Estate Planning: Is a Trust a Must?

  Jon Palfrey, CFA
  Senior Vice President, Portfolio Manager

 

Some recent high-profile divorce and estate cases among the ultra-rich, such as Vancouver’s Aquilini family or the Wal-Mart heirs in the U.S., could lead a person to believe that trusts are a powerful wealth-creating device exclusively for the high net-worth crowd.

That’s a misguided notion. Almost as misguided is the idea that trusts can shirk income taxes while arming its owner with iron-clad protection from creditors, ex-spouses and various others looking to stake a claim on an asset.

The truth lies somewhere in the middle. Trusts can be great estate-planning tools for people in many income brackets, but the expectation of the benefits of trusts must be realistic.

A trust is a legal entity that holds assets outside of a will. The person setting up the trust is known as the settlor. Trustees are chosen to run the trust, and beneficiaries are the ones who receive income, capital, or both, from the trust.

There are different types of trusts. Personal trusts set up and used by beneficiaries during the settlor’s lifetime are known in legal terms as Inter-Vivos, or living trusts. Trusts that are planned for use with assets from the settlor’s estate are referred to as testamentary trusts. In both cases, there are settlors, trustees and beneficiaries.

In Canada, living trusts have the benefit of providing some degree of income splitting (paying income out to beneficiaries in a lower tax bracket), avoiding probate fees when the settlor passes, providing a degree of certainty as to how the assets will be distributed from the trust, and the assurance of privacy when transferring assets to heirs. However, some of these benefits can be somewhat muted. Living trusts are taxed at the highest marginal tax rate and assets transferred into them are taxed on their capital gains as if they were sold (with the exception of “alter ego” and “joint partner” trust available for those over 65 years of age). However, a living trust will avoid after-death probate fees, which are charged at 1.4 per cent of the value of the estate in B.C. That’s peanuts compared to U.S. estate taxes, which can run up to 40 per cent.

Testamentary trusts are created from an estate and are appropriate for the planned distribution of assets to family members. They’re particularly useful for blended families, spendthrift heirs or beneficiaries with disabilities. These trusts are taxed at marginal tax rates, so there is a tax benefit compared to living trusts. However, once again, assets must be taxed before going into a trust and once in the trust, they are subject to realizing capital gains every 21 years, rather than an open-ended deferral of taxes. 

The selection of trustees is an essential element when setting up a living or testamentary trust. Trustees legally become the “owners” of the trust and control its assets. While trustees are obligated to always act in the best interest of the beneficiaries, the settlor has to be willing to give up an element of control of the assets. 

In the past, some trusts were set up to keep assets out of a marriage to avoid a division in the case of matrimonial breakup. However, the new Family Law Act in B.C. calls this type of planning into question and could include trust assets as family assets if indeed they should be considered family assets.

Newer generations of trusts have evolved that offer specific benefits. Alter ego Trusts avoid challenges to one’s will and what are knows as charitable remainder trusts provide specific gifts to charity over time.

As with most things in life, there is a cost. Trusts require initial legal costs, ongoing accounting costs for additional income tax filings and advice, and ongoing trustee fees.

Setting up a trust is not “do it yourself” territory. They must be established properly to be effective. A careful cost-benefit analysis should be done and the future generational benefits should be considered. The ultimate goal when deciding on the implementation of a trust should be to prudently manage and protect your assets rather than to try to trick the taxman and grow your assets. Seek professional advice to explore the types of trusts that suits your needs.

 

This article is not intended to provide advice, recommendations or offers to buy or sell any product or service.  The info provided in this article is compiled from our own research and is based on assumptions that we believe to be reasonable, accurate at the time the report was written, but, is subject to change without notice.

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