What is a Trust?

The earliest Trusts date back to the Middle Ages. They were first widely used during the Crusades and other foreign campaigns, when prolonged absences were commonplace. Over the centuries, the concept of Trusts developed in countries using the English Common Law system. Today, Trusts are used for a wide variety of purposes.

The following definition of a Trust is taken from a noted author on the subject of Trusts, Sir Arthur Underhill:

“A trust is an equitable obligation binding a person (called a Trustee) to deal with property over which he has control (called the trust property) for the benefit of persons (who are called beneficiaries) of whom he may himself be one, and any one of whom may enforce the obligation”

In plain English, a Trust arises when a person (known as the Settlor) transfers legal title to property to another person (known as the Trustee), with instructions as to how the property is to be used for the benefit of named persons (known as beneficiaries).

To be valid, a Trust must have a Settlor, a Trustee and identifiable beneficiaries. The beneficiaries may be identified by name, or as being members of a class - for example, “my children” or “my grandchildren”.

A Trust cannot be created until legal title to some property has been transferred to the Trustee. Although the Trustee has legal title to the Trust property, beneficial ownership rests with the beneficiaries (beneficiary).

Assets of all kinds can be placed in a Trust, including bank accounts, real estate, stocks and bonds, mutual fund units, limited partnership interests and private businesses. Some assets, however, may not be appropriate to place in a Trust, so be sure to consult with your advisor before making such transfers.

What Types of Trusts are Available?

While there are many different uses of Trusts, there are two main categories that we focus on. Living Trusts (also referred to as inter vivos trusts) and Testamentary Trusts.

What is a Living Trust?

To fund a Living Trust, ownership of assets must be transferred from the Settlor’s name into the Trustee’s name. The Trust can be funded with cash, stocks, bonds or almost any other asset. As mentioned above, the Trustee has legal title to the Trust property, but beneficial ownership rests with the beneficiaries.

One of the advantages of a Living Trust is that the Settlor may choose to be the Trustee, or one of several co-Trustees. This may be important to individuals who want continued control of the assets while they are alive. This is often the case when a family business is placed in a Trust, and the Settlor wants to continue to have some influence on the business.

What is a Testamentary Trust?

A Testamentary Trust is created under the terms of a Will, and only operates on the death of an individual (the “Testator”). Prior to the testator’s death, the terms of the Trust can be modified, or the Trust can be removed, simply by having a new Will prepared. Testamentary Trusts are funded from the proceeds of the deceased’s estate.

The terms of a Testamentary Trust can be kept confidential until the Testator dies. After death, when the Will is probated (becomes a valid Will), it becomes a public document.

Discretionary Vs Non-Discretionary Trusts

Discretionary Trusts may provide the Trustee with the power to pay part or all of the income to an income beneficiary, or to pay capital to a capital beneficiary prior to the distribution date.

In a Non-Discretionary Trust, the trust document provides the Trustee with the amount of the income payments, or how much capital can be paid to any beneficiary prior to the distribution of the Trust.

What are Henson Trusts?

A Henson Trust is a highly specialized type of Trust containing two fundamental elements. A parent of a child with a disability must have a Henson Trust in their Will in order to leave an inheritance to the child with a disability without causing the child to lose their ODSP benefits (monthly cheque and drug card).

Read more about Henson Trusts here.

How can a Living Trust be Used?

Situation 1.

Today many parents are finding themselves on the receiving end of a generation of so-called “boomerang kids.” These are adult children who, because of job loss or a divorce, return home and become financially dependent on their parents once again. In many cases, parents simply provide financial support out of their after-tax dollars. A Living Trust, however, may be able to provide support in a more tax-effective manner.

Situation 2.

If you own assets, which have had consistent growth patterns over the years, are anticipated to grow substantially in the future, you may consider using an estate freeze, with a Living Trust and a corporation, to place any future capital gain in the hands of your children. Such an arrangement will essentially freeze the value of the assets, so all future capital gains will accrue to the beneficiaries (e.g., your children).

Situation 3.
An effective way to assist a favourite charity, and give yourself a tax break, is to donate a residual interest in a Trust to the charity. Such Trusts are often referred to as “Charitable Remainder Trusts”. The fair market value of the charity’s residual interest (the remainder) may qualify for a non-refundable tax credit. Typically in these arrangements, the income earned from the assets in the Trust is paid to you, and, after your death, the capital goes to the charity. This type of Trust may be suitable for older people with a high marginal tax rate, who wish to make a gift to charity and can afford to give up ownership on a portion of their assets.

Situation 4.

Living Trusts can be very useful in providing for family members with a physical or mental disability and cannot look after their own financial affairs. A Trust can be established which provides a family member with income for life. In situations where another family member will be providing the personal care, it may be appropriate to appoint them as the Trustee. If, however, the Trust is going to exist for a long time, when it is set up for a young child for instance, it may be appropriate to appoint a corporate Trustee to ensure management of the Trust for the life of the beneficiary. Corporate Trustees, however, can only look after the assets. The personal care of the individual must be provided by other means.

Situation 5.
Since assets that have been transferred to a Living Trust are no longer the property of the settlor, they do not pass to the settlor’s estate on death. This has two significant advantages. First, unlike a Will which becomes a public document when probated, the terms of a Living Trust remain confidential. Second, since Living Trusts do not have to go through the probate process, they do not have probate or estate administration fees charged against them when the settlor dies. This provides a planning opportunity for anyone who wants their affairs handled discreetly, avoiding probate.

Situation 6.

Today, many Canadians are living well into their 80s and 90s. Unfortunately, as the years go by, some are finding it increasingly difficult to manage their financial affairs. Often their children are unable to assist them because they live out of town or are busy raising their own children. A solution is the establishment of a Living Trust, structured so that the parent receives income for life, with the capital distributed ultimately to children and grandchildren. By naming a Trust company and a child as co-Trustees, the parents can rest assured knowing they will get professional money management and administration from the Trust company, and input on personal matters from one of their children.

Situation 7.
Because lump sum payments are often unattractive for the payer, many divorces today still end up with a lengthy or lifetime support arrangement. Where there is available capital, the best solution may be to set up a Living Trust.

How can a Testamentary Trust be Used?

Situation 1.

Spousal Trusts should be considered for larger estates where the surviving spouse lacks financial expertise, or is ill or incapacitated. Spousal Trusts are often structured to provide the income of the Trust to the surviving spouse for life, with the capital passing on to children or grandchildren upon the surviving spouse’s death. To qualify for special treatment under the Income Tax Act, the spouse must be a Canadian resident, entitled to the income for his or her entire life, with no one other than the spouse entitled to receive capital during the lifetime of the spouse.

Situation 2.
Trusts for minors are versatile estate planning vehicles, offering a level of financial security. In addition, these Trusts can be established to ensure that there are adequate financial resources for a specific purpose, such as education.

This type of Trust is ordinarily established for children or grandchildren of the Testator. The terms of the Trust usually allow the beneficiaries to receive the capital at an age the testator feels they should be mature enough to handle the responsibility. While some testators direct that the capital be paid at the age of majority, others direct that it be held in Trust until the beneficiary attains a much greater age. For example, a Henson Trust Will can protect the inheritance of a “spendthrift” family member.

Situation 3.

Testamentary Trusts are ideal for individuals who want to provide for a family member, but, due to the lifestyle or abilities of the individual, do not want to put control of the assets directly into his or her hands. It is important to note that if funds are left directly to a family member who is incompetent at managing money, it may become necessary to have a court appoint a committee or guardian (curator in Quebec). The court, through the Public Trustee or Public Guardian, will supervise the management of the assets and may impose restrictions which would not be in keeping with the wishes of the parent.

Situation 4.
Testamentary Trusts are useful for individuals who want to provide for a financially dependent family member, but would also like to leave a gift to a favourite charity. In these situations, a Trust can be established to provide the family member with income for life, and, upon his or her death, the remaining capital is distributed to charity.

Situation 5.

Like Living Trusts, Testamentary Trusts can also be used to provide for family members who are mentally or physically challenged and cannot look after their own financial affairs. In such situations, a Testamentary Trust can be established from the proceeds of the deceased’s estate (usually the parent or a sibling), which will provide the individual with an income for life. In some situations, a family member or close friend is appointed Trustee. If, however, the Trust is to last a long time due to the young age of the beneficiary, a corporate Trustee may be more appropriate.

Some provincial governments provide assistance for mentally or physically challenged people, even if they are the beneficiary of a Trust. If this is the case, it is important that the Trust has been professionally drafted, making it clear that any income drawn from the Trust is at the discretion of the Trustee. To achieve this, a Henson Trust is required in the Will.

What are the Tax Implications of a Trust?

Although Trusts were once considered primarily for tax reasons, Canadian tax reform measures over the past decade have eliminated many former tax advantages.

The following provides a brief overview of the tax issues concerning both domestic and international Trusts, whether they be living or testamentary. It is essential that you obtain professional tax advice before establishing a Trust.

Transferring Property to a Trust.

The first tax issue arises when non-cash assets are transferred to any Trust, other than a spousal Trust. Generally, when property is transferred to a Trust, the transferor is deemed, for tax purposes, to have acquired the property for that amount. The impact is the same as if it had been sold and bought on the open market. If the capital asset transferred into the Trust has appreciated in value over the years, a capital gain may be triggered.

The main point to remember about establishing a Trust with capital property is that there may be some immediate tax consequences for the transferor. A professional advisor can determine the magnitude of any tax liability, and suggest means by which taxes may be minimized.

How Trusts are Taxed?

A Living Trust established after June 17, 1971 is subject to tax on all income at the highest marginal rate of tax in its province of residence. In most Canadian provinces this rate approaches or exceeds 50%. A Testamentary Trust on the other hand is taxed at the normal progressive rates applicable to individuals in its province of residence.

Income Attribution Rules Applying to Living Trusts.

Prior to 1985, Living Trusts were popular vehicles for income splitting between family members with differing marginal tax rates. Since then, changes to the income attribution rules have severely limited income splitting opportunities, particularly for spouses and minor children. The benefit of using loans for income splitting have also been restricted.

Understanding the Role and Importance of Trust Agreements, Trustees and Fees

What is the Trust Agreement?

The Trust Agreement is a written document that sets out the terms of a Living Trust. In the case of a Testamentary Trust, the terms of the Trust are contained in specific clauses within a Will. These clauses state what property is transferred to the Trustee(s), the powers and obligations of the Trustee(s), and most importantly, how and under what circumstances the income and the capital of the Trust will be distributed.

Why is it Important?

The Trust Agreement or Trust Clauses within a Will should clearly set out what the individual wants done, and give sufficient power to the trustees to carry out their duties. Generally, a domestic Trust is governed by the law of the province in which it is administered. Similarly, an international Trust is governed by the laws of the foreign jurisdiction in which it is located.

When considering the terms to put in a Trust Agreement, the key question is, “What if?”…

• What if the named beneficiary doesn’t survive you?
• What if the condition for taking a gift is not fulfilled?
• What if the capital beneficiary dies before the income beneficiary?
• What if it makes sense to sell the Trust property and invest in something altogether different, or collapse the Trust?

What is the Role of the Trustee?

A Trust is an agreement for the transfer of property from the Settlor to the Trustees, for the benefit of the beneficiaries. The Trustees become the legal owners of the property, with their ability to deal with the property limited by the Trust Agreement and Trust law. The Trustees have the following legal obligations:

• Trustees cannot transfer rights, powers, or obligations to a third party. They must act for themselves and not delegate powers.
• As the owners of the Trust property, Trustees have all the legal and equitable obligations to invest and manage the Trust property.
• Trustees must ensure that the income and capital of the Trust is distributed in accordance with the Trust agreement.
• Trustees are personally liable for acts or omissions which adversely affect the Trust or the beneficiaries.
• Trustees must deal impartially with the beneficiaries.
• Trustees cannot use the property in any way to benefit themselves. For example they are prohibited from purchasing property from the Trust unless specifically permitted in the agreement. However, under Trust legislation, Executors and Trustees are entitled to compensation for their services.

Characteristics To Look For In A Trustee

• Trustworthiness
• Sound business judgement
• Time commitment to fulfill the duties
• Impartiality
• Longevity
• Knowledge of trust and tax law
• Experience in trust management and administration

Professional Tax Advice

Before setting up a Trust, it may be necessary to have an accountant or lawyer who is familiar with Trust taxation review the tax consequences to you personally, your estate and your beneficiaries.

What fees and other costs does a Trust incur?

Set-up Fees.

• Domestic Living Trusts: The setup fees would include legal fees for drafting the Trust document. Although there is no such thing as a typical Trust, these fees might range from $1,000 to $2,000. Complex Trust structures which require specialized tax or legal advice can cost considerably more.

• Domestic Testamentary Trusts: The clauses established a Testamentary Trust are found in your Will, so the legal fees are included in the lawyer’s fee for drafting your Will. These fees range from a few hundred dollars to over $1,000, depending upon the complexity of the Will and local practice.

• International Trusts: The setup fees for Trusts vary depending on the international jurisdiction that administers the Trust and upon the assets settled.

Ongoing fees

• Domestic (vary by province): The method of compensating Trustees has evolved over many years. Some provincial Trustee Acts specify what range of fees can be charged, while others allow for reasonable fees based on the care and skill exercised in the discharge of the Trustees’ duties subject to limits set by court practice. The same fee basis applies whether you choose a personal Trustee or a professional Trustee.

• International: An annual administration fee is based on the gross assets of a Trust and ranges from 0.5% to 0.75% per annum, depending on the jurisdiction.

Capital Distribution Fees (domestic Trusts only):

Generally, when the trust’s assets are ultimately distributed to the capital beneficiaries, a fee of between 1% and 2.5% of the assets distributed is charged.

For more information on Estate Planning issues, contact Kenneth Pope through his web site at www.kpopelaw.ca