How to transfer wealth to next generation efficiently using trusts

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Trusts can play a significant role in estate planning, but how do you know which one would work for your family?

Trusts are legal entities that are designed to transfer wealth and property to someone else. They also protect your family’s assets and reduce your tax liability. Trusts fall into two main categories: inter vivos trusts, which are in effect during the client’s lifetime, and testamentary trusts, which go into effect after the death of the client.

Another thing to know about trusts is that once you transfer assets into one, you don’t legally own them anymore. They are the property of the trust, which is then administered for the benefit of the beneficiaries, usually your family.

When considering a trust, you need to decide which goal takes precedence for you: control over your estate, or tax efficiency.

Before adding a trust to an estate plan, advisor Elke Rubach offers some advice. “It’s important that the client actually understands what they’re trying to do with their assets, and then decides if a trust is the correct route,” as each trust has its pros and cons, says the president of Rubach Wealth in Toronto.

Also, trusts can be especially helpful if you own a business.

Here are several types of trusts you’ll find in Canada:

Alter ego or joint partner trusts

These trusts are good options for people 65 years or older, says Damian McGrath, senior trust advisor at Raymond James Trust in Saskatoon. “You’re essentially moving assets that you personally own into a trust,” he says. “When you’re over 65, you can do that without any real tax implication.”

The client and spouse or common-law partner are the only ones entitled to the income, he says, and since the assets are dealt with under the trust, they’re not part of the estate.

Once the last survivor dies, the trust has a deemed year-end date and the assets are then passed on to the beneficiaries, avoiding estate administration and probate fees.

This type of trust also allows for trustees who can manage it if the client becomes incapable, says Ethan Astaneh, a wealth advisor with Nicola Wealth in Vancouver. “You have to have a governance mechanism in place to make those decisions,” he says. “People die, trusts don’t.”

Among the negatives are the setup and ongoing costs to create and manage the trust, but all the advisors said that’s the same no matter which type of trust you choose. Using this trust does mean losing spousal rollover, which is the transfer of assets without tax implications.

Family trust

This is the trust for tax efficiency; it’s used to split income with family members.

“You can now multiply the lifetime capital gains exemption across every beneficiary in that trust,” says Astaneh. Plus, with income splitting, having the trust takes advantage of the potentially lower tax rates of the beneficiaries, as they may not have reached a high tax threshold, he said.

McGrath says the costs of setting up the trust can be high, but the tax savings usually outweigh the initial financial outlay.

Spousal trust

For a blended family, this trust may provide the most benefit, says Astaneh. “This way, your partner in your second marriage would be able to have an income from the capital, but they don’t get control over the capital.”

Instead, once the client’s partner dies, those assets can then pass back to the client’s side of the family such as children from a first marriage, says McGrath.

Both advisors say this trust provides a lot of control over how the assets in the estate are divided among beneficiaries.

Apart from the emotional fallout if the kids don’t like the idea of a spousal trust (because they won’t be able to access the capital until after the death of their step-parent), this trust also prevents the triggering of capital gains upon the death of the client.

As for the disadvantages, once again apart from the setup costs, McGrath says it’s not effective for registered assets such as RRSPs. He also says that some planning is needed to decide when the beneficiaries would receive the capital.

“I might say, ‘After my spouse passes away, I want two of my kids to get their capital right away, but I want another trust set up for my one child who has a disability.’”

That leads us to the next type of trust.

Henson trust

This vehicle provides support for beneficiaries with disabilities in a way that they can maintain their provincial benefits.

“You can have all the money in the world, but the right provincial and municipal support systems are actually what you care about,” says Astaneh. That’s because while bountiful money is useful, it can be useless if there are no good systems to make sure somebody’s checking in and somebody cares.

The advantage of a Henson trust is that assets are in ownership of the trust, says McGrath. “The person with a disability isn’t considered to have those assets as part of their own personal assets.”

In Saskatchewan, for example, if you have more than $100,000, you don’t qualify at all for provincial or municipal supports, he says. So if a beneficiary received an inheritance that pushed his or her assets over the threshold, provincial benefits would be lost until the excess money is spent.

Qualified disability trusts

They are similar to Henson trusts in that assets are also held in trust. In this case, the trust and beneficiary can elect to have the trust taxed as a separate taxpayer. That means the beneficiary would have access to capital from the trust but also qualify for provincial and municipal disability benefits.

“That money in the trust doesn’t threaten the support system that I want my kid to have, which is why I say you get to have your cake and eat it, too,” says Astaneh.

No matter what kind of trust a client chooses as part of an estate plan, all the advisors said it’s important to know exactly what and why a client wants to have a trust and how it will be used.

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