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Testamentary Trusts - Are They Still A Useful Tool In Estate Planning?


As you may be aware, the 2014 Federal Budget did not bode well for the tax savings achieved through the use of testamentary trusts. Currently, establishing a trust during someone’s lifetime (inter-vivos) results in income earned by the trust being taxed at the highest marginal rate. In contrast, a trust settled on the death of an individual (testamentary) allows for the use of marginal tax brackets. Using a testamentary trust can result in large tax savings.

The proposed legislation eliminates the use of marginal tax brackets for grandfathered inter-vivos trusts, trusts created by Will and estates. It’s important to note that an estate created on death will have a grace period of 36 months. This means that the estate (or trust) will have access to the marginal tax brackets for that period. At this time, the trust will be considered a “graduated rate estate”. The grace period of 36 months was determined to be the time it will take to clear up all administrative matters of the estate.

Other notable changes are: (1) testamentary trusts will no longer be able to choose any year-end (they will all now have December year-ends); (2) they will no longer be exempt from tax instalments and (3) they will also not benefit from the basic exemption when computing alternative minimum tax. These changes come into effect January 1, 2016.

It is clear that the change to the legislation was prompted by a desire to minimize the tax savings derived from the marginal tax rates. Therefore, the question is whether or not using a testamentary trust is still a useful tool in estate planning. Speaking strictly from a taxation perspective the use of the testamentary trust lost a lot its luster; however, there are still benefits to using these types of trusts:

• Grace period: For an estate (a trust) established on death, the trust is still able to benefit from the graduated rates for 36 months. Therefore, there will be some tax savings available in regards to any income received within this time period.

• Control of the trust assets: While there are no tax advantages to this, the use of a testamentary trust allows the trustees to still maintain control of the assets within this trust. For example, if Dad passed away, leaving a large sum of assets to one of his minor children or a child who may not be mature enough to make decisions, the trustee can still manage this money until the age at which the child is responsible enough to have access to it. All income can still be allocated to the child, in order to benefit from the use of the child’s marginal tax brackets. Another example where this may be used is when one spouse passes away and they want the surviving spouse access to the income earned on the assets during the surviving spouse’s lifetime, but want the ultimate owner of the assets to be a child. By using a testamentary spousal trust you can ensure this happens.

Disabled children: Leaving a testamentary trust for a beneficiary who is eligible for the disability tax credit is not subject to all the proposed changes. If the child is receiving the disability tax credit, the trust will still have access to the graduated tax rates. By allowing the trust the use of the marginal rates, the income does not need to be reported on the disabled child’s tax return, thereby not impacting any social assistance received by the individual.

Creditors: The use of a testamentary trust may still be beneficial for holding assets that would otherwise be exposed to creditors.

Marriage breakdown: Some parents are concerned that leaving certain assets to their children will allow their child’s spouse access to this asset if there was ever a breakdown in their marriage. However, the use of a testamentary trust will allow the asset to be held by the trust and thus the spouse may not have access to this asset in the event of a marriage breakdown.

In conclusion, while the tax advantages of a testamentary trust are not as lucrative as they once were, there are still good business / family reasons for the use of these types of trusts going forward.