Many people don’t know much about trusts because they can be intimidating, technical and complicated. Don’t worry because there is really nothing to fear. Trusts, as a legal estate planning concept, have been around for hundreds of years, and are well understood by experienced Will, estate, and trust lawyers. Many textbooks have been written about all aspects of trusts, but here is the briefest of introductions to the concept.
A trust is simply a relationship. One person (called the trustee) holds something (the trust property or the trust fund) for the benefit of another person (called the beneficiary). When there is more than one trustee, they are the trustees. When there is more than one beneficiary, they are the beneficiaries.
Ownership of the trust property is divided into two people. The trustee has legal ownership, while the beneficiary has beneficial ownership. Consequently, the trustee has special legal obligations (called fiduciary duties) to manage the trust property solely for the benefit of the beneficiary.
To create a trust, someone such as you (called the settlor) must clearly:
- Intend to create the trust, as shown by creating the trust in a Will or by signing a deed of trust
- Identify the trust property by description or a formula, and
- Identify the people or purpose (such as a charity) who will benefit from the trust property.
Property you put into a trust is called capital. Investment returns on the capital are called income. If income is not distributed to beneficiaries at the end of the year, then the income is added to the capital.
Two kinds of trusts used in estate planning
There are two kinds of trusts that you can create for estate planning purposes:
a) A trust that exists only after your death is called a testamentary trust, and
b) A trust that exists during your lifetime is called an inter vivos trust.
Why would you create a testamentary trust?
- To protect property – by giving legal title to the trustee, the trust property is protected from the creditors of the beneficiary
- To take care of your loved ones – the trustee is legally obligated to manage the trust property in the way you decide
- To obtain income tax benefits for your beneficiaries – if a trust is created in a Will, then income from the trust property is taxed as though it is income of a separate individual (see example below). This is a basic form of income splitting.
As you can see, testamentary trusts are all about taking care of other people and should be a serious consideration in your estate planning. In your Will, you can create as many testamentary trusts as you need – for example, one for each of your children, or you can create one trust for all of your children.
Why would you create an inter vivos trust?
- To avoid estate settlement and probate processes upon your death
- To limit income tax on capital gains during your lifetime and upon your death
- To minimize probate tax upon your death
- To distribute income from the trust among many people (a complex form of income splitting)
But be careful because an inter vivos trust also has some negative aspects:
- You lose the income tax benefits of testamentary trusts, and
- Income in an inter vivos trust is taxed at the highest income tax rate
Due to these negative aspects, inter vivos trusts are much less common in estate planning for most people. However, in the right situation — such as when you own business assets that are rising in value — they are still very useful.
Terms of a trust
When it comes to the terms (rules) of the trust, you generally have very wide latitude to decide what they are. In a situation where the beneficiary is someone who cannot handle money wisely (for example, due to addictions or disability), then the rules you create might be very strict. On the other hand, if the beneficiary is healthy and wise, then the terms might be liberal and allow for great generosity by the trustee. Discussion of appropriate terms will occur where trusts are recommended.