How best to use testamentary trusts

Testamentary trusts are taxed at graduated rates, but the government wants to eliminate that benefit.

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“One of the common planning opportunities is [people] can leave inheritances to spouses and children, and those inheritances will go over to [the beneficiaries] inside of a trust,” says Jamie Golombek, managing director of Tax and Estate Planning for CIBC Private Wealth Management.

Read: Being a good executor

Even better, “every year those trusts earn income from the inheritances—income from those properties—that will be taxed at graduated rates,” he adds.

The benefit is holders are “effectively giving the beneficiaries of trusts access to a separate set of graduated. The savings could be more than $12,000 to $15,000 a year.”

However, “in the [2013] budget and in a consultation paper,” officials proposed “the elimination of the graduated tax rates of testamentary trusts,” says Golombek.

Read: Testamentary trusts still useful

The government wants “all income…taxed at full rates unless it’s paid out to beneficiaries.” That’s similar to the rules for family or inter vivos trusts, which are created while clients are still alive.

For more on inter vivos trusts, read:

• Help clients keep windfalls
• Move assets out of estates before death

Even if the tax benefits of testamentary trusts disappear, says Golombek, “There are still significant planning opportunities for those using testamentary trusts as part of estate planning. They can protect inheritances in the case of remarriage, for example.”

Say a husband leaves his surviving wife money after he dies, with the intention the funds will passed on to their children after the wife dies. If the wife remarries, she could end up leaving all of her deceased husband’s money to the new man and nothing to her first set of children. She needs to protect that former inheritance. Read: Help wealthy clients overcome 4 estate mistakes

“We may use a testamentary trust in that example [to shelter] part of [her] estate,” says Golombek. “Perhaps the surviving [second husband] could use the income from the trust while he’s alive, but that income won’t then be deemed part of his estate” after he dies.

Instead, the money “goes to the beneficiaries, who are the kids from the first marriage. That process will cut out a potential second family from [taking] part of their inheritance.”

Read:

Tips for blended-family estate planning: IAFP

Handle U.S. estate tax exposure

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