If you're like most people, your knowledge of the tax system is limited to an annual foray into income-tax land when you sit down, year after year, to do your tax return. But did you know that there is also taxation after death?

If you ignore the financial consequences of your death, you run the risk of creating considerable problems for your loved ones. Here are a few general concepts and examples of situations that will give you a better idea of what can be expected.

You Can't Escape!

Even after someone's death, there are still income taxes to be paid-at least for the tax year in which the death occurred.

As a result, the estate of the deceased must file a tax return declaring all employment, business, and investment income (interest, dividends, etc.), as well as other sources such as retirement plans or employment insurance.

Furthermore, because the person is deceased, any gains or losses resulting from the deemed disposition of certain assets must also be declared as if they had been sold.

Because of these tax provisions, and given existing tax brackets, a deceased person's tax burden can be as high as 43% of total taxable income.

Solutions: Tax-Free Transfers and Life Insurance

However, a number of arrangements can be made to avoid placing too heavy a tax burden on the estate. For example, RRSPs and RRIFs held by the deceased can be transferred tax-free to the spouse (or a dependent) subject to certain conditions. Other investments may also be transferred to the spouse.

Unfortunately, the Income Tax Act is not as generous with nondependent children at the death of the surviving spouse. In this case, RRSPs and RRIFs are treated as income and taxed as such.

Parents can, however, help their children avoid the financial consequences of such a situation by taking out survivors' life insurance payable in the event of the second death for an amount equal to the tax that would have to be paid on RRSPs or RRIFs.

Cottages and Other Investments

Individual insurance can also be a great help in paying taxes on capital gains on certain investments, thereby protecting the estate's value.

Investments in securities and property such as stocks or rental buildings are among the assets a deceased person is deemed to have sold at death. Capital gains (as well as the recapture of depreciation, if applicable) on these investments must be calculated. The equivalent of 50% of capital gains is taxable.

Once again, these investments can be transferred to your spouse, but not your children.
For example, a small family lakeside cottage built some 20 years ago would be subject to the same tax treatment as a rental building if it were considered a secondary residence. Under tax law, surviving children wishing to keep a family cottage that has increased in value over the years could face a heavy tax burden.

If the estate does not have the money to pay the tax on the capital gains, the children would probably have to sell the asset in question to pay the tax, whatever the current market value of the property.

However, some inherited assets are not taxable, such as the main family residence and life insurance benefits.

It's Never Too Late!

These are only a few examples of the tax consequences resulting from a death. Many factors can have an impact on the taxes your heirs may be required to pay after your death, including your marital status, your will, and the type of assets and investments you own.

It's never too late to think about the tax consequences of your death. Whether you are young, middle-aged, or retired, they're an important part of your financial plan.