Setting Up a Trust for Your Children—A Case Study

September 6, 2017

 

If you want to be sure that the assets you have accumulated over your lifetime will be passed on to your family after your death, you should consider the benefits of setting up a trust in your will.

The following example illustrates the many benefits of setting up a trust in your will for your children and grandchildren.

Dr. Black1 and her husband have twins: a son named John and a daughter named Julie. Dr. Black and her husband visited their lawyer to have their wills prepared. All of their assets were left to each other and, when they both die, everything will be held in trust for their minor children.

Several years after the will was prepared, their daughter Julie entered the medical profession, while their son John started his own business.

Dr. Black and her husband decided to update their wills, thinking that it might be time to delete the trusts and provide outright gifts to their adult children. After doing some research, however, they realized that the trust structures would still prove useful. They re-drafted the trusts, adding Julie’s children as beneficiaries of Julie’s trust and adding John’s children to John’s trust. Why did they come to this conclusion?

Protecting your children’s inheritance from creditors

As it turned out, John’s business had begun to experience some difficulty. He was forced to refinance with his bank and suppliers, and issued personal guarantees on his business’s debt. When Dr. Black and her husband died, John’s inheritance could have been in jeopardy if creditor claims crystallized.

Instead of providing an outright gift to their son, Dr. Black and her husband chose to instead maintain his inheritance in trust. This was because income and, if necessary, capital could be paid to John at the discretion of the trustee(s), in satisfaction of any trust provisions outlined in the will; for example, if the trustees were satisfied that payments to John would not end up in the hands of his creditors. And, if John’s credit concerns continued, payments from the trust could go directly to his children, Dr. Black’s grandchildren. When his credit worries disappeared, the trustees also would have discretion to pay the whole amount to John.

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. Black 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 trustees’ discretion. Julie’s goal was income splitting. If Julie received the inheritance directly and added 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 could have the option of paying the income to Julie or to either of 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 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 your children’s trust

  • Spendthrift trust—Other circumstances where an extended trust for a child might prove beneficial include concern over the child’s ability to manage the money, the child’s spending record or concern about the marital status of the child.

    For instance, you can create a spendthrift trust for a beneficiary who is at risk of squandering a lump-sum inheritance, and prevent the beneficiary’s creditors from gaining access to funds in the trust. An independent trustee would determine how, when and for what purpose the trust’s funds can be used by the beneficiary.
     
  • Administration costs—Something to consider before setting up a trust for your children might be the administration involved in a trust, as well as the potential administration costs. There are also some technical tax details to consider.
     
  • Direct inheritance—Your child may simply prefer to receive his or her 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 child the same control that outright ownership provides.

Trust in 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 if a trust for your children is suitable for your will.

Learn more about MD's estate and trust offering or contact an MD Advisor to find out how we can help.

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