Family Trusts 101 – Everything You Need to Know and More!

A family trust is a powerful tool for estate planning. You can use it to reduce your tax liability, as well as to transfer your wealth and protect your family’s assets. In this essential guide to family trusts, Nour Private Wealth tells you everything you need to know about the functions and benefits of family trusts, including the particular characteristics of family trusts in Canada. This is all the information you need to decide whether a family trust is right for you.

The basics – what is a family trust?

Let’s start with the essentials. You have probably heard the term many times, perhaps without knowing exactly what a family trust is. A family trust is a legal entity created to hold assets and enter into agreements and contracts with third parties. From a legal standpoint, once assets are transferred into a family trust, they are no longer the property of the person who transferred them. Instead, they belong to the trust, which is then administered for the benefit of the trustees or nominated beneficiaries, who are usually members of the relevant family. 

What exactly does a family trust do?

Aside from being a legal entity in its own right, a family trust is a relationship between its trustees and its beneficiaries. The trustees are usually the parents or other heads of the family – perhaps a grandparent, aunt, or uncle where extended families are involved. A trusted financial advisor might also be included as a trustee. The beneficiaries are any family members expressly included as such: grandparents, parents, children, grandchildren, etc. Companies wholly-owned by one or more of the beneficiaries can also be listed as beneficiaries in their own right. Another individual, known as the settlor, is the family member who sets up the trust, establishing it with a gift, which could be anything from a sum of money to a real estate portfolio or their total assets. After establishing the fund, the settlor has no further involvement. From the time the trust is set up, it holds the assets in question, and the trustees can administer them with the benefit of the trust and its beneficiaries in mind. The trust can buy or sell assets, make investments, and transfer assets to other persons or organizations as the trustees see fit. 

The advantages of having a family trust

Family trusts offer several attractive financial benefits that make them popular solutions for estate planning and the protection of assets. Here are some of the key benefits:

  • Reduce taxes payable on death: An individual who holds many assets, from real estate to shares, can transfer these into a family trust to prevent their estate from having to pay exorbitant taxes after they pass away. The trust, rather than the individual, becomes the owner of the assets, meaning that any capital gains are earned by the trust as well. As a result, these gains are not taxable when the individual dies.
  • Easier wealth transfer: A trust smooths and facilitates the transfer of assets within the family after the settlor’s death.
  • Protection of assets: A family trust holds assets on behalf of its beneficiaries, shielding them from any claims that creditors might make against individual beneficiaries. If a beneficiary loses a lawsuit, for example, assets held in the trust cannot be seized for the benefit of a third party. 
  • Protection of children: There are numerous ways for a trust to be used for the benefit of children. The specific rules are laid down when the trust is established, setting out specific ways in which wealth may be transferred to children. It could come in the form of an annuity or a donation to be managed by the trustees rather than being transferred directly into the child’s hands. In this way, a trust can be used to provide for a child who is unable to work due to a disability or to create long-term financial benefits for grandchildren.
  • Asset Protection: Family trusts offer a layer of protection for your assets, shielding them from potential creditors, lawsuits, and claims.
    Estate Planning: By transferring assets to a family trust, you can ensure their smooth transition to future generations, avoiding probate and simplifying the estate distribution process.
  • Tax Efficiency: Properly structured family trusts can help minimize tax liabilities, potentially reducing estate taxes and maximizing the wealth passed down to beneficiaries.
  • Continuity: Family trusts provide a means to manage and preserve wealth over multiple generations, ensuring the ongoing financial stability of your family.

Real Estate Family Trusts:

Real estate holdings are often a significant part of a family’s wealth. Family trusts can be particularly advantageous for managing and protecting real estate assets. By transferring properties to a trust, you can consolidate ownership, streamline management, and facilitate seamless succession planning.

  • Setting Up a Family Trust for Real Estate: To set up a family trust specifically for real estate assets, consider the following steps:
    Seek Professional Advice: Engage an attorney or financial advisor with expertise in real estate and trust law. They can help structure the trust to align with your objectives and navigate any legal complexities.
  • Transfer Property Titles: Transfer ownership of the desired real estate properties to the trust. This involves executing the necessary legal documentation, such as deeds or titles.
  • Clarify Ownership and Usage: Define the rules and guidelines for property usage, maintenance, and occupancy within the trust. This can include provisions for rental income, property improvements, and other related matters.
  • Ensure Proper Administration: Appoint a trustee who will oversee the management and operation of the real estate assets. The trustee should act in the best interest of the beneficiaries and comply with the trust’s terms.

How are Canadian family trusts different?

Family trusts have the same benefits in Canada as elsewhere. However, some of the legal frameworks applicable in Canada mean that trusts, which are commonly used by the wealthy in all countries, can be used to great advantage even by middle-class families. 

The dividend tax credit and personal tax credit enable Canadian beneficiaries of family trusts to potentially receive thousands of tax-free dollars in dividends or other revenues tax-free. This is the same for wealthy families in other countries. However, Canadian law allows for an estate freeze, making a trust very beneficial, even for a middle-income company. With an estate freeze, the owner of the estate can transfer assets to beneficiaries without any tax consequences. The current generation’s assets can be locked in at their current value, making it easier to prepare for the tax liability incurred when they die. 

How to set up your family trust in Canada

Three conditions must be met for a family trust to be created in Canada. Firstly, the settlor must state their intention to create trust. Secondly, the beneficiaries must be clearly identified, and thirdly, the assets that will be held by the trust must be expressly earmarked and itemized. These seem fairly simple, but the validity of the trust depends on several actions taken by the settlor and trustee once these conditions are met.  

In practical terms, the creation of a trust entails four relatively easy steps:

  1. The trust agreement is drawn up with the aid of a notary or tax lawyer. The agreement clearly states the names of the trustees and beneficiaries and includes specific clauses outlining the assets to be transferred and how they are to be managed.
  2. The settlor makes an irrevocable donation. This does not have to consist of the entire sum of all assets that will be held by the trust in the long run. It may consist of a certain sum of money or a gold or silver bar. Once the donation is made, the trust formally exists.
  3. A bank account is opened in the trust’s name.
  4. A closing agenda is set in place and executed according to the guidelines provided by a tax practitioner. The guidelines list the steps to take to transfer assets from the settlor’s possession into the trust.
  5. Review and Update Regularly: Family circumstances and financial goals can change over time. It’s crucial to review the trust periodically, ensuring it remains aligned with your objectives. Make any necessary amendments or updates to accommodate evolving circumstances, such as changes in beneficiaries, trustees, or assets.

Although these steps seem straightforward, they are best carried out by – or with the advice of – a professional tax practitioner or wealth manager.

How long does it take to set up a family trust?

The exact time taken to set up a trust differs depending on the specifics of the agreement and the pace at which the settlor and their advisors move. Generally speaking, it takes an average of about two to four weeks.

How tax works with family trusts

A family trust is considered a taxpayer for federal income tax purposes and pays the top marginal tax rates. However, the trust’s tax liability can be reduced by allocating income or capital gains to one or more of its beneficiaries, who would then pay at their own marginal tax rates rather than that which would typically be levied against the trust. Trustees have the power to decide which of the beneficiaries will receive the income allocation each year. This practice is referred to as income splitting.

There are three main tax benefits involved with family trusts.

  1. Income splitting: As mentioned above, by dividing the trust’s income among its beneficiaries, the overall tax liability can be lowered. Instead of paying the high marginal rate, each beneficiary pays a much lower amount at their respective tax brackets. 
  2. The ability to access other family members’ Capital Gains Exemptions: Every individual taxpayer gets one Capital Gains Exemption (CGE) in a lifetime. If a trust is a shareholder in a company, any capital gains that accrue to the trust can be allocated to the beneficiaries, each of whom can then use their CGE to shelter the gains and reduce the tax burden.
  3. Tax deference through corporate beneficiaries. If one of the beneficiaries of the trust is a company, there is the possibility of allowing dividends to flow to the company on a tax-deferred basis. 

Types of trusts – which one is best for you?

There are two types of trusts in Canada: testamentary trusts and inter-vivos trusts. A testamentary trust is created as part of a will and comes into effect only after the testator/ settlor passes away. An inter-vivos trust is established while its creator is still alive. Which one you choose depends on what you intend to do with it. If your primary concern is to ease the transfer of assets to your heirs while ameliorating your estate’s tax burden, then a testamentary trust is probably all you need. On the other hand, if you want to use the benefits of a trust for your business and your family during your lifetime, you will want to establish an inter-vivos trust.

The Role of a Trustee: Duties and Responsibilities

The role of a trustee is crucial in the management and administration of a family trust. A trustee is responsible for managing and investing the assets of the trust, as well as making decisions and distributions in accordance with the trust’s terms and the best interests of the beneficiaries. Trustees must act with integrity, impartiality and in good faith, and should always put the interest of the beneficiaries first.

The trustee is also responsible for keeping accurate records of all transactions, and for filing annual tax returns for the trust. They must also ensure that the trust is in compliance with any legal and regulatory requirements. Additionally, the trustee must communicate with the beneficiaries regularly and provide them with regular reports on the trust’s assets and financial performance. It is important to choose a trustee who is reliable, trustworthy, and has experience in managing assets, as they will be responsible for the management of the trust for many years to come.

Managing and Administering a Family Trust

Managing and administering a family trust requires significant time and effort. The trustee must ensure that the trust is being managed in accordance with the terms of the trust document, and that all assets are invested and managed in a way that will benefit the beneficiaries. This includes monitoring the performance of investments, making decisions on buying and selling assets, and ensuring that the trust is compliant with any legal and regulatory requirements.

In addition to managing the assets, the trustee must also keep accurate records of all transactions and file annual tax returns for the trust. They must also keep the beneficiaries informed of the trust’s financial performance and any decisions that are being made. Communication with the beneficiaries is an important aspect of trust management, as the trustee must act in the best interests of the beneficiaries and make sure they understand the trust’s goals and objectives. It’s recommended to keep the beneficiaries informed regularly and provide them with a detailed report of the trust’s financial performance.

It’s important to remember that managing a family trust is a long-term responsibility. It requires ongoing attention and effort to ensure that the trust is being managed in the best interests of the beneficiaries. Therefore, it’s important to choose a trustee who is willing and able to take on this responsibility, and who has the experience and knowledge necessary to manage the assets effectively.

Terminating a Family Trust: Understanding the Process

Terminating a family trust is a process that should be done in accordance with the terms of the trust document and with the best interests of the beneficiaries in mind. The trust document will typically specify the conditions under which the trust can be terminated, such as when a specific event occurs, or a certain date is reached. The trustee must ensure that all assets are distributed to the beneficiaries in accordance with the trust’s terms and in compliance with any legal and regulatory requirements.

The process of terminating a family trust may also involve selling assets, paying any outstanding debts and liabilities, and filing final tax returns for the trust. It’s important for the trustee to communicate with the beneficiaries throughout the process, to ensure that they understand the terms of the trust and the reasons for its termination. Additionally, the trustee must document all transactions and keep accurate records of the trust’s assets, liabilities, and distributions to the beneficiaries.

It’s also worth noting that in some cases, a trust may be terminated prematurely due to unforeseen circumstances. In these cases, the trustee must take extra care to ensure that the rights of the beneficiaries are protected and that the assets are distributed fairly. They must also make sure that they comply with any legal requirements and that the beneficiaries are informed and consulted throughout the process.

Common Mistakes to Avoid When Setting Up a Family Trust in Canada

When setting up a family trust, it’s important to avoid common mistakes that can have serious consequences. One common mistake is failing to properly fund the trust. This means that the assets are not transferred to the trust, and the trust does not have the necessary assets to fulfill its purpose. This can result in the trust being ineffective and unable to provide the intended benefits to the beneficiaries.

Another common mistake is failing to choose the right trustee. The trustee is responsible for managing and administering the trust, and it’s essential that they are reliable, trustworthy, and have the knowledge and experience necessary to manage the assets effectively. Choosing the wrong trustee can result in poor management of the trust, which can lead to financial losses for the beneficiaries.

Additionally, failing to keep accurate records, not filing tax returns on time, or not complying with legal and regulatory requirements can cause serious problems for the trust and its beneficiaries. It’s important to seek professional advice when setting up a family trust, to ensure that these mistakes are avoided, and that the trust is set up and administered correctly.

Lastly, not updating the trust document regularly, not reviewing the trust’s assets, and not communicating with the beneficiaries regularly are also common mistakes that can cause the trust to fail to fulfill its intended purpose, and lead to disputes among the beneficiaries. It’s important to take a proactive approach to the management of the trust and to make sure that it is reviewed and updated regularly to ensure that it continues to meet the needs of the beneficiaries.

About Nour Private Wealth

Nour Private Wealth (NPW) is a team of highly skilled and experienced wealth advisors, who are licensed to provide services in seven provinces across Canada. We are dedicated to helping high-net-worth families and individuals manage their wealth in a tax-efficient manner.

Our team of experts specializes in wealth management, estate planning, and investment planning, and we have a wide range of tools at our disposal to help our clients protect and grow their wealth. We understand that every client has unique needs, and our goal is to provide customized solutions tailored to each individual’s specific situation. We take pride in our ability to provide comprehensive and personalized service to help our clients achieve their financial goals. For more information on family trusts and the other services we provide, please contact us today.

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