Estate Planning
Sep 24, 2024
Estate Planning with Alter Ego Trusts in Canada
Learn how an alter ego trust can simplify estate planning for Canadian seniors. Avoid probate and secure your assets.
If you’ve dedicated a lifetime to building an asset base and caring for your family, establishing a family trust might be the next essential step in continuing that legacy. The family trust not only helps reduce tax liability, protects assets, increases privacy, but also helps your estate avoid probate when you pass away.
The following sections will explain everything you need to know about family trust in Canada, including the different types, their benefits, tax implications, and the steps to establish one.
A family trust is a legal entity that contains the assets of its settlor to benefit the family members while the person is alive or after their death. The legal relationship created between the trustee and the beneficiaries is laid out in the trust agreement. The settlor creates the document and outlines the following:
In Canada, the trustees can be parents, grandparents, or other older family members. These are the people whose role and duty will be to manage the trust. The beneficiaries you can include in a family trust are children, spouses, grandchildren, parents, charitable organizations, or corporations.
Family trusts' primary purpose is to enhance estate planning so that you can efficiently manage your finances in your lifetime and after your passing. They promote asset protection by holding the property on behalf of your beneficiaries. They also ensure your property passes on to the beneficiaries without going to court, thus avoiding the lengthy, and costly probate process.
A family trust also helps with wealth management and financial planning for your trustees. As you create the trust, you can outline how you want the assets to be used and managed to ensure continuity and wealth preservation for future generations. You can outline when and how minors can access the funds and what to do with the money. Your trustee should have an idea of wealth management to ensure proper asset utilization.
Establishing a family trust in Canada is not complicated if you understand what it entails and seek legal advice to ensure you add all the relevant elements to make it valid. For a trust agreement to be valid, it must consist of the following legal requirements:
For a trust agreement to be legally binding, you must show clear intent of forming the trust. You must also own the assets you want to transfer to the trust and clearly outline the beneficiaries and what you intend to give them.
As you establish a trust, the selection criteria of the trustee should be well-thought-of and must consider the following qualities:
The roles and responsibilities of trustees are to invest, manage, and distribute the trust’s assets. They must also perform administrative duties to ensure trust expenses and fees are paid. Beneficiaries receive and enjoy the assets according to the standards and methods laid out in the trust. They have the right to capital and income distribution and have equitable title to the trust’s property.
Even though trusts are not separate legal entities, they are treated as a separate taxpayer, and you must file a T3 tax return, report its own income, and pay the income tax bill. Let’s consider the various tax implications:
Canadian trusts reach the highest marginal income tax rate at an extremely lower threshold than individual taxpayers. For instance, in 2024, the top marginal tax rate for an individual starts after $609,359, while that of trusts is $15,200. The inter-vivos marginal tax rate is 33% nationally, but the provincial rate varies between 15% and 25%. Testamentary trusts’ marginal tax rate ranges from 15% to 33%.
The income the trust receives comes from diverse sources of revenue, such as capital gains, dividends, and business income. The taxable income is then calculated by subtracting this income from the deductions and credits made to the trust. After the calculations, use the taxable income rate (currently at 33%) to calculate the taxes payable.
A family trust allows income splitting, where the trust’s income is distributed to the beneficiaries in a lower income bracket than the settlor. This provision minimizes the amount of tax payable. On capital gains, the trust can allocate the capital gain to the beneficiaries with lower marginal tax rates. Further, the trust allows deferment of capital gain taxes until the beneficiaries decide to sell the assets. This provision can help the beneficiary plan for taxes and minimize the tax burden.
A family trust with shares in a Canadian corporation can benefit from the dividend tax credit. When your family trust becomes eligible for dividends, you can claim the dividend tax credit and reduce the amount you pay as tax for the dividend income. The dividend tax credit is among the tax benefits because it prevents double taxation on corporate profits as it appreciates that the corporation had already paid income tax before distribution.
In Canada, the 21-year rule in family trusts under the Income Tax Act considers that a family trust disposes of the property 21 years from the date it was created. This rule means that the trust is assumed to have sold the assets, and the capital gains are subject to taxation.
The main aim of this rule is to prevent indefinite deferral of capital gains tax on property held within a trust. So, you must decide when the trust should be wound up to avoid excessive tax burden. A trustee can prevent excessive loss of assets from capital gains tax by:
Family trusts are a favourite to many because they offer superior benefits that other estate planning tools cannot match. Here are three undeniable benefits:
Asset protection: When you transfer your assets to a family trust (discretionary), you protect it from lawsuits, creditors, and other unforeseeable claims. Since you transferred the asset to the trust, it does not belong to you or the beneficiaries. No individual or entity can ask for it as payment for legal judgments or to satisfy a debt.
Tax advantages: Family trusts' main tax benefit is to reduce the estate tax burden, especially in wealthier individuals. When you move assets to a family trust, you avoid paying some of the estate tax when you die. Trusts also allow income splitting. This is where taxation is distributed to the beneficiaries, and those falling within a lower income bracket than you will receive the benefits at a reduced tax rate. Family trusts also enable beneficiaries to be exempted or receive a discount on the capital gains tax when selling assets in the trust.
Control over assets: Although you may lose ownership of the assets after you create the trust agreement, you can maintain control by choosing a trustworthy trustee. You must also ensure you created a detailed document stating how everything should be done and the precise role of beneficiaries.
As an estate planning tool, a family trust secures your loved ones’ future and helps you minimize your tax liability, protect your assets, and avoid probate. Choosing a trustworthy and reliable trustee ensures you acquire superior asset management services before and after your demise.
Careful financial planning can help reduce the tax implications and allow you to enjoy the various tax benefits. As a settlor creates the trust, they must be aware of the 21-year rule in Canada and plan for it with the assistance of an estate planning expert. Book a free consultation with us, and let us help you safeguard your future.
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