Testamentary trusts – they’re not dead yet
Remember the good old days? Vacations without smartphones, real letters in your mailbox, tax-effective testamentary trusts? Ah yes, those testamentary trusts.
Before 2016, income and realized capital gains within most testamentary trusts were taxed favourably in the trust, at graduated personal tax rates, not the top tax rates associated with inter vivos trusts. It was an estate planning tool that let many trust beneficiaries, typically spouses or other family members of the deceased, lower their overall taxes through income splitting, with trust earnings taxed in the trust and the beneficiary’s other income taxed personally.
Today, testamentary trusts are taxed at the highest marginal rate, with only two exceptions:
- Graduated Rate Estates – which are trusts arising as a consequence of the death of a testator, rather than because a trust was expressly provided for by the terms of a will. These are still taxable at marginal rates for the first 36 months after the testator’s death; and
- A Qualified Disability Trust, which is a testamentary trust with a beneficiary who qualifies for the disability tax credit. These trusts are still taxable at marginal rates.
With the graduated tax rate advantage now eliminated, those planning their estates are weighing alternatives, specifically alter ego and joint partner trusts that are available to those age 65 and older. Advisor.ca has a good discussion of these alternatives in light of the new tax treatment of testamentary trusts: http://www.advisor.ca/tax/estate-planning/alternatives-to-testamentary-trusts-158703.
But it’s also important to remember that testamentary trusts can still play an important role in estate planning, even without the benefit of graduated tax rates. Testamentary trusts can still be beneficial from a tax standpoint if beneficiaries have low levels of income, they still offer protection from creditors, and they’re still a very effective tool in second marriage situations, providing income to a second spouse for their lifetime and capital to children from a first marriage thereafter.
This Globe and Mail article provides a good overview of the many potential uses of testamentary trusts today: https://www.theglobeandmail.com/globe-investor/personal-finance/taxes/consider-these-testamentary-trusts-in-your-will/article27031380/.
While the good old days for testamentary trusts may be over, there’s still life left in this estate planning structure in a number of situations.
Thanks for reading … Have a great day.