Family Trusts in Canada for Estate Planning and Wealth Management
Written by Tiffany Woodfield, CRPC®, CIM®, TEP®, Dual-Licensed Financial Advisor
If you’re looking for information about family trusts in Canada, it might be because you’re starting to consider your estate planning needs. There are four common reasons people choose to use a family trust in Canada.
You might wish to protect your family members from themselves or from, creditors or other conflicts. You may want to save on taxation now or when you pass. You may wish to ensure that your estate is handled correctly or simply have privacy concerns.
TABLE OF CONTENTS
- What is a family trust?
- What is a trust?
- What is a settlor?
- What is a trustee?
- What is a beneficiary?
- What is the purpose of a family trust?
- Tax Benefits of a Family Trust in Canada
- Attribution Rules
- Other Uses and Benefits of a Family Trust in Canada
- Disadvantages of a family trust in Canada
- What is the 21-year rule?
- Are family trusts testamentary trusts or living trusts?
- How to Form a Family Trust in Canada
- How long does it take to set up a family trust?
- How much does it typically cost to set up and maintain a trust?
- Taxation of a Family Trust
- Family Trusts and Succession Planning
- How are Canadian family trusts different from common US trusts?
- Setting Up Trustee Support with Raymond James and SWAN Wealth
- Common Additional Questions about Family Trusts in Canada
- Estate Planning in Canada
- Summary of Key Points
- Next Steps
What is a family trust?
A family trust is set up to hold and pass on family property. It is typically used to reduce taxes and have family members in lower tax brackets realize the income.
What is a trust?
A trust—in simple terms—is just a relationship where one person gives property or assets to another person to manage on behalf of beneficiaries. In Canada, a trust might be a testamentary trust which means it is created with the will. This trust will come into effect after the testator dies. Or you may also have a living trust or inter-vivos trust, which is established while the settlor is alive.
As much as this definition seems simple, a trust has many implications from a tax and control perspective. It is essential to speak to a lawyer and accountant about your situation.
In addition, trust laws vary in Canada and the US, so keep that in mind as you read through this article.
What is a settlor?
The settlor is the person who gifts or transfers property to the trustee.
Let's look at an example. Mary wants to set aside money for her grandson Tom's university education. So Mary sets up a trust.
Mary transfers the property* to a trustee who has the legal responsibility to manage and invest the funds and make them available to Tom when he attends post-secondary education.
In this case, Mary is the settlor, and Tom is the beneficiary.
Often people think that if they settle property on trust, it is still their property. They think that they can still control the property. However, once the settlor has transferred the property, they will no longer have control unless they have reserved the right to control the property.
It is important to note if they keep the right to control the property, there may be negative tax implications.
*Trust property can be any type of asset including real estate, cash, investments or insurance policies
What is a trustee?
The trustee is the person who holds the title to a property or assets for the benefit of the beneficiary.
You can have more than one trustee. In addition, the settlor can also be a trustee or beneficiary. A trustee has several legally enforceable duties. They can be found liable for negligence if they do not complete these duties. The most important duty is to act in the best interest of the beneficiaries and to follow the trust document powers.
Some of a trustee's duties include:
- Duty of Loyalty: Not personally profiting from decisions made on behalf of the trust.
- Duty to Act Impartially: To treat all beneficiaries equally.
- Duty to Act in the Beneficiaries' Best Interests: To set aside their interests.
- Duty to obey the trust document: To act according to the powers that were given when the trust was created.
- Duty of Care: To act as a prudent person would.
What is a beneficiary?
When a trust is constructed to benefit a person or people, those people are referred to as beneficiaries.
Keep in mind that a beneficiary can be an individual or a corporation. In Canada, a corporation is seen as a "legally recognized person."
Moreover, a settlor or a trustee can also be a beneficiary. In many cases, a trust will have vested or contingent beneficiaries, or both. A contingent beneficiary means that someone becomes a beneficiary contingent on some future event which may or may not happen.
For example, you might name your husband or wife as the primary beneficiary of your trust and your kids as the contingent beneficiaries.
What is the purpose of a family trust?
Often people consider setting up a family trust because they want to protect and benefit their family financially. Having a family trust may also reduce taxes and probate fees. Additionally, a family trust may help minimize family conflicts in the future.
VACATION PROPERTY EXAMPLE
For example, it's not uncommon for a family trust to be used for a vacation property or cabin when you want several family members to share the property for multiple generations.
A family trust is beneficial in such cases. Here's why:
If you don't use a family trust to ensure that a vacation property will be shared among family members, then you have two options:
1) You name multiple people on the title of the property, which means that they each have part ownership and claim on the property.
2) Or you add one person on the title and hope they share the usage with the other members.
Instead, you can put the property in a family trust. The trust document would clearly outline your intentions, name primary and contingent beneficiaries such as grandchildren, and name a trustee with a fiduciary responsibility to manage the asset. This family trust would allow multiple people to enjoy the use of the property beyond your lifetime.
Tax Benefits of a Family Trust in Canada
A trust is considered a taxpayer in Canada even though it is not considered a legal entity. A trust pays tax at the highest personal marginal tax rate on its taxable income and doesn't have the benefit of individual tax credits.
Thus, it is often better from a tax perspective to flow out the taxable income to beneficiaries each year rather than have it taxed at the highest rate inside the trust.
However, you need to be aware that attribution rules may apply to prevent tax avoidance in Canada.
ATTRIBUTION RULES
Attribution rules prevent people from shifting income to lower tax bracket beneficiaries. If the "attribution rules" apply, the dividend or interest income may be attributed back to the person who transferred the property if the recipients are close relatives such as a spouse or child under 18.
Attribution back to the transferor also occurs if the transferor still has control over the assets, except in the case of an alter ego trust or joint partner trust. Essentially the government doesn't want someone to set up a trust to avoid paying tax at their higher rate by using the trust to shift income to a lower tax bracket beneficiary.
Due to these attribution rules, revocable trusts are less common in Canada compared to the US.
Keep in mind this information is general, and you will need to speak to a lawyer and accountant about your particular situation.
However, there still are some tax benefits of a family trust in Canada. You might use a family trust to provide any of the following benefits:
1) Reduce taxes your family will pay upon the death of a trust beneficiary.
2) Lower income tax by income splitting with a spouse or children.
3) Defer tax with a corporate beneficiary.
1) Reduce taxes your family will pay upon the death of a trust beneficiary.
If a shareholder doesn't need the future capital gain in their company, they can use an estate freeze strategy. With this strategy, when the shareholder dies, the capital gain is not taxed as it is in the trust. You need to speak to a lawyer to determine if this makes sense in your situation.
2) Lower income tax by income splitting with a spouse or children.
Although "kiddie tax" rules have made this less effective, using a family trust for income splitting is still a planning tool. In Canada, we have a progressive tax rate which means the higher the income, the higher the tax rate. So the person in the family who earns the most also pays the most in taxes. But by shifting some of the trust income to a lower rate beneficiary family member, you reduce the overall tax paid.
When the trust earns income, it is distributed to the lower tax bracket beneficiaries. In such a manner, income splitting can be successful. However, attribution rules need to be considered.
3) Defer tax with a corporate beneficiary.
If you name a corporation as a beneficiary, the profits of an operating company can be paid to a family trust and then to a corporate beneficiary.
Other Uses and Benefits of a Family Trust in Canada
This article cannot be exhaustive, so I'll name a few additional uses for family trusts but not all of them.
1) Reduce taxes your family will pay upon the death of a trust beneficiary.
2) Manage Probate. With a living trust, your assets are not considered your assets. Instead, they are the trust's assets. Thus, they do not form part of your estate when you pass away.
3) Privacy. With a living trust, your assets remain private even after death.
4) Capital Gains exemption. Every individual has a lifetime capital gains exemption (LCGE) for the sale of a qualified small business corporation.
Please note that you will need to speak to a qualified tax professional to determine if this is an option for your business.
5) Protect your assets. When you put assets in a trust, you create a wall around these assets if set up correctly. As the ownership is no longer in your name, your creditors cannot take the assets.
6) Ensuring wealth is distributed to all family members as desired and without conflict, important for blended families.
7) Providing lifetime income to your spouse with the remainder of assets.
8) Protect your children. If you want to specify how the assets are distributed to your children, a family trust may be an option you choose. You can define rules for when and how funds are given to your kids.
Disadvantages of a Family Trust in Canada
While a family trust can be beneficial, it also has its downsides. Here are a few of the potential disadvantages of using a family trust in Canada.
21-year Rule
After 21 years, it is as though the trust has sold all the property for the fair market value on the day the 21-year rule applies and tax will likely be owed on the capital gains. Speak to your accountant as there are ways to plan for this and mitigate the taxes such as donating securities from the trust that have big embedded capital gains.
Cost of Tax on Split Income (TOSI)
The TOSI rule came into effect in 2018, significantly restricting private business owners from using a private company to split their income with related persons who aren’t sufficiently involved in the business. The rule has several complicated rules and exceptions.
From a trust perspective, before the TOSI rules, a corporation owned by a trust could pay income to the trust and then distribute that income to adult family members. Now, disclosure requirements require all individuals connected to the trust to be disclosed to the CRA. In addition, income from a trust from a business where the beneficiaries aren’t sufficiently involved can attract TOSI.
Cost of Setting Up the Trust
You will have to cover the cost of setting up a trust, and you may still need to have a will. In addition, you will have to file a tax return each year for the trust, which will increase your accounting bill.
If you are considered a US citizen or long-term resident, a trust may not work the same way. You have to work with a lawyer familiar with cross-border clients to ensure everything is done correctly.
What is the 21-year rule?
The 21-year rule applies to most trusts in Canada. After 21 years of a trust being in effect, it is like the trust sold all the assets at fair market value and realized the capital gains. This can result in a significant taxable event if not planned for properly. If the value of the property and assets have gone up significantly, the tax bill may be high.
Are Family Trusts Testamentary Trusts or Living Trusts?
A family trust can be a testamentary trust or a living trust, depending on when it comes into effect.
A testamentary trust is part of your will and comes into effect after the testator passes away. A testamentary trust's assets may still be subject to probate. In such cases, the executor has to apply to the courts to prove the will is valid. This can be a time-consuming and costly process.
On the other hand, a living trust is set up during the contributor's lifetime. It can be revocable or irrevocable. With a revocable trust, you can alter it in the future. While with an irrevocable trust, you cannot make changes.
When you set up a living trust, the settlor changes the title of the assets from their name to the name of the trust. When the settlor dies, the assets avoid probate because the assets are in the trust's name and not the individual's name.
In the case of a living trust, once the trust assets are in the trust's name, the assigned trustee(s) now manage the trust according to the trust document. You might choose this option if you want the beneficiaries to gain from the assets during your lifetime as well as after you have passed
How to Form a Family Trust in Canada
In brief, these are the steps you would take to form a family trust. This is not exhaustive but rather an overview.
1) First, you need to contact a lawyer.
2) Then you must decide who will be the settlor, who will be the trustee, and who will be the beneficiaries.
3) You will need to decide how much money you want to settle into the family trust.
4) Your lawyer will ask how you want the money to be managed and how much discretion you want the trustees to have.
5) With your lawyer, you will decide whether this will be a living trust or a testamentary trust.
6) When your lawyer is drafting the trust document, they will ask questions about provisions for asset protection, rules on when and how the funds can be used, and whether to include second-generation beneficiaries. Once these decisions are made, the lawyer will draft the trust agreement.
How long does it take to set up a family trust?
How long it takes to set up a trust will depend on how long it takes you to make the critical decision about how the trust. It can be done in as little as two weeks. But it could take up to six months. Again, the time largely depends on your decision-making process.
How much does it typically cost to set up and maintain a family trust?
The cost of setting up and maintaining a family trust will depend on the lawyer you use. It is recommended that you to use a lawyer who specializes in estate planning. The costs can range from $5000-$10,000 to set up. As long as you do not make any changes, the yearly cost to maintain your trust is the cost to file the separate trust tax return.
Taxation of a Family Trust
The tax rate on a family trust is the highest personal marginal tax rate on all taxable income. It doesn't have the benefit of any personal tax credits, unlike an individual who may get personal tax credits that lower their effective tax rate.
However, you can distribute the income a family trust earns each year to the trust's beneficiaries. Then the trust will get a deduction for the amount of income distributed. The trust will pay the taxes on the income that remains in it. The tax will then be paid by the beneficiaries who receive the income and capital that was paid out by the trust.
Family Trusts and Succession Planning
Family trust are important in succession planning. Using a family trust is an opportunity to guide how you wish your assets to be managed and distributed. A trust vehicle also ensures accountability and proper oversight because your trustee has a fiduciary duty and obligation to be impartial when dealing with beneficiaries. Trustees must follow the trust document, which details all requirements and restrictions.
In addition, family assets settled into a trust offer creditor protection if any beneficiaries are sued. The assets are in the name of the trust and not the settlor or beneficiaries. Having this protection can be helpful, particularly if you have a spendthrift beneficiary. You have essentially created a gate in front of the assets. Moreover, the trust document outlines how you wish the assets to be used and distributed.
A trust allows you to safeguard investments for the next generation. When the settlor dies, the trust doesn't have to dismantle. It can continue to be managed according to your wishes.
An important use for family trusts is to manage communal property like a cottage or vacation home. There is shared ownership which otherwise could be complicated if you had to have multiple titles on the property. This way, several family members can share use of the property for this generation and the next generation.
How Are Canadian Family Trusts Different from Common US Trusts?
Many people use a revocable living trust in the US for estate planning. They put their home, investments and other assets in the living trust. It is revocable, which means that the grantor (a settlor in Canada) can alter the trust. In the US, a revocable living trust is considered a disregarded entity by the IRS, which means that it is not taxed separately from the individual. There is usually not a taxable event in the US if you collapse the revocable living trust or contribute to it.
In Canada, this is not the case. A trust is considered a separate taxpayer, so you need to do critical tax planning before contributing to or collapsing the trust. Thus, if you are moving across the border, you will likely want to collapse your revocable living trust before becoming a Canadian tax resident because the foreign tax credits will not match up.
Setting Up Trustee Support with Raymond James and SWAN Wealth
When working with Raymond James as your trustee, you can have your trust administered in the way you intended. At SWAN Wealth, we can help you with your estate planning through our connection to Raymond James Ltd. This means that your investing and retirement planning can be done more effectively. Everyone on your team will work together and communicate to ensure your needs are taken care of correctly.
A trustee needs to understand the legal, tax and practical requirements of trust administration. Managing your trust becomes much easier when you have it all under one roof. Our trust services can help alleviate the administrative burden and the complications due to demanding beneficiaries and intricate tax rules.
Common Questions about Family Trusts in Canada
Who controls a family trust in Canada?
The settlor contributes the assets, while the trustee manages the trust and oversees the assets. The trustee is responsible for handling the assets and distributing them according to the terms of the trust.
Can you take money out of a family trust?
Whether you can take money out of a family trust depends on how the trust document was drafted. You may or may not be able to take money out of a family trust in Canada.
Whether you can access funds often depends on how the funds you are withdrawing will be used. For example, the trust deed may say a beneficiary can use funds for education or to start a business. In contrast, another trust deed may allow funds to be distributed to beneficiaries after they reach a certain age.
When you draft a trust, you may include provisions to allow some funds to be used for emergencies; this isn't uncommon.
A trust is typically designed to restrict how the assets in the trust can be used. A trust is also designed to restrict when the assets can be accessed. The exception to this is a fully discretionary trust, which is rare. If it were easy to get money out of a trust, just like going to the bank, it would likely defeat the purpose of the trust.
Can a family trust own property?
Yes, a family trust can hold a vacation property or other property that a family enjoys. You could even draft a trust whereby a portion of the income earned in the trust can be used to take care of property maintenance costs.
Such a plan is helpful in the case of multiple family members and where one sibling doesn't have much money to help contribute to maintaining a property.
Who pays taxes on a family trust?
The trust pays the taxes on the income that remains in the trust. The trust does not pay taxes on any income that has been paid out. Income and capital that is paid out will be taxed in the hands of the beneficiaries.
Can a family trust be broken in Canada?
Depending on how it was drafted, a trust can be broken in Canada. A revocable trust can be changed or revoked, whereas you need to take extra steps with an irrevocable trust. Typically, the trust will be settled with a promissory note, and if the trust is to be revoked, the note will be called. This can have serious tax issues as the unrealized capital gains on the assets in the trust become payable on the date the note is recalled. As there are relative complexities to this, it is best to speak with your lawyer about this topic.
How does the Income Tax Act affect family trusts in Canada?
The Income Tax Act governs how income generated by family trusts is taxed in Canada. It includes specific rules on income attribution, distribution, and reporting, which are crucial for ensuring compliance and optimizing the tax benefits of a family trust. Also, the trust must file a tax return every year, whether it has income or capital gains to disclose. This is costly. If it is not done, there are penalties.
How can a family trust help manage tax liability for my estate?
When doing estate planning in Canada a family trust can help to manage your tax liability because any assets that are held in the trust are not subject to the deemed disposition on your death. This means your estate will save capital gains tax on your death which is a significant savings in many cases. In addition, assets in a family trust are not subject to probate fees.
What is a personal tax credit, and how does it relate to family trusts?
Although a trust is not a legal entity, it is considered a separate taxpayer in Canada and pays tax at the highest marginal rate. Unfortunately, a trust does not get the benefit of personal tax credits to reduce the amount of tax owed by the trust. However, beneficiaries of the trust may use their personal tax credits on income distributed to them from the trust.
How is capital property treated within a family trust?
Capital property held within a family trust, such as real estate or investments, is subject to being taxed as per trust rules. Any capital gains, losses or income/losses realized by the trust are typically taxed within the trust unless made payable to beneficiaries. Then it would be taxed at the beneficiaries marginal rate.
What is the dividend tax credit, and how does it apply to family trusts?
The dividend tax credit allows individuals to receive a credit for dividends received from Canadian corporations, reducing the overall tax on dividend income. In a family trust, dividend income can be distributed to beneficiaries, who can then claim the dividend tax credit on their personal tax returns, or the trust can be deducted from the dividend tax credit.
Estate Planning in Canada
Summary of Key Points:
A family trust is used to create a wall around the money or other assets within the trust. In this article we covered the use of a family trust extensively. Here is a summary of the key points:
- A family trust can be an excellent tool for estate planning in Canada. It can help you to protect your loved ones and ensure your wishes are fulfilled now and in the future.
- It is important to speak to a qualified estate attorney when you are considering creating a family trust because there are strategies that will help you save time and make sure your goals are protected.
- A family trust is a great tool for managing family assets, particularly a vacation property where having many different people on title can become complicated.
- A family trust is also helpful when you have several beneficiaries and an asset that has costs attached to it. The trust can pay the costs so a lower-income beneficiary won’t have to pay to cover these costs.
Next Steps
If you’re a Canadian resident or are planning on moving to Canada and need assistance with estate planning, investing, and portfolio management, please get in touch. At SWAN Wealth Management we specialize in Canadian wealth management, financial planning, cross-border financial planning and cross-border wealth management. We help individuals and families protect the legacy they have worked hard to build with comprehensive long-term planning and investing.
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About the Author
Tiffany Woodfield is a dual-licensed financial advisor and the co-founder of SWAN Wealth Management, along with her husband, John Woodfield. Tiffany specializes in advising clients who live both in Canada and the United States and need to simplify their cross-border financial plan, move their assets across the border, and optimize their investments so they can minimize their tax burden. Together Tiffany and John Woodfield help their clients simplify their cross-border finances and create long-term revenue streams that will keep their assets safe whether they live in Canada or the US.
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Information in this article is from sources believed to be reliable, however, we cannot represent that it is accurate or complete. It is provided as a general source of information and should not be considered personal investment advice or solicitation to buy or sell securities. The views are those of the author, SWAN Wealth Management, and not necessarily those of Raymond James Ltd. Investors considering any investment should consult with their Investment Advisor to ensure that it is suitable for the investor’s circumstances and risk tolerance before making any investment decision. Raymond James Ltd. is a Member of the Canadian Investor Protection Fund. Raymond James (USA) Ltd., member FINRA/SIPC. Raymond James (USA) Ltd. (RJLU) advisors may only conduct business with residents of the states and/or jurisdictions for which they are properly registered.
