21 Year Rule – Hull on Estates and Succession Planning – #203
Listen to: 21 Year Rule – Hull on Estates and Succession Planning – #203
This week on Hull on Estates and Succession Planning Ian continues the discussion surrounding different issues trust arrangements can bring about and solutions to these issues. The specific issue discussed in this episode is the 21 Year Rule. Ian discusses how it creates problems and possible solutions to look to.
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Welcome to Hull on Estates and Succession Planning, a series of podcasts hosted by Ian Hull and Suzana Popovic-Montag. The podcast you’re listening to will provide information and insights into estate planning in Canada. From the offices of Hull & Hull in Toronto, here are Ian and Suzana.
Ian Hull: Hi and welcome to Hull on Estates and Succession Planning. You’re watching and possibly listening to episode 203.
Well, welcome back. And again as a solo performance on my podcast today for Hull on Estates and Succession Planning, it’s Ian Hull.
I want to keep flushing out and talking about some of the problems that trusts arrangements bring about and how we have been able to start to look to different solutions. And the last day we talked about a very creative and maybe controversial model, avoiding the trust by using two different insurance products, the annuity and the life insurance product.
Today I want to talk a little bit about a slightly different twist on that, and that is, talk about the 21 year rule and how does that create problems and what solutions can we look to?
So the 21 year rule is this – and as we’ve talked about on trust law many times, someone will take and we’ve been using an example. Take $1,000,000 and decide you want to create a trust for the benefit of your surviving spouse and your children to basically enjoy the income from that $1,000,000 for their lifetime. And then on their death, all the rest should go out to what will be effectively your grandchildren. So it’s a nice legacy to leave. It’s tax efficient, it’s creditor-proofing. All those sorts of things it brings with it. The difficulty is, one of the tax issues that arises with all trusts is that in Canada, after 21 years, CRA says you are deemed to dispose of the assets. You are going to now pay the capital gains on that trust asset after the 21 years. Basically, the rule is set up so CRA can somehow catch all of the taxes and that you can’t shelter your tax benefit forever. And so they say, 21 years is the maximum a trust can last for tax purposes.
Now it’s not the maximum a trust can last for trust purposes. And let me explain that. Obviously CRA is wanting their tax money as often and as quickly as they can. And so they say we don’t care what documents you enter into. We don’t care what arrangements you’ve entered into by way of a contract, by way of a trust, by way of a handshake. It doesn’t make any difference to us. We want to get our fair share of our taxes in a timely way. So if you’ve entered into at trust arrangement, you only have 21 years of the tax benefit that gets created by that. And essentially you’re going to be sheltering some of the growth in the trust and some of the benefits, the tax benefits. But after 21 years, you have to pay the piper and Revenue Canada makes sure that happens.
Now there are, of course, ways to avoid what we call that deemed disposition on the 21 year point in time. And we’re not the tax experts in terms of the methodology of it but the nice thing is, is that it’s not necessarily the end of the day. CRA doesn’t necessarily get all of your money. When I say all of your money, all of the tax owing on your money after the 21 years. But having said that, what we find often as an important tool is proper estate planning, knowing we have a 21 year rule out there and knowing that it is not easy to avoid paying those taxes after the 21 years.
So what will often happen is we look at the estate arrangement and how we can use the estate planning arrangements to help manage the 21 year rule. And the easiest and most obvious result is to create an estate plan, not a trust, but an estate plan that accomplishes a pay out of those assets before the 21 years come into place. And one of the ways we can do that, of course, is to incorporate an early pay out of the money before the 21 years hits. And one of the classic arrangements is that someone will put in their Will that part of the money comes out when their children hit 18, another part comes out when they hit 25, and the rest of it comes out when they hit 35. Something like that. That is a tailing off of the money so that within 21 years, the children are not getting it all at once but they’ve enjoyed the chunks of money over time. That’s a classic arrangement. Many, many Wills across Canada and in the US many trusts provide for that trickling out effect, therefore avoiding the 21 year rule.
The other classic scenario to help us defer taxes and not get caught up on this definitive 21st anniversary of the trust being established is using a Will and providing for a spousal roll-over of the assets, so that in a sense you are just simply taking the assets of one spouse, rolling it over for the lifetime of the next spouse. So what you’ve done is, you’re not necessarily in a trust arrangement. You’re simply providing in the Will that all of my assets roll over to my wife – another classic scenario. But what it’s doing is it’s giving another tax deferral, and that is that the wife doesn’t have to pay the tax owing on…and an easy example of this would be an RRSP. Husband and wife own an RRSP. The husband owns one for $500,000 and dies. Well, there’s a deemed disposition that would typically be paid on that. And all of the capital gains within that RRSP are paid right away, essentially. That’s rough tax law, very 101 basics. But to avoid that, you roll it over automatically to the spouse. And CRA says that roll-over is okay. And therefore the spouse then enjoys that RRSP, doesn’t have to pay the tax immediately, there’s no deemed disposition when it comes into the wife’s hands. And that wife can enjoy the trickle out of the RRSP monies during her lifetime. So it’s a classic deferral between the death of the husband and the death of the wife. No trust arrangement has been created and you’ve avoided a deemed disposition. You’ve taken more time for the deemed disposition to occur. And that is, again, 101 tax planning to the extent that you can do it. And that is, avoid paying the tax until you absolutely have to. And that’s why the 21 year rule is there because eventually CRA says to you finally now look, you’ve wasted my time long enough. You finally now have to pay the taxes. And the easy scenario is the classic roll-over that accomplishes the same result.
So waiting and pushing out the payment of taxes through non-trust techniques is, as I say, another useful tool to avoid some of the draconian and problematic issues that arise with the 21 year rule and with trust arrangements generally.
So I think that covers off two easy solutions that we’ve talked it through at CALU. We enjoyed the conference tremendously and really had a good time talking with the advisors who then also fed into us different insurance solutions within these parameters. But one of the central themes was sure, a trust works, but not necessarily. And as we’ve learned a long time ago, each client comes with their own special assets, their own special needs and just automatically turning to the trust format as the solution isn’t, in my view, the answer. You need to, in my view, look at other options and see if they fit your client a little bit better.
So thanks again for taking the time and joining our podcast. We look forward to our next one. I’m almost certain that that one Suzana will be at. But it’s been great, I’ve enjoyed it and thank you.
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Hull and Suzana Popovic-Montag. The podcast that you have been listening
to has been provided as an information service. It is a summary of current
issues in estates and estate planning. It is not legal advice and you are o
reminded to always speak with a legal professional regarding your specific circumstance.
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