When you’re deciding how best to transfer your wealth to heirs, it’s common to have several competing concerns. You may want to keep your assets private, minimize taxes, and ensure that your gift is distributed according to your wishes. A family trust is a popular estate-planning tool that can address these issues and more.
What is a family trust?
At its most simple, a trust is a way to hold and distribute assets. A settlor places trust assets under the management of a trustee on behalf of a beneficiary. When the beneficiary is related to the settlor, it’s called a family trust.
Family trusts offer several advantages in estate planning.
- Greater control. When you establish a family trust, you can set specific conditions on when and how the assets are distributed. For example, you can decide that beneficiaries only access the assets when they reach a certain age or milestone.
- Greater privacy and quicker distribution of assets. Because a family trust will typically avoid probate, trust assets may be able to remain private and pass more quickly to beneficiaries.
- Potential tax benefits. Depending on how the trust is set up, the assets may no longer be part of your estate and therefore not subject to estate taxes.
There are also potential limitations.
- Irrevocability. Assets you place in the trust are no longer part of your estate, and you generally can’t change or dissolve the trust once it’s created.
- The 21-year rule. After the trust has been in existence for 21 years, it faces a “deemed disposition.” That’s when any inherent capital gains in the trust are realized and subject to taxes. It can be a financial shock, if not prepared for it.
- Income tax. Family trusts are taxed on the income they generate at the highest marginal rate.
Four major use cases for family trusts
Family trusts’ advantages can be put to several different uses. Here are a few of the most common:
Income splitting. Income splitting is a tax minimization strategy that seeks to move income from a family member in a higher tax bracket to a family member in a lower tax bracket. If you pay the highest marginal tax rate, it might be appealing to make a large tax-deductible donation to a family trust and have the trust allocate the money to someone with a lower income, who will pay a lower marginal rate on the money. It’s important to consult a professional before attempting this strategy, as there are several laws that limit the practice.
Estate freeze. A family trust can be part of a tax minimization strategy for business owners called an estate freeze. In an estate freeze, you lock in the value of your ownership of a business and allocate all further appreciation of the company to a new person or group of people by issuing new shares. By putting those new shares into a family trust, you can earmark them for your heirs without saddling them with direct ownership for the time being.
Setting conditions on an inheritance. When setting up a family trust, you can decide how the assets are distributed and used. This can be useful in several situations. You can define specifically how a vacation property is to be shared among your heirs, for instance. If you’re worried about your younger heirs spending their inheritance unwisely or failing to learn the value of hard work, you can decide that they won’t receive the money until they’re older. Alternatively, you could stipulate that your heirs only receive money if they graduate from college. You could even create a list of approved expenses, such as education expenses or a home purchase.
How to set up a family trust
Family trusts can be complicated, and the rules differ under common law and Quebec civil law. You’ll need to engage the services of an estate planning attorney to ensure that yours is set up properly. It’s also a good idea to speak with a financial advisor who is already familiar with your values and financial goals. They can help you consider how a family trust may fit into your plan, which type may best suit your financial situation and big-picture goals, and how to distribute assets accordingly.
SOURCES:
https://www.npw.ca/family-trusts-101-everything-you-need-to-know-and-more/
https://www.sunnet.sunlife.com/files/advisor/english/PDF/advisor_notes_legal_Trust_in_quebec.pdf
https://www.nbc.ca/personal/advice/taxes-and-income/family-trust-advantages.html
