Vehicle helps parents care for disabled children

Tax-free RRSP or RRIF rollovers are commonly used as an estate-planning strategy to transfer assets from spouse to spouse and from parent or grandparent to financially dependent children and grandchildren. But difficulties arise if the beneficiary has a mental disability. For one thing, there can be practical and legal obstacles standing in the way of the beneficiary establishing, administering and managing the account — not to mention drawing up the documents necessary to leave the assets to the next generation of heirs.

Perhaps equally important, says John Poyser, partner and member of the wealth and estate law group with Winnipeg-based law firm Inkster Christie Hughes LLP, the former RRSP or RRIF rollover to a disabled child was only tax-free under certain conditions. One of those conditions was that the assets had to be used to purchase a life annuity that paid income directly into the hands of the beneficiary, which could cost the disabled child his or her eligibility for government benefits.

“The government will provide you with income support and programming if you’re disabled and you satisfy the eligibility requirement, which is basically twofold: you can’t be rich and you can’t have a whole pile of income,” says Poyser. “For a lot of disabled individuals, the income support isn’t necessarily that big, but the programming the government pays for is very expensive and hard to replace.”

The solution many families embraced was a Henson trust, named for a groundbreaking Guelph, Ont., court case on behalf of Audrey Henson, who had a developmental disability and whose government benefits were terminated after her father, Leonard, left his assets to her in an absolute discretionary trust. (For more on Henson trusts, see IE:TV “Features” on www.investmentexecutive.com.)

Ultimately, the courts ruled that the bequest in the original Henson trust did not count toward Audrey’s income or assets, allowing her to continue to receive government income support and programming. The Ontario government’s final appeal to the Supreme Court of Ontario was dismissed in 1989. Since then, parents across Canada (except in Alberta) have successfully structured their estate plans to pay bequests into Henson trusts, so that the income from the trust doesn’t interfere with the beneficiary’s eligibility for government benefits.

Henson trusts were an improvement, but there was still a wrinkle. Registered assets flowing into a Henson trust had to be de-registered first, so only pure, after-tax cash entered the trust. That left parents with a tough choice: they could take advantage of the tax-free rollover of registered assets and, in some circumstances, give up on government benefits for the disabled heir; or, they could establish a Henson trust to protect the disabled heir’s access to government benefits and swallow the potentially massive tax liability when the registered accounts were de-registered.

CHANGES FOR THE BETTER

Enter the lifetime benefit trust.

“With the introduction of the lifetime benefit trust, under Section 60.011 of the Income Tax Act, things have changed radically for the better,” says Poyser. “Now, the rollover is available if a special form of annuity is purchased, and the annuitant under that annuity is no longer the disabled individual, but the trust established for the disabled individual.”

Essentially, when the family members of a disabled individual establish a lifetime benefit trust in their wills, RRSP or RRIF assets can flow into the trust in a tax-free rollover and be used to purchase a qualifying annuity that pays income to the trust — not directly into the hands of the beneficiary. Nothing goes to the beneficiary unless the trustee elects to allocate funds to the disabled child. The trustee can measure out these amounts so they don’t go over the maximums allowed by government benefits programs.

While this is cause for celebration, Poyser says, it could go further. He’d like to see an amendment that would take away the requirement to purchase a qualifying annuity. Instead, he wants families to have the option to maintain — and rebalance as necessary — an RRSP’s existing investments. That way, there would be no requirement to draw income within the trust until the beneficiary turned 71, at which point the assets could be transferred into a RRIF-style account, resulting in a longer-term tax deferral.

@page_break@To accommodate the lifetime benefit trust, Poyser recommends that families who choose to set up a Henson trust for other assets should ensure that the language they use matches the language used in a lifetime benefit trust. For example, the Income Tax Act allows income or capital to be expended for the “comfort, care and maintenance” of a disabled individual, while the traditional Henson trust wording talks about the beneficiary’s “health, welfare, benefit and education.” The goal is to ensure that the Henson trust also qualifies as a lifetime benefit trust. In that case, he says, it should be possible to flow registered assets and non-registered assets into a single trust, saving set-up and accounting fees.

ONTARIO REQUIREMENT

Additionally, Ontario advisors should be aware: provincial rules say income can accumulate inside a trust for only 21 years. Previously, families with Henson trusts often named several income beneficiaries starting on the 21st anniversary of the trust, in order to protect the disabled individual’s eligibility for government benefits. However, the rules governing the lifetime benefit trust specify that the income and capital from the trust can be used only by the beneficiary during his or her lifetime. As a result, the strategy of naming several beneficiaries after 21 years may mean a trust no longer qualifies as a lifetime benefit trust.

Poyser will probably discuss this complexity, along with others related to the lifetime benefit trust, in his in-depth session on the use of trusts in tax and estate planning as part of the Knowledge Bureau‘s cross-Canada educational tour this month. (See www.knowledgebureau.com.)

“Estate planning for disabled individuals,” says Evelyn Jacks, president of the Knowledge Bureau in Winnipeg, “should be done in conjunction with retirement and estate planning for the parents themselves.”

Jacks points out that a broader strategy might mean the parents decide to move assets out of registered plans during their retirement because they are in a lower tax bracket, reducing the need for a lifetime benefit trust.

“What advisors need to do,” Jacks says, “is take a really good look at the personal net-worth statement of the parents overall.”

She adds that this process should begin as early as possible, in consultation with an accountant and a lawyer, so parents of a disabled family member can evaluate all the available options and make the best choices for the disabled family member. IE