Use of trusts by seniors in estate planning

There seems to be a growing interest among seniors to consider options that improve the administration and security of their assets during their lifetime, providing a greater degree of certainty that their estate’s assets will be distributed in accordance with their wishes. One option to consider is certain trusts available to individuals who are at least 65 years of age. 

Where an individual implements a trust for his/her own benefit, the trust is generally referred to as an alter ego trust. Where an individual establishes a trust for her/his benefit and the benefit of their spouse or common law partner¹, the trust is referred to as a joint partner trust. The person(s) contributing assets to the trust are generally known as the settlor(s)². These trusts are settled where an individual transfers assets – which would otherwise form all or part of the individual’s estate – to the trust. 

Such trusts are legal arrangements between a settlor, trustees and its beneficiaries evidenced by a trust indenture, which generally provides detailed instructions on how to administer and distribute the trust’s assets before and after the death of the settlor. The trust is governed by trustees, which often includes the settlor and other trusted persons.

The settlor transfers assets to the trust to be governed by the named trustees based on their wishes as documented in the trust indenture. As a result, the assets are no longer administered directly by the individual or through the individual’s will. Instead, the terms of the trust, as administered by the trustees, governs the administration and disposition of the transferred assets. For this reason, such trusts are often referred to as power of attorney substitutes and/or will substitutes. 

These types of trusts must satisfy all of the following conditions:

1. The contributor, referred to as the “settlor,” must be resident in Canada and over 64 years of age at the time the trust is created.
2. The settlor and/or the settlor’s spouse must be entitled to all of the income of the trust that arises before the later of the settlor’s death or that of his/her spouse or common law partner³, and   
3. No person other than the settlor and/or the settlor’s spouse or common law partner may – during the settlor’s (or that of their spouse’s) lifetime – receive or otherwise obtain the use of the income or capital of the trust⁴.

For tax purposes, the assets transferred to these trusts can be accomplished on a tax deferred basis with any inherent gains deferred until the death of the settlor or, in the case of joint partner trusts, the later of the settlor and their surviving spouse.

These trusts offer several benefits, including:

1. Asset administration
   The settlor can continue to control the assets by virtue of being a trustee.  However, other persons or alternate trustees can be identified, so there are alternate trustee(s) if the settlor becomes mentally incapable of managing his/her own affairs. An added advantage is that, if and when the settlor no longer wishes to manage his/her own financial affairs, other named trustees can assume such responsibility. However, it is important to note all trustees would have a fiduciary obligation to manage and distribute the trust assets in accordance with the settlor’s wishes, as provided for in the indenture.
   
2. Asset protection from unforeseen influences
   In some cases, as individuals age, they can become more susceptible to inappropriate requests, threats and demands by third parties via phone, email, mail and other sources. To the extent there are one or more other trustees who would be involved in assessing the validity of such requests, threats and demands, the settlor may be more protected from financial losses. 
   
3. Reduction of probate fees
   If an individual owns real estate and certain other assets not covered under a secondary will⁵ (“property”), the Will governing the property will generally need to be probated. For some provinces, the fee is determined as a percentage of the fair market value of the assets included in the will being probated and the fees can be substantial. Trust assets are not included in estates for the purposes of most provincial probate tax calculations, which can result in additional savings due to avoiding probate fees on the trust assets.
   
4. Streamlining of estate administration
   If assets are governed under a will that needs to be probated, the executors generally have limited scope to sell, transfer or otherwise deal with those assets before probate proceedings have concluded. This process can take months or longer in circumstances where the validity or contents of the will are challenged. Assets owned by these trusts are not subject to such process and delays, allowing the trustees to more efficiently and effectively administer the trust’s assets.
   
5. Confidentiality of estate assets
   Information – including estate asset schedules and values – is generally available to third parties with an interest in reviewing the information. The affairs of a trust are private and generally not available to third parties in the absence of legal or other proceedings, which could compel the trustees to release such information.
   
6. Principal residence exemption is available to such trusts
   Upon the death of the settlor – or, in the case of a joint partner trust, the death of the surviving spouse – the trust would be deemed to dispose of all assets for an amount equal to the fair market value (determined at the applicable date of death). In circumstances where the settlor and/or his/her spouse occupied the real property as their principal  residence and subject to other individual-specific eligibility criteria, the trust would be entitled to a principal residence exemption on capital gains otherwise subject to tax in the hands of the trust.

These trusts also have a number of disadvantages

1. Implementation and annual costs
   1. It is highly recommended professional advisors be retained to draft the trust indenture and implement the planning, resulting in costs that could exceed the normal costs of drafting a will.
   2. Each year a trust return must be filed with the Canada Revenue Agency, resulting in annual compliance costs.
2. Potential tax consequences upon the death of the settlor and/or his/her spouse
   • The transfer to the trust can be accomplished on a tax deferred basis and any tax otherwise payable on inherent gains is deferred until the death of the settlor or, in the case of a joint partner trust, the death of the surviving spouse. However, the trust inherits the settlor’s cost base of each asset transferred to the trust. The date the settlor dies (or, in the case of a joint partner trust, the date the surviving spouse dies), the trust is deemed to dispose of all its assets at their then fair market value. The trust – subject to the principal residence exemption discussed above – is subject to tax levied at the top marginal rate in effect in the jurisdiction in which the trust is resident. If this is properly constructed in the right circumstances, the ultimate income tax burden payable by the settlor and the trust may not be materially different from that tax payable in circumstances where no such trust was implemented. However, without proper planning, the exposure to tax on gains may be higher than if the settlor held assets personally at the time of death.
3. Some control can be lost
   • If the trust has trustees other than the settlor, in order to maximize asset protection and streamline asset administration, the settlor can become subject to authority exercised by those other trustees. Accordingly, if the settlor appoints trustees other than himself/herself, careful consideration is needed to ensure those other trustees are aligned with the wishes of the settlor. Regardless of how much consideration is given, if the settlor does become incapable of administrating the trust assets, conflict is inevitable.
4. Charitable donations can be tricky
   • A full discussion of charitable giving through alter ego or joint partner trusts is beyond the scope of this alert. However, in the first 36 months of a deceased individual’s estate, there are often several options related to charitable gifts, each of which allow the resultant tax credits to be claimed in the final return of the deceased individual or the return for the year prior to death. Unfortunately, this flexibility does not extend to these trusts⁶. If an individual contemplates a significant charitable gift upon death, these types of trusts may not be the optimum structure to consider in all circumstances. 

Under the right circumstances, alter ego and joint partner trusts can be very beneficial estate planning tools. To ensure implementation of either of these trusts would be beneficial to your overall estate plan, consult your Baker Tilly advisor.