REFERENCE GUIDE – FAMILY TRUST

Family trusts continue to be a legitimate and valuable planning tool that can be highly effective in providing solutions to succession planning and addressing various concerns such as tax reduction and asset protection from commercial liabilities and creditors. The key is understanding how they work, and how they can most effectively fit into an estate plan.

What is a family trust?

A trust is an obligation that binds the trustee(s) to deal with the trust property for the benefit of the beneficiaries, basically a relationship between trustees and beneficiaries. A family trust is simply a form of lifetime trust established for the benefit of a particular family or for certain members of that family.

To create a trust, a person (referred to as a settlor), transfers legal ownership of property to the trustee(s), and provides instructions to the trustee(s) regarding how the property is to be used for the benefit of the beneficiaries.

A commonly-used trust arrangement is a testamentary trust – generally made in a will which takes effect only on the death of the person who made the will.

Further information can be found on Testamentary Trusts. 

A family trust is simply a form of lifetime trust established for the benefit of a particular family or for certain members of that family.

How can family trusts be used?

One of the most valuable features of trusts is their flexibility with regard to matters such as the selection of beneficiaries, how the beneficiaries are to benefit and the ongoing investment and management of trust assets.

Other features of trusts include the ability to:

• provide for successive beneficiaries
•  place a wide variety of assets into a trust
• maintain privacy, and the unique tax rules that apply to trusts.

These features combine to make trusts an effective way to meet a wide range of objectives. Family trusts can be used for both tax and non-tax purposes.

How are family trusts taxed?

A trust is a separate taxpayer required to file annual income tax returns. The trust can deduct income and capital gains that are paid or payable to its beneficiaries during the year and the beneficiaries must include these amounts in filing their own tax returns.

Dividends and capital gains received by a trust retain their identity when paid out to the beneficiaries. Similarly, a dividend received by a trust and distributed to a beneficiary would be taxed as a dividend to the beneficiary.

Taxable income is taxed at the highest marginal tax bracket in the province where the trust resides. Trusts are not allowed to claim personal tax credits such as the personal credit and the age credit. Trustees ensure that income and capital gains earned are made payable to the beneficiaries, to be taxed in the hands of the beneficiaries.

There are numerous provisions in the Income Tax Act that restrict or limit the tax benefits of using a trust. 

Please refer to the Family Trust PDF document for details.

How is a family trust established?

A family trust is established by the transfer of certain assets to one or more trustees, along with directions to the trustee(s) regarding how the assets are to be managed and how the named beneficiaries are to benefit. This is all typically set out in a trust agreement (trust deed or trust indenture).

To ensure the validity of the trust for tax and legal purposes, there are certain requirements that must be met. It is extremely important to involve well-qualified professionals in the planning and establishment of a family trust.

The Transfer of Assets

Depending on the purpose the family trust is being created, the initial transfer of assets may be made by different individuals. A wide variety of assets can be held by trusts, including real estate, cash, a portfolio of securities such as shares, bonds and mutual funds, and shares of privately held corporations. The income tax implications must also be considered.

The Trustees

The trustees selected should be willing and able to act and have the necessary knowledge and ability to handle the assets to be held in the trust as well as all of the other obligations required of trustees. A mechanism should also be included for the replacement trustees in case those named are unwilling or unable to act or to continue to act.

An important factor in selecting the trustees is the residence of the trustees. A trust is considered to be resident in the jurisdiction in which the majority of the controlling trustees reside. Consider seeking advice if you are naming an individual who lives in a foreign country as a trustee.

The Beneficiaries

The trust document identifies which family members are potential beneficiaries. Adult children/grandchildren are often named as beneficiaries. It could also include any present or future spouses or common-law partners of children and grandchildren.

Corporations can be included as a beneficiary of the family trust. A corporate beneficiary may be owned by one or more of the beneficiaries of the family trust.

The individual who establishes the trust or transfers assets to the trust may or may not be named a beneficiary. That individual should be named only as a possible income beneficiary, and not a capital beneficiary.

Careful tax and legal planning are necessary in selecting trust beneficiaries

Payments of Income and Capital

In most cases, a family trust gives the trustees complete discretion to decide whether, how much and to whom income and capital are to be distributed in any year. This allows for maximum flexibility, so that the trustees can decide each year, based on current circumstances, what amount, if any, of the income and/or capital is to be paid to the beneficiaries, and in what proportions.

What are the tax benefits of a Family Trust?

Family trusts save on probate fees, which run as high as 1.5% in some provinces. This is because property held in a family trust would not form part of the estate of the individual who transferred the property to the trust and would therefore not be subject to probate fees.

How are the tax benefits achieved?

The tax benefits of a family trust arise in different ways, depending on the family situation and on the primary objectives of the trust. Here are three examples how a family trust can be used to achieve tax savings.

•  Owner/Manager Incorporated Family Business
•  Investment Corporation
• Investment Assets

For full details for each reference review the PDF on Family Trusts

What are the non-tax benefits of a family trust?

Business Succession

For incorporated family business, family trusts can be used to provide for the smooth succession of the business from one generation to the next. The trustees of the family trust could hold the shares of the corporation for the benefit of the entire family until details regarding the succession of the business have been determined.

Protection from Creditors

Family trusts can help to protect assets from possible future creditors. If all distributions of income and capital are at the discretion of the trustees, the beneficiaries’ creditors should not generally be able to seize any of the family trust’s assets.

Providing for Financially Dependent Adult Beneficiaries for those with Special Needs

If an individual is providing financial support for an adult relative, such as elderly parents or a child or sibling with special needs, a family trust can be an effective way to provide for their ongoing financial needs. In the case of special needs adults, there are special considerations in planning and establishing a trust for their benefit.

More detailed information about planning for a special need’s beneficiary is provided in a separate reference guide called Planning for a Disabled Beneficiary.

Privacy

Unlike a will, which becomes public once it is probated, a family trust need not be disclosed to anyone other than the parties directly involved. This makes a family trust especially useful for a person who wishes to make private arrangements to provide for others.

What are the risks and costs of using a family trust?

Any strategy involving the use of a family trust in the context of a family business should be made only with the involvement of a professional advisor who is familiar with family trusts and the family’s business interests.

Be aware of the costs that would be involved in planning and establishing a family trust such as professional fees for setting up the trust and drafting the trust document, ongoing costs for filing annual tax returns for the trust and the payment of trustee fees. This should be considered when determining if the use of a family trust would be worthwhile.

Summary

In the right circumstances, and with proper planning, a family trust is a useful tool and may provide significant tax savings and other benefits.