Complicated family situations often involve more complicated financial solutions.
One example of this is the use of a trust in your overall plan. A trust is an equitable obligation binding a trustee to deal with property over which they have control for the benefit of beneficiaries.
The person who creates the trust is referred to as the settlor who transfers legal title of the property to the trustee. This transfer of title to the trustee imposes a fiduciary duty on the trustee to manage the assets of the trust, for the beneficiaries. The settlor may choose to establish a trust during their lifetime (Inter Vivos) or via his will, upon death (Testamentary).
A trustee can be a lawyer, accountant, trust company, or other trusted individual familiar with the family situation. The qualities we look for in a trustee are continued existence, residency, impartiality, and expertise. Two important terms to know are alternate trustee and co-trustee. An alternate trustee is one that can act in the event that your primary trustee is unable or unwilling to act. Co-trustees are groups of two or more trustees who act together. Generally more than two trustees can be cumbersome; however, two can provide group judgement in the right circumstances.
A major benefit of a trust is to provide more certainty with respect to the outcome of the distribution of your assets or estate. This comes at a cost, but for some the benefits outweigh the costs. The beneficiaries may not see the same “benefit” in the trust structure as the settlor, especially if access to the funds is restricted in any way.
Here are a few examples of why a settlor may set up a trust:
In this case, a trust might be valuable in segregating the ownership of funds received from an inheritance to keep them from being co-mingled with family assets. A trust may provide for the care and maintenance of a spouse during their lifetime, while controlling the disposition of the trust property on the spouse’s death.
Disabled Child or Adult
A trust enables the beneficiary’s trustee to manage the trusted funds for the care and maintenance of a child with special needs. If properly structured, a completely discretionary trust can also serve to keep the trusted funds separate from the child’s personal assets.
Child That May Not Be Responsible Enough
A trust can provide for the care and maintenance of individuals who are unable, for medical or other reasons (i.e. drug or alcohol dependencies), to manage their own affairs. A trust can be set up to provide a degree of financial independence for an adult child while postponing the time at which the child will obtain full management and control over the property. It is possible to postpone the payment of a child’s inheritance through a staged distribution.
A charitable remainder trust could allow an immediate tax credit while allowing the settlor to receive income from the gifted property during his or her lifetime. On death, the capital is passed onto the charity.
Need For Privacy
Unlike a will, an Inter Vivos trust is a private document which does not have to be filed with the courts for the public to examine. Note that this aspect does not apply to testamentary trusts which are created via a will.
Assets passing through an Inter Vivos trust on death are transferred directly without probate, outside of the individual’s estate.
Testamentary trusts are essentially separate taxpayers and are taxed using graduated rates applicable to individuals. This feature can provide significant income splitting opportunities. Income earned by a testamentary trust may be taxed in the trust, rather than in the beneficiaries’ hands. The trustee can elect to have income and gains taxed in the trust even if these amounts have been paid or are payable to a beneficiary.
As a result, income that might otherwise be taxed at the highest marginal tax rate in the beneficiary’s hands can be taxed at a lower graduated rate in the trust. For example, trust investments worth $1 million and earning four per cent per annum generates $40,000 in income. Taxing this income in the trust rather than in the hands of a beneficiary already in the top marginal bracket, may reduce annual taxes by approximately $11,365 in British Columbia at current rates.
Taxes can be reduced by income-splitting capital gains with minor beneficiaries or splitting dividend income from small business corporations to a spouse or child who may be in a lower marginal tax rate.
Generally, when a settlor transfers assets into an Inter-Vivos trust there is a deemed disposition of any capital assets, and the resulting capital gain, or loss is declared in the year of transfer.
The settlement of an Alter Ego or Joint Partner Trust, however does not trigger taxation on the transfer of capital assets. Instead the settlor can elect to have assets rolled over to the trust at their adjusted cost base without incurring capital gains or losses, where they can then be deferred until the settlor (and surviving spouse) passes away.
Because of the complexities involved, it is important to involve your professional advisors (Wealth Advisor, Accountant, Lawyer and Estate Planner) in the process of determining whether a trust is right for you.
All trust documents should be prepared by a practicing lawyer. Our thanks to Joseph Taylor, Senior Will & Estate Planner, for providing input into today’s column.