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Using trusts to protect assets

Preserve your wealth. Trust your heirs.

It may not be a fortune, but it's yours. And after you’re gone you still want to keep the taxman from claiming too much of it. Family vacation property? Time to establish some ground rules now to keep the peace later. Trusts are a great way to do all this and a lot more.

How trusts work.

A trust is created when an individual (you) transfers assets to a trustee (a family member or professional), who then administers these assets on behalf of beneficiaries (usually your heirs). Assets can include investments, shares of private companies, principal residences, vacation property and family heirlooms. Beneficiaries can also include a company, a charity or even unborn grandchildren.

Trusts are an excellent way to transfer wealth to family members while maintaining control over the assets. For family business owners, trusts can play a vital role in managing a management transition to the next generation.

Trusts set out a relationship between the trustee and the beneficiaries. Essentially, the trustee has legal title to an asset, while beneficiaries enjoy its use according to the guidelines set out in the trust agreement. This can be a good arrangement where family property is involved. Trusts come in two basic types:

  • A testamentary trust only takes effect at death, and your wishes for the trust’s operation are outlined in the trust documents, usually included in your will. You can have several testamentary trusts.
  • An inter vivos (living) trust is in effect while you're alive, and the beneficiaries are usually your children or grandchildren. A family trust has a major benefit: you can be trustee and beneficiary of your trust, so you can design it to suit your specific situation. Your financial advisor can recommend whether it's a good strategy. Because all income kept in a living trust is taxed at the top rate, children 18 or older with no other source of income can receive the maximum personal amount. A number of tax rules affect spouses and minor children.

Trusts have many benefits.

  • Flexibility and control. Assets can be rolled over tax-free to children in the future. Trustees have full discretion to allocate and time the distribution according to the directives of the trust.
  • Income splitting. Beneficiaries (other than spouses and minor children) can receive cash or direct expense payments at a presumably lower tax rate.
  • Creditor protection. A beneficiary's interest in a trust can protect family wealth from creditors or divorce claims.
  • Reduce or avoid probate fees. Trusts are held outside the estate and are not subject to probate.
  • Enhanced lifetime capital gains exemption. By having a trust participate in the equity of a qualifying small business corporation, several beneficiaries can benefit from the enhanced lifetime capital gains exemption.
  • Estate freezing. Capital gains tax can be reduced by "freezing" certain assets in a trust and allowing all or a portion of their future growth to accrue to beneficiaries.
  • Caring for a disabled dependent. Providing it's structured and administered properly, a trust can ensure additional funding for a disabled family member. This needs to be done carefully because it could trigger a lump sum payment and cause the loss of their free government services and benefits.
  • Supporting elderly parents. A trust lets you set aside an amount for your parents, the income from which is paid directly to them. After they pass on, the capital can be transferred to other family members.

Trusts can be good for family business.

A trust can also ensure your family-owned business carries on with your children. Particularly if you’re not quite sure who to hand the reins over to. For tax-planning reasons, the trust becomes a shareholder in the business.

Generally, the share structure is reorganized this way: you own preferred shares with controlling votes that reflect the current value of the business. Your children own common shares, which will reflect future increases in the company's value. The common shares are held in the trust, with your children as beneficiaries. This allows you a substantial period of time to "wait and see" before deciding who should get control.

Beware of taxing implications.

Because a trust is a taxable entity, separate tax returns have to be filed. Here are some other tax issues to keep in mind:

  • Any income earned in the trust not distributed to beneficiaries is taxed at the maximum provincial rate.
  • Income distributed is taxed in the hands of the beneficiaries.
  • Investment income retains its character. This means only half of a capital gain is subject to tax, and the dividend tax credit on Canadian dividends is available.
  • Dividends on private Canadian corporation shares paid to minors (either directly or through a trust) are subject to tax at the highest marginal rate. Tax on investment income earned through the trust is attributed to whoever set up the trust (you).

You'll want to seek specialized legal and tax accounting expertise to ensure your trust is structured for maximum efficiency.

Charitable remainder trusts can do good things.

If you’ve decided to leave part of your estate to a charity, you could eliminate a tax liability by setting up a charitable remainder trust rather than leaving it through your will. If you do it while you’re alive, you receive the income earned and on your death the charity gets to keep the remaining capital without having it go through your estate and be subject to probate. In the meantime you also enjoy a tax credit, which can be used anytime within five years.

Trusts are very useful. But they can also be very complex. Talk to your BlueShore Financial Advisor and legal counsel to ensure you get the best professional advice.

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