Anticipating Issues in Trust Arrangements – Hull on Estate and Succession Planning Podcast #86
This week on Hull on Estate and Succession Planning, Ian and Suzana discuss trust planning options and anticipating issues that may arise in the future.
Anticipating Issues in Trust Arrangements – Hull on Estate and Succession Planning Podcast #86
Suzana Popovic-Montag: Hi, and welcome to Hull on Estate and Succession Planning. You’re listening to Episode #86 of our podcast on Tuesday, November 13th, 2007.
Welcome to Hull on Estate and Succession Planning, a series of podcasts hosted by
Ian Hull and Suzana Popovic-Montag, that will provide information and insights into estate planning in Canada, from the offices of Hull Estate Mediation in Toronto, Ontario, Canada. Here are Ian and Suzana.
Ian Hull: Hi Suzana.
Suzana Popovic-Montag: Good morning Ian, how are you?
Ian Hull: I’m great.
Suzana Popovic-Montag: That’s good.
Ian Hull: We’ve had some interesting discussions about, at the end of the last podcast, we talked about sort of an interesting dovetail between tax and family law claims, and just talked about the capital gain and Family Law Act issues. And one thing that we wanted to finish off with on that discussion, because we’ve been really talking about, you know, how these core tax issues do make such a big difference in estate planning. And, you know, I would say in the context of estates administration, there are two of the most fundamental issues: one is the tax issue; and the other is, of course, what does the surviving spouse have, in terms of rights, that will screw up the deal, so to speak, screw up the plan that you’ve already done. And one of the points that we don’t want to forget is that when we do draft our Wills, that we need to consider as well the possibility of the Family Law Act claims being made. And that that will in turn accelerate the interest of the other beneficiaries under the Will, should an election occur. So there may be a tax consequence when someone says the Will’s not good enough for me. The surviving spouse says, the Will’s not good enough for me, I want to elect under the Family Law Act. That may have a ripple effect on all the other beneficiaries, so we can anticipate that and sometimes plan around that.
Suzana Popovic-Montag: And anticipating it really is the key, I think, because we try to create these plans and we call them as bullet-proof as we possibly can. But the reality is that things can get frustrated, those intentions can fall to the wayside, and the FLA election is the prime example of that. And in those cases, there’s an unexpected result that arises. And so you try, to the extent that you can, to anticipate what the diminished value of the estate is going to be in those kinds of circumstances. And what you do in light of the fact that the tax liability that you’re trying to so desperately avoid, might actually be accelerated as a result of what’s been done.
Ian Hull: It’s so true, because we have the situation, the classic scenario where someone does elect under the Family Law Act and the remaining beneficiaries, and a lot of cases it’s the children, either of the first and/or second or both marriages, sit around the table and they go, wow, I got a lot less to spread around here now. There may be tax issues you want to consider and there may be diminished beneficiaries that have other approaches they may want to take. For example, maybe there is going to be…you can anticipate that there’s a possibility of an election, and there’s going to be a lot less money for the remaining beneficiaries, and you may want to anticipate, you know, how that will affect them personally in their individual circumstances. So it’s just something to consider as we round off our discussion on the interplay between the family law and the tax issues.
Now, when we first started this sort of section of our podcasting, we talked about the fact that one of the core issues relating to estate planning is, of course, that we would want to consider setting up a spousal trust. And we’ve talked a lot about the spousal trust. We’ve put a lot of emphasis in the past few podcasts on the rights of the spouse. There is, of course, the secondary part of that. And that is, a testamentary trust. And we’ve already talked a little bit about what that is. But I think we should spend some time talking more through some of those issues. Because you either are going to…if you’re going to set up a trust arrangement, you’re either going to set it up in a spousal trust arrangement, or you’re going to set it up in a testamentary trust arrangement, or both. So let’s not forget what those are, and how some of the core tax issues reflect on that issue.
Suzana Popovic-Montag: And just as a quick refresher point on that, a testamentary trust, of course, is a trust that arises by virtue of the terms of the Will. And so it comes about and is created in a Will and it provides…the tax laws provide that testamentary trusts are actually taxed in the same manner as an individual is taxed under the Income Tax Act here in Canada.
Ian Hull: So that’s the same manner as, of course, the marginal rates and the graduated rates that you would have, as opposed to an inter vivos trust. So there’s sort of these three types of trusts. There’s the inter vivos trust, which his typically, and we can broad stroke it a little bit, but it’s typically taxed at the highest marginal rate. So while they’re good for some reasons, they’re not good for tax reasons sometimes. And we’ve got the spousal trust, which we…the tax rate is the same as the testamentary, and that is, at the individual rate. But we’ve talked a lot about, you know, it’s a very restrictive trust. It only can apply to the spouse and you have to be so, so careful as to who enjoys the benefit of that trust. And now this third trust and how it’s taxed is this graduated rate and what we will do typically in these trusts is create a series of beneficiaries in most cases. We have options: include the spouse; include the first children of the marriage; include the second children of the marriage; whatever you think makes sense in your own individual circumstances.
Suzana Popovic-Montag: And so in that case, you’re going to, I guess, anticipate having several testamentary trusts arising in the same Will, like you’re setting up, as you say, one for the spouse, for the children individually, in order to be able to capitalize on the tax advantages of that.
Ian Hull: That’s right. And we mentioned in a previous podcast this idea that you’d set up, and you could have numerous trusts. It depends on your circumstances. But let’s talk about the basic scenario. You’ll have a surviving spouse, male or female, and you will have children surviving. And if you have wealth that you want to put into a trust, as opposed to giving it to them outright, you will try to set up these two trusts. And you often will put in the Wills, lots of estate planning techniques will say that $1.00 into each one, and the rest…and its up to the executors to decide, how much goes in the spousal, and how much goes in the testamentary. So it gives lots of flexibility and it gives tremendous lifetime, ongoing protection for the good reasons that if you’re going to do a trust, exit.
Suzana Popovic-Montag: And adding to that flexibility is the fact that the testamentary trust, the fiscal period for that trust, can actually be chosen by the executor and they can take into account what would be most beneficial for the beneficiaries of each trust in setting that fiscal period.
Ian Hull: That’s right. And there’s a technical twist that adds to that too, is that the trust beneficiary is deemed not to have received trust income until the very last day of that fiscal period of the trust. So again, that’s another twist. I mean, what…I guess that pushing out the time that the income is received, Suzana, where does that help the beneficiaries?
Suzana Popovic-Montag: Well, what it does Ian, is that it defers the tax the year in which the individual beneficiary has to pay tax on that trust income.
Ian Hull: Okay. Well, now we’ve talked about this idea of multiple trusts. And let’s talk about multiple testamentary trusts, where there are two or more trusts that are created, and income is accruing to the same say, group of beneficiaries, or as we sometimes describe, the class of beneficiaries. What sort of, again, what kind of creative advantages do we get under the Income Tax Act and those scenarios, where we’ve got that kind of situation?
Suzana Popovic-Montag: In that kind of scenario, Ian, the trust can actually be designated as one for tax purposes. So, notwithstanding that there’s more than one, it can be merged together, so to speak, so that it’s treated as one in order to be taxed.
Ian Hull: Okay. So I think that, you know, it’s a good lesson for us to make sure that when we create these trusts, we want to be careful when we draft them because generally, separate trusts for each child or grandchild, for example, will be taxed separately. And, you know, it’s not the purpose of this podcast to get into graduated rates and the like, but you can see just from the basic math, it would be, sometimes, depending on your situation, it might be more advantageous to separate these trusts, especially when you have a significant amount of wealth. You might want to set up the Betty trust and set up the John Trust and then set up the Great Grandchildren’s Trust, all thereby allowing different treatment of the tax on the income. And, you know, as I say, it…so much depends on the individual circumstances. But its worth considering.
Suzana Popovic-Montag: And adding to that flexibility, the testamentary trust, you can take all or part of the trust income that is paid or payable to the beneficiary, and it can be taxed either directly in the trust, or into the hands of the beneficiary. And that’s a little bit of an interesting twist that the executors can use to protect, or to the benefit of, the beneficiaries.
Ian Hull: That’s right. And there’s no attribution of income in those scenarios. And again, I mean, we want to look at the Act, as this is…a lot of these rules are tied into Section 104 of the Income Tax Act. And that particular example you gave is 104(13).1. But, you know, these testamentary trusts that extend over a period of years, which we are presumably going to set up when we have it for minor children and grandchildren, really can result in significant tax savings.
Suzana Popovic-Montag: The testator may also want to consider, when they’re creating their Wills or their plans, if the income-splitting trusts for their children or grandchildren, is something that they want to consider, if it’s something that’s appropriate, rather than perhaps giving 100% outright gifts to the children or the grandchildren.
Ian Hull: That’s so true. And I think that’s a good, sort of, final point to consider here, as we’re talking through this. You know, we’re getting a good idea of how to do this, some of the flexibilities of the various trusts we want to set up in the testamentary context. But, again, we want to, I think, sit back and take a deep breath and decide what we’re doing here, and looking at the kind of wealth that would be involved. And, first of all, ask yourself the first question is, is there enough money to make these trusts make sense? Is…does it make economic sense to be filing tax returns every year and to go through the professional headaches that you’re going to have to do, hire an accountant and probably a lawyer at some point, to administer all of this money. So you’ve got to have enough wealth to make that make sense. And then you need to sit back and say, okay, well, would it make sense just to simply give some of this money outright to children. And especially if they are adult children, you know, it maybe make sense to give them some money in that they could use it for a down payment on a house, as opposed to pouring it into what can be an elaborate trust arrangement. So, like you say, we need to sit back, look at what we’re doing here before we dive into some of these, what can be, complex trust scenarios, because the economics of it may not make sense.
Suzana Popovic-Montag: And it really does become a balancing act in those situations, I think Ian, between, you know, is there enough, as you say, money to justify doing that in light of the benefits of it. You know, knowing the creditor protections that may be available, the fact that you’re delaying a payment to perhaps minors who are not necessarily ready to be coming into a large amount of cash. Those kinds of situations are all weighed against each other in deciding if this is the right arrangement for you and for your estate.
Ian Hull: For sure. Well, that’s great. I think we still have lots to consider in the context of the testamentary trusts and I don’t want to cut it short but we’re coming up to our time. And I think we’ll continue on with this discussion and consideration of how we can use testamentary trusts in our next podcast. Thanks very much, Suzana.
Suzana Popovic-Montag: Thanks to you, Ian, and I’ll look forward to our next podcast.
You’ve been listening to Hull on Estate and Succession Planning with Ian Hull and Suzana Popovic-Montag. The podcast you have been listening to has been provided as an information service. It is a summary of current legal issues in estates and estate planning. It is not legal advice and you are reminded to always talk with a legal professional regarding your specific circumstances.
To listen to other Hull On podcasts, or to leave a question or comment, please visit our website at www.hullestatemediation.com.
Our theme music is UpTempo14 by Gary and is courtesy of the Podsafe Music Network.