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Planning with Inter-Vivos Trusts

In the previous article, I discussed the many benefits of a testamentary trust.  Trusts are potentially the most powerful tool in any estate planners toolkit.  As stated in that article there were two types of trusts as far as the CRA was concerned and they were inter-vivos and testamentary trusts.  The basic difference between the two is that an inter-vivos trust is created while the settlor is still alive.  A testamentary trust is created by a testator, or by the last will and testament of a deceased taxpayer.

The CRA taxes inter-vivos trusts at the maximum marginal rate regardless of the amount of income earned and retained by the trust, while testamentary trusts are taxed at the applicable marginal rates.  Don’t let the high marginal tax rates on inter-vivos trusts deter you from these though, because they’re potentially an even better planning tool than a testamentary trust.

In December of 1999, the Finance Department introduced legislation that would allow for two new types of inter-vivos trusts.  They are the alter-ego trust and joint spousal trust.  For those aged 65 and older, these trusts offer some very effective estate planning options that everyone should consider.  These trusts are so powerful that they can even replace a will in its entirety, as the ownership and distribution of all your assets can be arranged long beforehand.

The Basics

In the past, a transfer of property to a trust would trigger the accrued capital gains on that property, thus resulting in a higher tax assessment in that year.  The new rules allow this transfer to occur tax-free and the accrued capital gains are only triggered upon your death in the case of an alter ego trust, or on the death of the surviving spouse in the case of a joint spousal trust.

These trusts have very minimal requirements for formation:

  • You are 65 years of age or older,
  • Only you or your spouse are entitled to receive income or capital from the trust during the remainder of your lives.

There are limited income-splitting opportunities in these trusts, as the income from any assets in the trust will be attributed to and taxed in the hands of the person that contributed that asset.  However there are many other benefits to consider.

The Benefits

Using a will or testamentary trust is a common technique used to distribute assets upon the death of an individual.  Using these new inter-vivos trusts provide the following benefits:

  • Avoid Probate Fees – Assets distributed by way of a testamentary trust or by will are subject to provincial probate fees. In Ontario, this rate is 1.5%, the highest of any province. Assets held in an inter-vivos trust are not included in an individual’s estate and are therefore not subject to such fees.
  • Privacy – Anyone, after paying a nominal fee, can obtain the complete listing of a deceased individual’s probate application list, which lists all the assets of the deceased person. Assets held in a trust do not become public information.
  • Avoid Conflicts – With wills, your survivors are able to apply to the courts in order to overturn the provisions of your will if they feel they were not adequately provided for. These trusts avoid such conflicts and ensure that your assets pass to your beneficiaries in the way you intend them to.
  • Escape the 21-Year Rule – Every 21 years a deemed disposition of all the trusts assets triggers all the accrued capital gains and a tax liability. These trusts are only deemed to dispose of their assets upon your, or your surviving spouses death. The 21 year rule only activates after this point.
  • Successor Trustee – You can act as the settlor and trustee of the trust during your lifetime, as well as have your assets pass to another trustee upon your death or in the event of your mental incapacity.

Taxation

As already stated, inter-vivos trusts are taxed at the highest marginal rate, which is over 40% in Ontario at present.  This is not an issue to wealthy families since they’re already paying the highest rates.  However, as long as all of the income generated by the trust is distributed it will be taxed as income in the hands of the beneficiaries at their individual marginal rates.  This may offer some tax saving opportunities.

Conclusion

Alter-ego and joint spousal trusts are a powerful method for individuals and families looking to protect their assets, minimize their tax burden, retain control and pass their assets to their successors in a private and cost-effective manner.  At myCFO, we can aid in the formation and trusteeship of such trusts.  Please call to find out more.

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