An elderly wealthy person approached Kim Moody looking for tax advice. All their assets, mostly GICs, were held personally, the founder of Calgary-based tax firm Moodys Private Client recalled. “So, I was like, ‘There’s no tax plan here based on the assets, what else are you planning for?’”
After a bit of probing, it turned out that the client had been married for half a century but had plenty of extra-marital relationships along the way, Moody said. Instead of tax advice, they wanted help bypassing probate to keep their estate’s value private from those relationships when they died.
That happened over two decades ago, when alter ego trusts and joint partner trusts were first introduced. These trusts allow people aged 65 and over to transfer specific capital assets without triggering a tax disposition, maintain beneficial ownership, avoid probate and determine how assets will be distributed after death.
Alter ego trusts can be suitable for clients with complicated family dynamics. For example, someone with a blended family might use the trust to direct certain assets to their first family instead of their second family, said Daniel Collison, managing partner at financial education firm Advice2Advisors in Toronto.
When talking to a client about alter ego trusts, experts recommend advisors learn more about the client’s objectives, understand family dynamics and remind them that they will still need to set up wills and powers of attorney for other assets.
Who alter ego trusts are (and aren’t) for
Advisors can use trusts to open a conversation about the aging client’s estate intentions, Collison said. “[Only] a small minority of Canadians ever get to the point where they’re going to set up these, so get more information from them to see if it’s even an opportunity to look at.”
In most cases, an alter ego trust will yield no tax savings for the client, come with additional professional fees and be subject to trust reporting rules, said Michelle Connolly, head of advanced wealth planning at Q Wealth Partners in Toronto. “These trusts are not driven by income tax savings.”
Alter ego trusts can also be helpful if a client owns assets that are difficult to valuate, such as artwork or a small business, Connolly said. When probate applications can take a year or more to process, the waiting period could impact the value of those assets. An alter ego trust can be an alternative in provinces where secondary wills aren’t recognized.
“Those assets are essentially in purgatory,” Connolly said. “Convenience and privacy are generally what’s driving the need for alter ego trusts.”
Pay attention to family dynamics
Every client’s case is different, and what information to share with each beneficiary of an alter ego trust is driven by family dynamics, Moody said. In some cases, gathering an entire family around a kitchen table to talk about estate planning could be a complete disaster.
Not everyone has to be included in the discussion and beneficiaries don’t have to know how much assets are worth, but an intergenerational conversation can reduce tensions and reveal problems before they occur, Collison said.
Beneficiaries should know why a trust is being set up and what the client’s goals are, Collison continued. However, an adult child who has an addiction or financial issues could be excluded from the conversation and have their assets moved into a different trust.
If there is unequal distribution of estate assets to children beneficiaries, clients can’t assume they know what their kids expect. For example, a family conversation might reveal that one child doesn’t want anything to do with the business but would be happy to take the cottage, Collison said. And a financially successful daughter might be more understanding if her parents explained that they wanted more assets to go towards supporting her disabled brother.
“During these conversations where tensions arise, it actually affords clients the opportunity to strengthen their estate plan,” Connolly said. “It’s not the money that’s driving the [estate] challenges; it’s the emotion and perception.”
Clients still need a will
An alter ego trust will help a client bypass probate, but they still need a will for assets that aren’t in a trust and for funeral arrangements, Moody said. They also need to assign someone medical and financial power of attorney in case they become incapacitated.
For example, those with shares in a Canadian-controlled private corporation might leave it out of a trust to maximize lifetime capital gains exemptions and consider using a secondary will to bypass probate, Collison said. Clients will also need to regularly update their beneficiary and survivor annuitant information on registered accounts, as they lose tax-advantaged status when placed in a trust.