ago for $500,000. It quickly be­came a cen­tral fea­ture in the fam­i­ly’s so­cial life.

The kids were in their late teens and early twen­ties when the Reynolds bought the prop­erty, and it is put to good use.

What’s more, the neigh­bor­hood they are in has boomed over the years with an in­flux of high-net-worth fam­i­lies pur­chas­ing ad­ja­cent prop­er­ties and build­ing/​ren­o­vat­ing their own beau­ti­ful cot­tages.

The Reynold’s lake­front prop­erty is in high de­mand, but the Reynolds have no de­sire to ever let the prop­erty go.

Further, the kids love it. They want to en­sure they keep it in the fam­ily for gen­er­a­tions to come.

TAXES, TAXES, AND MORE TAXES

So, here’s the prob­lem: Taxes.

It’s well known that spouses can hor­i­zon­tally trans­fer their es­tates to each other with­out trig­ger­ing taxes at death. However, in­ter­gen­er­a­tional trans­fers trig­ger tax.

How much tax? Let’s look at the pro­jected taxes ow­ing on the Reynolds’ cot­tage:

Based on a mod­est 4% an­nual pro­jected growth rate in the value of the prop­erty we are look­ing at a tax bill of $573,000.

That’s a lot, and that’s ONLY on the cot­tage!

THE SO­LU­TION

Coming to grips with the tax pro­jec­tion was dif­fi­cult. There were very few so­lu­tions avail­able other than sav­ing the money to fund the tax bill.

The Reynolds had other plans for their other as­sets and were not in­ter­ested in hav­ing the chil­dren fund the even­tual tax bill, nor were they in­ter­ested in forc­ing the chil­dren to re-fi­nance the prop­erty at their even­tual deaths.

The cou­ple was in a good fi­nan­cial po­si­tion, they were both still work­ing and earn­ing a strong liv­ing. They car­ried no per­sonal debts other than mort­gages on rental prop­er­ties. They had am­ple sav­ings and cash-flow and were in­ter­ested in an es­tate trans­fer so­lu­tion that was:

1. As close to guar­an­teed as pos­si­ble to work
2. Presented as close to zero chance of loss as pos­si­ble

Traditional so­lu­tions that met their needs were GICs and fixed-in­come se­cu­ri­ties. But there were two prob­lems with these:

1. They were hor­ri­bly tax in­ef­fi­cient
2. They were not pro­jected to re­turn much at all

For ex­am­ple, ac­cord­ing to FP Canada Standards Council’s 2022 Projection Assumption Guidelines, GICs and other “cash” type of in­vest­ments had a long term pro­jected an­nual re­turn of 2.3% and fixed in­come of 2.8%.

Considering the Reynolds’ tax bracket, their net, af­ter-tax re­turns were pro­jected at 0.98% and 1.3% re­spec­tively. The same guide­lines pro­ject long term in­fla­tion at above 2%.

The out­look was bleak.

UNIVERSAL LIFE IN­SUR­ANCE

The Reynolds be­gan look­ing at life in­sur­ance prod­ucts to help solve their prob­lem. They had ex­pe­ri­ence with more tra­di­tional poli­cies such as term and whole life poli­cies and in fact owned each. Their term poli­cies were set to ex­pire and their whole life pol­icy was al­ready paid up and ear-marked for other pur­poses.

However, nei­ther of these types of fi­nan­cial prod­ucts were ad­e­quate for their needs.

1. Term in­sur­ance was not per­ma­nent, they needed per­ma­nent cov­er­age to meet their fu­ture tax oblig­a­tion
2. Whole life in­sur­ance, al­though at­trac­tive, was more ex­pen­sive than they were pre­pared for

In came Universal Life (UL).

Universal life Insurance is a hy­brid fi­nan­cial prod­uct that com­bines life­time in­sur­ance cov­er­age with the long-term growth po­ten­tial of tax-ad­van­taged in­vest­ing.

At its core, it is a per­ma­nent life in­sur­ance pol­icy that al­lows you to over-con­tribute to a tax-free in­vest­ment ac­count based on leg­isla­tive lim­its.

Now, the Reynolds were not cur­rently in­ter­ested in the in­vest­ment ac­count, they al­ready had a di­ver­si­fied port­fo­lio of in­vest­ments. They were, how­ever, in­ter­ested in the fol­low­ing fea­tures:

1. Lifetime Coverage: for a fixed pre­mium, UL poli­cies can be de­signed to pro­vide a fixed ben­e­fit for life that can­not be can­celled or changed
2. Tax-Free Benefit: the death ben­e­fit of a UL pol­icy, when stripped away from com­plex­i­ties, is re­ceived by the es­tate or ben­e­fi­cia­ries tax-free
3. Death Benefit Options: UL poli­cies can be struc­tured to have level or in­creas­ing pro­tec­tion. The level pro­tec­tion fea­ture was at­trac­tive to them.
4. Flexibility: With their other poli­cies paid-up and no re­main­ing op­tion to in­crease cov­er­age, the cou­ple found it ben­e­fi­cial that the UL pol­icy did pro­vide the op­tion for ad­di­tional con­tri­bu­tions down the road.

THE POL­ICY

The Reynolds set­tled on a Universal Life Policy with the fol­low­ing char­ac­ter­is­tics:

• Fixed amount of per­ma­nent in­sur­ance: $573,000
• Joint last-to-die, costs to last death
  • This led to a Joint equiv­a­lent age of 49!
• Level cost of in­sur­ance to age 100

The over­all cost of the pol­icy was $8,619.60 per year.

In com­par­i­son to their al­ter­na­tives (GICs and fixed in­come) it was a no-brainer…

The UL pol­icy gave them ex­actly what they needed…

• Guaranteed re­sults
• No guess­ing
• Tax-efficient re­sults
• Flexibility to im­prove the re­sults if needed

The PRE-TAX equiv­a­lent rate of re­turn re­quired to match the UL pol­i­cy’s pro­jected per­for­mance would be 15.81%. Not sure if you’ve checked GIC rates re­cently, but that’s highly un­likely.