Why Your Will Doesn’t Include a Trust (and Why That May Save You Money)

Articles about trusts often make them sound like a tax shortcut that every family should be using. So we understand why clients sometimes ask: “Why didn’t you put a trust in my will?”

The short answer is that, for many Ontario families, a trust in a will doesn’t save tax and costs money every year it exists. Trusts are valuable tools in the right situations. But for a typical estate made up of a home, a RRIF, a TFSA and some savings, the ongoing costs can easily outweigh any benefit. They are governed by two sets of rules. The federal Income Tax Act decides how a trust is taxed and what it must report. Ontario law decides how trustees are appointed, paid and held accountable.
 

The Tax Advantage Mostly Disappeared in 2016

Many articles still describe planning that worked before 2016. A trust created in a will used to be taxed at graduated rates, like an individual. That made it useful for spreading income across family members at lower tax rates.

That changed for most trusts. Income kept in a testamentary trust is now generally taxed at the top tax rate. There are two main exceptions. A graduated rate estate (the estate itself, for up to 36 months after death) still gets graduated rates. So does a qualified disability trust.

So the main tax reason people once used them in wills is no longer available to most families.
 

A Trust Doesn’t Avoid Probate Tax

A trust created in your will is funded by assets that pass through your estate. That means those assets are usually included in the probate application and are subject to Ontario’s Estate Administration Tax. There is no tax on the first $50,000, then about 1.5% of the value above that.

Different tools are used to avoid probate tax, such as beneficiary designations, joint ownership and certain trusts set up during your lifetime. Each one has its own risks and costs.
 

What It Means for Your Home and RRIF

Your home. The gain on your principal residence is generally sheltered on your final tax return whether or not your will has a trust. Since 2017, only certain trusts can claim the principal residence exemption themselves. These include spousal trusts, qualified disability trusts and trusts for a minor child whose parents have died. If a home is held in trust for adult children, any increase in value while it sits in the trust may be taxable when it is sold.

Your RRIF. A RRIF usually passes outside the estate by beneficiary designation. If your spouse, or a financially dependent child or grandchild, is the beneficiary, the funds may be able to roll over without immediate tax. If the RRIF goes to an estate or an ordinary trust instead, the full value is generally taxed on your final return. A trust doesn’t make that tax go away, and it can bring the RRIF back into the estate so that probate tax applies.
 

What a Trust Costs Each Year

Setting up the trust in your will is a one-time cost. Running it is the bigger expense, and it continues every year until the trust ends.

Trustee compensation. Ontario trustees are entitled to fair and reasonable compensation. Courts commonly start with 2.5% on receipts and disbursements, plus an annual care and management fee of 2/5 of 1% of the assets being managed. Family trustees sometimes waive their fees. Professional or corporate trustees will not.

Annual tax filings. A Canadian-resident express trust generally must file a T3 return every year, even if it has no income or tax to pay. Most must also file Schedule 15, which reports the trustees, beneficiaries and anyone with control over the trust. It is required again each year, even if nothing has changed. Most families pay an accountant to prepare these returns.

Penalties for missed filings. If a return is late and no tax is owing, the penalty is $25 a day, from $100 up to $2,500. If the failure is knowing or grossly negligent, the penalty can be the greater of $2,500 or 5% of the highest value of the trust’s assets during the year.

Investment and banking costs. The trust needs its own accounts, an investment approach that meets the trustee’s legal duty to invest prudently, and its own records.

Accounting to beneficiaries. Trustees must keep detailed accounts and may have to justify them, sometimes through a formal court process called a passing of accounts. That adds legal fees.

Long-term tax events. Most trusts are treated as having sold their capital property every 21 years, which can trigger tax on any gains. Distributions and winding up the trust also take professional time.

A Simple Example

Suppose $500,000 is held in a trust for 10 years. The annual care and management fee at 2/5 of 1% is about $2,000 a year, or about $20,000 over 10 years. That figure doesn’t include T3 preparation, investment fees, legal advice or the compensation charged when money comes in and goes out. If the trust produces little or no tax saving, that money simply reduces what your beneficiaries receive. If a Bank Trust Division is involved, that can be 10% per year.
 

When a Trust Is Worth It

We do recommend trusts when they solve a real problem. Common examples include:

• Minor beneficiaries. A trust avoids a court-supervised process and lets you choose the age at which children receive their inheritance.
• A beneficiary with a disability. A Henson trust can help protect eligibility for ODSP, and a qualified disability trust may still get graduated tax rates.
• Blended families. A spousal trust can support a surviving spouse while protecting the inheritance for children from an earlier relationship. It can also allow a tax-deferred rollover.
• Vulnerable beneficiaries. Can help where addiction, creditor problems or poor money management are concerns.
• Family law protection. An inheritance can lose its protection if it is mixed with family assets or used toward a matrimonial home. A trust can help keep it separate.
• Complex assets. Business interests, a family cottage or property in more than one country may call for a trust.

A trust is a tool, not a tax strategy in itself. If none of the situations above applies to your family, a simpler Will, with properly updated beneficiary designations, is often the more cost-effective plan. It is also easier for your executor to administer.

If your circumstances have changed since you signed your Will, such as a new grandchild, a beneficiary with a disability, a remarriage or a significant increase in assets, it is worth reviewing whether a trust now makes sense.

This post provides general information about Ontario estate law and Canadian income tax. It is not legal or tax advice. Please speak with us at Smartwills about your own situation.