The tributes of a trust
Trusts have been used in England since the Crusades. Men who went off to battle wanted to ensure their assets would be looked after while they were away so they would transfer them into a trust to be managed on their behalf and their value preserved for beneficiaries.
Many people think only the very wealthy can benefit from using a trust, but many types of trusts can be useful for estate planning – and all trusts can have benefits. Some of these trusts and their benefits have more to do with your family situation than how wealthy you are although, in most cases, the minimum amount required to set up a trust is usually more than $100,000. In addition to the initial legal fees, trusts incur annual costs, such as bookkeeping and separate tax returns, so a certain amount of assets is needed to make the cost worthwhile. Trusts add to the complexity of your estate plan but can have powerful advantages: management, privacy, protection and tax savings, to name a few.
Every trust has:
• A settlor who sets up the trust and either transfers assets into the trust while he or she is alive, or upon the settlement of the estate after hi or her death, according to the wording in the will. The types of assets can be as varied as the reason for setting up the the trusts and could include cash, investments or, in certain situations, the family cottage.
• A trustee(s) to manage the assets in the trust.
• A trust document containing the rules for managing the assets in the trust.
• A beneficiary or beneficiaries who receive benefits resulting from the assets in the trust, according to the rules of the trust.
Assets can be transferred into a trust while you are alive (for example, an inter vivos trust, a living trust or alter ego trust) or after you die (for example, a testamentary trust). Trusts can have a wide variety of applications. This article discusses the most common types I see used. There are details and other types of trusts not included in this article due to limited space. Here’s a primer on some trusts used for estate planning.
A TESTAMENTARY TRUST
A testamentary trust is set up after your death according to the wording in your will. The trust document part of your will specifies at a minimum:
• Which assets are to be transferred to the trust.
• How the assets are to be managed.
• The names of the trustee(s), (sometimes this defaults to the trustee/executor of the estate).
• How long the trust will exist.
• Who the beneficiaries are.
There are a number of family uses for a testamentary trust. It could be used for:
• Minor children. The most common use of the testamentary trust is by couples or grandparents leaving assets to children who might be under the age of majority at the time of death. To ensure there is no need for the provincial public trustee to enter the picture, the testamentary trust enables the grand/parent(s) to name a trustee to manage the money on the minor’s behalf.
• Adult children. Parents also use testamentary trusts to help ensure their young adult children do not receive too much too soon. And for parents who are concerned for the future for their spendthrift child, a testamentary trust can make sure that “child” never receives too much money at any one time.
• Spouses. Traditionally, a spousal testamentary trust may have been set up so a surviving spouse did not have to worry about managing the family fortune. Today, they are found in wills where families want to:
How a testamentary trust works
On settlement of the estate, the assets indicated in the will are transferred to the testamentary trust. Since the trust is a separate taxpayer, the trust pays tax based on graduated rates, which could result in tax savings. As well, if the trust can pay income to a beneficiary who has little or no other income, even more tax may be saved.
The proceeds of a life insurance policy can be put into a testamentary trust using an insurance declaration. Assets settled through a will can be put into a testamentary trust. But assets held in joint ownership or that have a named beneficiary are settled outside the will. There are very valid reasons for naming beneficiaries on certain assets or for holding assets jointly, just as there can be valid reasons for wanting to use a testamentary trust in your estate plan. Putting one strategy in place could cancel out the effectiveness of the other.
A HENSON TRUST
Be especially prudent when seeking legal advice regarding assets being left to a disabled child or grandchild. If the disabled person is expected to receive social assistance and/or a training allowance for the rest of his or her life, receiving an inheritance outright could interfere with eligibility for these benefits. Setting up a carefully structured trust (often referred to as a Henson Trust based on the Henson family’s court experience) is often recommended.
A LIVING TRUST
You could set up a living trust, or inter vivos trust, while you are alive. You determine what assets are to be transferred to the trust and when. The trust agreement determines how those assets will be managed, for how long and for whom, allowing you to maintain an on-going level of control. There are two key living trusts that I’d like to highlight for estate planning: the living trust used by business owners and the alter ego trust.
While tax rules have been tightened for some of the non-estate planning uses of the living trust over the last decade, a living trust is still seen as part of estate planning for business owners concerned about taxes that could be due on their death. These business owners are interested in keeping the business running and do not want it to be sold on their death to raise money to pay the tax bill. Now older and ready to transfer any future growth to the next generation, the owner might freeze the value of the business (often referred to as an estate freeze) and transfer the growth shares – which are now in the name of the adult children – into a living trust, which is managed by the business owner.
How a living trust works
The estate freeze involves, among other things, setting up a new class of shares for the child(ren). However, since the business owner is usually not ready to hand over control of the business, the new shares are transferred to a living family trust, managed by the business owner.
AN ALTER EGO TRUST
The alter ego trust and the joint spousal (or joint partner, which includes same-sex partners) trust are also living trusts. These trusts can be set up for the exclusive use of the settlor (and his or her partner) – who are 65-plus – during his or her lifetime, provided all income and any capital earned are paid to the settlor (or partner) during his or her lifetime. On the death of the settlor (or the last survivor), the trust assets are distributed at fair market value according to the trust instructions. The alter ego trust can also save probate tax because the assets are distributed according to the wording of the trust, rather than the wording of any will.
Like other trusts, the alter ego trust or the joint partner trust is not for everyone but can offer a number of benefits, including privacy, where the alter ego trust is used as a will substitute. The assets in these trusts are distributed on the death of the settlor according to the instructions in the trust, not a will, which can become public. Benefits of these trusts may include minimizing probate tax; an alternative to the continuing power of attorney for financial affairs; or minimizing claims against trust assets, such as a dependent relief claim or, perhaps, a matrimonial claim or protection from creditors.
Before you set up a trust
If you think a trust might be a helpful estate planning tool for your personal situation, here are three questions to ponder:
• Why would you consider a trust?
• Given a trust could exist for many years, do you have trustees who are willing and able to act on your behalf?
• Will there be enough discretion in the wording of the trust for your trustees to adapt to future needs of the beneficiaries, as well as future legal and tax changes that could affect this trust?
The use of trusts in your estate plan adds to its complexity. Readers are encouraged to consult with a professional adviser to determine if and/or how these ideas may be applied to their own personal situation. Do-it-yourself? Don’t trust yourself.
There are legal fees to have the trust document prepared. Your lawyer may charge an hourly rate or a package fee. The hourly rate depends on the type of trust and the number of bells and whistles that will be included.
Annual management and administration fees can range from zero (in the situation where you are your own trustee, as with an alter ego trust) to the fee schedule charged, such as $2,500 or more. The actual fee is dependent on the value and complexity of the assets held in the trust and the fee schedule agreed upon.
Sandra Foster is the author of five financial books, including You Can’t Take It With You: The Common-Sense Guide to Estate Planning for Canadians (John Wiley & Sons, 2002).