Types of Estate Trust

This blog deals with the basics of a trust as an instrument to be used for estate planning. We will outline different kinds of trusts and different circumstances in which a trust is either created or deemed to be created. It is important to understand the dynamics of trust for strong estate planning as trust can be used extensively to ensure maximum flow of wealth after the death of an individual saving thousands of tax dollars.

There are two kinds of estate trusts:

Testamentary Trusts

Intervivos Trusts

Testamentary Trusts

A testamentary trust is a trust that arises because of the death of a person. The assets must be contributed to the trust on the death of the settlor and no assets can be contributed beforehand or by any person other than the deceased person at the time of their death. A testamentary trust will cease to exist the moment any contribution to the assets of the trust is made other than the assets of the settlor who passed away. The trust is normally established under the terms of the Last Will and Testament of the settlor. However, a Testamentary Trust may or may not form a part of a Trust's estate. For Example, the insurance proceeds do not form part of an estate and therefore an Insurance Trust or an RRSP trust will not form part of settlor's estate.

Advantages of testamentary trusts are:

REDUCING TAXES: Under the Income Tax Act, all trusts, including testamentary trusts, must file annual income tax returns and pay tax on income and capital gains that are not paid or payable to a beneficiary during the year. However, unlike intervivos trusts which are taxed at the highest marginal tax rate, testamentary trusts are taxed at the same graduated marginal rates that apply to individuals for the first 36 months when they are treated as graduated rate estates (GRE).

HELPING TO PROTECT THE INHERITANCE FROM CREDITORS: If property is left to a beneficiary who has debts or liabilities, the ultimate beneficiary of the inheritance may end up being the beneficiary’s creditors. If this is a concern, leaving the property to a trust for the beneficiary may help to protect the inheritance if the trust is drafted properly.

For example, the trust can include specific instructions regarding matters such as who is to manage the assets of the trust, to ensure that the trustees control the assets, and not the beneficiary alone. The trust could also give the trustees complete discretion regarding payments of income and capital from the trust, so that the trustees would have the ability to distribute the income and capital in a way that would truly benefit the beneficiary. Alternatively, the trustees could distribute income and capital to or for the benefit of the beneficiary’s family members, if they are also beneficiaries.

ENSURING THAT THE TESTATOR’S WISHES AND INTENTIONS WILL BE RESPECTED: Testamentary trusts are very flexible tools that offer the testator the ability to exercise significant control over how property left on death is to be used, including which heirs are to benefit and when. Ideally this ability can be used to guide beneficiaries, minimize family disputes and maximize the benefit of the beneficiaries’ legacies.

Intervivos Trusts

Intervivos Trusts on the other hand do not get any special treatment in taxation. They are treated at the highest marginal rate for taxation with no provision for graduated tax rates. Also, when an asset is contributed to an Intervivos Trust by the settlor, it triggers capital gain for the settlor as the asset is assumed to be disposed of to the trust in the hands of the trustees. Nevertheless, intervivos trusts offer a number of tax and estate planning opportunities: For the scope of this blog, the most important tax planning strategy that can be achieved through an intervivos trust is Estate Freeze and Probate Avoidance.

An estate freeze is a way for estate owners to pass on their assets to their loved ones without paying taxes. Estate freeze strategies are usually planned and implemented by asset managers, who use different investment tools to make it happen. A common method of doing an estate freeze is to swap common shares of a private company for preferred shares that have a set value that matches the market value of the common shares when the swap happens. The company then gives new common shares to the people that the estate owner wants to benefit, such as children, relatives, employees, or a family trust. This means that the value of the company when the freeze happens is fixed or “frozen” in the preferred shares that the estate owner has, and the future growth goes to the new common shares that the beneficiaries have.

Probate avoidance means that by having the intervivos trust in place the need for a probate court’s involvement in your affairs while you are alive or after you die, can be avoided. Probate is the legal process that happens when a person dies and their property is transferred to their heirs or beneficiaries. Probate can be a long, complicated, public, and costly process. Probate can by avoided by transferring your assets to your heirs through joint ownership, beneficiary designation, or a revocable trust.

There are different ways to avoid probate in Canada. One way is to choose beneficiaries for all of your life insurance policies so that life insurance will go directly to the beneficiaries and will not have any probate fees or taxes. Another way is to keep assets in cash/bearer certificates so that they will not be part of the probate estate and will lower any taxes and fees. You can also add a Pay on Death (“POD”) or Transfer on Death (“TOD”) designation to your accounts so that they will go directly to the person you choose and will not have any probate taxes. Estate planning is important to avoid probate.

For further information please contact Softron at 1-877-SOFTRON or visit www.softrontax.com