A well drafted will is critical to any estate plan. A will is an essential document which allows an individual to direct the disposition of his or her estate on death, to specify the beneficiaries, and identify at what age and in what proportion each beneficiary is to receive the gift. In addition, a will enables the taxpayer to implement tax planning with the result of either reducing or deferring income tax. Without a will, assets will be divided based on the intestacy laws of the province and all of the other controls noted above are lost.

There are several key aspects of creating a will that are extremely important and should be undertaken with care and forethought. One of the primary decisions relates to the timing of the receipt of assets by beneficiaries. In designing the will, should it create one or more trusts, or should it allow for the immediate distribution of the testator’s assets?

Trust or Immediate Distribution

Should the assets be distributed immediately, or should all or part of the estate be held in trust for some period of time? The simplest scenario is one where all assets are immediately distributed to the beneficiaries. This provides for a quick resolution without ongoing responsibilities for the executors. However, this may not always be the best choice. Both tax and non tax issues must be considered when choosing to create one or multiple trusts.

Non-tax Considerations

There are several benefits to creating a trust. The trust gives the testator the flexibility to establish who will benefit from the estate and at what age. If no trust is created then anything bequeathed to a minor child will vest with them when they attain the age of majority. Anything bequeathed to a non-minor will vest with them immediately. Where an estate is significant, the testator may not feel that the beneficiary has attained sufficient maturity to properly handle the bequest.

Creation of a trust through a will results in the transfer of the testator’s assets to a testamentary trust. These assets are under the control of the trustee of the trust. For this reason it is important to choose a capable trustee. If the trustees are capable, they may be able to maintain or enhance the value of the estate better than the beneficiaries themselves.

The creation of a trust is also a means to ensure that the testator’s assets are disposed of in the preferred manner. A typical situation arises where a testator wishes to provide for his or her spouse, but also wishes to ensure that his or her assets eventually pass to the children. If the testator leaves the assets to his or her spouse directly they may spend the assets, or choose to bequeath these assets to beneficiaries other than the testator’s children (for example they may remarry and bequeath the assets to their new spouse). To resolve this issue, the testator may create a spousal trust through their will, leaving the spouse a life interest in the assets, and the remainder to his or her children. In this way the capital will be preserved for the children.

There can be any number of reasons to establish one or more testamentary trusts. Some of these could be as follows:
•    to provide funds for the education of children or grandchildren;
•    to provide for the care and maintenance of a physically or mentally infirm adult child;
•    to ensure that the estate is preserved for the testator’s children and grandchildren, particularly if the testator’s spouse marries someone who also has children;
•    to ensure the separation of funds among beneficiaries so that the accelerated use of funds for the needs of one beneficiary does not erode the funds earmarked for another; and
•    to provide income splitting.

There can be drawbacks to the creation of trusts in terms of the commitment required by the trustees as well as costs and administration. A trust is a separate legal entity and, as such, must keep records and file tax returns. Where there are multiple trusts there are multiple filing requirements.

It should be noted that certain assets owned by the deceased will not be available for transfer to a trust. These assets include assets that are jointly owned with another individual with rights of survivorship, and assets for which the testator has made a specific beneficiary designation.

Where an asset is placed in joint ownership, and the joint ownership arrangement carries with it the right of survivorship, on the death of the first joint owner, the asset will not become part of the individual’s estate, but rather will pass directly to the surviving joint owner. Unless the new joint owner is the individual’s spouse, the transfer of an asset into joint ownership is a taxable event. Any accrued gains will be triggered in connection with the disposition of one-half of the value of the asset.

Where the testator owns life insurance, Registered Retirement Savings Plans (RRSP), Registered Retirement Income Funds (RRIF), or similar types of plans in respect of which a beneficiary may be designated, specific beneficiary designation will keep the plan proceeds out of the testator’s estate.

Any asset that is kept out of the testator’s estate, as noted above, will not be available for transfer to a testamentary trust.

In addition, it should also be noted that Probate fees are levied by provinces at varying rates and can be as high as 1.5% of the value of an estate in Ontario. These fees can be a significant cost to an estate. The fee applies only to assets that are probated; that is, those that pass to beneficiaries pursuant to the direction of the deceased through the deceased’s will. As a result, assets that are transferred outside a will as a result of joint tenancy ownership, whereby the survivor automatically becomes the owner of the property, or designations of a specific beneficiary in an investment contract, will not be subject to probate fees. Many individuals choose to own assets in joint tenancy or make specific beneficiary designations in order to avoid paying probate fees on the value of those assets. While this technique does reduce probate fees, the testator has given up the potential benefit of transferring these assets to a testamentary trust.

Tax Considerations

Where a trust is created through an individual’s will it is taxed on the income earned on the trust assets at the marginal income tax rates that apply to individuals. If properly structured, a will can result in several testamentary trusts, each of which is taxed at the marginal tax rates for individuals. This can result in significant income tax savings if the income would have otherwise been taxed at the highest marginal rates on the beneficiaries’ personal tax returns.

There are different types of trusts which can be beneficial in achieving the dispositive goals of the testator, while significantly reducing the tax payable by the beneficiaries. These trusts include a spousal trust and trusts for the benefit of children or grandchildren. A separate trust could be created for each designated beneficiary. The number and structure of trusts in an estate plan is determined based on each testator’s estate and dispositive wishes.

Use of a spousal trust can result in the deferral of income tax on death related to any accrued capital gains on the transferred assets. It also allows the income to potentially be taxed at lower rates. The tax deferred on death becomes payable by the trust on a disposition or on the spouse’s death. There are a number of conditions to be met to qualify as a spouse trust. First, the spouse must be entitled to receive all of the income of the trust. Second, no one other than the spouse can access the capital of the trust while the spouse is alive.

As noted above, creation of one or many trusts for the benefit of children or grandchildren can ensure that the testator’s assets are used for the benefit of these children or grandchildren and provide a level of control over the assets. At the same time, the trust effectively allows access to a second set of graduated personal tax rates. While children are young, this may not be a significant advantage since their income may not otherwise be significant. However, once the children start to earn income from full time jobs, the access to the second set of tax brackets can provide a significant advantage.

Summary

In deciding whether to have an outright distribution or a trust, regard must be had for the size and the nature of the assets, and the ability and maturity of the beneficiaries. If in doubt, it is preferable to opt for the trust. While the trust does involve additional expense and inconvenience, this is generally more than compensated for by the advantages set out above. If the choice of a trust is a potential error, it is an error on the side of caution.

For further advice or assistance with these or any other financial issues, please contact a Millards representative at (519) 759-3511.