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Feb 7, 2020

Reasons To Consider Setting Up A Trust

by Jason Heath

Jason HeathTrust funds may be synonymous with billionaires and Beverly Hills, but there can be common uses of trusts for average people, too.

Trusts are a fiduciary relationship established between trustees and beneficiaries whereby the trustees hold assets on behalf of beneficiaries. Most mutual funds and exchange traded funds are structured as trusts. The fund company is the trustee and the investors are the beneficiaries.

There are different reasons an individual would set up a trust for their loved ones. Some would apply during their lives, while others only after their deaths.

Testamentary Trust For A Child Or Grandchild

Anybody who has minor children or grandchildren should have a Will that includes a trust. A testamentary trust is a trust created on death, and a testamentary trust for minors can ensure that assets are managed by a trustee of your choice for your little ones if you die. You can include parameters on how those assets are managed, as well as when and how money is to be used for or given to your children or grandchildren.

A minor child cannot inherit assets directly until the age of majority. The age of majority ranges from 18 to 19 depending on province or territory of residence. Many Wills have boilerplate trust clauses that pay out an inheritance at the age of majority. It is important to consider whether that is appropriate, particularly when you consider how much money your assets combined with your life insurance could be if you died.

It may make sense to consider a staggered distribution in more than one tranche to minor children—say at age 20 and 25. You can even put conditions on a distribution from a testamentary trust, like successful completion of a post-secondary degree, as a means of motivating children even after you are no longer alive.

Some testamentary trusts could last the lifetime of a beneficiary. A common example is a Henson trust, often used for children who are disabled.

A Henson trust appoints a trustee to allocate money to a child over time at their discretion and has a secondary objective of maximizing potential government benefits. The fact that the child does not own the assets—they are held in trust—may enable that child to receive government support or participate in government programs they may not otherwise be able to access. Besides that, some children with disabilities may not be able to manage their financial affairs on their own regardless of age.

Discretionary Family Trust For Non-Registered Assets Or Family Business

Many parents and grandparents open informal trust accounts for a child or grandchild. A bank account is one example and a good way to teach a child about money. Opening informal trust accounts to buy investments may not be the best option for a parent or grandparent, unless someone has maximized their Registered Retirement Savings Plan (RRSP), Tax-Free Savings Account (TFSA), and Registered Education Savings Plan (RESP) contributions. Even then, the informality of an account can be risky in the event a parent or grandparent dies, or upon that child or grandchild attaining the age of majority, because an informal trust has no controls or parameters.

When a parent or grandparent opens an informal trust investment account using their own money for a minor, the income—interest and dividends—may be taxable back to the adult. Capital gains are taxable to the minor child or grandchild. The interest and dividends are only taxable to the minor child or grandchild if the source of the funds is their own. For example, child benefits, a part-time job, and birthday gifts.

If someone has a sizable non-registered portfolio, establishing a formal discretionary family trust may be an option. This is a way to legitimately move income from your own tax return onto the tax returns of lower income children and grandchildren, to the extent you use the income to pay for their expenses or give it to them (now or in the future).

How much money is enough to establish a family trust depends on several factors, like how aggressively you invest, your investment fees, the age of your beneficiaries, and whether you loan the money or commit it forever to them.

Discretionary family trusts can also be used for private corporations, farms, or fishing properties. Companies that are qualified small business corporations—as is often the case for private Canadian businesses—may qualify for a lifetime capital gains exemption on sale. Up to $883,384 of capital gains may be tax-free as of 2020. Qualified farm or fishing properties may also be exempt from capital gains tax up to $1,000,000.

A discretionary family trust can be used to multiply the lifetime capital gains exemption on sale and use the exemptions of other family members. Because the trust is discretionary, a parent or grandparent may be able to maintain some flexibility as to how much money gets allocated to which beneficiaries at the time of sale, rather than having to transfer ownership or make a commitment today.

Spousal Trust For Second Marriages

Prior to 2016, an individual could establish a testamentary spousal trust on their death and have the income taxed at graduated rates, meaning low and progressively higher tax brackets on the trust’s income. It was a way to reduce tax payable for a surviving spouse who had a high tax bracket in the first place, by having some of that income taxed at lower rates within a spousal trust.

There may still be an opportunity to reduce tax payable in this manner in the first 3 years after death as an estate may qualify as a Graduated Rate Estate for up to 36 months.

But spousal trusts can be more useful for those in a second marriage as means to provide for a spouse while still having control over the eventual distribution of one’s assets. They are an alternative to leaving assets to a spouse outright and simply hoping that children from a first marriage will be the ultimate beneficiaries.

A spousal trust may be used to hold a house for a surviving partner, for example, with the house proceeds eventually being paid to the children of the deceased.

Spousal trusts can be used to hold investments, businesses, and other estate assets.

Alter Ego Or Joint Partner Trust For Seniors

An Alter Ego Trust is a type of trust that can be used by a single senior over age 65. A Joint Partner Trust is for married seniors over 65. Assets transferred into an Alter Ego or Joint Partner Trust can only be used for the benefit of you or your spouse during your lifetimes.

These trusts can be used to avoid probate, which is the process by which a Will is approved as being valid prior to distribution. Some provinces have high probate or estate administration costs that can be mitigated by these trusts. Even in provinces with low costs, estates can be subject to distribution delays that will not apply to these trusts.

Alter Ego and Joint Partner Trusts can also provide confidentiality, as assets held in them do not form part of an estate and are therefore not disclosed to beneficiaries of a will.

They can act like Power of Attorney and Will equivalents, so that children can take over a trust as trustees if a parent becomes incapacitated or dies.

They have drawbacks, like set-up and ongoing costs, negating access to the lifetime capital gains exemption for private corporations, farms, and fishing properties, capital gains being taxed at the highest tax rate for the second to die, and therefore, these trusts need to be considered as part of an overall estate plan.

Trust law has its origins in ancient Rome and medieval England. Trusts have always been more commonly associated with the wealthy. Regardless, there are many situations today in which trusts can be useful estate and tax tools for average Canadians who have spouses, children, or grandchildren.

Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.