For families concerned about intergenerational wealth transfer, a testamentary trust is an indispensable tool.
A testamentary trust is a type of trust established through your will that enables you to give assets to your beneficiaries with certain conditions that you have specified, while providing them with income tax advantages.
In a trust, you specify an amount of money or other property to be held for a specified period for beneficiaries you have identified and on the terms directed by you. For example, you may wish to leave your children a portion of your estate, but you may feel that they should not receive their inheritance until they are old enough to manage it responsibly. Through your will you would direct your chosen trustees to hold and invest the inheritance in a trust for your children until they reach the age that you have specified. Alternatively, you can give your trustee full discretion on the amount and timing of trust distributions to the beneficiaries.
Testamentary trusts are generally created with assets passing through one's estate. Therefore, probate taxes (negligible in Alberta and Quebec) will likely have to be paid. However, there will be no probate tax for a properly-structured testamentary trust funded with insurance proceeds.
Testamentary trust vs. outright inheritance
One of the major benefits of establishing a testamentary trust is the annual income tax savings for the surviving beneficiaries. These income tax benefits are not available to beneficiaries who receive outright inheritances. Taxable income earned in a testamentary trust can be subject to the same graduated tax rates as an individual taxpayer.
Since the income earned within a testamentary trust can be taxed on a separate tax return at graduated tax rates (although the basic exemption is not allowed), an income-splitting opportunity arises for each beneficiary.
Assume an adult child is in the top marginal tax bracket of approximately 46% (varies by province). Upon the parent's death, this child is expected to receive an outright inheritance of approximately $500,000. Further assume that this inheritance will be invested by the child and will produce annual taxable income of 5% or $25,000 per year. The after-tax income earned this way would only be $13,500 - compared to $19,000 if the inheritance had been transferred to a testamentary trust instead.
If you intend to have your assets pass through your estate so they can fund a testamentary trust, then Joint Tenancy with Rights of Survivorship accounts (not applicable in Quebec) may not be appropriate, and you may also need to restructure beneficiary designations. Furthermore, if you are a high-income earner and you have elderly parents that you know will be providing you with an inheritance, consider speaking to your parents about the benefits of including a testamentary trust provision in their will.
Not just tax benefits
In addition to the tax benefits, there are many reasons why a testamentary trust may be advantageous. A testamentary trust provision in the will can make sense in the following scenarios:
Individuals in second marriages
Disabled or minor beneficiaries
Parent is concerned about spendthrift beneficiaries
Parent is concerned about inheritance being accessed by son- or daughter-in-law
Beneficiaries are high-income earners or will receive a large inheritance
This article is supplied by Colin MacAskill CFP, CIM, a Vice-President and Investment Advisor with RBC Dominion Securities Inc. Member CIPF. This article is for information purposes only. Please consult with a professional advisor before taking any action based on information in this article. Colin welcomes your calls on his direct line (604) 257-7455.