Joint with Rights of Survivorship - Proceed with Caution
The primary motivation for parents to add their adult children as joint owners of their financial assets often appears to be compelling, whether those assets be bank accounts, houses, or investment accounts. However, there are inherent risks associated with these practices that are frequently overlooked.
While adding a child as a joint owner may achieve the desired result, the potential risks should be taken into consideration before doing so.
The two most common reasons that seem to spur this do-it-yourself planning are one, the flexibility to have children assist in managing their parents’ financial affairs as they grow older, and two, to avoid probate fees upon death. While adding a child as a joint owner may achieve the desired result, the potential risks should be taken into consideration before doing so.
When you add a child to your financial assets you are effectively giving them partial ownership of your assets. When they have partial ownership, it opens the door to future liability. For instance, if your child is married or gets married in the future and subsequently divorces, their spouse may be entitled to a portion of those joint assets, because they form part of the property that has to be divided. Similarly, if they encounter financial hardship, those assets may be subject to a lien from a creditor. Another not so immediate risk is during the estate administration when children or family members dispute the distribution of the estate when one member was added to an account and therefore may receive a disproportionate share of the estate. Keep in mind that depending on what assets are in joint names and the ownership structure, those assets could appreciate significantly from the time the child is added as a joint holder.
When you add a child on as a joint owner there is an immediate deemed disposition for tax purposes on the parent’s share of the assets. That last point ties into one of the biggest risks- tax liability. When you add a child on as a joint owner there is an immediate deemed disposition for tax purposes on the parent’s share of the assets. For example, Mom has an investment portfolio with a fair market value of $5 million and a book value of $2.5 million. She then decides to add her child as a 50% beneficial owner. The CRA will deem that half of the assets were sold and Mom will now owe tax on a $2.5 million capital gain.
Another tax consideration is adding a child as joint owner of the parent’s primary residence – typically the largest asset of the estate and subject to probate fees. The motivation here is not without justification, after all, probate fees in Ontario are 1.5% on estate assets over $50,000. While there is no immediate tax liability, given that a primary residence in Canada is exempt from capital gains taxes, it can eliminate a tax break for your children at death.
Let’s look at an example. Dad decides he wants to add his son as a joint tenant with rights of survivorship so that the house will not form part of his estate upon death and will therefore avoid probate fees. The home is worth $2 million the day he adds his son. As noted earlier, there is no tax due, given Dad’s primary residence is tax exempt, however his son now owns half of the value of the home and his cost base is $1 million. 15 years down the road Dad passes away and the home is now worth $5M and his son decides to sell the home. If he had never added his son, there would be no tax owing,but it would formulate part of the estate and be subject to probate fees of $74,500, based on Ontario rates. However, since he added his son, when he goes to sell the home his half of the home will most likely be subject to capital gains tax as it is not his primary residence. The capital gain would be $2 million ($3 million -$1 million) of which $1 million would be subject to tax. The taxes payable would be significantly more than the probate fees if Dad had retained full ownership.
There are a lot of alternatives that can achieve the desired effect while mitigating some of the risks noted.
As you can see, the motivation for adding children to financial assets is not without merit, but it should be reviewed carefully before implementation. There are a lot of alternatives that can achieve the desired effect while mitigating some of the risks noted. For instance, instead of adding a child to a bank account to manage financial affairs, a power of attorney may be used instead. In addition, a variety of trust structures can be utilized for various estate planning purposes. If you or your family are considering adding someone to the ownership of your financial assets, we at Northland Wealth would be happy to discuss this with you and explore additional options.