At my law office in Ottawa, practically on a daily basis I explain to clients about the exciting estate planning opportunities offered by testamentary trusts. Just the other day, I met with Jim and Sue (not their real names) and suggested they consider including trusts in their Wills for each of their three adult children.
As I explained to Jim and Sue, a trust that is created as a result of a death is known as a ‘testamentary’ trust. Trusts in wills are an example of testamentary trusts. One benefit to setting up a testamentary trust is to provide for the possibility of income splitting. A testamentary trust is taxed as a separate taxpayer at the same marginal tax rates as individuals. So for Jim and Sue, a properly-drafted trust can offer significant tax savings as their adult child’s personal income and the trust income can be taxed separately for the first 21 years of the trust’s existence. Also, naming the child’s spouse and children as potential trust income beneficiaries can offer further income splitting and tax savings. Income splitting is but one of a number of benefits offered by testamentary trusts.
There is a possibility that changes are afoot however. In this year’s federal budget, the Canadian government has suggested that it will be reviewing the taxation of testamentary trusts. In a consultation paper released earlier this month, the Department of Finance set out its proposals to eliminate the graduated rate of taxation of testamentary trusts. They are proposing that testamentary trusts be taxed at the top taxation rates as inter vivos (a trust created while you are alive) trusts currently are. This rate would also be applied to the deceased person’s estate which is considered to be a testamentary trust. This would occur after 36 months following death to allow for a reasonable period to administer the estate. During this 36-month period, the graduated rates would continue to apply. It is proposed that the new taxation rules take effect in 2016. The consultation period wraps up December 2, 2013.
So, what will this mean for the use of testamentary trusts in estate planning such as trusts in wills? The key question will always be “What is the purpose of the trust?” For example, if it is to provide for a beneficiary with a disability and particularly to avoid the loss of Ontario Disability Support Plan (ODSP) benefits, then a particular kind of testatmentary trust commonly known as a Henson trust will still be essential. In other cases, where there are young children (minors), a ‘spendthrift’ beneficiary, or a spouse who might squander an estate to defeat a gift to the deceased’s children of a previous relationship, testamentary trusts will continue to be a crucial part of estate planning.
What about clients like Jim and Sue? It has been suggested that it is this use of multiple, tax-planned testamentary trusts that the government is targeting. What the trustee does with the trust assets and how income is generated and taxed will become much more important. For example, when investing the trust assets, the trustees will have to consider how much taxable income is generated on an annual basis. Income earned by the trust may be paid out to a beneficiary who is taxed at a lower rate such as a minor child assuming this is allowed by the terms of the trust.
I think it is safe to say that because of the many benefits of testamentary trusts, they will continue to be an important estate planning tool. It is possible. However, that depending upon what the government ultimately decides, they may lose a little of their sparkle.
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Blog posts pre-dated December 1, 2015 were originally published under Neff Law Office Professional Corporation.