Trusts

16.1 Trusts

Overview of Trusts

A trust is a legal arrangement through which one party (the trustee) holds and manages property for the benefit of one or more beneficiaries, in accordance with the instructions laid out by the settlor (also called the grantor). Trusts serve a crucial function in estate planning because they enable individuals to maintain control over how assets are managed and distributed, both during their lifetime and after death.

Trusts are recognized across Canada, but the specific rules governing their formation and administration can vary by province. Common legislation affecting trusts (collectively referred to as “Trustee Acts”) cover requirements for establishing a trust, the powers and responsibilities of the trustee, and any court oversight or intervention that may be required.

Key Purposes of a Trust

• Preserving family wealth across multiple generations.
• Managing assets for family members who may lack financial experience or capacity.
• Minimizing potential conflicts among beneficiaries.
• Providing income-splitting opportunities (within legal guidelines).
• Shielding assets from creditors or legal claims under certain conditions.
• Ensuring continuity in managing funds for charitable purposes or special needs beneficiaries.

Types of Trusts in Canada

Trusts generally fall into two main categories: inter vivos (living) trusts and testamentary trusts. Each type carries specific implications for tax treatment, timing, and administration.

Inter Vivos (Living) Trusts

• Created and funded during the settlor’s lifetime.
• Allows the settlor to specify how the trust assets should be managed and distributed while they are alive.
• Offers flexibility and can help in avoiding probate fees if structured properly.
• Often used in family estate planning, asset protection strategies, and for charitable giving.

Testamentary Trusts

• Established through a will and activated upon the death of the settlor.
• May provide long-term management and control of assets for minor beneficiaries, spouses, or dependents.
• Historically beneficial for income splitting, though tax rules have tightened in recent years.
• Clarity in the will is essential to ensure that the trust’s purpose, trustees’ powers, and the rights of beneficiaries are well-defined.

How Trusts Fit Into Estate Planning

Trusts often form a cornerstone of an estate plan, especially for individuals with substantial assets or complex family circumstances. They can:

1. Clearly designate what assets go to whom and under what conditions.
2. Reduce the risk of estate disputes, especially when family businesses or large real estate holdings are involved.
3. Provide financial security for dependents with special needs or for minors until they reach a specified age.
4. Facilitate the orderly transfer of wealth and potentially help reduce taxes through effective income splitting.

Asset Protection Benefits

Depending on trust terms and structures, assets placed in a properly designed trust may be more difficult for creditors to access. This protection can be beneficial for entrepreneurs or professionals with potential liability exposure, ensuring that family assets remain safeguarded. However, it’s essential to establish a trust well before any creditor claims arise, as setting up a trust in anticipation of specific creditors can be challenged in court.

Taxation Considerations

Under the Income Tax Act, trusts are generally considered separate taxpayers for income tax purposes and must file annual T3 returns with the Canada Revenue Agency (CRA). Here are key tax aspects to consider:

• Income Splitting: In certain circumstances, distributions to beneficiaries in lower tax brackets can reduce the overall tax burden. However, the “kiddie tax” and attribution rules may limit these benefits for minors or related beneficiaries.
• 21-Year Deemed Disposition Rule: Most inter vivos trusts are subject to a deemed disposition of capital property every 21 years, which can trigger capital gains tax. Trustees often plan distributions or “rollouts” to beneficiaries before that date to avoid large tax bills.
• Testamentary Trusts Taxation: Since 2016, testamentary trusts are generally taxed at the top marginal rate (with exceptions for Qualified Disability Trusts). This change has reduced the previous tax advantage that testamentary trusts once offered.
• Residency Issues: If trustees or the management of the trust are located outside Canada, the trust may face additional complexities concerning compliance and taxation.

Important: Always consult legal and tax professionals when establishing a trust. Provincial rules and residency factors can significantly affect how a trust is taxed and administered.

Trustee’s Fiduciary Duty

One of the most critical features of a trust is the relationship between the trustee and the beneficiaries, called a fiduciary relationship. The trustee must:

1. Act with loyalty: Place the interests of the beneficiaries above their own.
2. Exercise prudence: Make careful and informed decisions regarding trust property.
3. Remain impartial: Treat all beneficiaries (current and future) fairly and without bias.

Setting Up a Trust: Key Steps

1. Define the Trust’s Purpose and Beneficiaries
   • Clearly specify why you are creating the trust (estate preservation, providing for beneficiaries, etc.).
2. Select a Trustee
   • Choose a reliable individual or corporate trustee experienced in handling trust matters (e.g., RBC Royal Trust, BMO Trust Company).
3. Draft the Trust Deed or Agreement
   • Work with legal counsel to outline the trust’s terms, powers of the trustee, and distribution guidelines.
4. Transfer Assets into the Trust
   • Ensure proper documentation for transferring title to the trust.
5. Address Tax and Regulatory Compliance
   • File the relevant forms (e.g., T3 Trust Returns) with the CRA; maintain records of the trust’s activities and distributions.

Administering a Trust: Ongoing Requirements

• Investment Management: Trustee must prudently invest the trust’s assets, adhering to the “prudent investor rule” in most provinces.
• Records and Reporting: Keep detailed financial statements, transaction records, and beneficiary communications.
• Tax Filings: Compile and submit annual T3 returns to the CRA, ensuring compliance with all current rules.
• Distribution Guidelines: Follow the precise instructions set out in the trust deed. In many cases, distributions require trustee discretion or must meet periodic milestones.

Real-World Canadian Examples

1. Case Study: RBC Wealth Management and Inter Vivos Trust
   Suppose an Ontario-based family business owner sets up an inter vivos trust for their children. They appoint RBC Wealth Management as a corporate trustee. By transferring shares of the business into the trust, they may achieve some tax efficiency via income splitting (subject to relevant attribution rules) and minimize probate fees when the settlor eventually passes away.

2. Canadian Pension Funds
   Large public pension funds, such as the Canada Pension Plan Investment Board (CPPIB) or the Ontario Teachers’ Pension Plan (OTPP), often use trust structures or pooled funds when investing internationally to simplify cross-border tax and regulatory compliance. While not identical to personal trusts, these vehicles share fundamental trust principles of separate and dedicated asset management.

Diagram: Basic Trust Structure

Below is a simplified representation of the relationship between the settlor, trustee, and beneficiaries:

    flowchart LR
	    A[Settlor (Grantor)] -->|Transfers Assets| B[Trust]
	    B --> C[Trustee]
	    C --> D[Beneficiaries]

• The Settlor transfers assets to the Trust.
• The Trust is managed by the Trustee on behalf of the Beneficiaries.

Tips and Pitfalls

Tip: Conduct a thorough situational analysis before creating a trust:

• Evaluate your family’s needs, the future growth of the assets, and your beneficiaries’ financial acumen or vulnerabilities.
• Use professional advice to structure the trust align with your estate planning goals.

Pitfall: Failing to regularly update the trust deed or will can cause misalignment with changes in family circumstances or tax rules.

• Keep trust documents current after major life events (e.g., births, deaths, divorces, or acquisitions of major assets).

Pitfall: Selecting an inexperienced trustee can endanger the trust’s purpose.

• Trustees who do not understand their fiduciary duties or lack investment experience may mismanage assets or violate their obligations.

Regulatory Framework and Further Resources

• Canada Revenue Agency (CRA):

  • Overview of Trusts
  • T3 Trust Guide and Forms

• Provincial Trustee Acts:

  • e.g., Ontario Trustee Act, Alberta Trustee Act, etc. (check your province’s legislation).

• Society of Trust and Estate Practitioners (STEP Canada):

  • Offers professional designations and specialized trust and estate resources.

• Open-Source Estate Planning Tools:

  • Platforms like “Estateably” provide digital solutions. Some features might be accessible for free or on a trial basis.

• Recommended Reading:

  • “The Canadian Guide to Will and Estate Planning” by Douglas Gray and John Budd for an in-depth discussion of various trust strategies.

Importantly, if a trust establishes an account with a Canadian investment dealer to manage securities, the dealer will be regulated by the Canadian Investment Regulatory Organization (CIRO). Funds held in that account will also typically be covered by the Canadian Investor Protection Fund (CIPF) in case of dealer insolvency, subject to coverage limits and eligibility.

Conclusion

Trusts are a powerful and flexible mechanism for managing and transferring wealth in Canada. By offering significant benefits—ranging from creditor protection to tax planning opportunities—trusts can help ensure that your estate planning goals, family security, and wealth preservation intentions are fulfilled. As with any sophisticated arrangement, consultation with legal, investment, and tax professionals is essential to create the optimal structure. When implemented correctly, trusts provide a firm foundation for long-term financial stability and peace of mind.

Building Wealth With Trusts in Canada: Test Your Knowledge