Family Trusts in Canada
Tiffany Woodfield, Senior Financial Advisor, Associate Portfolio Manager, CRPC®, CIM®, TEP®
Summary of Key Points
Family trusts in Canada hold and manage family assets, support estate planning, and help transfer wealth to family members in a more tax-efficient way.
Key roles include settler, trustee, and beneficiary: the settler creates the trust, the trustee manages the trust's assets, and the beneficiaries receive benefits.
A family trust is a separate taxpayer; trusts are taxed at the highest personal rate, so distributing income to beneficiaries can improve family tax outcomes. (There are some exceptions.)
Trusts can protect assets from creditors, help avoid probate delays, provide a spouse with lifetime income, and set clear rules for distributions.
Downsides include complex rules, attribution risks, the 21-year deemed disposition, and significant setup and ongoing costs, all of which require advice from legal and tax professionals.
Video Script
In this video, I’m going to go over family trusts in Canada and the basics everyone needs to know. For more details review the blog post I’ve written on Family Trusts in Canada on the SWAN Wealth Website. I’ve included the article in the description box below.
Stay to the end to find out my honest opinion about trusts and whether they’re a good fit for the average Canadian.
I’m John Woodfield, a CFP and Portfolio Manager and the co-founder of SWAN Wealth Management. I work with US and Canadian clients every day, and over the years, I’ve seen how much stress the question of taxes can cause dual citizens.
If you’ve moved so that you can enjoy your next adventure or pursue a career opportunity, the last thing you want is to be worried about the IRS.
So let’s get into it!
A family trust may be established to hold and manage family property and assets. It serves as an important tool for estate planning by enabling assets to be passed on to family members, often in a tax-efficient manner.
This can be beneficial for families that have accumulated substantial assets and would like to minimize taxes and ensure that property is transferred to family members according to the wishes of the trust's creator.
In other words, if you want to make sure the inheritance and legacy you leave for your family is protected, then a trust might be a good estate planning tool for you.
But what are the roles and Responsibilities within a Trust? Who creates the trust and manages the trust?
Let’s go over a little bit of vocab:
The main roles to understand are: settlor, trustee, and beneficiary.
The settlor creates the trust and transfers assets to it.
The trustee manages those assets in accordance with the trust agreement.
And the beneficiaries are the individuals or entities that benefit from the trust.
Trustees have a fiduciary duty to act in the best interests of the beneficiaries, which includes duties of loyalty, impartiality, and care. This structure is crucial as it establishes a legal framework for asset management that safeguards the interests of beneficiaries.
Now, you might be wondering about tax? Are there tax benefits in having a trust?
You should speak to your accountant and lawyer about this to get all the details that are relevant to your situation. However, I can give you a brief overview.
Family trusts can offer tax benefits, but they are also subject to complex tax laws and regulations.
In Canada, a family trust is considered a separate taxpayer, but tax must be carefully managed to ensure it is advantageous to distribute income to beneficiaries rather than accumulate it within the trust.
Additionally, attribution rules may apply that prevent income shifting to lower tax bracket beneficiaries for the purpose of tax avoidance. However, one of the key benefits of a family trust in Canada is its ability to facilitate tax efficiency by distributing taxable income to beneficiaries who are in lower tax brackets.
Trusts themselves are taxed at the highest personal marginal tax rate on their income, so it is often more tax-efficient to flow out the income to beneficiaries. This is important as it can result in overall tax savings for the family, especially when capital gains and dividends are concerned.
However, caution must be exercised due to "attribution rules," which may attribute income back to the transferor if specific conditions are met, to prevent the abuse of income splitting.
Understanding and navigating these tax rules is vital for maximizing the benefits of a trust, and for ensuring compliance with tax laws. So it’s very important to consult with legal and financial professionals to manage the tax implications associated with trusts.
Next, does using a trust help you to protect your assets?
Establishing a family trust does provide a mechanism for protecting assets and ensuring that they are distributed according to the settlor's wishes. Remember that the settlor is the person who created the trust. By placing assets into a trust, the settlor effectively separates their ownership from the assets, safeguarding them from creditors.
This is particularly important for individuals who want to protect the family’s wealth and ensure that the assets are distributed among family members as desired, without conflict or lengthy probate problems.
Trusts can also provide lifetime income to spouses or protect children by defining specific rules for asset distribution. While a trust might be a good solution for your family, it’s important to be aware of the rules and down sides. The complexity of the rules governing them is substantial.
Let’s talk about one of these complexities:
The 21-Year Rule.
In Canada, the 21-year rule is an essential consideration when using a family trust because it subjects the trust to a deemed disposition of its assets every 21 years. This rule can create a significant tax liability based on capital gains if the assets within the trust have gone up in value.
Planning strategies can be discussed with your tax lawyer and financial professional such as donating securities with high capital gains can help mitigate these taxes, but understanding and preparing for the 21-Year Rule is crucial for effectively managing a family trust.
Finally, the initial and ongoing costs of setting up and maintaining a family trust are significant. Besides the legal fees for establishing the trust, there are recurring expenses related to filing annual tax returns for the trust. For individuals with cross-border considerations, such as U.S. citizenship, additional complexities arise, requiring specialized legal advice.
Understanding and budgeting for these costs is vital for ensuring that the benefits of establishing a family trust outweigh the expenses and that the trust is set up correctly to serve its intended purpose.
So should YOU get a trust?
If you have substantial assets and wish to protect them and pass them along to your family members, a trust may be a good fit.
I recommend that you speak with a lawyer and work with your wealth management team to decide what is the right path for you.
If you’re a Canadian or American or dual-citizen living in Canada and you need a wealth management team that can help you on both sides of the border, I recommend you schedule a call with a SWAN Wealth advisor to see if we can help you with your estate planning and wealth management.
If you find this information helpful and want to read more, go to our website and read the full article on Family Trusts in Canada.
It has even more information, so I’ve included the link below.
https://www.swanwealthcoaching.com/guides/family-trusts-in-canada