Case study: Estate planning when one spouse has a terminal illness

Some married couples delay drafting wills, believing their assets automatically transfer to the surviving spouse. However, there are various advantages to having a will in place.

A will can be considered a final gift for your family, outlining your wishes for your legacy and providing your family with a roadmap to follow.

This case study looks at what happens when a spouse is diagnosed with a terminal illness. It outlines steps to help ensure the surviving partner is taken care of and the deceased partner’s wishes are fulfilled.

The situation

Alex and Jamie have been married for 10 years and recently sold a successful technology business. They are both residents of Canada for tax purposes and are not U.S. citizens or green card holders.

Alex was recently diagnosed with a terminal illness and is expected to survive for just three to six months. Neither Alex nor Jamie has a will, nor do they have any children. They both expect Alex’s assets will automatically go to Jamie.

The couple have agreed that Jamie will manage the assets after Alex’s death and fulfill the wishes Alex has verbally expressed. This includes making significant donations to the university where they met and obtained their degrees.

The couple’s assets currently consist of the following:

• Jointly owned principal residence in Ontario
• Jointly owned vacation property in Colorado, U.S.
• Registered Retirement Savings Plan (RRSP) for Alex, with Alex’s niece named as beneficiary; Alex’s niece is a resident of Canada for tax purposes
• RRSP for Jamie, with Jamie’s brother named as beneficiary
• Tax-Free Savings Account (TFSA), with each other named as beneficiaries
• Non-registered investment accounts each in their sole names
• Life insurance policy for Alex, with Alex’s niece named as beneficiary

The challenges

Alex and Jamie need to consider the tax implications and other issues on Alex’s passing. 

From a tax perspective, one is deemed to have disposed of all their assets upon passing away. These assets may pass to a surviving spouse at their adjusted cost base (i.e. on a tax-deferred basis).

Assets passing to individuals other than a surviving spouse will be deemed to be disposed of at fair market value, potentially resulting in a taxable capital gain on the departed’s final (terminal) personal income tax return.

These considerations will have a significant impact on Alex’s beneficiaries.

Principal residence

There will be no immediate income tax issue with Alex and Jamie’s jointly-owned principal residence. Alex’s interest in the property will pass to Jamie at the adjusted cost base. This will defer taxes until Jamie chooses to sell or when the property passes into Jamie’s future estate.

When one of the homes is sold in the future, a decision will be made as to which property will be designated as Jamie’s principal residence for each year of ownership. The principal residence exemption may be used to offset the taxes on the capital gain (the difference between the adjusted cost base and proceeds of disposition) in the year of the sale.

U.S. property

The jointly owned property in Colorado may require a separate estate filing in the U.S. and may generate a tax liability on Alex’s passing. Alex and Jamie should review their purchase agreements with legal and accounting tax advisors as soon as possible to determine their filing obligations, potential tax liabilities and timing. 

RRSP

An RRSP can pass to a surviving spouse — as a qualifying survivor — on a tax-deferred basis. Funds will be taxed as income in the surviving spouse’s income tax return as they are withdrawn in the future.

However, Alex’s niece is the named beneficiary and is not a qualifying survivor. This means that although the RRSP will pass in full to Alex’s niece, the funds will be taxed on the terminal personal tax return, payable by Alex’s estate. 

Life insurance

Alex’s life insurance will be paid directly to Alex’s niece as the named beneficiary. No income tax consequences are expected for Alex’s niece upon receiving the life insurance proceeds.

TFSA

The TFSA account has Jamie named as a successor beneficiary. This account balance may be transferred to Jamie’s TFSA account or withdrawn — either option would be on a tax-free basis.

Other investments

Alex’s accountant has noted that Alex has significant capital losses from previous years that have not been utilized.

Upon Alex’s death, the non-registered investments may pass to Jamie at Alex’s adjusted cost base. This defers the taxes on the increase in value of the investments (i.e. the capital gain) until Jamie sells the investments or they pass into Jamie’s future estate.

Alex may choose to gift some of the investments to Jamie at fair market value during Alex’s lifetime. This would enable Alex to utilize any unused capital losses to offset the capital gains.

Alternatively, Jamie may elect to report the deemed disposition of a portion of the investments at fair market value on Alex’s terminal personal income tax return to utilize the capital losses.

Charitable intent

Alex wishes to make donations to the university where the couple met and obtained their degrees. Alex’s will should outline these intentions and give the executor flexibility to make donations of assets in-kind, such as shares from Alex’s non-registered investment portfolio.

This will allow Jamie to fulfil this wish in the most tax-effective way possible.

Moving forward

Alex and Jamie should meet with a lawyer immediately to draft a will and other recommended documents to define their wishes — including the distribution of assets upon their death, and how to deal with issues during an illness and at the end of life.

Alex should consult with tax advisors to consider any pre-planning that would be beneficial. The couple should confirm all wishes are drafted in such a way that post-mortem tax planning may be implemented effectively.

Every family’s situation and needs are unique. We suggest you consult with an experienced tax and legal advisor to develop and monitor your estate plan to ensure it continues to meet your and your family’s needs.