Picture this: a husband and wife, Frank and Lea, are married for 30 years. They have 3 children together. At age 65, they decide to divorce. And while the situation of “grey-divorce” brings up many complicated discussions, what happens when someone decides to remarry?
This is a common situation among today’s retirees. In 2011, 12% of Canadians 65 and over were divorced or separated, and 20% of Canadians 55 to 64 were either divorced or separated. Of the seniors who separated, 76% of senior men and 55% of women ended up in relationships again, with approximately three-quarters of them remarried.1
Back to our story … 2 years later, Frank meets someone, Catherine, and decides to remarry. They spend the next 20 years together.
The person who gives someone else power over their property is called the donor; the person who exercises that power is called the attorney.
Catherine has 2 children of her own. Together they have 5 grandchildren — 4 from Frank’s children and 1 from Catherine’s side.
After splitting from his first wife, Frank created a will that distributed his assets equally among his 3 adult children and their children. At the same time, he appointed his adult children as joint attorneys under a power of attorney for property to act on his behalf in case he was ever incapacitated. All three of them had to act together for the power to be effective. However, Frank’s power of attorney for property didn’t address what would happen if one or more of his attorneys became incapacitated, bankrupt or passed away before Frank. After his second wedding, he updated his will to leave the matrimonial home to Catherine, and appointed her as his health-care representative. But he kept his children as his attorneys (i.e., they would determine which assets to use for any long-term care expenses) and left them everything else.
This is where the story takes a complicated turn. Later in their marriage, Frank was diagnosed with dementia, and a year before Frank passed away he became incapacitated. At the same time, his eldest son, John, became very ill. Frank’s children were concerned John could pass away before their father, leaving them without an effective enduring power of attorney to manage their father’s affairs. They sought legal advice on how to protect their father in the event that John predeceased him. Based on their lawyer’s advice, the 3 children set up an alter-ego trust (also known as a self-interest trust) and transferred all of Frank’s assets, including the home, into the trust for Frank’s benefit. The trust agreement stated that any remaining assets after Frank’s death would be distributed in the same way Frank had stated in his will. John unfortunately passed away shortly after the alter-ego trust was set up. And Frank passed away a year after the trust was set up, at the age of 87.
When Frank passed, Catherine and her 2 children felt slighted. After 20 years together, they felt they should have been included equally, along with the 1 grandchild. Catherine challenged the attorney’s power to set up the alter-ego trust, hoping that by challenging the trust she could bring the assets back to the estate and have these assets fall under the will. At this point, she could then make a wills variation claim to get a larger share of the assets.
What are the issues?
- Do the powers granted in the power of attorney authorize the creation of an inter vivos trust?
- Was the trust created testamentary in nature and therefore beyond the capacity of the attorneys?
- Did Frank’s attorneys have the power to set up an alter-ego trust for Frank, given it may impact his estate plans?
With estate laws, a common debate is whether inter vivos planning could result in a testamentary disposition. With inter vivos planning, the planning happens while the donor is still alive. A testamentary disposition is a planned action that impacts the distribution of an individual’s assets, triggered by his/her death. In this example, because all of the assets were transferred into an alter-ego trust for Frank’s benefit before he died, there were no personal assets to be passed through the estate. Before we attempt to answer the issues above, let’s quickly discuss the advantages and disadvantages of an alter-ego trust.
What is an alter-ego trust?
An alter-ego trust is a special trust set up for a settlor’s own benefit, authorized under the Income Tax Act (ITA) for individuals 65 or older.
- Assets in the trust can only be used to provide benefits for the settlor during that person’s life.
- Personal assets can be transferred on a tax-deferred basis while the settlor is alive.
- An alter-ego trust is a common planning technique used for seniors in preparation for potential future health issues or incapacity.
Like any trust, assets are set aside for the beneficiaries; this can provide potential protection against creditors and family law situations. When the settlor passes, the assets are no longer in their name and aren’t required to go through probate. Unlike other inter vivos trusts, assets can be transferred to the trust on a tax-deferred basis.
The biggest concern is the uncertain income tax implications. Effective January 1, 2016, legislative changes to ITA subsection 104(13.4) state that assets in an alter-ego trust will be deemed to be disposed when the settlor dies. Any taxes on possible capital gains on assets held by the trust are payable by the estate. Individuals who want to set up an alter-ego trust should consider additional planning to provide for income tax liabilities when the settlor dies.
Issues at hand
While each case will be reviewed on its own merits, let’s consider our hypothetical example based on an existing case.
In a similar scenario, Easingwood v. Cockroft, 2013 BCCA, the judge determined that the two joint attorneys’ fiduciary duty was to act in the best interest of the donor. In the event that one of the joint attorneys predeceased the donor, the remaining joint attorney couldn’t act on the donor’s behalf. Therefore action was required to ensure continuing care for the donor.
According to the judge, when an attorney sets up an alter-ego trust for the sole benefit of the donor, the attorneys are acting within their powers. The attorneys were within their power to set up an alter-ego trust for the donor’s benefit. This type of planning impacts existing testamentary planning but is not testamentary in nature. The Court stated that “a testamentary disposition is one that is dependent on death for its vigour and effect,” and found that, in fact, the trust in this case was not dependent on the husband’s death. The trust was established within the donor’s lifetime. When there are assets remaining in the trust after the life tenant passes, and if the distribution of assets mirrors the existing will, it will likely be considered acceptable.
What should clients consider?
Emerging trends show us that:
- Courts are more open to planning by attorneys on behalf of incapacitated donors.
- After a donor’s incapacity, beneficiaries of the donor’s estate must be given notice of any change to the planning.
- Generally, inter vivos planning may be challenged if it involves:
- adding beneficiaries,
- avoiding an established gift, or
- disposing of assets, where the principal has chosen not to make a will.
When determining a power of attorney, it’s important that clients understand what their attorney can do. Have clients think about the following:
- Do they want to allow their attorney(s) to set up inter vivos gifts, or settle funds in a trust?
- Would they like to put provisions on the types of planning transactions their attorney(s) could set up?
- Have they specified in a trust document whether their attorney(s) can amend any terms of the trust under an enduring power of attorney, or if they want to keep this under their power?
Planning for the possibility of a client’s incapacity can be quite complicated when you consider the consequences to their estate plans. Individuals should seek legal advice from a seasoned tax and estate practitioner and consider all implications with these types of plans.
To learn more, contact a Sun Life Financial Sales Director.
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1 Statistics Canada, 2011.