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Benefits of testamentary trust

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When my father passed away 21/2 years ago, he left my inheritance in the form of a testamentary trust. This means the trust did not exist while he was alive, but it was only created in his last will and testament, and only came into existence after his passing.

He had received some good estate-planning advice, which was really for my benefit. The advantages of this trust for me were the assets in it are protected from my creditors, they are not part of my marital property if my marriage broke up (so it would be maintained for my children) and the trust is a separate taxpayer from me.

In my case, it is the separate taxpayer status and the benefit of the graduated tax rates that provide me with the most benefit. (I don't plan on having either creditor problems or a marriage breakdown, though I suppose people never plan for either.)

The graduated tax rate means any interest, dividends or capital gains earned by the investments in this trust are taxed at the low tax bracket first, then the medium brackets and only at the top tax bracket if the annual investment income exceeds $135,000.

Such trusts are often used to help out surviving spouses and provide a valuable way to continue some of the income splitting a couple can access. This may help the widow or widower decrease taxes, avoid OAS clawback or loss of other credits provided to moderate income earners.

Whenever I have presented seminars or provided advice on this topic in the past, people often express skepticism that the Canadian tax system would actually provide this advantage for surviving family members. My answer was always, "CRA is not that generous; you have to be willing to die to get the special treatment."

Well, it looks like the government has decided that even dying might not be enough to merit this potential tax break. Let me explain.

In the March 2013 federal budget, the government announced an intention to invite submissions from stakeholders on this issue, with a view to limiting this tax treatment, after providing a reasonable period of time for the completion of the estate administration.

However, when they announced more details on June 3, 2013, the government language was highly prejudicial against such trusts, using terms like "inappropriate tax planning" and "unintended tax advantages," neither of which is accurate or fair. I personally found that highly objectionable, as was their conclusion that changes would increase fairness.

Further, they announced fairly definite plans to implement a flat top-rate tax on such trusts starting in 2016, after allowing up to 36 months for estate settlement.

At this point, the only sector protected would be the preferred beneficiary rules, which apply when trusts are created for the benefit of a disabled child.

How does this affect your own estate plan?

Until such changes become official, my suggestion is you continue on with your best estate-planning strategies under the current rules, while keeping an eye on these possible changes and their effects.

Changes to the tax rules that affect plans already put in place have happened in the past, and should always be contemplated in any thorough planning. Specific to this case, writing into a new will the opportunity for testamentary trust creation may still be worthwhile, especially for non-tax reasons, but flexibility must be ensured. This is done by giving the trustees discretion to not form the trust, or wind up a trust put in place, if the tax rules change and there is no longer a benefit to the trust.

Some similar government initiatives never come to pass. I can think of two such consultations that have gone on for more than 12 years, without any tax changes being implemented. In the case of testamentary trusts, you can submit your views by email to trusts-fiducies@fin.gc.ca.

We would hope this tax treatment would be extended at least to widows and widowers, if not to future generations, and that might help form your submission.

Enjoy the remaining "dog days of summer."

David Christianson, BA, CFP, R.F.P., TEP, is a financial planner and advisor with Christianson Wealth Advisors, a vice-president with National Bank Financial Wealth Management, and author of the book Managing the Bull, A No-Nonsense Guide to Personal Finance.

Republished from the Winnipeg Free Press print edition August 2, 2013 B12

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