Although changes coming to the tax treatment of testamentary trusts will render them less tax-advantageous for clients, financial advisors should still consider them as valuable estate planning tools in certain circumstances, according to Jamie Golombek, managing director of tax and estate planning with CIBC Wealth Advisory Services.
For instance, he said clients can use these trusts in creative ways to control when their beneficiaries will receive an inheritance, how it can be spent and to ensure the beneficiaries are motivated to continue working despite their sudden windfall.
Speaking at the Canadian Institute of Financial Planners (CIFPs) Annual National Conference in Halifax on Tuesday, Golombek discussed the impact of measures introduced in the 2014 federal budget, which effectively eliminate the benefits associated with the graduated rate taxation available to testamentary trusts.
“The tax advantages are enormous,” he said. “What they’re trying to do is eliminate the tax advantages.”
Testamentary trusts are currently taxed at the same graduated rates that apply to individuals. Under the new rules, which take effect in 2016, the trusts will face flat top-rate taxation at 29%.
The changes do not apply to individuals who are eligible for the disability tax credit, and for estates, the new rate will kick in 36 months after the death of an individual, in order to allow time for the administration of the estate.
Despite the tax changes, Golombek said testamentary trusts still represent an attractive tool that advisors can use in certain planning scenarios.
“I still believe the testamentary trust plays a critical role in planning for the estate,” he said. Golombek outlined the following examples of situations in which testamentary trusts can be useful:
Motivate behavior of beneficiaries
Testamentary trusts can play a key role in situations in which clients are concerned that their children will lose motivation to work once they receive an inheritance, and simply live off the funds. Such clients can set up a matching incentive version of the trust inside the will, which specifies that in order to access money from the trust, beneficiaries must show tax returns to prove that they’ve earned at least that much money themselves.
Clients can design the trust such that the beneficiaries will receive an amount equivalent to what they’re earning each year, or a multiple of that amount, such as two or three times their salary.
“This is an incentive to get the kids actually doing something with their lives, instead of relying on a multimillion dollar trust,” Golombek said.
Inheritances by minors and staged distributions
In cases in which a client dies and there is no trust set up, minor beneficiaries will receive the money they’re entitled to on the day they turn the age of majority. If the client would rather have their children receive the money when they’re older and more mature, a testamentary trust can be used to specify the preferred age of distribution.
Clients can also use testamentary trusts to avoid having the inheritance paid out in one large lump sum, and instead, have it paid out in stages. For instance, the beneficiary could receive half of the sum at age 25, and the other half at age 35.
Spendthrift beneficiaries
In situations in which clients are concerned about the ability of their beneficiary to manage the money they are poised to inherit – due to substance abuse or a lack of experience with investing and finances, for instance – clients can use a testamentary trust to control the way the money is used, Golombek said.
“You could set up a trust to manage money for them,” he said, “and to maybe use that money for housing, for education, for food, clothing, things like that.”
Protect kids’ inheritance in case of remarriage
Many families have wills specifying that upon death of one spouse, all assets will go to the other spouse, and upon the death of the second spouse, the remaining assets will go to the children.
In cases where one spouse remarries following the death of the first spouse, however, the assets could ultimately end up going to the new spouse. By using a testamentary trust, Golombek said clients can ensure their children will still be entitled to receive the assets in this scenario.