You may have read at some point in financial newspapers or heard at a cocktail party about the latest tax saving vehicle: the alter ego trust.
There are many different kinds of trusts extant; however, last June, the government passed legislation permitting this new type of trust. Details of an alter ego trust include:
- It must be created after 1999
- The settlor must be an individual 65 years of age or older
- Property transferred to the trust is not subject to capital gains tax on a deemed disposition as it is with other types of inter vivos trusts
- Only the settlor may receive the income from the trust and is entitled to all of the income of the trust
- This income is taxable to the settlor
- Only the settlor may obtain use of the capital of the trust
- On the death of the settlor, property remaining in the trust is distributed to the trust’s beneficiaries in accordance with the settlor’s wishes set out in the trust document (not in a will)
- The assets in the trust do not form part of the settlor’s estate on his death and therefore are not subject to probate
- Because the assets are not covered by a will, they are not subject to claims under the Wills Variation Act
- An exception to this being when the trust is created after a separation or other marital event triggering a right or claim to division of property. This could be characterized as a fraudulent conveyance
- On the death of the settlor, the trust is deemed to dispose of all its property at fair market value on that date. An inter vivos trust pays capital gains tax on any gains at the top marginal rate. These gains are calculated as the difference between the settlor’s original cost and fair market value at the time of death
- A trust is taxed at the rates of the province in which the trust resides (normally that of the trustee), not at the rates of the province in which the decedent resided
- If the settlor is the trustee, the trust document may name a successor trustee in the event of the mental or physical incapacity of the settlor. This could be used as an alternative to an enduring Power of Attorney or a Representation Agreement (when this comes into force)
- Trust details are confidential both before and after death of the settlor, as opposed to the details contained in a Will which can be made public once the Will is probated
- Except when the trust is registered on title to land or other made public
A parallel piece of legislation, a joint partner trust, also was passed which achieves the same general idea, except for couples. There are additional rules which contemplate the complexities of two beneficiaries, rather than one.
The new trusts promise many advantages over other kinds of trusts.
Before, when an individual transferred financial assets into a trust, this was considered a disposition by the individual, and capital gains tax was triggered. The alter ego, or “other self”, trust eliminates this capital gains tax and allows you simply to transfer your assets to your trust at your original cost. So, that’s a “win” over the other kinds of trusts, but still not a win over keeping everything in your own name in the first place.
Some pros to consider:
- The real win with the new trust is upon death, where assets in the alter ego trust do not need to be probated to pass to your beneficiaries. This saves the provincial probate fee (typically 1.4% presently in BC, for larger estates) and nuisance and professional costs associated with obtaining letters probate.
- A second win is that your estate does not become a matter of public record through a trust, while probate documents are in the public domain of information.
- A third win is that you may name a second trustee, who would take control of your affairs while you remain alive but are mentally or physically incompetent.
- A fourth win is said to be that a deceased’s wishes would not be attackable under the Wills Variation Act.
Many advisors believe that trusts are a standard solution to many people’s financial affairs. No doubt, many advisors will encourage their clients to embrace this new kind of trust. We, on the other hand, are more circumspect. Hitting a fly with a sledge hammer is effective, but its not efficient, and it may damage the wall upon which the fly has landed, costing you more damage than the fly was doing!
Here are some cons to consider:
- The saving of probate fees may be more than outweighed by the professional costs of setting up the trust and filing annual trust tax returns
- Also, other transfer and registration fees by financial institutions will still apply… twice —– once into the trust and once out at death
- The testamentary trust that is created under a last will and testament has a preferable tax rate structure to an inter-vivos alter ego trust
- It is much easier and cheaper to change a will with a codicil than to change a trust, if one’s life circumstances change
- Deemed capital gains on death will incur tax at the top tax rate, not the marginal rate scale of the deceased
- We believe that social policy ultimately will not allow injustices against aggrieved parties who have been frozen out of an estate. In fact, the Succession Law Reform Act may already address this.
In summary, tread carefully if you think that these new trusts are for you. As this is so new, you also will be pioneering out on the bleeding edge of estate planning.