Trusts and Taxes: You Earned It You Keep It
By Kenneth C. Pope
Trusts are not just for those who are wealthy or for families who have a child with special needs who require the provision of a Henson trust.
Contrary to general belief, trusts can potentially be useful for a significant segment of the population.
A testamentary trust (one which is included in a will) is especially useful for tax reduction where a family has young children .The tax savings for survivors are indeed significant. Let’s look at an example.
John Smith and his wife have one child. When John dies, he leaves his life insurance proceeds of $200,000 in trust, with all other property going directly to his wife. He indicates that the beneficiaries are his child and his wife and the trustee is his wife. She is free to spend the money in the trust in the interests of the child: Fees for summer camp or purchasing a computer, anything that furthers the child’s advancement in life and if desired she also can receive from the trust.
Now lets say that the $200,000 insurance proceeds are invested and earn 3% interest for a sum of $6000. If there were no trust and Mrs. Smith was working and earning $38,000 and as well she received the insurance money herself, her marginal rate of taxation in the province of Ontario would go from 22% to 33%. She would then need to pay another $2,000 in taxes. With the trust however, the earnings are declared in the hands of the child, therefore no tax is incurred and her rate of taxation stays at the lower rate. Even if the sum received from the trust is greater than the personal exemption the additional amount would, in all likelihood only be taxed at 22%.
In my opinion, a lawyer’s best practice for estate planning purposes, is to create an initial trust arrangement with a nominal bequest of $100, which can later be funded with the parents’ insurance or grandparents’ gifts, when appropriate. It could also be that a grandparent wishes to establish a trust for their grandchild, with one or both parents as trustees. They have the authority to spend the money in any way they deem appropriate for the benefit of the child, and the income would again be taxed in the hands of the grandchild, at the lower rate. Should the parents decide to forgo their inheritance to fund the grandchild’s trust, this can be referred to as a “skip generation trust”. It is an extremely flexible and valuable planning tool in many cases.
When you consider the modest fees involved in establishing a trust, offset by saving thousands of dollars as demonstrated in the Smith family illustration, the belief that trusts are only for the wealthy becomes nothing more than a myth. You earned it you keep it!!
