Seniors look for estate planning options beyond wills and powers of attorney1 (POA) because they wish to enhance security and protection regarding how their accumulated assets are passed along to the next generation(s). Alter ego trusts and joint partner trusts, which are available to individuals aged 65 or older, are options for helping seniors create a customized, orderly wealth management and transfer plan.
Alter ego trusts, which are set up for one individual, and joint partner trusts, which are set up for a couple, are both “inter vivos” trusts, meaning that they are put into effect during the lifetime of the person/people setting up the trust, not after death as is the case with a testamentary trust in a will. Alter ego and joint partner trusts provide seniors with more flexibility and control for protecting and passing along assets, and can become an important part of estate planning.
People create inter vivos trusts for a variety of reasons, but two of the most common are personal needs (as a POA substitute) and ease of asset distribution upon death. Because the trust can potentially reduce the probate2 tax and executor3 fees associated with a traditional will, the total value of your legacy can be significantly enhanced. And, since you can specify how and when your beneficiaries will receive their inheritance, you can ensure your wealth continues to be responsibly managed beyond your lifetime.
Normally, a transfer of property to an inter vivos trust is a taxable event. With this disposition of property, the deemed proceeds are equal to the fair market value (for tax purposes), resulting in possible taxable capital gains. For alter ego and joint partner trusts, in most cases the transfer of property may occur at its adjusted cost base (i.e., the calculation used for tax purposes to determine an investment’s cost), so that no capital gains arise. The first deemed disposition date for the trust property is your death for the alter ego trust, or the date of death of you and your spouse (whichever is later) for the joint partner trust.
Requirements for an alter ego or joint partner trust
Here are the terms that must be satisfied:
- You must be 65 years of age or older when the trust is created.
- You must be a resident of Canada at the time the trust is created.
- In the case of an alter ego trust, you must be entitled to receive all of the income of the trust that arises before your death, and no person other than yourself may, prior to your death, receive or otherwise obtain the use of any of the income or capital of the trust.
- In the case of a joint partner trust, you or your spouse—and no other person—must be, in combination, entitled to receive all of the income of the trust that arises before the latter of your deaths.
Alter ego trusts: An example
For some people, these types of trusts are attractive substitutes for wills and POAs. As an example, consider the case of Dr. Wilson.4 He is widower close to 75 years of age and owns a non-registered investment portfolio of substantial value, which he is finding more difficult to manage. After discussing his situation with his accountant and MD Estate and Trust Advisor, Dr. Wilson transfers his investment portfolio into an alter ego trust. The trustees of the trust are Dr. Wilson and MD Private Trust. Dr. Wilson is the sole beneficiary of the trust during his lifetime and, on his death, the balance held in trust, after payment of tax, will be divided among his children.
Dr. Wilson finds the trust to be a more flexible and tailored vehicle than the traditional POA, as he maintains greater control over how his assets are passed along.3 He also finds peace of mind in knowing that if he becomes incapacitated during his lifetime, the trust property will continue to be managed by his co-trustee (MD Private Trust) for his benefit.
On Dr. Wilson’s death, the property will be administered by his co-trustee according to his wishes, but will not form part of his estate that is subject to executor’s fees and probate tax. The trust, in effect, allows a seamless transition of the portfolio during Dr. Wilson’s lifetime, right through to his possible incapacity and, ultimately, to his death. If Dr. Wilson had a spouse and they had chosen to create a joint partner trust, then the trustee would not distribute the estate assets until the death of the second spouse.
Important points regarding alter ego or joint partner trusts
- They are not income-splitting vehicles.
- There will be a deemed disposition of capital property in the trust upon your death (or last death in the case of a partnership). Any capital gains triggered in the trust will be taxed at the top marginal tax rate in the trust’s tax return (those gains would otherwise be taxed in your hands on your death). There is no ability to move these capital gains onto your personal terminal return (i.e., the income tax return that is filed on your behalf for the tax year in which you died).
- Any further trust created on your death out of an alter ego or joint partner trust will not qualify as a testamentary trust. Rather, it will be an inter vivos trust, and its income will be taxed at the top marginal rate unless it is paid out to the beneficiary to be taxed in their hands at their personal marginal tax rate.
- Concerns over losses, charitable donations or testamentary trusts may be met by carefully choosing which assets to put into the alter ego or joint partner trust.
- There may be initial set-up costs for the trust and potential—but typically minimal—costs for ongoing legal or accounting advice, plus it will also require annual tax filings. Please speak to an estate and trust advisor to discuss your potential options for distributing your estate property efficiently and according to your wishes.
- You still need to have a will and POAs accompanying your alter ego or joint partner trust to ensure all your assets and objectives are addressed in your estate plan.
- As part of a total financial planning strategy to maximize wealth management and transfer of the estate, you may choose to purchase a life insurance policy outside of the trust. Proceeds of the policy will be disbursed tax-free to named beneficiaries, and the total death benefit could fully or partially compensate the beneficiaries for the reduced (after-tax) distribution received from the trust.
There may be other benefits or implications arising from the creation of an alter ego or joint partner trust, which you should discuss with an estate and trust advisor.