How you transfer your assets to your loved ones after you are gone is as important as how you built those assets during your lifetime. A spousal trust created in your will can protect your spouse’s (and your children’s) eventual inheritance, while also ensuring your assets are distributed the way you had intended.
We all have hopes for the way our assets will benefit our spouses and children after we die. And although we have a number of choices in the way we structure these assets for transfer, certain strategies offer unique advantages.
Take, for example, the benefits of a spousal trust in this case study featuring Dr. Novak.1
Case study: By offering protection, a spousal trust gives peace of mind
Dr. Novak, age 74, is a retired neurologist. He and his wife, who was a stay-at-home parent, have two sons.
Dr. Novak’s assets consisted of a small registered retirement income fund (RRIF) and a sizeable non-registered investment portfolio. His will was structured to leave all his assets to his wife. He then began to contemplate the transfer of his investment portfolio into joint ownership with his wife to save on executor’s2 fees and probate tax.3
Around this time, Dr. Novak’s wife was diagnosed with Alzheimer’s disease, but she was in early stages and still retained her mental capacity.
After meeting with an estate and trust advisor, Dr. Novak decided to change his will so that if he predeceased his wife, his estate would be held in trust for her during her lifetime. All the investment income earned in the trust would be paid to Mrs. Novak, with the capital in the trust available to her if circumstances required it. Upon Mrs. Novak’s death, the remaining assets in the trust would be divided between their two sons.
Dr. Novak was reassured knowing that if he predeceased his wife, the assets accumulated over his lifetime would be protected, prudently invested and managed by the trustee, and available for his wife.
Other benefits of spousal trusts
Let’s consider a scenario where Mrs. Novak is Dr. Novak’s second wife, while his sons are from his first marriage. Mrs. Novak, too, may have children from a first marriage.
A spousal trust would help Dr. Novak ensure that his wife would be cared for after his death, while also protecting his estate for his sons. The ultimate disposition of his estate would be detailed by the terms of his will, not by Mrs. Novak’s actions during her lifetime or the provisions of her will after her death.
Spousal trusts can be effective in many situations where there is concern about the surviving spouse — for example, that they could be taken advantage of by an unscrupulous family member; or that they have spending habits that could deplete the inheritance.
Things to consider when looking at a spousal trust
1. Choose your executors wisely
Mrs. Novak would have been a possible choice as Dr. Novak’s executor and trustee if it weren’t for her Alzheimer’s diagnosis. One or both of their sons could be choices for executor and trustee, provided they have the time and knowledge, are accessible, and are residents of Canada.
Conflicts could arise, however, as Mrs. Novak may want to maximize her income from the trust, while Dr. Novak’s sons may be more interested in capital growth to increase their inheritance. Drafting the trust to ensure that Mrs. Novak’s needs come first would be a good starting point for Dr. Novak. A further step might be to appoint an impartial third-party executor and trustee, such as MD Private Trust Company, instead of one or both of the sons.
2. Assets must pass under the will
Remember that a spousal trust is established through provisions in the will. If Dr. Novak had transferred his investment portfolio into joint ownership with his wife, it would pass, by right of survivorship, directly to Mrs. Novak upon his death. In other words, the portfolio would bypass his will — and as a result, may not be subject to Dr. Novak’s wishes as outlined in the trust. Dr. Novak’s estate and trust advisor had alerted him to this issue, and the portfolio was left in his name only.
As for Dr. Novak’s RRIF proceeds, current income tax rules do not allow for a rollover into a spousal trust — so they would not be subject to the provisions of the trust. Dr. Novak’s RRIF is relatively small, so he may feel comfortable naming Mrs. Novak as the beneficiary, meaning the RRIF proceeds would pass directly to her. It would be a good idea for Mrs. Novak to execute a power of attorney now while she is still capable,4 so that there is someone in place to manage the RRIF should Mrs. Novak be unable to as a result of the progression of her illness.
If Dr. Novak does not name a beneficiary for his RRIF, the proceeds would go to his estate, pass under his will and be included in the trust. In passing under his will, however, the proceeds may incur additional tax and probate fees.
3. Avoid triggering capital gains upon death
The transfer of assets into the spousal trust on Dr. Novak’s death does not trigger capital gains; there are no capital gains until Mrs. Novak’s death. It’s important, however, that the trust be structured properly. To qualify for the tax-deferred transfer into the trust, income tax rules require that 1) all income from the spousal trust be payable to the spouse; and 2) that no one except the surviving spouse can access the capital as long as the survivor is alive.
Even with a spousal trust, claims can be made against your estate. It’s important that you discuss all the options available for your estate plan with professionals, such as your MD Advisor* and an Estate and Trust Advisor at MD Private Trust Company, when setting up a spousal trust.
* MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec), or an MD Private Investment Counsel Portfolio Manager.
1 The hypothetical case study is for illustrative purposes only and does not represent actual clients. Any resemblance to actual people or situations is purely coincidental.
2 An “executor” is called a “liquidator” in the province of Quebec and an “estate trustee” in the province of Ontario.
3 In the province of Quebec, notarial wills do not require probate, whereas the majority of other wills do require probate and are subject to a fixed application fee. All references to probate and probate tax in this document should be read accordingly.
4 In Canada, a power of attorney can be called a “continuing power of attorney,” “enduring power of attorney” or “protection mandate,” depending on the jurisdiction and the terms contained in the document. A power of attorney for personal care can be called a “representation agreement,” “personal directive,” “enduring power of attorney appointing a personal attorney,” “health care directive,” “advance health care directive” or “protection mandate,” depending on the jurisdiction.
Estate and trust services are offered through MD Private Trust Company.
The above information should not be construed as offering specific financial, investment, foreign or domestic taxation, legal, accounting or similar professional advice, nor is it intended to replace the advice of independent tax, accounting or legal professionals.