Testamentary trust: taking care of your loved ones after your death

Do you want to leave an inheritance to your children, but are concerned that they are not yet mature enough to manage it? Would you like to protect the assets until your children are 22 years of age or older? A testamentary trust could be the wealth transfer vehicle you need.

Who can benefit? What are the benefits? We will answer these questions.

What is a testamentary trust?

A testamentary trust is created by a will under which the testator transfers property to a trust for the benefit of one or more beneficiaries upon his or her death. All of the trust property constitutes a separate estate of the testator, trustee and beneficiary.

The three actors required to set up a testamentary trust are the settlor, the trustee(s) and the beneficiary(ies). The settlor is the testator, i.e. the person who transmits the property and prescribes the rules to be followed for its management. The trustee is the person who manages the property according to the wishes of the deceased. The beneficiary is the testator's heir in whose favour the trust assets are managed.

Who can benefit? What are the benefits?

In theory, anyone can decide to create a trust in their will. But, there are still two types of scenarios where people are more likely to use it:

• For heirs who are minors, unfit, or even adult children: The testamentary trust ensures control over the management of assets that will be held in trust until a predetermined age for the beneficiary. This allows the parent who dies prematurely to continue to provide for his or her children while retaining control over distributions and preventing the dilapidation of capital. Another significant advantage of a testamentary trust in favour of a minor is the avoidance of the administrative burden resulting from the Civil Code. Normally, when a minor child inherits more than $25,000, a guardianship regime is opened and a family council is set up. The trust avoids this hassle.
• For a blended family: A testamentary spousal-only trust allows the second spouse to benefit from the trust assets and retain control while ensuring that the remaining funds, following the death of the second spouse go to the biological children of the first union.

Asset protection

In addition to the benefits listed above, the testamentary trust also provides protection in the event of any judgment against the beneficiaries of the trust since the estate of the testamentary trust is separate.

New since 2016

Effective January^1, 2016 estate executors must comply with new tax measures regarding testamentary trusts. The two most important changes to note are the increase in tax rates and the deemed sale on death of the spouse:

• The rate hike: In the past, testamentary trusts were often used for income splitting within an estate. Income earned by the trust could be divided and allocated in part or in whole to other beneficiaries in order to pay less tax. The advantage was the graduated rates to which the trust was subject. However, since 2016 the testamentary trust is no longer taxed at graduated rates, but rather at the highest rate for individuals (53.31% in 2016).

• Deemed sale on death of spouse: Prior to January¹, 2016, the death of a spouse triggered a deemed sale of the property held by the spouse trust. This deemed sale triggers a capital gain. The tax bill is then paid with the trust principal and the balance is distributed to the children. Under the new rules, the death of the spouse will trigger a deemed tax year end for the spousal trust. In this case the tax bill will be paid by the estate of the deceased spouse. So, in a situation where the spouse's heirs are different from the testator's biological children, the deceased spouse's heirs will be at a disadvantage because they will be paying the tax bill of the testamentary spousal trust, without even benefiting from it. The balance of the trust is paid to the biological heirs.

Will

If your current estate plan involves a testamentary trust for income splitting or a testamentary spousal trust, you may want to review your will.

Despite these changes, testamentary trusts can still play an important role in estate planning. A notary can analyze your needs and objectives and recommend one if necessary.