Alter Ego Trusts Offer Estate Planning Opportunities
by Del Elgersma
If you are over 65, the Income Tax Act permits you to use two new types of inter vivos trusts to achieve your estate planning goals. (An inter vivos trust is a trust created during your lifetime, as opposed to a testamentary trust, which takes effect upon death.)
A trust is a legal relationship and, for tax purposes, is a separate legal entity. When you transfer property to a trust, you no longer legally own it, even though you can continue to control and benefit from it. Inter vivos trusts have always been available as a tool for estate planning. However, because of the tax rules that apply to inter vivos trusts, they have not been widely used.
Those rules provided that a transfer of assets to an inter vivos trust (except a “spousal trust”) was, for tax purposes, a disposition of the assets at their fair market value, which could result in capital gains tax. As a result, inter vivos trusts have normally been created only in the following situations:
- to create an inter vivos “spousal trust”, where the spouse is entitled to all of the income, and is the only person who can receive any capital, of the trust during the spouse’s lifetime;
- to create an inter vivos trust with assets that do not trigger a capital gain (such as cash, unappreciated stocks or a principal residence)
- to create an inter vivos trust to acquire future growth shares of a new corporation, or of an existing corporation, as part of an estate freeze transaction.
Amendments to the Income Tax Act in 2000 created two new inter vivos trusts, the Alter Ego (meaning “other self”) Trust and the Joint Spousal Trust. These trusts enjoy the same benefits of other inter vivos trusts, with the added advantage that transferring assets to these trusts will not trigger any liability for income tax.
To create an Alter Ego Trust, you must meet the following conditions:
- you must be over the age of 65
- you must be entitled to receive all of the income of the trust before your death
- no one else can receive the capital of the trust before your death.
The Joint Spousal Trust has the same requirements except that you and your spouse must be entitled to all of the income of the trust, and no one other than you and your spouse can receive any of the capital while either of you are still living.
If you transfer assets to one of these trusts, you will no longer legally own them (the trust will), so they will not form part of your estate when you die. During your lifetime you can continue to control the assets as the trustee of the trust, or you can name other trustees to manage the assets for you. You can name beneficiaries who will receive the assets after your death. The trust can be changed or even revoked as long as you have the capacity to make those decisions.
The use of these trusts can be advantageous for many reasons:
1) Probate Avoidance
A trust can avoid probate and probate fees. Because the trust owns the assets, they are not part of your estate when you die. Probate, and the payment of probate taxes, applies only to assets that are part of your estate (click here for more information about avoiding probate fees).
2) Asset Protection
The Wills, Estate and Succession Act allows your spouse or children to apply to the court to vary your Will if they have not been adequately provided for. Because assets in a trust are not part of your estate, the use of a trust can avoid these claims. This could be useful if you wish to treat your children differently, or if you are in a second marriage and wish to provide for your spouse while also preserving the assets for your children from a previous marriage.
For the same reasons, the use of a trust can potentially protect assets from claims by creditors.
3) Centralized Ownership and Management
While you will likely want to control the assets in the trust, you can name other trustees, such as family members or friends, to manage the assets for you. For example, the trust could provide that if you become incapable, your spouse or another trusted family member would act as trustee in your place. As a result, you will not require a power of attorney for the assets in the trust.
If your Will is probated, it will become a public document, along with a listing of all of the assets that formed your estate and the value of those assets. Certain people are entitled by law to receive a copy of your Will after your death. A trust is a private document and can be used to keep your affairs confidential.
To avoid probate and protect assets from claims, many people are giving assets away before they die or putting assets into joint tenancy. This can result in many unintended consequences, including taxes. The Alter Ego Trust and Joint Spousal Trust can help you avoid probate and claims against your estate without the problems that can arise by giving away your assets or putting them into joint tenancy.
So should everyone over age 65 create an Alter Ego or Joint Spousal Trust? Definitely not. Although they have many advantages, other factors must also be considered, including:
- for tax purposes, charitable bequests from the trust will not be treated as favourably as charitable bequests under a Will
- transferring real estate into the trust may require payment of provincial Property Transfer Tax (the transfer tax can often be avoided for the transfer of your principal residence)
- a trust costs more than a Will, and the preparation and filing of an annual tax return for the trust will be an extra cost
- a Will may still be required if any assets are not transferred to the trust or if assets are acquired after the trust was created
- it is more difficult to change a trust than a Will.
While these trusts are not for everyone over 65, they have considerable potential as an estate-planning tool. For a personal review of your estate plan, including whether a trust might be right for you, call us to arrange a consultation (250-656-3280).