Why Future Taxes Matter When Dividing Family Property in Divorce
- Paul Beck
- Oct 28
- 3 min read
One of the biggest oversights in do-it-yourself divorce settlements is the failure to account for future taxation. While separating couples often focus on dividing assets based on their current market value, they frequently miss a critical piece of the puzzle: the tax liabilities that will arise when those assets are eventually accessed or sold.
This issue is especially relevant when dealing with pensions, RRSPs, and unrealized capital gains. These assets may look equal on paper, but their after-tax value can differ significantly. Ignoring this can lead to unfair settlements and financial surprises down the road.
Why Future Taxation Is a Real Liability
In Ontario, when preparing a Net Family Property (NFP) Statement, couples are required to list all assets and liabilities as of the date of separation. However, many people don’t realize that future taxes payable on certain assets should also be included as liabilities. This is not just a best practice, it’s essential for ensuring a fair and equitable division of property.
For example, consider an RRSP worth $100,000. While it may seem
like a straightforward asset, the reality is that when the funds are eventually withdrawn, they will be taxed as income. Depending on the tax bracket of the individual at the time of withdrawal, the actual value could be significantly less. If one spouse receives the RRSP in the settlement without any adjustment for future taxes, they may end up with far less than the other spouse in real terms.
The Challenge of Calculating Future Tax
Estimating future tax liabilities is not a simple task. There’s no universal formula to apply, as tax rates can change over time and depend on individual circumstances. The best approach is often a reasonable estimate based on current tax brackets and anticipated future income.
In Ontario, the lowest combined Federal/Provincial marginal tax rate is 20.5%, while the highest can reach 54.5%. This wide range makes it crucial for both parties to agree on a reasonable tax rate to apply when calculating the future tax liability of each asset. In cases where taxable assets are being equalized between spouses, using the same tax rate for both parties can help maintain fairness and consistency.
Understanding How Taxable Assets Are Transferred
Another important consideration is how taxable assets are transferred between spouses. In most cases, these transfers can occur without immediate tax consequences. For example, an RRSP or investment portfolio can be transferred from one spouse to another at market value for NFP purposes, but at the adjusted cost base for tax purposes.
This means that any unrealized capital gain and the associated deferred tax liability are also transferred to the receiving spouse. If this isn’t accounted for in the settlement, the receiving spouse could end up bearing a disproportionate tax burden in the future.
Why Professional Advice Is Essential
Given the complexity of tax rules and the long-term financial impact, it’s not enough to simply complete the NFP statement and divide assets based on those numbers. Couples should seek professional financial and legal advice to fully understand the implications of their decisions.
A financial professional with experience in family law can help estimate future tax liabilities, advise on appropriate tax rates, and ensure that both parties are making informed decisions. This can prevent costly mistakes and help both spouses move forward with greater financial clarity and confidence.
A Real-World Example
Consider a couple with the following assets:
Spouse A has an RRSP worth $150,000.
Spouse B has a non-registered investment account worth $150,000, with $50,000 in unrealized capital gains.
On paper, these assets appear equal. But when you factor in future taxes, the picture changes: The RRSP will be taxed as income when withdrawn. Assuming a 40% tax rate, the after-tax value is $90,000.
The investment account will incur capital gains tax when sold. Assuming a 25% tax rate on the gains, the tax liability is $12,500, making the after-tax value $137,500.
Without adjusting for taxes, Spouse A would receive significantly less in real terms. A fair settlement would require either a cash equalization payment or a reallocation of other assets to balance the difference.
Don’t Overlook the Tax Trap
Dividing family property during a separation or divorce is never easy, but overlooking future taxes can make it even harder. By recognizing that not all assets are created equal, and by factoring in future tax liabilities, couples can avoid costly mistakes and ensure a more equitable division of property.
Comments