Plan the future- The Testamentary Trust

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Plan the future- The Testamentary Trust

Jonathan M. Charron, LL.M. Tax, TEP

Tax Lawyer – Wealth & Tax Planning

jonathan.charron@bluebridge.ca

Philippe Bouchard, LL.B. J.D., LL.M.

Director – Trust Administration

philippe.bouchard@bluebridge.ca

Broad wealth planning necessarily raises the issue of transferring wealth after a person’s death. The testamentary trust is a helpful planning tool in this regard. It provides asset protection after death and, more generally, a degree of control over the ultimate destination of a person’s wealth after his or her death.

The following is a summary of the fundamental elements of a testamentary trust and the major benefits of using it as a wealth planning tool.

 

  1. Fundamental Elements

A testamentary trust is essentially a trust that is created on and as result of the death of the person. It is a legal vehicle with its own patrimony and considered a taxpayer for taxation purposes. This type of trust is created under the terms of the deceased individual’s will.  Accordingly, on an individual’s death, all or part of the property included in the estate patrimony may be transferred to a trust for the benefit of the individuals named by the deceased, rather than bequeathed directly to the same individuals.

The terms of the will that establish a testamentary trust must necessarily contain all of the clauses needed or useful to create the trust and to secure the appropriation of the property to be transferred it:

  • a description of the property contributed and transferred to the trust (or, as applicable, some mention that the residue of the estate patrimony is contributed to such a trust);
  • the names of the persons who will serve as trustees, as well as their replacement(s) (or, alternatively, the mechanism for their replacement);
  • the beneficiaries of the capital and/or income, with clarification indicating which beneficiaries are first rank and/or second rank;
  • the powers of trustees, especially with respect to decision-making and the management or investment of assets; and
  • the discretionary or non-discretionary nature of the trustees’ decision-making authority, including any potential distribution of income or capital to beneficiaries.

The testamentary trust therefore constitutes a vehicle for holding an individual’s wealth post-mortem, allowing the testator to transfer all or part of his or her wealth to the trust at the time of his or her death for the benefit of designated persons and according to specific terms and conditions provided for in advance by the testator.

 

  1. The Advantages of Using a Testamentary Trust for Wealth and Estate Planning

Setting up a testamentary trust offers several advantages, including:

i.Asset Protection

Transferring property to a testamentary trust involves creating a patrimony, autonomous and distinct from that of the trustees and beneficiaries. Assets transferred to the trust are therefore protected against the personal creditors of the beneficiaries, which would not otherwise be the case if the assets were passed on by bequest directly to the beneficiary.

Also, contributing assets in a testamentary trust eliminates confusion about the beneficiary’s wealth, which can facilitate things such as the possible division of matrimonial rights in the event that the marriage of a given beneficiary is dissolved.

A testamentary trust makes even more sense in situations where an individual dies leaving substantial wealth and minor children. In this case, instead of bequeathing a portion of the deceased person’s wealth to the guardian appointed to meet the children’s needs and maintain a certain standard of living, a testamentary trust could be used to hold the assets of the deceased person and provide for the children’s needs, which may also include the proceeds of life insurance payable upon death. A testamentary trust can also be used to eliminate the formalities and rules of tutorship and supervision of the public curator that would otherwise apply if the assets were bequeathed directly to minor children.

ii. To preserve assets after death

Since the property in the trust is administered by the trustee according to the terms specified by the testator in his or her will, the testamentary trust ensures a certain preservation of wealth in that the time for distributing assets to a given beneficiary, or even the precise purpose for which the capital is to be used, can be planned.

In some cases, heirs may not be mature enough to manage a large amount of wealth. Some may be in financial difficulty, while others may confront health problems that make them vulnerable, thus opening the door to poor administration or even squandering of the estate patrimony.

In these situations, the wealth bequeathed to a testamentary trust according to the terms set out in the will is administered by a trustee, a third-party chosen by the testator, who can preserve and grow the wealth not only for the benefit of the current beneficiaries, but potentially, for the beneficiaries of the next generation.

iii. Ultimate destiny of an estate

The establishment of a testamentary trust makes it possible to plan the terms and conditions for transferring wealth at the time of one’s death and even of the first-rank beneficiaries’ death. This occurs when several ranks of beneficiaries are set out in the terms of the will, allowing the testator to ensure the survival of his or her wealth over a multi-generational timeline.

For example, the income and/or capital of the trust can be earmarked to meet the needs and maintain the standard of living of the testator’s spouse during his or her lifetime, while specifying that any capital remaining on the death of the surviving spouse will devolve to the benefit of the testator’s children. This type of planning ensures that the testator’s patrimony does not end up in the hands of a third-party on the death of the surviving spouse. Such planning could also be considered with respect to the testator’s grandchildren to ensure that the capital in the trust devolves to them following the death of the testator’s children. This kind of planning can benefit our own child during his or her lifetime, but also our grandchildren upon his or her death.

 

  1. Taxation of Testamentary Trusts

The taxes applied to testamentary trusts since 2016 are similar to those applicable to a private law trust created during a person’s lifetime. Such a trust is therefore taxed at the highest marginal rate applicable to individuals starting with the first dollar of income earned. However, all or part of the trust’s income can be allocated to its beneficiaries, in which case it is rather the beneficiaries who are taxed on the income earned based on their respective personal tax rates.

In the past, testamentary trusts offered certain specific tax advantages, including the progressive tax rates applied to individuals, and the possibility, in some cases, of establishing several testamentary trusts for the benefit of each heir in order to take advantage of the lowest progressive tax rates.

Although these specific tax advantages have been abolished, the fact remains that the testamentary trust is no less relevant, if only because of the legal aspects discussed above. From a strictly tax perspective, tax savings can still be achieved, particularly by splitting the income generated in the trust among family members. Consider the following situations, for example:

  • a surviving parent responsible for the testator’s children earns a substantial income and is taxed at a high rate, or

 

  • a child of the testator, who has dependent children themselves, earns a substantial income and is taxed at a high rate.

 

In both these cases, it may be appropriate to establish a testamentary trust in the will for the benefit of the testator’s children or grandchildren, as the case may be, and to allocate part of the testator’s wealth to the trust in question at death. The income generated on the assets held in the testamentary trust could eventually be distributed to the testator’s children or grandchildren, and potentially qualify for the lower personal tax rates of the individuals in question.

 

  1. The Relevance of the Institutional Trustee

Choosing the person(s) who will act as trustee(s) plays a key role in structuring the testamentary trust, since these are the people who will eventually be vested with the powers of administration and control of the patrimony concerned after the testator’s death. It is therefore essential, when drafting the clauses of a testamentary trust, to choose a person who is not at risk of predeceasing the testator, who can fulfill the role competently, and who can exercise his or her powers in a neutral, impartial manner, in the best interests of the beneficiaries.

The decision to appoint an institutional trustee is often a good one. The Blue Bridge Trust Company acts as an institutional trustee for testamentary trusts and offers the following advantages:

  • As a legal entity, the preservation of family wealth and its multi-generational transfer is more easily achieved, unlike a trustee who is a natural person and who may not be able to fulfill his or her duties upon the death of the testator, or for the full term of the trust’s existence;

 

  • The Blue Bridge Trust Company’s trust officers have extensive trust administration experience acquired in Canada and internationally, and are primarily lawyers who are members of the Quebec Bar;

 

  • The Blue Bridge Trust Company is regulated by the Autorité des marchés financiers du Québec (AMF), which provides added legal certainty for beneficiaries given that the AMF audits the company’s internal procedures for administering the property of others; and

 

  • The Blue Bridge Trust Company’s internal policies and procedures ensure that the trustee makes fiduciary decisions independently, and allow the trustee to act in a neutral, impartial manner in addressing family governance issues.

 

  1. Conclusion

The testamentary trust is a helpful wealth transfer planning tool after death. As a post-mortem asset holding vehicle, it allows the testator to separate and protect all or part of his or her wealth for the benefit of the beneficiaries he or she names, with the option of providing for multi-generational transmission, which would not otherwise be possible by direct bequest.

People interested in protecting their assets during their lifetime could also consider transferring assets to a discretionary, irrevocable trust. These assets would become part of a distinct, autonomous patrimony within the trust, “outside the estate” at the time of death. This would offer extra protection on the testator’s death that the assets will not be used to pay the estate’s creditors, contrary to a testamentary trust at the time of death.

The Blue Bridge estate planning team has developed a special expertise in wealth planning and trust structuring. Please contact us to discuss your goals for transferring your wealth and wealth planning more generally.