Types of Trusts
Trusts can be an important part of your estate plan. There are many types of trusts, and your estate planning lawyer can help you determine if a trust will be beneficial for you. To help you understand a bit about the various trust used in estate planning, the following is a basic primer on types of trusts.
Alter Ego Trust
A trust created during a person’s lifetime, the income of which must be for the sole benefit of that person during his or her life. The terms of the trust can include a gift over to on the maker’s death to beneficiaries chosen by the maker of the trust. The maker of the trust must be over 65 and a Canadian resident within the meaning of the Income Tax Act. This type of trust is used to avoid probate fees, avoid claims by a spouse or child who would have the right to challenge the will of the maker, or to keep the affairs of the maker private (a probated will becomes public, but a trust does not). There is no deemed disposition when the assets are transferred into the trust and the 21 year deemed disposition rule does not begin counting until the death of the maker. The maker of the trust is still taxed on the income earned by the trust as if the trust didn’t exist. In order to qualify for the tax advantages associated with being an alter ego trust, during the maker’s life, the maker must be entitled to all income of the trust and no other person may benefit from the income or capital of the trust.
Joint Partner Trust
Similar to an Alter Ego Trust, except that the income of the trust must be for the sole benefit of the maker and his or her spouse during their lifetimes, and no person other than the maker and his or her spouse may benefit from the income or capital of the trust during the life of the maker and his or her spouse.
Discretionary Family Trust
A trust created during a person’s lifetime, usually to hold growth shares in a business as part of estate or succession planning. It allows the growth in a company to accrue to the benefit of the next generation for tax purposes, while still giving the older generation control over distribution decisions and access to income flow as required. The distribution of income and capital is usually completely discretionary among a group of beneficiaries, who may include self, spouse, children, grandchildren, other family members, and other corporations or trusts controlled by the beneficiaries. There are very strict rules to be followed in creating the trust and in paying out from the trust to ensure that income is not attributed to the wrong taxpayer and to be sure that corporations are not accidentally “associated” for tax purposes. There is a deemed disposition for tax purposes when assets are transferred into this type of trust, so the trust usually borrows money to acquire shares at a nominal value after a corporate reorganization. The trust is deemed to dispose of all its assets every 21 years, triggering a capital gain on the growth in value of the assets, so steps must be taken to deal with this tax consequence prior to the 21 year anniversary occurring.
A trust created during a person’s lifetime or on his or her death in a will or a life insurance trust declaration for the sole benefit of the person’s spouse. Assets can be transferred to a spousal trust without triggering capital gains tax liability, using a spousal rollover. Spousal trusts are often created in a will to give a spouse the use of the income (and perhaps the right to encroach on capital) during the spouse’s lifetime, while preserving the bulk of the capital for the benefit of children of a previous (or current) marriage. Choice of trustees of the spousal trust is important if the intent is capital preservation. Spousal trusts created in a will also have the benefit of offering income splitting for the surviving spouse as the trust is taxed as a separate taxpayer and gets the benefit of the same graduated marginal rates as a separate taxpayer. In order to qualify for the tax advantages associated with being a spousal trust, the spouse must be entitled to receive all the income of the trust during his or her life, and no person other than the spouse may benefit from the income or capital of the trust during the spouse’s life.
A trust created in a will or life insurance trust declaration, which comes into effect on the maker’s death, and which is commonly used to provide protection for young, spendthrift, or unhappily married beneficiaries, or to give income splitting advantages to successful beneficiaries. A spousal trust and a disability trust created in a will are also forms of testamentary trusts. The trust can be completely discretionary, so that the trustee decides when and how much is disbursed to which beneficiaries, or the trust can specify what each beneficiary gets and at what age.
A trust created during the maker’s lifetime or on the maker’s death under a will or life insurance trust declaration, for the benefit of a person in receipt of disability benefits from the government. A disability trust (sometimes called a Henson Trust) is usually completely discretionary to preserve the right of the disabled person to continue to receive government benefits. A gift over to another beneficiary on the disabled person’s death is required to make an effective trust.