For example, you might think it makes sense to simply leave everything to your spouse. However, this could lead to your own children getting nothing. To prevent this, you would need to customize your estate plan carefully, rather than putting all of your assets into joint ownership with your spouse or naming them as the sole beneficiary on assets that allow direct beneficiary designations, such as insurance policies.
What are beneficiary designations?
A direct beneficiary designation is when you name the person who will receive your RRSP, RRIF, TFSA or the money from a life insurance policy when you die. The money/assets don’t become part of your estate and will not be included in your will.
How estate planning for blended families can go wrong
Deciding on how you write your will and structure your estate can become complicated if you want your children from a previous relationship to receive a fair inheritance. Let’s look at a case study where a blended-family couple’s estate leaves out their children.
Pierre and Melissa are married, each having children from a previous relationship. Their home and non-registered investments are held jointly, and they’ve named each other as direct beneficiaries of their insurance policies, tax-free savings accounts and registered retirement savings plans. Here are some possible outcomes:
- If Pierre dies first, then Melissa will inherit everything, because nothing goes through his estate (his assets pass directly to the joint owner and beneficiary, which is Melissa). Even if Melissa’s will says that everything should be divided among her children, this would be interpreted as her natural or adopted children, not step-children. Pierre’s children would have to be named specifically in Melissa’s will if they are to receive their inheritance.
- If Pierre and Melissa sign wills which include provisions for all their children, and Pierre leaves everything to Melissa, her will could be voided if she remarries (depending on where she lives).
- If Melissa remarries without making a new will, she will effectively die intestate (if she lives in a province or territory where marriage revokes all previous wills). This would mean that all her assets would pass on to her new spouse and her own children.
- Even if Melissa does make a new will that includes Pierre’s children, her new spouse could still have a first claim against some (or all) of her estate. And if the stepchildren are not included in the will, they will likely receive nothing.
- If Pierre and Melissa want each other to be bound by their original wills, they both need to sign a contract agreeing not to change those wills after their spouse’s death. Otherwise, a court may not agree that the original will is still binding.
- Even if Pierre and Melissa sign wills that specifically include all of their children, and a contract agreeing not to change their will, it’s still possible for some of their children to be disinherited. For example, Melissa could remarry and then structure her affairs so that her new spouse receives everything outside of her estate (by adding him as a joint owner or direct beneficiary of her assets), effectively leaving nothing in her estate to give to Pierre’s children.
As you can see, if you leave everything to your spouse and you die first, you’ll have little control over whether your children receive any inheritance. The following strategies for estate planning for blended families can help prevent this from happening.
1 Spouse or common-law partner trusts
A spouse trust can name certain assets (such as a home) that the surviving spouse is entitled to use during their lifetime, but upon their death, pass on to the children from the previous relationship. The trust distributes the assets it holds according to the will of the spouse who died first (since those assets will never belong to the surviving spouse).
For this strategy to work, you also need to make sure that your assets go through your estate, meaning that they don’t pass automatically to the surviving spouse (as would be the case if you own assets jointly or name each other as beneficiaries for your TFSAs, etc.).
However, if the trust is not carefully drafted, there could be tax consequences when the first spouse dies. This is why it’s crucial that you speak to an experienced estate lawyer if you choose this option.
There are a number of reasons why using a spouse trust may not be a good idea:
- Given that the children will not receive the assets until the stepparent dies, they are not recommended if the new spouse is close in age to the children of the previous relationship.
- If the spouse has the right to withdraw money from the trust (which they will probably need in order to meet family property rights), there could be constant disagreements between the spouse and the children, as regards the amounts taken from the trust.
- Although your spouse will be liable for paying ongoing maintenance costs, your children will be liable for paying costs related to capital improvements, even though they won’t benefit from the asset until after the stepparent dies. Most children become quite resentful of having to maintain a property they don’t live in, and in fact, many of these properties become dilapidated when the children refuse to pay these costs.
Although there are instances where using a spouse trust may be recommended, they should be used with caution.
2 Dividing assets between your spouse and children
An alternative to a spouse trust is to leave a portion of your estate directly to your spouse and different assets directly to your children. However, a surviving spouse may have rights in certain provinces or territories, which could include applying for dependant’s relief (or wills variation, in BC) or an application for a division or equalization of family property. It can be difficult to disinherit a spouse, which is why it’s important to properly structure your will and ask your spouse to waive any rights to challenge it.
Leaving assets to anyone other than your spouse can also trigger tax liabilities, such as capital gains tax. Also, RRSPs and RRIFs left to your children will usually become taxable immediately (except in very limited circumstances).
Apart from assets and cash, you should also think about family mementos and heirlooms, which could have huge sentimental value for your children. Passing these on to your new spouse rather than your children could lead to disappointment, family tensions and even litigation. Ask your children if there are any items they’d like and then include them specifically in your will or give them to your children before you die.
When estate planning for your blended family, if you’d like to split the proceeds of your estate between your spouse and your children, speak with your financial advisor and an estate lawyer. The lawyer will be able to tell you how much of your estate your spouse will be legally entitled to, and your financial advisor can provide you with the approximate after-tax value of your estate, so you know how much you can leave to your kids.
3 Using life insurance to keep everyone happy
If you find you don’t have enough assets to pay what you’d like to leave to your spouse (or what they’re legally entitled to), plus what you’d like to leave to your children, life insurance could provide the difference and, in many cases, can be the simplest solution to this problem. It can allow both the surviving spouse and children from your previous relationship to each receive a portion of the estate, minimizing potential arguments.
You’ll need to be cautious if you have young children, however. If you name minors as beneficiaries of an insurance policy, the provincial government may have the power to manage the funds until they reach the age of majority, at which point your children will receive it all in one lump sum. It might be wiser to having the proceeds go into an insurance trust, managed by a family member, with funds given to your children over a period of time.
Discuss your will with your financial advisor
As we’ve seen, estate planning for blended families can become quite complex. You should speak to your IG Advisor to make sure your estate plan is structured in such a way that your spouse and children are both included. You should also structure your estate plan with the help of a lawyer with extensive estate planning experience, as laws can vary greatly depending on your province or territory.
If you have a bended family, arrange a meeting with your IG Advisor to discuss a suitable estate plan. If you don’t have an IG Advisor, you can find one here.
1 The information in this article is relevant for Canadian provinces and territories other than Québec. In Quebec, assets held in joint ownership do not have a right of survivorship, and direct beneficiary designations are only allowed on insurance products.
Written and published by IG Wealth Management as a general source of information only. Not intended as a solicitation to buy or sell specific investments, or to provide tax, legal or investment advice. Seek advice on your specific circumstances from an IG Wealth Management Consultant.
