Investment Trust

Family Trust

A family trust is a legal entity created by a granter (e.g. you) for the benefit of designated family members (elderly parents, children, etc.) who are beneficiaries under the laws of trust.

You would place the assets of your choosing (e.g. cash proceeds from the sale of shares, real estate assets, or any other investments) in the family trust. Each year sufficient funds would be paid out of the Family Trust to pay for whatever expenses at your discretion.

In order to better understand a Family Trust, we need to better explain the concept of what a trust is, how it operates, and how it can be used as a funding source.

A trust is an equitable obligation binding a person (called a Trustee) to deal with property over which the Trustee has control (called the trust property) for the benefit of persons (who are called beneficiaries) of whom the Trustee may be one of, and any one of whom may enforce the obligation. If the beneficiary of the trust is also a trustee of the trust, the trust is considered a discretionary trust.

In plain English, a Trust arises when a person (known as the Settlor, you for example) transfers legal title to property to another person (known as the Trustee which is also you), with instructions as to how the property is to be used for the benefit of named persons (known as beneficiaries which can be elderly parents, children, etc.).

Assets of all kinds can be placed in a Trust, including bank accounts, real estate, stocks and bonds, mutual fund units, limited partnership interests and private businesses.

Discretionary Vs Non-Discretionary Trusts

Discretionary Trusts may provide the Trustee with the power to pay part or all of the income to an income beneficiary, or to pay capital to a capital beneficiary prior to the distribution date. A family trust is a discretionary trust.

In a Non-Discretionary Trust, the trust document provides the Trustee with the amount of the income payments, or how much capital can be paid to any beneficiary prior to the distribution of the Trust. This would not be a good solution in the case of an amount of funds needed for living assistance as this can vary according to the needs of the beneficiaries.

Deemed Disposition Rule for Trusts

All trusts are deemed to have disposed of all their assets every twenty one years. Although the assets in the trust remain the property of the trust, for tax purposes they will be considered as being sold at the fair market value at the time. The trustees need to plan for this tax event to ensure they have taken the appropriate action to avoid paying unnecessary taxes at that time.

Taxation of Trusts

A Living Trust established after June 17, 1971 is subject to tax on all income at the highest marginal rate of tax in its province of residence. In Ontario this rate is over 46%.

A Testamentary Trust on the other hand is taxed at the normal progressive rates applicable to individuals in its province of residence.

Accordingly, with a living trust or inter vivos trust, it is important that all income be distributed to the beneficiaries and avoid being taxed at the highest marginal tax rates. Income distributed by a trust retains its income source (i.e. dividends received will be taxed as dividend income, interest income is taxed as interest etc., to the beneficiary). This is very important as this allows for income splitting with beneficiaries who are in lower marginal tax bracket than the granter. Approximately $32,000 of dividend income can be earned in Ontario without attracting any income tax.

Income Splitting

A well-structured family trust allows for splitting the income earned by the trust among the various beneficiaries. Such an income split is effective to the extent that the tax rate of the person who would otherwise earn the income directly is higher than that of the beneficiaries of the trust. The beneficiaries of a family trust are generally the individuals who would otherwise hold the shares directly, a spouse or children, the latter generally benefiting from a low tax rate.

Main Advantages of a Family Trust:

1. The family trust is a discretionary trust and therefore, annual payments are not fixed and can be adjusted to meet the financial needs of the beneficiaries. This flexibility is important as future financial assistance can vary significantly (i.e. nursing home, special medical equipment, home renovations and other professional services).
2. This solution enables income splitting among beneficiaries, effectively reducing overall taxes paid by the trustee.
3. New trustees can be appointed by the trust in the event of the death of the existing trustees ensuring that beneficiaries will continue to be looked after according to what the original trustee would like.
4. You may continue to control the assets in the trust as you are the trustees.

Main Disadvantages of a Family Trust:

1. Set-up Fees: In order to set up a properly structured family trust, you will require the expertise of an experienced trust lawyer. The set-up fees would include legal fees for drafting the Trust deed. Complex Trust structures which require specialized tax or legal advice can cost considerably more. We anticipate total set-up costs to range around $10,000 to $15,000. These fees are tax deductible to the family trust.
2. Ongoing fees: Family trust fees vary by province: Aside from provincial fees which are nominal, there are no other trustee fees.