Trusts are integral to wealth, tax, and estate planning, allowing individuals to control when and how assets are distributed to intended beneficiaries, both during one’s lifetime – via an inter vivos or living trust – and after one’s death, via a testamentary trust usually created by the terms of a will.
Although upcoming changes to the tax treatment of testamentary trusts will eliminate certain tax-planning opportunities associated with these types of trusts, experts say they still represent valuable tools for many clients.
Until recently, testamentary trusts were taxed at graduated rates — the same tax rates that apply to individual taxpayers — rather than at the top tax rate on all income earned, which is the way that living trusts are taxed.
It was possible, therefore, for an individual to establish one or more testamentary trusts to achieve a form of income splitting, after death, with beneficiaries by accessing one or more sets of graduated rates.
“Depending on how big the estate was, your heirs could potentially save between $15,000 and $20,000, depending on the province, every year,” says Tim Cestnick, president and CEO of Toronto-based WaterStreet Group Inc. “The tax savings would add up.”
However, in the 2014 federal budget, the Department of Finance announced that testamentary trusts would be taxed at the top tax rates, beginning in 2016, putting an end to the income splitting opportunities afforded by the use of testamentary trusts.
“The government was concerned with the potential growth in the tax-motivated use of testamentary trusts and the associated impact on the tax base, on revenues,” says Wilmot George, director of tax and estate planning with Mackenzie Financial Corp. in Toronto.
There were two key exceptions to the change. Estates would continue to benefit from a 36-month grace period of access to graduated rates to provide enough time for them to be administered. And testamentary trusts that are set up for the benefit of a disabled individual who is eligible for the disability tax credit would also continue to have access to graduated rates.
Tax and estate experts agree that there remain multiple and significant benefits of testamentary trusts, despite the changes to their tax treatment.
“I have not seen, for example, everyone [going back and] rewriting their wills to get rid of their testamentary trusts,” Cestnick says. “And for good reason. I think there is still good value in these trusts.”
Testamentary trusts, for example, are particularly useful in cases where the beneficiary is a minor; or when the beneficiary is an individual who faces difficulty managing money, such as someone struggling with addiction. In these cases, the trustee can maintain control over the timing and the amount of any distribution from the trust.
Testamentary trusts are also useful in dealing with estates in cases of blended families. Using a testamentary trust may allow an individual to provide for a second spouse during his or her lifetime, for example, while making sure that remaining assets pass to heirs from a first marriage after the second spouse’s death.
Finally, assets in a trust do not have to go through the probate process, which is a matter of public record, and thus remain confidential.
Up next: Alter-ego and joint partner trusts.