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The Navigator NavigatorThe RBC Wealth Management Services Testamentary trusts A reason to consider amending your Will It is common to distribute your assets on death outright to your loved ones. A testamentary trust is an alternative to a direct or outright distribution of estate assets. It allows you to control the timing and distribution of assets to your beneficiaries. The assets held in the trust are invested and managed by the trustee of the trust, who distributes the income and capital to the beneficiaries in accordance with your wishes stated in your Will. This article discusses reasons why you may want to consider amending your Will and reviewing your current ownership structure to provide for a transfer of some or all of your assets to a testamentary trust. This article outlines several strategies, not all of which will apply to your particular circumstances. The information is not intended to provide legal or tax advice. To ensure that your own circumstances have been properly considered and that action is taken based on the latest information available, Please contact us you should obtain professional advice from a qualified tax and/or legal for more information advisor before acting on any of the information in this article. about the topics discussed in this What is a testamentary trust? contributed to it by anyone other than the deceased individual as a article. A testamentary trust is a trust or estate that is generally created on consequence of that individual’s death. the day a person dies. The terms Directions for the creation of a of the trust are established in the testamentary trust and the terms of deceased person’s Will, by court order, the trust should be specified in your in relation to the deceased’s estate, Will. The Will should identify, among or by a separate trust document, in other things, the amount of money or the case of a testamentary insurance other property to be held in the trust, trust funded by a death benefit on the the beneficiaries of the trust property, individual’s death. the trustees and their powers, the Generally, this type of trust is only duration of the trust, and when and created by a deceased individual and how distributions are to be made. comes into existence or is funded It is common practice (but not on the death of the individual. A mandatory) to have the executor testamentary trust can lose its of your estate also be the trustee status as a testamentary trust for of any testamentary trusts created. tax purposes if any property is Testamentary trusts may have 2 | RBC Wealth Management a lifespan of a few years or may Taxation of testamentary trusts continue for many years after the Before January 1, 2016 initial administration of your estate has been completed. For more One of the benefits of having a information on appointing an testamentary trust has been the executor or trustee, or for any estate income tax advantages for the planning questions, please speak with surviving beneficiaries, which your RBC advisor, who can arrange an are not available to beneficiaries introduction to an RBC Estate & Trust that receive outright inheritances. Services advisor. Currently, taxable income earned in a testamentary trust is subject Since generally only assets passing to the same graduated tax rates through your estate can be as an individual taxpayer (this is subject to change after December Currently, taxable transferred to a testamentary trust 31, 2015). Since the income earned income earned in a (an exception exists for insurance proceeds that may be paid directly within a testamentary trust is testamentary trust is to the trust, rather than through the taxed on a separate tax return at subject to the same estate), probate taxes will likely have graduated tax rates, an income- graduated tax rates as to be paid. Furthermore, once your splitting opportunity arises for your an individual taxpayer testamentary trust is established, beneficiaries. (this is subject to annual trust tax returns may be change after December required. Probate taxes and the For example, let’s assume an adult 31, 2015). additional costs and complexities of child is in the top marginal tax preparing annual trust tax returns are bracket of approximately 46% (top two reasons that may deter you from marginal tax rate varies by province). establishing a testamentary trust. Upon the parent’s death, this child is expected to receive an inheritance Testamentary spousal trust of approximately $500,000. Further assume that this inheritance will If a spouse is a beneficiary of your be invested to earn annual taxable testamentary trust, consider setting up income of 5% of the inheritance or a testamentary spousal trust, where $25,000 per year. The following table the assets may roll over to the trust at illustrates the income tax benefit prior their adjusted cost base (ACB). Speak to January 1, 2016 of investing an to your RBC advisor for a copy of the inheritance through a testamentary article “Testamentary Spousal Trusts” trust for the child’s benefit compared if you are interested in learning more to the child directly holding the about testamentary spousal trusts. inheritance and investing it. Inheritance transferred to the Inheritance transferred to adult child outright a testamentary trust* Taxable income $25,000 $25,000 Tax payable ($11,500) ($5,000) Trust tax return fees $0 ($500) Net income $13,500 $19,500 *It is assumed that trustee fees are nil and the trust is taxed at 20%. RBC Wealth Management | 3 As you can see in the table, the adult to the beneficiaries are taxable to child enjoys an overall savings of the beneficiaries on their personal $6,000 ($19,500 – $13,500) per year by tax return at their marginal tax rates. The graduated rates earning investment income through a If the beneficiaries have a higher testamentary trust. marginal tax rate than the trust, the for testamentary trustee can elect to have the amounts trusts will be However, there are some things you paid to the beneficiaries taxed in the replaced with flat need to keep in mind: the basic testamentary trust at graduated tax personal exemption is not available rates. This election serves to decrease top-rate taxation when completing a tax return for the tax owed by the beneficiary on the that’s currently used any trust including a testamentary income they receive from the trust. for most inter-vivos trust, and transferring assets to the After December 31, 2015, this election estate to establish the testamentary will no longer be available unless the trusts, subject to two trust could result in upfront probate trust has losses carried forward from exceptions. taxes. In our example, the estate could prior years. owe up to $7,500 (based on Ontario’s probate tax of 1.5%, the highest in After December 31, 2015 Canada: $500,000 x 1.5% = $7,500). The 2014 federal budget eliminated This probate tax would eliminate graduated tax rates that currently the tax savings of $6,000 and result apply to testamentary trusts, certain in an additional cost of $1,500 in estates and grandfathered inter- the first year; whereas transferring vivos trusts beginning in 2016. The the inheritance directly to the child graduated rates for testamentary without it passing through the estate trusts will be replaced with flat top- on the death of the parent (using rate taxation that’s currently used for non-registered accounts held in joint most inter-vivos trusts, subject to two tenancy with right of survivorship exceptions. An estate that designates [JTWROS] – not available in Quebec itself as a “graduated rate estate” will – or beneficiary designations, etc.) generally be subject to graduated rate would not be subject to probate. In taxation for the first 36 months of its addition, as discussed later on, after existence. As well, graduated rates December 31, 2015, testamentary will continue to apply in respect of trusts will be subject to flat top-rate testamentary trusts for the benefit of taxation, so there will be no tax disabled individuals who are eligible savings in taxation years after this date. for the federal Disability Tax Credit where the trust and the qualifying On a positive note, any assets beneficiary have jointly elected for the remaining in a testamentary trust trust to be a “qualified disability trust” after the death of the primary for a particular taxation year. beneficiaries can avoid a second probate tax. That is, assets remaining In addition, all testamentary trusts, in the testamentary trust that are ex cept for graduated rate estates, will distributed according to the terms of be required to have a December 31 the trust to contingent beneficiaries year-end. (There are other related after the death of the primary measures that are beyond the scope beneficiaries do not form part of the of this article.) These measures will estate of the primary beneficiaries. apply to both existing and new trust arrangements for 2016 and later tax In addition, if the income earned years. and capital gains realized within the testamentary trust are paid out or As a result of the new measures made payable to the beneficiaries, in the budget, the tax benefits of then it is not taxed within the trust. testamentary trusts mentioned in Instead any income and realized the previous section of this article capital gains paid or made payable will generally only be available for a 4 | RBC Wealth Management limited time. You should be aware, T3 return of income for the year to however, that while the measures be a qualified disability trust for the may increase the amount of tax year.
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