A family trust comprises a number of options (not just spousal and common law partner trusts) and essentially is set up to take care of your family members. Often they are used for business owners to perform estate freezes.
Most family trusts are discretionary trusts; this means that the trustee has discretion on the income or capital that is given to the beneficiaries. These family trusts help to minimize the overall taxes your family pays by having capital gains earned in the trust taxed in the hands of your children or grandchildren. One of the best ways to fund post-secondary education is through the use of a family trust.
- Each child will have a $813,600 lifetime capital gains exemption as of 2015.
- They don’t need to be involved in the business.
- The income will most likely be a tax-free distribution because of their low tax bracket.
- It’s a very flexible strategy.
The provincial rates vary, but in 2015 the federal basic personal amount that anyone in Canada can earn before being taxed is $11,327. This means that with the personal tax exemption we can earn the first $11,327 amount of taxable income free of federal tax each year. Since only 50 percent of capital gains are taxable, if it is taxed personally, and with no other income, one can earn approximately $22,654 of capital gains each year and not pay any tax at the federal level on it. This makes it ideal to income split with kids 18 years and older.
Here are some of examples of family trusts
- Income trusts give the beneficiaries income from the assets the trust generates. The trustee can also have the ability to disburse the capital to the beneficiaries over time.
- Henson trust is a lifetime trust, one that assists a disabled child or relative who is expected to be a long-term dependent and will never be able to manage their money. It allows them to have reliable income until the end of their days, without being cut off from government support benefits.
- Charitable remainder trusts are designed for charitable giving. It is set up so the income is paid to the person who set up the trust (settlor). Upon their death, the charity gets the capital gift. The tax receipt from the charity is given when the trust is set up and the amount is based on what they will receive when the settlor dies.
- Spendthrift trusts if the beneficiary has no capacity to handle money on their own; this is a way to give them income while protecting the capital from the beneficiaries irresponsibly depleting it.
These types of caretaker trusts don’t help develop character or responsibility and some parents believe they can be a disincentive for their children to be productive. The fear is that their kids will turn into what people refer as ‘trust fund’ kids or ‘trust babies’ who make little of themselves because their money is assured. That is where the next trust comes in.
- Incentive trusts if your beneficiaries are expecting a large inheritance, this structure can help to give them the incentive to do something with their lives instead of doing nothing and waiting for their payday. The aim of these trusts is to encourage a child to be responsible and productive, but it will only work if they are motivated by receiving the money from the trust.
- Age 40 trusts is used if there is only one beneficiary in the trust. It allows for income splitting so that the income is taxed in the beneficiary’s hands typically at a lower rate than you are at now until they turn 21. The minor beneficiary will be taxed on the income and capital gains annually even though it does not get paid to them. Instead it is reinvested in the trust.
Over 65? Have you considered setting up an alter-ego or joint partner trust in your lifetime?
These are known as Inter vivos
- Alter-ego trusts are created by someone who is over 65 years old for their own benefit; it is intended to ensure they are the only person who can receive income or capital during their lifetime.
- Joint partner trusts are set up for the benefit of the individual and their spouse or common law partner (same or opposite sex). The individual and their partner are the only people who can receive income or capital during their lifetimes. It can also be set up in a will once the settlor dies. Keep in mind these can create emotional conflict as the spouse and children can have opposing interests.
- Separate spousal or common-law partner trusts often can be used as a tool to plan for the care of the spouse in a second marriage. You can move an asset into the trust so your spouse can
benefit from the use of it until they die. The spouse or common-law partner is the only person who can receive or use any income or capital of the trust while they are alive. You defer taxes that would have been paid on your death if you die first. Once your spouse passes on, the estate (the house or other assets) flows to your children from an earlier marriage if you have made them the remainder beneficiaries.
Eight main reasons for having an alter-ego or joint partner trust:
- Tax strategies.
- Avoid probate costs (Estate Administration Tax or EAT).
- Protection from litigation after you die.
- Protection from manipulation before you die.
- Speed of distributing your assets.
- Power of attorney substitute.
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