Join our email list today to receive alerts, articles, invitations to events and more!
5 min read
Overview
Trusts can play a very helpful, versatile role in your estate planning, but they can also cause some challenges. Let’s look at what they are, when they might be useful, and what the pros and cons of using them are.
What is a Trust?
Trusts have a long history, dating back to the 1600s. A trust is unique in that it is a relationship, not a separate legal entity (although for tax purposes CRA treats a trust as an individual taxpayer). The relationship is between the person who starts the trust (the settlor), the person who holds the property and does what the settlor tells them to do regarding the property (the trustees); and the beneficiaries for whom the property is held. For example, A wants to set aside money for B, C and D. A wants E to hold the money, and to invest and use the money to help support B, C and D. A is the settlor, E is the trustee and B, C and D are the beneficiaries. A sets out the details of the trust in a trust deed, and hands over the money (the trust property) to E. E must use the money as per the terms of the trust deed, for the benefit of B, C and D. A has given up complete ownership and control of the money. E is now the legal owner of the money; and B, C and D are the equitable owners, since the money must be used for their benefit.
Types of Trusts
Broadly speaking, trusts are either inter vivos (created during the settlor’s life); or testamentary (created on the death of the settlor, through the settlor’s will). Some of the more common trusts, which can be inter vivos or testamentary, include:
Henson trusts: set up for the benefit of a disabled person, where the trustee uses the trust property for the lifetime of the disabled person, but the disabled person never owns the trust property outright, thereby preserving their government disability benefits
Spousal trusts: set up so that all of the trust property is held for a spouse’s lifetime, and terms for use of the trust property are set out, after which, whatever is left goes elsewhere. Spousal trusts are often used in second marriages where spouses want to provide for each other after they die, but they want to preserve at least part of their estate for their own family after the spouse’s death
Family trusts: set up so that the trust property is held for a defined group of beneficiaries, often children and grandchildren. Family Trusts are often used as part of a succession plan for a business, where the founder wishes to gradually pass the business along to family. Typically the trustees have wide discretion to favour one beneficiary over another, and to make nominal or full income and capital distributions.
When to Use a Trust
Generally speaking, trusts are often used in the following scenarios:
- Second or subsequent marriages where both spouses want to support each other but ultimately leave the bulk of their wealth to their own respective families
- A family member receives disability benefits which would be cut off if the person received a large inheritance
- The family member is unable to handle money, either because of mental or physical disability, vulnerability to others, addiction, spendthrift ways, or some combination
- A business founder wishes to gradually plan for the succession of their business to family members
- Parents wish to limit the ability of children’s spouses to make claims on the child’s inheritance.
Pros and Cons of Trusts
Some of the benefits of trusts include the following:
- Centralized ownership of assets, with easy transition through incapacity and death
- Greater privacy (other than to CRA)
- Discretion in distribution to a group of beneficiaries
- Protection of assets from third parties such as potential creditors, children’s spouses, disinherited family (mostly BC)
- Possible probate avoidance (more common in BC and Ontario where probate fees are a percentage of estate value).
Some of the concerns and costs of trusts include the following:
- Cost to set up, plus annual compliance fees - CRA requires annual tax filings for most trusts
- Ongoing compliance and reporting duties of trustees - CRA requires up to date information regarding the settlor, trustee, and all beneficiaries of the trust. This is a considerable administrative burden on the trustee, and an invasion into the privacy of the settlor, trustee and all beneficiaries
- With a few exceptions, higher marginal tax rates for all income earned and reported in the trust
- More complex tax rules for trusts.
Examples
Let’s go through a few examples to showcase the pros and cons of a trust.
Scenario #1
F and G have a net worth of $10 million. They have three adult children, H, I and J, all of whom live in Canada. H and I are independent and doing well but their spouses are not good with money. J has addiction issues and would be vulnerable to themselves and/or abuse from others if J received an outright inheritance. F and G could consider trusts in their wills for one or more of their three children.
For H and I, if their inheritance is held in a trust, their spouses would not have direct access to the funds, nor would the trust property be accessible by the creditors of the child’s spouse. Any distributions to H and I which are then shared with their spouses would likely form part of the matrimonial property. The question of who would be the trustee of their respective trusts would need some serious consideration.
For J, a trust through the will for J’s lifetime could be set up, and a letter of wishes prepared to outline F and G’s intentions regarding supporting J but not allowing the wealth to damage J, or make J vulnerable to abuse by others. The question of who would be the trustee of J’s trust would also need some serious consideration. If the trust remains in place for J’s lifetime, there will be considerable annual costs, including tax filings, which should be weighed as well. If J is receiving government support payments, the trust could be structured to be a ‘Henson’ trust, thereby preserving J’s government benefits.
Scenario #2
K is widowed and has two young adult children, L and M. K and his deceased spouse built up a successful business. K would like to eventually pass it along to his children, as they mature. K is also in a relationship that may become long term. K wants to be sure they keep the assets that K and K’s deceased spouse built together separate from any new wealth built with the new partner. A family trust would allow K to gradually pass the business along, and its contents would not be part of matrimonial property. Further, if K becomes incapacitated or dies, the succession of the business to the children is preserved, and kept private.
These are just a few of the many examples of when a trust might be useful, but where the pros and cons need to be weighed, and where the details of how the trust would be handled, who would be the trustees, and the extent of distributions to beneficiaries should be thoroughly considered and documented. For more details, or to set up a meeting to discuss possible trust options for your estate plan, please contact one of our estate and succession lawyers.
