For some Canadians, strategies to minimize probate fees1 are an essential part of estate planning. Part 1 of our 3-part series about probate fee minimization covered basic facts related to probate fees and beneficiary designations. Part 2 focused on the pros and cons of gifting. In our third and final article of this series, we explore how trusts can help reduce probate fees.
Types of trusts
Trusts are generally used to give someone (the beneficiary) the benefits that derive from property or assets (trust property) without giving them legal control or full access to it. Trusts can also help with asset management later in life or during incapacity.
Inter vivos trusts – Trusts created while someone’s still living are known as inter vivos trusts and can be made revocable by the person creating the trust, also known as the settlor. Others can be created with the power to terminate the trust. Unlike wills (which become public after probate), inter vivos trusts aren’t probated and offer a high degree of confidentiality.
Settlors may name themselves as beneficiaries to receive the income generated by the trust property during their lifetime and other beneficiaries to receive the trust property in full after the settlor dies. If not revoked, the trust relationship will continue past the death of the settlor and the other beneficiaries will be entitled to the property or assets. In this way, an inter vivos trust can be like a will by distributing property after a person dies. Unlike a will, however, once assets are settled into a trust, they’re no longer owned by the settlor and don’t form part of their estate when they die — and this is how probate savings can occur.
Insurance trusts2– Advisors sometimes recommend making life insurance proceeds payable to a trustee designated in the context of a provincial Insurance Act, especially when it involves minors as the ultimate beneficiaries (although a well-crafted will dealing with the insurance proceeds may be a better alternative).
Too often, the terms of the insurance trust aren’t spelled out. There may be no express power to invest, to pay or accumulate income, or anything else. In these cases, only the investment powers set out in provincial legislation are available to the trustees, which can be somewhat restrictive. Clients need to be mindful that proper powers are spelled out in the trust instrument.
In jurisdictions where an old trust interpretation called the Rule in Saunders v. Vautier3 still applies, failure to include contingent beneficiaries in the trust means the primary beneficiary may be able to collapse the trust and take the proceeds when they reach the age of majority. Most clients won’t want this, however. They’ll likely prefer varied distribution dates such as 50% at age 25 and 50% at age 30. This will require careful planning and advice from a qualified legal practitioner.
An insurance trust may be established through a separate trust instrument or through a clause in the client’s will. If the will is drafted properly, insurance proceeds flow directly into an insurance trust created in the will and shouldn’t form part of the taxpayer’s estate, avoiding probate.4 For clients who want to explore this option, encourage them to work with a lawyer who specializes in trust and estate planning.
Testamentary trusts – In addition to other benefits, testamentary trusts (which are trusts created upon someone’s death) can also help with probate fee minimization. Suppose a couple, John and Jane Smith,5 each have $1 million in assets that are subject to probate. John dies and leaves these assets outright to Jane, paying probate on the $1 million. When Jane dies, there will be $2 million in assets subject to probate, meaning that probate fees will be paid a second time on the $1 million originally transferred.
In John and Jane’s case, they could have avoided multiple probate fees on the same assets by putting John’s assets into a testamentary trust for Jane. Then when Jane dies, assets in the trust could go to a beneficiary – their daughter, Mary. (Alternatively, the assets may be held in trust for Mary’s lifetime, and go to yet another beneficiary on her death.) The assets that originally belonged to John never form part of the estate of Jane, and aren’t probated a second time on Jane’s death. By remaining in the trust after Jane dies, it’s possible to achieve probate fee savings.
If John and Jane are spouses (as defined by the Income Tax Act), and if the terms of the trust are properly designed, John’s death can still result in a capital gains rollover to the qualifying spousal trust for Jane. This will defer triggering capital gains, maintain the trust property at its pre-tax size, and allow the trustees to defer paying the capital gains tax until Jane dies, or until the assets are actually disposed of.
From Jane’s perspective (and especially if she’s the trustee or one of the trustees), there’s little difference between being the trust beneficiary and owning the assets outright. Jane has full enjoyment of the income and capital of John’s assets. Jane also has control, or at least some control. The only thing she lacks is legal ownership of the assets which, in light of other things, may not be a major issue. It’s even possible for John to give Jane the right to decide who will inherit the assets in the trust, through power of appointment. For all practical purposes, this brings owner status and trust beneficiary status very close together.
The taxation of trusts is beyond the scope of this article. However, there are common traps to be aware of, especially when clients are considering trusts to avoid probate fees.
When a taxpayer settles assets to a trust, there’s a change in legal title or ownership. If the taxpayer uses a bare trust and remains the only beneficiary, there’s no change in ‘beneficial’ ownership (that is, the taxpayer remains entitled to the benefits while maintaining legal control of the property). In past years, the Canada Revenue Agency (CRA) tried to address the issue of senior taxpayers increasingly using bare trusts and revocable inter vivos trusts for asset management, especially during incapacity. As a result, several new and potentially confusing terms for trusts such as ‘joint spousal’ and ‘alter ego’ trusts were introduced. Some of these terms are intended to designate trusts which won’t involve a disposition upon being settled. However, property in one of these trusts may also return to the settlor’s testamentary estate upon death, and be disposed of according to the testator’s will. As such, they won’t all help to avoid probate fees.
Another potential drawback can occur when settling an inter vivos trust. If there’s been a change in beneficial ownership of the trust assets, this will constitute an actual disposition for tax purposes, and will trigger capital gains.
The gift plan highlighted in part 2 of this series is also an actual disposition (a gift is an intentional change in beneficial ownership for no consideration). So is the transfer of assets into joint tenancy. Although only a half-interest or less is being transferred, there’s a new beneficial owner. And the death of a joint owner will create yet another disposition.
Plans involving spouses may entitle your clients to a tax-free spousal rollover, but don’t forget about the attribution rules. Setting up a testamentary trust avoids attribution rules but requires dying first, which is the most significant disposition a client can make.
Another potential drawback to establishing trusts is that they’re subject to a deemed disposition of capital properties every 21 years (except qualifying spousal and alter ego trusts). This deemed disposition can create problems with illiquid trust assets such as private company shares. However, this aspect of trust taxation may not necessarily be a problem. Many trust portfolios turn over gradually and the capital gains and losses are taken out over time. Some clients setting up trusts don’t have significant capital assets and the settling of GICs or cash into a trust won’t create any substantial capital gain problem.
How to help
Estate planning, including probate fee minimization strategies, can be quite complicated. Without proper guidance, clients may fall into traps that are far more expensive than the fees they wish to minimize. But you can help. Encourage your clients to seek professional legal and tax advice. You can also learn more. Visit the Money for Life legacy needs page on sunlife.ca/advisor or contact your sales director.
This article is based on a financial bulletin authored by Jeffrey Waugh, Director, Tax and Insurance Planning, Sun Life Financial, Probate Minimization Strategies: Tips and Traps, November 2014.
Beneficiary – Someone who’s eligible to receive distributions from a trust, will or life insurance policy.
Disposition – The act of distributing or transferring property or money to someone, usually by bequest.
Probate fees – The fee paid to the government when probating a will.
Settlor – A person who creates a trust.
Testator – A person who makes a will or gives a legacy.
Bare trust – A trust in which the beneficiary is entitled to both the income and the capital.
Revocable trust – A trust that may be altered or terminated during the settlor’s lifetime.
Inter vivos trust – A personal trust created while someone’s still living.
Alter ego trust – Trusts (created after 1999) where the settlor is the sole person who has a right to all the income of the trust each year. No one but the settlor can have a right to the assets of the trust while he or she is alive.
Joint spousal trust – Same as an alter ego trust except that both partners, married or common law, have a right to the income of the trust each year. No one but those 2 individuals has a right to the assets of the trust while either of them is still alive.
Testamentary trust – A trust or estate generally created on the day a person dies.
You might also like…
- Probate fee minimization: Important facts, tips and traps – part 1
- Probate fee minimization: Important facts, tips and traps – part 2
- Clients don’t want to be a burden. You can help.
1 In Ontario, taxpayers no longer pay probate fees. Instead, they’re subject to the Estate Administration Tax Act, 1998 (EATA), introduced in response to the Supreme Court of Canada ruling in Eurig Estate (Re),  2 S.C.R. 565, which held the former provincial probate fees constituted an invalidly introduced tax. This statute retroactively imposed a valid tax precisely equal to probate fees that had been collected since 1950. Despite the small variations in terminology across the provinces, the terms probate and probate fees are still used in this article.
2 Planning with insurance trusts may not be a valid option in Quebec.
3 The English case referred to was decided in 1841. Simplified, the modern (expanded) rule states that if the owners of all income and capital interests in the trust are legally capable, they may agree to vary or even terminate the trust. In practice, this means that in selecting trust beneficiaries, settlors usually include minor, contingent or unascertained beneficiaries who cannot consent to early termination. This ensures that the trust will remain in force regardless of the wishes of any beneficiary.
4 See the Supreme Court of Canada’s decision in Re MacInnes, (1934) D.L.R. 302, which confirmed that a separate insurance trust can be created within the will and not form part of the estate. This and additional court decisions regarding wording and trustee/beneficiary designation requirements should be carefully reviewed by the client’s legal advisor.
5All names used in this article are for example purposes only. They do not reflect real people or actual events.