Probate is one of the most misunderstood concepts in law. The misunderstanding has a massive impact on both estates and families. In my opinion, Probate is the biggest red herring in Estate Planning and is dealt with much too flippantly by families and advisors. I hope this article helps to clarify the misconceptions about Probate.
What is Probate?
Probate is a court process within the greater process of Estate Administration (which is the process of transferring legal ownership of property from a deceased person to an Executor and then to beneficiaries). Here in Ontario, we don’t call it Probate anymore (officially). Instead, it is known by its Court process name “Application for a Certificate of Appointment”. As that doesn’t have much of a ring to it we still refer to it as Probate.
Probate is a court process to prove the legitimacy of the Will. It is required when a third party (eg. bank, insurance company, Ontario’s Land Registry Office with respect to land) is in control of assets of a deceased person and this entity requires legal certification (hence Certificate of Appointment) that the person purporting to be the legal representative (Executor) is actually the legal representative. A bank cannot simply rely on a Notarized Copy of a Will because our great system allows people to make Wills at any time, anywhere. So how does a bank know that the Will is the last one? The proverbial Last Will and Testament. How do they know someone didn’t make a Will on their deathbed and shove it under a mattress? They don’t, so we have developed a system to deal with that.
A better and more accurate way to look at Probate is to think of it as a risk management tool used by third parties to ensure they are not releasing money/property to the wrong people. If an Executor can provide a Court Document (Certificate of Appointment) that vouches for the Executor, the bank is happy to release assets because the liability is not on the bank anymore. If you can’t rely on the Courts, who can you rely on? That’s the rationale, anyway.
As you can (hopefully) see, Probate is a legitimate process in Estate Administration. Like all Estate Administration processes, it promotes transparency and accountability. It’s a check and a balance within the system.
Can you avoid Probate?
The real problem is that people do not like it. Why is it presented as an evil of all evils? The boogeyman under the bed? It’s the way our government chooses to treat the court Application. The provincial government through the Courts essentially tells Executors, “Look, we’re not making you do this, but you need us to help you out, and if we’re going to use our resources to do it, we’re going to charge you a fee for the service and for taking on some liability in providing you with this certification.” Of course, it has been found unconstitutional to call it a ‘fee’ so they call it Estate Administration Tax (sometimes known as Probate Tax or Death Tax). The amount of tax is relative to the assets being distributed by the Will (that are part of the estate). The rate of tax? It’s the smallest tax we have – just under 1.5% of the value of the assets. Certainly, it’s 1.5% more than any of us would want to pay, but I bet you’ll pay more in tax on your car’s gasoline in a year.
Because of this tax, some advisors (bankers, financial advisors, accountants, and lawyers) preach “Probate Avoidance”. They think they’re heroes for ‘saving’ clients 1.5% as if this legitimate process that promotes transparency and accountability is some sort of frivolous tax grab. What these “heroes” rarely convey to their clients is the downside to common avoidance techniques. There are always potential downsides to our actions; there are no ‘no-brainers’ in estate planning – there is never only an ‘upside’. The applicable adage is often “penny wise, pound foolish”. You take this action to ‘save’ 1.5% but the result produces even greater costs, whether those are actual financial costs, loss of control, missed opportunity, emotional costs from conflicts/hard feelings/misunderstanding, and/or additional taxes.
Common probate avoidance techniques often involve decreasing the assets that transfer through an estate by means of joint ownership or named beneficiaries, therefore decreasing or eliminating what assets require the probate process and the tax associated with the process. On the face of it, nothing is wrong with these techniques when used purposefully and diligently. Unfortunately, they are used with only the avoidance in mind and miss the risks that are being incurred.
Understanding the risks
Joint assets mean loss of control and exposure to other owner’s creditors and financial struggles (eg. my son was in a car accident he caused and now my investment portfolio is up for grabs because he’s a joint owner). Named beneficiaries do not get the advantage of contingencies or trust terms in a Will. Adding a child onto real estate during your life exposes them to capital gains tax they otherwise would never have incurred had you allowed the house to go through your estate.
Probate avoidance is a shortcut. When we use shortcuts in life and business, it may work for a day or a year, but it’s important to understand that shortcuts often come back to haunt us. When you cut off something, you lose something. With probate avoidance, you often lose the ability to effectively dictate the results as well as the desired transparency and accountability with your estate and all its stakeholders.
Are you considering those risks? Do you understand the risks? Would your estate stakeholders benefit from transparency and accountability? What is the risk if they don’t get it?
Probate is not a tax; it is a legitimate process to promote transparency and accountability. You may not agree with the way our provincial government taxes this process (I don’t), but is it worth turning that dislike into a situation where you potentially undercut your planning and create greater financial and emotional costs?
Using the Will to direct assets is extremely useful and necessary for many families. The Will can do so much more to accomplish estate objectives. Bypassing the Will can result in objectives being unmet because joint property and named beneficiaries are blunt tools. If you do not meet your estate planning objectives, what’s the point of saving that 1.5%?
Probate avoidance is not a strategy. It’s an emotional reaction that often comes with real and costly consequences – consequences that frequently cost much more than 1.5%. If you have questions about Estate Planning, give me a call.