The primary function of a last will and testament is to name the beneficiaries of the assets of your estate. However, under some circumstances, it may be good planning to include a trust in your planning.
A testamentary trust is an arrangement whereby upon your death, property is managed by one person on behalf of another. While testamentary trusts are set up as a result of death, another form of trust – an inter vivos trust – is set up while the settlor (person who ‘settles’ property in a trust) is alive.
While there are many and complex reasons for creating a trust, three important reasons include paying less tax, expediting the transfer of assets upon death while also reducing probate fees, and determining how the inheritance is to be spent by the beneficiary.
Less Tax, Fewer Fees
Incorporating a trust into your will can result in substantial tax savings for an individual when compared to the same individual personally owning the property held in a trust. In general, trusts are considered to be a separate and individual ‘taxpayer’ for purposes of the Income Tax Act. Therefore, income earned on trust assets is taxed as though the income was earned by a person separate from the settlor, trustee (person who holds and administers the trust on behalf of the beneficiaries), or beneficiaries, and is subject to the same graduated tax rates as would be an individual. This can result in overall tax reductions for beneficiaries who already pay income taxes at high marginal rates.
Depending on the type of trust, setting up a trust can facilitate a fairly quick transfer of assets on death because, generally speaking, unlike wills, trusts are not subject to the public probate process. As such, inheritances in trust are also not subject to probate fees and can result in substantial savings to the estate and/or beneficiaries.
Another benefit when creating a trust is that the settlor can, if desired, set out the terms of how and when the inheritance will be spent. For example, a settlor can determine that the trust funds are to be used by the beneficiary solely for university tuition or for living expenses. As well, when planning a trust, the inheritance can be set up to be paid out over time rather than in a lump sum, thereby allowing for such things as ongoing living expenses.
While offering all of these benefits, inter vivos trusts also include benefits such as income-splitting, estate freezes, the formation of alter ego and joint partner trusts, and foreign trusts, which all entail the transfer of assets during the settlor’s lifetime. However, there are significant differences in the tax rates that apply to testamentary trusts versus inter vivos trusts. While testamentary trusts are subject to graduated personal marginal tax rates, inter vivos trusts are taxed at the top personal marginal tax rate.
Although testamentary trusts offer the benefit of graduated tax rates, inter vivos trusts can offer added benefits of such things as income-splitting, estate freezes for owners of corporations, the formation of alter ego and joint partner trusts, and the establishment of foreign trusts. Because there are benefits to both testamentary and inter vivos trusts, persons considering setting up a trust would benefit from sound financial and estate planning and advice to ensure their intentions and wishes are best served and carried out to realize the maximum benefits sought.
Trustees: Who Can You Trust?
Once the decision is made to set up a trust, choosing a trustee becomes a vital and important consideration. Trustees have many responsibilities ranging from administering the trust to making investment decisions to maintaining property (if the trust includes real estate). It can involve, among other things, opening bank accounts, making payments to the beneficiaries, maintaining financial records, and filing income tax documents. Depending on whether the trust includes discretionary power, the trustee may need to consider the amounts, timing, and type of distributions and the circumstances of the individual beneficiaries.
The trustee you choose must have the time, knowledge, skill, and desire to be the trustee. While your trustee can be a friend or family member, depending on the size and complexity of the trust, it might be beneficial to consider a corporate trustee. Certainly in situations where objectivity is required – such as where there is family conflict or complex issues – a corporate trustee can make good practical sense.
Regardless of your choice of trust and trustee, the laws governing trusts and their related taxation are complex. Before implementing any trust, advice from legal and tax professionals should be obtained.
Source: CIBC Private Wealth Management