A trust is a relationship between three parties: the settlor (or testator), the trustee and the beneficiary and is created by an individual (the settlor or trustee) through a will or document known as a Trust Deed. A trust company, such as Scotiatrust and/or an individual appointed as trustee is responsible for carrying out the terms of the trust.
There are two basic types of trusts: testamentary and inter vivos. A testamentary trust is defined as a trust that arises upon and in consequence of the death of an individual. Most commonly, a testamentary trust is created under the terms of a will, but the category may also include trusts established by order of the court. An inter vivos trust is any trust other than a testamentary trust set up during the settlor’s lifetime.
Trusts have been around for centuries and are used in many different circumstances. Trusts are flexible and effective planning tools, sharing a common purpose: to help protect your beneficiaries and transfer property effectively. They possess several unique features offering a broad range of benefits. Some of the features include:
- Separation of legal and beneficial ownership
- The ability to create successive beneficial interests, thereby extending control over the property for many years
- The ability to confer a variety of discretionary powers, including discretion concerning the selection of beneficiaries and the type and timing of benefit bestowed
While it is not possible to ‘rule from the grave’, many people wishing to ensure that the legacy they have built up during their lifetime lasts, try all manner of things to ensure that the next generation does not foolishly spend it away. Trusts can be used to facilitate several estate planning and wealth management goals. Some common examples include:
Trusts for Minors
Many people like the idea of gifting to children or grandchildren, but what if they are too young to manage it, or unable to handle it responsibly? You can keep the assets protected with a trust until the beneficiaries reach a certain age. At that point, you can either transfer all the assets to them or have the trustee follow a prescribed schedule whereby the beneficiaries may receive assets gradually – at certain ages and/or for certain purposes, such as paying for their education or buying a home. By receiving the funds gradually, beneficiaries would also have the opportunity to learn how to handle money over time.
Spendthrift Trusts
Even if your child is an adult, there may be several reasons for you to set up a trust to protect the child from mismanaging the inheritance so that it’s preserved for the child as well as for any grandchildren. Perhaps the child is a perpetually failed entrepreneur. Perhaps he or she is a gambler, or has substance abuse issues, or perhaps the adult child simply has poor financial judgement.
Spousal Trusts
Estate planning can be challenging if you are in a blended family. You want to ensure your current spouse is taken care of and know that your children will eventually receive an inheritance. The trust can be structured so that your spouse receives the income earned on the trust’s capital, but the capital goes to your children upon your spouse’s death, helping to bring financial harmony in blended family scenarios.
You can structure a spousal trust to defer taxes relating to unrealized capital gains that might otherwise be payable on your death, thereby leaving more funds for your spouse. When considering such a trust, you may want to ensure that the trustee you appoint is an impartial and experienced third party, thereby minimizing the risk of disputes amongst family members. Even if you’re setting up a testamentary spousal trust, be aware of your legal obligations to family members and dependants, as claims can still be made against your estate.
Asset Protection Trusts
A trust can be used to protect assets such as a family business or cottage from potential claimants such as a widow or widower’s new partner, or children’s spouses in the event of marital breakdown. Perhaps your spouse has no experience with bookkeeping or administration, or your adult children have little interest in financial matters. If these are your beneficiaries, you might be worried about how they would manage sizable assets. By creating a trust, you could enlist a professional trustee to oversee the management of the assets on your beneficiaries’ behalf.
Trusts for Incapacity Planning
You want to support your spouse in the case of their incapacity. A testamentary spousal trust supports your surviving spouse after you’ve died. If your spouse is (or becomes) incapacitated or otherwise vulnerable during their golden years, this kind of trust could be a good tool for protecting their interests.
Special Needs or Henson Trusts
If you have a disabled or special-needs child, a trust may offer peace of mind by helping to ensure that funds will be available to provide the child with proper care. The trustee may be able to make decisions with respect to the capital or income disbursements from the trust while also protecting your child’s eligibility for government or other income-tested disability benefits. If you simply leave an inheritance to your child outright, the assets could disqualify them from receiving such benefits.
A trust designed to benefit a person with disabilities is often called a ‘Henson trust’. Since the trustee has complete discretion over how the trust funds are dispensed, the assets would not be considered vested in the beneficiary. This is how a Henson trust could help to protect the beneficiary’s eligibility to collect government benefits and other entitlements.
Family Trusts
When all of the beneficiaries of an inter vivos trust are family members, the trust is commonly referred to as a ‘family trust’. Income splitting in the context of a family trust involves reducing a family’s overall tax burden. This is accomplished via a strategy that allows high-income earners to split income with family members (spouse, children, grandchildren; nieces and nephews may also qualify) who earn little or no income.
By taking advantage of basic personal exemptions and graduated taxation rates, the overall family tax burden is less than what would be payable if the full amount were taxed in the hands of the high-income earner. Properly structured, the trust is essentially how income can be paid or allocated to and taxed in the hands of family members, including minors.
However, to achieve the desired income splitting, care must be taken to avoid the income attribution rules. Income attribution rules are a set of rules in the Income Tax Act which can cause any income realized on property transferred directly or via a trust to another taxpayer to be assigned back to the transferor, thereby thwarting efforts to split income.
At a high level, the rules cause income and capital gains to be assigned back to the transferor when the transferee is the spouse. Where the transferee is a minor child, income, but not capital gains, is attributed back. To avoid the income attribution rules, the trust must be properly structured, an appropriate trustee selected, and all relevant rules and procedures must be followed.
Charitable Trusts
Charitable Remainder Trusts are defined as a personal trust where the settlor makes an irrevocable transfer of property to the trustee, retains a life interest in the net income, and names a registered charity as remainder or capital beneficiary. There can be no powers to encroach on capital. If these requirements are met, the settlor may receive a charitable receipt for the present value of the remainder interest, which is issued by the named charity/ies. Charitable Remainder Trusts may be either inter vivos or testamentary, although inter vivos is more common.
Legal Settlement (e.g. personal injury or medical malpractice) Trusts
On successful settlement of a personal injury or medical malpractice claim, the settlement proceeds may be used to purchase a life annuity or may be transferred to a discretionary trust for the benefit of the plaintiff. There are advantages to both, however the discretionary trust option allows for more flexibility, provides assurance that the plaintiff will not be disqualified from receiving government funded disability benefits, and may also provide an estate for the plaintiff to pass along to beneficiaries under his or her own will.
Choosing a Trustee
Choosing the right trustee is essential to the success of your estate plan. Whether you are considering whom to appoint as your trustee or are about to take on the role yourself, you should know just what’s involved. The trustee is responsible for carrying out the terms of the trust, is legally accountable to the beneficiaries and assumes what is known as ‘fiduciary duties’.
Much has been written about executor duties — checklists, worksheets, and other tools abound. However, when discussing the responsibilities of a trustee, the focus shifts from a laundry list of tasks (secure estate assets, apply for probate, cancel subscriptions, obtain appropriate insurance, etc) to the overarching duties and obligation inherent in the role. These include a duty of care, duty of even-handedness, duty of loyalty and a duty to account to the beneficiaries requiring careful stewardship and adherence to specialized regulatory regimes.
A failure to properly discharge the duties and standard of care may constitute what is termed a ‘breach of trust’ and may result in personal liability to the trustee.
When choosing a trustee, thought should be given to the expertise, availability and willingness of the individual you are considering to assume the duties and responsibilities of the role. Trust companies may be the ideal choice, as they provide more checks and balances to invest prudently, preserve the capital and ensure an income stream. They are also going to be around a long time.
Even though the individual trust officer handling the trust may change, the trust company will continue. Scotiatrust, a member of the Scotia Wealth family, has the depth, expertise and services available to look after your trust needs.
Kevin Greenard CPA CA FMA CFP CIM is a Senior Wealth Advisor and Portfolio Manager, Wealth Management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week at timescolonist.com. Call 250-389-2138, email kevin.greenard@scotiawealth.com, or visit greenardgroup.com.
