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Chapter Eight: Who Actually owns the Inheritance?

Chapter Eight: Who Actually Owns The Inheritance?

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The rest of the week was a real scorcher. The temperature was still in the mid-thirties, but there was no wind, not even a breeze.

David and Alice were coming up for a week of holidays, so they had planned to get away early on Friday afternoon to beat the traffic. We figured we had lost our babysitters because Scott and Jan were staying in the city this weekend. They said it was because they were putting in extra time at their summer jobs, but apparently, there was also a big party in the works.

When I saw the boat come into the bay, I dashed up to the cottage to get a couple of cold beers for David and Alice. They looked pretty haggard from the heat as they unloaded their gear. David was still wearing his dress pants, so Alice must have picked him up at the office.

“You guys sure picked a good week for your holidays,” David said wearily. “The humidity in the city was a killer.”

“I know,” I replied. “I feel sorry for your poor kids. Imagine being a teenager and having to stay home in this humidity with the run of a big air-conditioned house and nothing to do but party with all your friends.” I was trying to get Alice’s goat, but it wasn’t working.

“You’re right, Jack,” she said, rolling her eyes. “They’ve got it as tough as you did when you were sixteen and had to work up here all summer.”

“Yeah, it was tough all right,” I admitted. “All those parties and no supervision. I remember one time …” Something in the look on Sandra’s face stopped me dead in my tracks.

David started to laugh. “Some code of silence! You keep breaking it on yourself, you big dummy!”

I thought I could save the day by changing the subject, so I turned to David and said, “The Tiger-Cats play the Argos tonight. One of my old college buddy’s son has been really playing well lately.”

“Jack, Jack, Jack,” Alice interjected. “Enough already. We’ve all had it up to here with your stories about your buddies and the so-called glory days!”

“Well, Alice, at least I had some glory days.”

BREAKFAST

With the heat and humidity, Sandra and I woke up feeling groggy, so we decided to shake out the cobwebs with a quick dip. At the dock, we saw Aunt Lorraine take the plunge, while Mark waded in step by step. I could never do that. It was like a slow death.

When we went back up, we saw Connor and Paige playing on the porch with Aunt Sally while David was fiddling with the barbecue.

“I hope Alice is cooking,” I said to him, “and by the way, you owe me five bucks. After you went to bed, the Cats kicked a field goal to win as time expired.”

“I’ll tell you what,” David replied, “either I’ll pay you, and you have to eat my cooking, or I’ll try to talk Alice into cooking. If I succeed, you forget about the five bucks. It’s your choice.”

“You really are a cheap son of a … oh, good morning, Connor. How’s my boy today?”

Mark’s sons were up this weekend with their girlfriends again, and they had offered to take Connor and Paige out for a boat ride during our planning session. Mark was delighted. He thought that an hour or two with a couple of kids might provide a good reality check for these young couples. If nothing else, it might put the brakes on all that kissy-face stuff.

They headed over as soon as they saw Uncle Wayne’s boat on the way. Alice had cooked (it was worth the five bucks), so David, Mark, and I were cleaning up the dishes. Aunt Lorraine figured she’d go back to her place for a bit of peace and quiet, and Sandra took our kids down to the dock so they could go off with their cousins.

She walked back up with Uncle Wayne, who was his usual boisterous self. “Good morning, campers! Let’s get rolling; I have a golf game today.”

“Since when don’t you have a golf game?” Sally asked.

“Since whenever I’m over here counselling all of you,” he said, putting Sally in her place. “For starters today, we’re going to talk about who legally owns the inheritance. Then we’ll get into estate planning and how to minimize probate fees and taxes using trusts.

“Now, I know this business about who really owns the money is emotionally loaded, but it’s something we have to address, given the high incidence of divorce these days.”

“Tell me about it,” said Mark.

“So here’s the big question,” Uncle Wayne continued. “If your marriages break up, or if Jack or David were to die, who does the inheritance belong to? Each couple is going to have to think long and hard about this and take some appropriate action after we investigate all sides of the issue.”

“David and I will never get divorced,” Alice protested.

“But there’s more at issue than our own marital status,” Mark said. “I plan to leave an inheritance for my boys, and let’s say they’re married when I die but get divorced later. I’d prefer to go to my grave knowing that the money I leave to my sons will be passed on to my grandchildren rather than thinking a bundle could go to some ex-wives someday”

“I hope your sons don’t follow in your footsteps when it comes to divorce,” Alice remarked, “but I see what you mean, and it’s close to home. So, Uncle Wayne, what kind of legal rights do Sandra and I have to the money that David and Jack inherited?”

“Well,” he answered, “an inheritance or gift given to one spouse by a third party is not considered to be part of his or her family property if received after the date of the marriage, so the other spouse has no claim to it as part of a divorce settlement. The same thing goes for proceeds from life insurance. However, the re-investment income earned from an inheritance, through investments and the like, is considered to be family property, unless the instructions in the will specifically prohibit this.”

“Let me see if I get this,” said David. “An inheritance or gift, if received after the marriage, is not part of the matrimonial property, but the income earned on the capital over time is. And the only way to get around it would be for someone like Dad to have specified in his will that the income earned from the inheritance is not to become family property, and this is normally a standard clause in professional wills.”

“That pretty well sums it up,” said Uncle Wayne.

“And also,” continued Alice, “when Mark gets around to changing his will, he should insert a clause stating that any income earned on the inheritance he leaves to each of his sons is for their use only.”

“I guess we should all put that kind of condition in our wills,” I added. “But what happens in a case like mine and Sandra’s, where we’ve used the inheritance for our mutual benefit? As you know, we’ve paid off our mortgage and have topped up our RRSPs. How does the inheritance stay separate under those circumstances?”

“Let me try to answer that,” said Sally. “I had a call from my lawyer friend this week. He said that once you’ve started using the money for the benefit of both partners, such as paying off the mortgage or purchasing a matrimonial home, then it’s pretty much-considered family property, and the value of the joint benefit would be split 50/50 in a divorce. If the spouse who originally inherited the money wants to prevent this, they could have a marriage contract signed, and/or he or she could try to keep the inheritance in his or her own name and segregated from any other assets, especially assets owned jointly.”

“But Uncle Wayne has been advising us all summer to do exactly those things,” I complained. “And now you’re telling me that by doing what makes the most financial

sense, I’ve made it possible for Sandra to take half of the money from Dad’s will with her if she decides to leave me! Great. Is there any way to ensure that the inheritance will go to Connor and Paige someday? Frankly, if Sandra does leave me for some young stud, I don’t want her to have enough money to set up housekeeping in some Mediterranean villa!”

“The chances of my leaving you would go down considerably if you’d stop talking about your past moonlight cruises,” Sandra joked.

At least, I think she was joking.

“But seriously,” she continued, “I’m sure we’ve done the right thing by taking Uncle Wayne’s advice to heart. It wouldn’t have made sense to keep paying interest on a mortgage while we were sitting on a substantial amount of cash. And there must be some way to make sure Connor and Paige get the full benefit of the money left to you by your dad.”

Uncle Wayne watched to see if anyone would step forward with a proposal, and sure enough, Alice did.

“How’s this for a solution?” she wondered. “Since much of the inheritance, in Jack’s case, was used for the house, couldn’t Jack and Sandra change the ownership papers? If they became tenants-in-common rather than joint tenants, and if Sandra and Jack signed a marital agreement in which Sandra agreed that she was only entitled to 25% of the house, for example, then Jack could make sure he could get his money out if they ever divorced, and leave his portion to the kids in his will. They could also make sure the money used to top up the RRSPs would go to the kids if Jack died by naming the kids as the beneficiaries.”

“That’s one way they could go at it,” Uncle Wayne said thoughtfully, “but it could get very complicated if Jack did die young. For example, would Sandra have to sell the house to make sure that the kids get the full value of Jack’s portion? And would selling the house be in the best interest of the kids? As for the RRSPs, your proposal may not be tax effective. When children over the age of eighteen inherit RRSPs, the plans are collapsed, and the entire RRSP amount is taxed as part of the deceased person’s income at the date of death, so in Jack’s case, half of the money would go to the government.”

“Hey,” I said, feeling more than a little hurt, “it’s bad enough that I’m always the one who has to die. Now you’re saying I must die before the kids are eighteen. That’s not fair.”

“Well,” David remarked, “if Jack’s going to be selfish and refuse to die young, then we’ll have to find another way to protect our inheritances for the eventual use of our kids. What can we do, other than keeping it separate from family property?”

“I think it’s safe to say that you and Jack will probably stay married to Alice and Sandra,”

Uncle Wayne answered, “So your best bet is to follow the strategies we’ve been discussing this summer. However, there are several things you can do to keep parts of the inheritance out of the realm of family property and make sure that the value is passed on to your children.

  1. Keep good records of precisely how the inheritance was utilized.
  2. Any investments made directly with capital from the inheritance should be in Jack’s or David’s name only. We discussed earlier that the spouse in the lower tax bracket should make the monthly investments, but due to the attribution rules, this only works when investing money earned from income when both people work, not a lump sum that belongs to one spouse. However, both David and Jack could create spousal trusts in their wills so that Sandra and Alice could use the income from the investments for living expenses, while the principal itself is willed to the kids when Alice and Sandra die. I’ll go into more detail on trusts a bit later.
  3. You can earmark some of the money as a gift you give to the kids now, in trust.
  4. You could add up all the money from the inheritance that was used to pay off the mortgage or other debts, or for RRSPs or anything else, and take out a permanent life insurance policy on David or Jack for that amount, with the kids named as the beneficiaries.

“For example, if Jack has spent $100,000 of his inheritance to pay off the old mortgage and top up RRSPs, plus another $50,000 on a new house, he would get a permanent life Insurance contract worth $150,000, with Connor and Paige as the beneficiaries. You should check that the structure of the contract lets you pay off and own the policy in about twenty years and that the money will grow with inflation over that period of time. In addition, you might want to consider having the kids actually ‘own’ the policy as well as being the beneficiaries. This would ensure that in the divorce scenario, we discussed, Jack or David wouldn’t be forced to pay money to Sandra or Alice based on the cash surrender value of the insurance policy. If the kids are going to own the policy, watch out for the attribution rules, as they tend to get you every time.

“If you follow these steps, you can be sure that the money your dad left will eventually go to his grandchildren, which I’m sure is what he would have wanted.”

“I understand the logic behind all this,” Sandra said, “but Jack and I will never get divorced. If Jack dies first, I’ll leave everything to Connor and Paige anyway, so why should we spend money on life insurance?”

“The odds are good that you won’t get divorced,” Uncle Wayne agreed, “but if Jack dies tomorrow, I think the odds are just as good that you’d eventually remarry. And if the inheritance was in your hands at that point, it could become part of the family property of that marriage. And suppose you had more children? It’s entirely possible that Connor and Paige might see only 25% of their granddad’s money. However, if you act now to protect the value of the inheritance with life insurance, you will guarantee that the

money goes to them, and the whole process is much cleaner.”

“And since we’re all saving money by having paid off our debts,” Alice added, “the insurance premiums won’t be a financial burden.”

“I kind of like this plan,” admitted David. “It combines the best of both worlds. We can structure our current finances to take advantage of the inheritance and still ensure that an amount equivalent to the original capital is passed on to our children, regardless of what happens in our lives.”

“I agree,” Sandra nodded, “and Jack, I’m sure your dad would approve as well.”

“It’s not that I feel left out or anything, but what about Sally and me?” Mark asked. “I’m not planning on getting married again, but heck, you never know. And Sal’s bound to tie the knot someday. Should we be taking any special steps to protect our inheritance?”

“I asked my lawyer friend the very same question,” Sally said. “He advised that I insist on a domestic or marriage contract that excludes all prior assets from becoming family property if I ever decide to marry. I reacted by saying it would feel awkward and that a prospective spouse might find it pretty insulting, but he said I’d be surprised at how many people sign contracts like that these days. He also said it helps if you explain that you’re safeguarding the inheritance for the next generation.”

“You’re getting good at this,” praised Mark. “I suppose we could also make use of permanent life insurance to be certain that the entire value of the inheritance is passed on to our kids too.”

“A few weeks back, you told us that term insurance is cheaper,” I said to Uncle Wayne, “and I just bought a bunch of it. Now you’re recommending permanent life insurance. Please don’t tell me I did the wrong thing again!”

“Relax, Jack, and remember what each type of insurance is for. Term insurance is cheaper for the ten to twenty-year period when you want to provide enough capital so that the income from investments would support your dependents if you died. You’ll need less of this insurance as your other assets appreciate over time, plus the need will disappear altogether at the end of twenty years because Sandra and the kids will be capable of supporting themselves.

“However, the need to protect the value of your inheritance so that it passes on to your kids is an ongoing requirement. It doesn’t end after ten or even twenty years, so you want an insurance policy that builds value and keeps pace with inflation. You can’t get that with term insurance, but you can with permanent life if the contract is structured properly.

“And now, if there are no more questions about this, I’d like to take a break. Let’s get some more coffee before we finish off estate planning.”

“I do have a question,” Alice said. “Since he can’t even get a date, what makes Mark think he has even a remote chance of ever getting married again?”

For more information, you can refer to Preserving Wealth: The Next Generation – The definitive guide to protecting, investing, and transferring wealth by Jack Lumsden, MBA, CFP®

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