There are many good reasons to use a trust set out in your will to distribute assets to your children: for example, you could provide continuous support to them after you die, and the assets held in the trust would be distributed according to the terms and conditions you had established. This approach could also help avoid probate and minimize taxes.
The following example demonstrates the many benefits of setting up a trust in your will for your children.
Dr. Ellen Kealey and her husband have twins, James and Julie.1 When the children were young, Dr. Kealey and her husband had their wills prepared, leaving all of their assets to each other. If they both were to die, everything would be held in trust for their minor children.
Many years later, their daughter Julie became a physician too, while their son James started his own business, and both children had families of their own. Dr. Kealey and her husband decided to update their wills, thinking that it might be time to delete the trusts and instead provide outright gifts to their adult children.
After doing some research, however, they realized that the trust structures would still prove useful. They redrafted the terms of the trusts, adding Julie’s children as beneficiaries of Julie’s trust and adding James’ children to his trust.
How did they come to this conclusion?
Protecting your children’s inheritance from creditors
It has turned out that James’ business has experienced some difficulties. He was forced to refinance with his bank and suppliers, and issue personal guarantees on his business’s debt. When Dr. Kealey and her husband die, James’ inheritance could be in jeopardy if creditor claims were to crystallize.
Instead of giving an outright gift to their son, Dr. Kealey and her husband chose to maintain his inheritance in trust. In this case, if necessary, capital could be paid to James at the discretion of the trustee or trustees, in satisfaction of any trust provisions outlined in the will; for example, if the trustee were satisfied that payments to James would not end up in the hands of his creditors.
If James’ credit concerns continued, payments from the trust could go directly to his children, Dr. Kealey and her husband’s grandchildren. If his credit worries disappeared, the trustee could decide to pay the entire balance of the trust to James.
Minimizing tax through income splitting
Daughter Julie (and her husband), on the other hand, were in the top income tax bracket and had begun to save. When Dr. Kealey and her husband pass away, their daughter Julie is expected to simply add her inheritance to her investment account.
That said, Julie’s inheritance could also continue to be held in trust. Income and, if necessary, capital could be paid to Julie or her two children at the trustee’s discretion. The goal here is income splitting. If Julie were to receive the inheritance directly and add it to her investment account, she would pay tax on the investment income at the top tax rate.
By leaving Julie’s inheritance in trust, the trustees would have the option of paying the income to either Julie or to her two children, or to tax it in the trust and accumulate it for future use. While the income in the trust will always be taxed at the top marginal rate — as will Julie’s income if she remains in the top tax bracket — income splitting may be achieved by taxing income in the hands of the children at progressive tax rates, so long as they remain in a lower tax bracket.
Other considerations for setting up a trust for your children
If you have concerns about your children’s ability to manage the money, or about the children’s marital status, you can create a spendthrift trust. This type of trust is for beneficiaries who are at risk of squandering a lump-sum inheritance, and it can prevent the beneficiaries’ creditors from gaining access to funds in the trust. An independent trustee would determine how and when the trust’s funds could be used by the beneficiary.
Before setting up a trust for your children, you may wish to consider the future administration and potential costs required to maintain a trust. There are also some technical tax details to consider.
Your children may simply prefer to receive their inheritance directly, despite the protection and potential for tax planning provided by a trust. This may also be a suitable option since an inheritance held in trust does not give your children the same control that outright ownership provides.
The trust decision for your children
Before setting up a trust for your children, consider your circumstances — and those of your children —carefully. If the fit is right, the use of a trust in your will can help achieve protection and tax planning opportunities over longer periods. Speak to an MD Advisor* today to determine whether a trust for your children is suitable for inclusion in your will.
* MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec), or an MD Private Investment Counsel Portfolio Manager.
1 This example is hypothetical and is for illustrative purposes only. It does not represent the financial situation of any actual client. Any resemblance to actual people or situations is purely coincidental.
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.
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.