The $$$ Maker Report
Bi-Monthly Investments Newsletter by Karl
Jung, CLU SEPT/OCT 1998
Gibsons
office: (604) 886-2691 Cellular: (604) 760-9899 Fax:
(604) 886-3014 kjung@dccnet.com
DEALING
WITH "TRUSTS"
Trust funds have usually been associated with the very wealthy, with names like the Bronfmans and the Reichmans. They have also been thought of as the vehicle the rich have used to escape taxes through "offshore trusts". While these wealthy families still use the advantages of trust, trust funds have become more mainstream over the years. Since there are so many variations of trust funds, you may find the concept of value to your own family. Here are a few of the more common trust funds being used in Canada.
Informal "Bare Trust" Agreement
Typically, Bare Trust arrangements have been used for years by parents and grandparents setting up educational plans for minors, usually involving bank accounts, government bonds or mutual funds. Amounts tend to be monthly contributions close to what the child tax credit pays out. One parent should be the contributor (called the "settlor") and the other parent owns the investment "in trust for the child". The trustee can be the beneficiary in the event of the child's death, and a co-trustee should be appointed. A notarized informal trust agreement stating who the parties are and how long the trust should exist is mandatory. If properly set up, taxation of any capital gains should flow to the child. However, interest income and dividends are taxed to the contributor. On the downside, parents can dip into the investment, thus defeating the main purpose of the trust.
Formal Trust Agreement
Although costs may originally be high to set up this form of trust, it does have many advantages over the "Informal Agreement". Attribution of income does not go back to the parents - it's taxed either in the trust or to the beneficiary when it is distributed. Distribution of the trust starts when the child is 18, and under current tax rules the first $10,000 is tax-free and the rest is taxed at the child's low marginal rate. Specific rules ensure money is not squandered away or not used for educational purposes. This trust is excellent when larger lump sums are to be deposited, or gifts of capital can be lent to the trust. As an example, a grandparent may wish to "loan" a stock portfolio to the trust to generate income for the child while in school. After, the stocks can be transferred back to the grandparent's use again. On the downside, original set-up costs are not cheap. Yearly tax returns must be done as well.
Irrevocable Trust
A trust must be considered irrevocable if the intent is to minimize any tax liability by deflecting taxes to a beneficiary. This form of trust is usually set up by parents of adult children with the intention of keeping the trust going for longer periods of time. As an example, a parent may want to leave certain investments or a cottage to continue for the life of the child. The child is responsible for any taxation of income distributed by the trust. Some assets, such as lands or stocks, would not trigger taxes until the asset is sold. Capital going into the trust is completely flexible in the sense that no regular contribution need be made. Irrevocable Trusts are also useful in estate planning, as the assets do not attract probate fees.
A trust created upon the death of the settlor is referred to as a
"Testamentary Trust". When assets are made into trusts during a
person's lifetime, they are referred to as "Inter Vivo Trusts". A
"Spendthrift Trust" guarantees the beneficiary a form if income, but
capital is not accessible.
Spousal Trust
This trust is
usually created upon the death of a spouse, with the primary purpose being to
guarantee a stream of income for the survivor. It has also been used when there
are fears the survivor would not manage funds properly. Funds are also
protected against future divorce proceedings should the survivor remarry. This
form of trust is also used to defer capital gains liability, and to make sure
the inheritance ultimately passes to the children after the survivor's death.
Although the settlor can set up a Spousal Trust while alive, many are created
following the death of an individual. These are also referred to as
"Testamentary Spousal Trusts".
Family Trust
For those with an incorporated business, the "Family Trust" offers a unique way of distributing income to minor children. The trust owns shares in the family business, and each year a tax-free dividend is paid to the trust. The trust can use these proceeds to pay for the children's educational costs, unusual medical/dental expenses or other named expenditures. To make this type of trust work properly, the company must be profitable enough to warrant paying a dividend, and have a class of shares available for the trust to own.
Note: The above descriptions are only
meant to give a rough overview, and not a legal opinion. Any further
explanation should be done in consultation with your lawyer, account and
financial advisor.
