Advantages of testamentary trusts

This year’s federal budget proposed changes to testamentary trusts. Currently, a testamentary trust has its own graduated rates of income tax. In contrast, a trust established during one’s lifetime, known as an inter vivos trust, is taxed at the highest marginal tax rate. If the draft legislation is enacted, testamentary trusts will also be taxed at the highest marginal rate, starting in 2016.

However, an estate will generally have access to graduated rates for 36 months after the individual’s death. Graduated rates will only be available to certain testamentary trusts with disabled beneficiaries who are eligible for the federal Disability Tax Credit.

Clients updating their estate plans may now wonder: Why still use a trust under a will?

Although the tax advantages of using a trust under a will to split income between the trust and higher-tax-rate beneficiaries will be curtailed, there are still compelling reasons for using testamentary trusts, including:

• Income splitting. A trust can be used to minimize tax by sprinkling income among several beneficiaries in lower tax brackets. This can include the main beneficiaries and their children, if also beneficiaries.
• Succession planning. A trust can ensure succession of capital to the next generation, particularly for blended families. For example, a spouse may be entitled to income from the trust fund to maintain his standard of living for his lifetime, after which the children receive the trust fund’s capital.
• Protection of minors and other beneficiaries. Assets can be held in trust until a beneficiary reaches a financially responsible age. They can also be held on protective terms for beneficiaries with special needs.
• Protection against matrimonial and creditor claims. A trust can limit a beneficiary’s rights to the trust fund. This includes allowing income and capital to be paid only on the trustee’s discretion. Generally, a creditor of a beneficiary will not have better rights to a trust interest than the beneficiary.
• Avoiding unnecessary probate fees on beneficiary’s death. Depending on the jurisdiction, assets that are paid outright to a beneficiary under a will can later be subject to substantial probate fees if the assets are owned on the beneficiary’s death. Fees are not payable if the assets are held in a trust that doesn’t form part of the beneficiary’s estate.
• American estate planning. If your client or her spouse or intended beneficiaries are U.S. citizens or are domiciled in the U.S. and subject to U.S. gift and estate tax, a trust can be used to defer or minimize U.S. estate tax liability.

Testamentary trusts are versatile and have many uses, notwithstanding proposed changes to the rates they’re taxed at. When considering estate planning using trusts, consider your client’s unique circumstances.

By Margaret O’Sullivan, principal of O’Sullivan Estate Lawyers in Toronto.


Margaret O’Sullivan
Tax & Estate
Margaret O’Sullivan is founder of O’Sullivan Estate Lawyers LLP.