You may be in the process of topping up your tax-free savings account or TFSA with the additional $5,000 contribution permitted for 2010. However, have you designated a beneficiary on your TFSA account? Designating a beneficiary is a smart thing to do in most circumstances to potentially reduce income taxes and probate fees payable upon your death. Probate fees are generally payable on all assets that form part of your estate at death other than items with named beneficiaries such as life insurance policies, RRSPs and TFSAs.

TFSAs
TFSAs were brought into effect by the federal government in 2009 and provide that any income earned on the funds in the account is tax free, even when it is withdrawn from the account. As of 2010, the most you can contribute to your account without a penalty is $10,000, but the plan allows for up to an additional $5,000 contribution for each successive year. At the moment your TFSA may seem like a small amount of money to worry about upon your death, but if you continue to contribute each year, this may soon be a substantial asset in your portfolio.

Here is what to think about when considering a beneficiary for your TFSA:

Designating a “Successor Holder” (for spouses)
If you decide to designate a beneficiary, there are two choices. The first is to designate a “successor holder”. This can only be done in favour of a spouse (or common law partner). This type of designation allows your spouse to take over the TFSA upon your death and preserves the ability of the funds in the TFSA to earn income tax-free. The spouse cannot make further contributions to your TFSA, but can either maintain it and designate a new beneficiary, or transfer it over to his or her own TFSA without affecting his or her own contribution room. This will also prevent your estate from being required to pay probate fees on the TFSA funds (currently approximately 1.4% in British Columbia). This is normally the best choice if you have a spouse.

Designating a “Designated Beneficiary”
The second choice is to provide for a “designated beneficiary” such as a child or sibling or any other person. This type of designation allows the person named to receive the proceeds of your TFSA (either in cash or in kind) upon your death, but the TFSA itself will cease to exist. This designation does not preserve the tax-free status of the TFSA, other than for income earned prior to your death. Income earned in the TFSA after the date of death will be taxable to the beneficiary. However, making the designation will prevent your estate from paying probate fees on the value of the TFSA.

No Beneficiary Designation
The third option is to refrain from providing for a “successor holder” or “designated beneficiary”. This will result in the proceeds of the TFSA being paid out to the beneficiaries of your estate. There may be reasons why you wish the TFSA proceeds to be paid out pursuant to the terms of your Will, such as if you have a trust in the Will for minor children or disabled beneficiaries. In that case, you may not want the TFSA funds to go directly to the beneficiary pursuant to the designation, but may rather want to ensure you have made provision for a trust in your Will and have the funds be paid into that trust. You should consult a lawyer with respect to this type of planning to ensure that it is right for your circumstances. Under this option, probate fees will be payable on the funds from the TFSA, but this may be outweighed by the benefits of having the funds go into the trust where they would be managed appropriately for a minor or other beneficiary. This will also prevent the involvement of the Public Guardian and Trustee, who would need to step in to hold funds in trust for any minor or disabled beneficiary who inherits funds directly from a TFSA.

More information on TFSAs, including how to make a designation, is available at the federal government website: http://www.tfsa.gc.ca/thingstoknow-eng.html or from your financial institution.

Mediation is particularly well-suited for estate disputes because it provides for the consideration of factors outside the adversarial arena. Very often in estate disputes there is a multiplicity of interests and motivations.  Mediation provides a forum to not only identify those interests and motivations, but to respond to them.  When a dispute arises in the family context, mediation allows for consideration of the factors that might contribute to the dispute or interfere with its resolution.  For example, family dynamics, suspicion of abuse or undue influence, blended families with opposing views on testamentary entitlement, and interpretation of the testator’s, donor’s or settlor’s wishes can be more effectively considered in the mediation context than during the course of litigation.

Where family is involved, there is often a natural reticence towards litigation.  While the disputants want the opportunity to settle their disputes behind closed doors, they often need the assistance of a neutral third party to reach an appropriate resolution.  Mediation allows for the leveling of the playing field because each party has a voice and can participate in the process.  Each party has the right to have counsel present and the ability to influence the discussion and eventual outcome.  If there is a desire to repair relationships, mediation provides an opportunity for this reparation.  Parties can more readily move from a position-based stance to an interest-based stance.  It is possible that, once the discussion moves to one of interest, the parties will discover that they have common interests that can be brought to bear in resolving the dispute.

It is interesting to note that of the 31 millions people currently residing in Canada, 12.5% (3.9 million) are age 65 or older.  By 2040, it is predicted that 25% of Canadians will be over 65.  While there are currently only 150,000 people in Canada over 90 years of age, by 2026, there will be 400,000.  We are living longer and accumulating greater wealth.  This gives rise to the potential for even more disputes arising on either incapacity or death.  Mediation will be an important tool in resolving some of these disputes, including, but not limited to:

• challenges to the validity of a will (e.g. , preparation, execution or interpretation of a will, capacity to make a will, holograph wills, and will kits);
• personal injury claims (where the incapable or deceased person is injured or causes a third party injury);
• discrimination claims (including age and disability discrimination, and accessibility rights);
• elder abuse claims (including physical, psychological and financial claims, and civil and criminal remedies);
• dependants’ relief claims (where the deceased or incapable person is either the dependant or the provider);
• parental support claims (where the parent is in need and the child is capable of providing assistance);
• variation of trusts (the terms of any proposed variation, subject to court approval);
• grandparent access claims;
• long-term care issues (including consent to treatment and admission);
• power of attorney disputes (including capacity, and use and abuse issues);
• guardianship plans;
• access to health care issues; and
• housing issues (including tenancy issues, house-sharing arrangements and assisted living).

Find out more about our mediation services here.

What is a Mutual Will?

The starting point for any discussion on wills is that a person may always revoke his or her Will. This may even happen unintentionally, as each time you marry, law dictates that your Will is revoked.

A mutual Will is a binding agreement that parties will dispose of property by a Will in a certain manner, and that they will not change their Wills.

What is a Mutual Wills Agreement?

A Mutual Wills Agreement is a written agreement between two spouses to execute Wills and to not change or revoke their Will without notice to the other spouse. This is a contract at law, and there must be evidence of this. Once made and one of the parties dies, the agreement become irrevocable.

Often the spouses prepare mirror Wills and at the same time sign a mutual wills agreement containing the appropriate language.

Why would we want mutual wills?

These Wills are often considered when one spouse (or both) has concerns or fears that they may die leaving assets to their spouse, and the surviving spouse may subsequently remarry. The newly married spouse may then leave their assets to their new partner, or their new partner’s children, leaving the testator’s children or intended beneficiaries inadequately provided for. A mutual wills agreement can provide peace of mind that this situation has been avoided, as the courts will give effect to the agreement.

Can I revoke the agreement?

Either party to the agreement may revoke the agreement during their lifetime, with due notice to the other party. However, once the first spouse dies, and the second spouse receives the benefits of the first spouses’ Will, then the agreement becomes irrevocable. The agreement will also become irrevocable when one of the living spouses is unable to alter their Will due to incapacity.

What happens if the surviving spouse does change their Will?

A mutual wills agreement operates to create a trust in favour of the beneficiaries named in the Will. The trust becomes “locked-in” when the first of the spouses dies. If the surviving spouse later changes their Will and does not adhere to the terms of the mutual Will, the beneficiaries then have an action for a declaration of a constructive trust.

What this permits the Court to say is that the second spouse broke an agreement, and in fairness they cannot change the agreed upon distribution of the assets.

Alternative to Mutual Wills

Another method that may accomplish this goal would be to create a qualifying spousal trust.

Where do I find out more information on mutual Wills?

As usual, the law on mutual Wills, their creation, operation, and enforcement, is more complicated than can be addressed in a short period of time. Often people think that their estate is not large and does not require attention, or that their Will is a simple matter. This is a big mistake, especially if you wish to provide for several beneficiaries. Estate litigation, litigation over your assets after you have passed on, is very destructive to your family who remain, as well as extremely costly. It can be avoided with a well thought-out estate plan. It is important to realize, there are always good estate planning options.

Please see an estate planning lawyer, and ask the questions you have on your mind.

If you would like to know more about Estate Planning, including a Mutual Wills Agreement, please do not hesitate to contact Steve Andrea at Heritage Law.

Considering what will happen to your property and affairs when you die may be an uncomfortable topic. Or perhaps you are thinking that there are laws in place that will take care of these things, so you don’t have to worry about it. Or you just can’t find the time to get around to dealing with making a Will or considering your other estate planning options.

There are significant benefits to everyone in having a Will. Most importantly, if you do not have a Will, your estate will be distributed not how you may have wished, but as provided for under the Estate Administration Act (British Columbia).* In addition, if you do not have a Will, or have not considered other estate planning options, you may be missing out on significant opportunities to save on the income taxes or probate fees that your estate may have to pay when you die.

There are several common circumstances where it is very important to have a Will or other estate planning documents in place:

Minor Children – If you have minor children, you should have a Will that appoints a guardian (and an alternate) to look after your children until they reach adulthood, in the event both parents die. If you do not have a Will, the Ministry of Children and Family Development of B.C. will decide who is best suited to look after your children. In addition, you should set up trusts in your Will for your children, so that your estate assets can be managed by someone financially responsible on behalf of your children. If you do not have a Will, or do not appoint a trustee of your minor children’s inheritance, the Public Guardian and Trustee of B.C. will be appointed to manage this money on behalf of your children until they reach age 19 (even if only one parent dies, the Public Guardian and Trustee will be required to manage a portion of your estate assets on behalf of your minor children).

Blended Families – If you have children from a first relationship and have entered into a second marriage or common law relationship, you will need to consider carefully your estate planning options. You have an obligation under the Wills Variation Act (British Columbia) to make adequate provision for the proper maintenance and support of both your spouse and children upon your death (spouse includes common law spouse). Unfortunately, this often creates conflict between your new spouse and the step-children as both are entitled to a share of your assets. There are several estate planning tools, such as trusts included in your Will, that can proactively deal with this situation, to avoid conflict in your family in the future.

Disabled Child – If you have a child with a disability, you will want to make arrangements for your disabled child in a Will, including appointing a guardian and a trustee of any assets to be inherited. The use of trusts in the Will in this situation is particularly helpful to ensure there are sufficient funds to support the child, and they can be structured in such a way that the disabled person does not lose their entitlement to government benefits, which may otherwise be the result if they inherit assets directly from you when you die.

Marriage – If you have a Will, but have since been married or are engaged to be married, you should immediately do a new Will. Marriage invalidates your Will (unless it was prepared in contemplation of marriage).

Separation – If you have just separated from your spouse, you should immediately do a new Will if you do not want him or her to inherit your assets. Until you have separated with the intention of living apart for at least one year or have obtained a divorce, your spouse will still be entitled to inherit a portion of your estate (if you have no Will) or will inherit whatever portion of your estate you gifted to him or her under your Will.

* The Estate Administration Act provides that if you die without a Will, if you have a surviving spouse or surviving children (but not both), your estate assets will be transferred solely to your spouse or children. If you have a spouse and children, your spouse receives the first $65,000, the household furnishings and a life interest in the family home, and the remainder is split either 50/50 between the spouse and child (if only one child) or 1/3 to the spouse and 2/3 to the children (if two or more children). If your children are minors, the Public Guardian and Trustee will assume responsibility for managing approximately 1/2 to 2/3 of your assets (other than the family home) on behalf of your children and your spouse will not have control over these funds. If you have no spouse or children, your estate will be transferred to your parents, your siblings or your next closest family members.

Where both spouses (or common partners) are potentially exposed to creditors (i.e. where they are professionals or partners in a business), it may be appropriate for them to transfer the principal residence to an inter vivos discretionary trust. An inter vivos trust is one that is created during your lifetime. A discretionary trust is a trust where the beneficiaries’ entitlements to the trust fund are not fixed, but are determined by the trustees of the trust.

Creditor Protection, Centralized Management and Multiple Beneficiaries

The trust can be structured to govern who is entitled to benefit from the property, how it is managed and what to do if the trustees can’t agree.

The trustees of the trust are one or more individuals who have the power to make certain decisions, and the beneficiaries can include not only the trustees, but also children, grandchildren or other relatives. An advantage to a discretionary trust is that none of the beneficiaries have any vested right to the property – they will only be entitled to use the property as the trustees allow and/or when the trustees decide to distribute the property to them. If a beneficiary experiences creditor issues, they will have a strong argument that they have no interest in the property, and that it therefore should not be subject to seizure.

Probate Fee Avoidance

The property in the trust will not be subject to probate fees, currently approximately 1.4% of the gross value of the estate (and subject to being increased by the acting Provincial government of the day).

Retention of Primary Residence Capital Gains Exemption

The Income Tax Act allows a home owned by a “personal trust” to qualify as a principal residence if the property was ordinarily inhabited in the calendar year ending in the relevant fiscal year of the trust by an individual beneficiary of the trust or a child, spouse or former spouse of such a beneficiary.

Note: Property Transfer Tax Issue

For a primary residence, a transfer of legal ownership from you to the Trust in the Land Title Office will not incur any capital gains taxes but it will trigger property transfer taxes under the BC Property Transfer Tax Act (1% of the first 200,000 and 2% of the balance).

There is a way to work around this issue where legal title to the property will continue to be held by you as bare trustee on behalf of yourself as trustee of the Trust for the benefit of the beneficiaries of the Trust. The mechanisms to effect this transfer are an Agency Agreement, a Bare Trust Agreement, a Transfer of Beneficial Interest and a duly executed Form A Transfer. Legal title to your property in the name of the Trust will not be registered unless there was a potential creditor concern or you passed away and the property transfer taxes will be payable at that time by the trust. It is important to note that while this strategy will avoid the payment of property transfer taxes at this time, there is a risk that a creditor could register a judgment against the property against you as bare trustee in the interim. That said, there is a large amount of unregistered trust property in existence and you may be prepared to accept this risk.

If there appears to be a significant risk that a spouse or children will challenge your will or distribution of your estate after the time of your death, you should consider using an alter ego or joint partner trust, which are trusts you create during your lifetime which set out the distribution of trust assets at the time of your death. We will discuss alter ego trusts below (for single individuals), but the concepts are equally applicable to joint partner trusts (for couples).

An alter ego trust is one established after 1999 by a living individual who is at least 65 years of age where that individual is entitled to receive all the income of the trust arising before his or her death and no person except the individual may receive or otherwise obtain the use of any of the income or capital of the trust before the individual’s death.

Trust income is paid or payable to the income beneficiary throughout his or her lifetime and is therefore taxed at the individual’s marginal tax rates. The transferor has access to the trust income and full control of the trust property prior to death.

Generally speaking, an individual may transfer property to his or her alter ego trust on a tax deferred (rollover) basis. The rollover will apply automatically unless the settlor elects to have the transfer take place at fair market value.

Benefit 1: Avoiding Wills Variation Act Litigation

In British Columbia, a child or spouse of a deceased individual who is unhappy with their share under a Will may apply to Court to have the Will altered, pursuant to the Wills Variation Act. A “child” includes all natural or adopted children, and a “spouse” includes someone you may have been living with for over two years in a common law relationship. The Wills Variation Act causes uncertainty as to how an estate may be divided after someone’s death. There are many similar fact patterns which have had very different outcomes in court. Accordingly, it is very difficult to predict what the eventual decision will be with a specific case. As well, the practical effect of any such action, win or lose, is greater legal fees payable by the estate, acrimony between surviving family members and the freezing of the estate assets until the case is resolved, which could take years.

If there is a risk of litigation under the Wills Variation Act, an alter ego trust is a good preventative measure. Since the assets are gifted before the person’s death to the alter ego trust, and are no longer owned by the person, those assets do not pass through that person’s estate when they eventually pass away. Accordingly, the assets would not be subject to the Wills Variation Act litigation. Note that a disappointed spouse may have remedies to undo the transfer of property to an alter ego trust, so it is important to get advice from an experienced estate planning lawyer.

Benefit 2: Probate Fees Avoidance

The probate process can be expensive. All of your assets are subject to probate fees, currently approximately 1.4% of the gross value of the estate (and subject to being increased by the acting Provincial government of the day). As well, there will be legal and accounting fees, which vary, depending on the nature of the assets involved. Altogether, the amounts involved to the estate can be significant. As the assets are no longer in the estate, there will be no probate fees payable on assets located in an alter ego trust. Particularly in larger estates, this can be a large savings.

Blended families are families where one or both spouses (or common-law partners) have been in a previous relationship, and have children from that relationship.

A blended family cries out for pro-active estate planning.  The failure to engage in such planning increases the likelihood that someone will seek redress from the courts in the event of incapacity, splitting up or the death of one or both of the parties.  Generally speaking, a prudent approach is to hope for and expect the best, but to put in place a plan to guard against the worst.  Planning is often centered around the “three Ds”: disability, divorce (or ceasing cohabitation if common law) and death.  The documents that should be considered in each of these categories are as follows:

Disability:

• Powers of Attorney;
• Representation Agreements;
• Nominations of Committee; and
• Living Wills.

Divorce/Splitting Up:

• Marriage Agreement or Cohabitation Agreement;

Death:

• Wills (may include spousal trusts).

I. Disability/Incapacity Planning

A Power of Attorney is a legal document where you can appoint someone (the attorney) to manage your financial and legal affairs in the event you were unable to do so yourself, for example due to illness, injury or travel.  An Enduring Power of Attorney remains valid even if the person giving it loses mental capacity.  It must be signed before the person loses capacity.

A Representation Agreement (which is a combined advance health care directive, personal directive and living will) allows you to designate someone you trust to make health and personal care decisions for you should you not be able to make such decisions yourself. If you have any particular health care wishes, you can include them in a Representation Agreement.

A Nomination of Committee designates the person that you would want to be your “legal guardian” in the situation where you are no longer mentally capable of making decisions for yourself. According to the Patients Property Act, if you have nominated someone to be your committee, the Court must appoint that person to be the “guardian” of your person and your property unless good reason can be shown to the Court why that person should not be appointed.  This is a back up document to a Power of Attorney and a Representation Agreement.

A Living Will or Health Care Directive generally covers instructions related to refusing life support.  Although Living Wills have limited legal effect in BC, there is a requirement for health care providers to follow your pre-expressed wishes in emergency situations. Your Representative (appointed in your Representation Agreement) can confirm that you have not changed your mind and can help ensure the circumstances at hand are the ones you anticipated. A Living Will is a back up document to a Representation Agreement.

II. Divorce/Splitting Up Planning

Marriage Agreements (for Married Spouses)

Division of property between spouses on a marriage breakdown in B.C. is governed by Part 5 of the Family Relations Act, R.S.B.C. 1996, c. 128 (“FRA”). Without a marriage agreement, assets that qualify as family assets are presumptively owned and divisible equally between spouses. This presumption of equal ownership and division can be rebutted by a spouse who satisfies the Court that an equal division would be unfair, taking into account specific factors listed in s. 65 of the FRA.

It is possible for spouses to contract out of the asset division regime under Part 5 of the FRA by entering into a marriage agreement. Some typical property division arrangements in marriage agreements, which differ from the division arrangements under the FRA, are as follows:

Parties retain their respective property as separate property during and after the marriage, except for any property which is specifically registered or recorded in joint names, which is divided equally or under Part 5 of the FRA;

All property owned by either party before marriage is kept separate during and after the marriage, but assets acquired by either party during marriage are divided equally, or under Part 5 of the FRA;

All property is kept separate except that a graduated percentage share is acquired over time in property such as the matrimonial home and/or RRSPs by the non-owning spouse (eg. 3% per year to a maximum of 50%); and

All property is kept separate but there is a graduated lump sum compensation to less affluent spouse on a marriage breakdown instead of a share of property.

Marriage agreements can also include provisions which address issues such as obligations for spousal support and responsibility for living expenses.

Effectiveness of Marriage Agreements

In 2004, the Supreme Court of Canada decided the case of Hartshorne v. Hartshorne, [2004] 1 S.C.R. 550 (“Hartshorne”) in which the Court enforced a marriage agreement in a long-term traditional marriage where the wife’s entitlement to property was significantly less than what she would have obtained under the FRA. The Court emphasized that an agreement does not need to reflect the 50/50 entitlement provided by the FRA to be substantively fair.

The Supreme Court of Canada decided that, provided that certain requirements are met, the terms of prenuptial agreements will be enforced in all but the most unusual of cases. The Court reasoned that it should avoid substituting its idea of what is fair for what the parties believed would be fair at the time they entered into the agreement.  Although the courts do reserve the right to set aside or overrule any terms in a prenuptial agreement which they believe to be unfair, in the post Hartshorne environment, courts are less likely to vary prenuptial agreements.

Cohabitation Agreements (for Common Law Partners)

As mentioned above, only married couples can claim for the division of assets under the FRA.  Since unmarried couples cannot apply for the division of assets under the FRA, they can only make a claim against assets owned by the other spouse under the common law of constructive trusts, express trusts or resulting trusts, or under the Partition of Property Act if they jointly own real property together.

Trust claims, based on common law, are more difficult to make than claims under legislation such as the FRA.  If a trust claim is successful, the amount awarded is generally less than what the property award would have been had the couple been legally married and the FRA governed.  It is possible for common law spouses to contract out of potential common law trust claims for property division by entering into a cohabitation agreement.

Effectiveness of Cohabitation Agreements

Unmarried spouses (people who have lived in a marriage-like relationship for at least two years) can “opt-in” to the FRA property division scheme by making an agreement under s. 120.1 of the FRA. Some lawyers feel that this section of the FRA can be interpreted to mean that the FRA property division rules apply to any cohabitation agreement between unmarried spouses, even if the cohabitation agreement specifically provides that the FRA does not apply. The risk is that a common law partner, seeking a property award in the future, could ask a court to rely on the more preferential FRA rules and find that the cohabitation agreement was unfair.

As a result, there is some uncertainty with respect to whether or not a cohabitating couple should enter into a cohabitation agreement, if the agreement is meant to protect property. Since the Hartshorne case noted above, it is less likely that courts will impose FRA statutory property rules where a cohabitation agreement itself attempts to preclude a property claim. Of course, the FRA property division rules will still apply where a cohabitation agreement indicates that this is what the parties wish.

A cohabitation agreement is also a good option if children are being brought into the relationship, if one party wants to ward against the chance of a spousal support claim when the relationship ends or to deal with allocation of and responsibility for living expenses.

III. Death

Estate planning for blended families is difficult due to competing interests: how to leave at least some of your estate to the second spouse, without disinheriting children from a previous relationship.  If an estate plan is not structured correctly, there is a risk of litigation and/or an unequal distribution of wealth occurring between branches of a family.

Issues: Assets Left to a New Spouse or Common Law Partner

Many people draft mutual wills which state that upon the first spouse or partner to die, everything goes to the surviving spouse or common-law partner, and upon the death of the second spouse or partner, everything is to be divided equally between all of their respective children.  In other cases, the couple places all assets in joint ownership with a right of survivorship.  This planning is risky for the following reasons:

• The second spouse may remarry, rendering their previous will void.  If they die without a new will, the estate will go by intestacy rules to the second spouses’ new spouse and their children only, since the Estate Administration Act does not include step-children (i.e. the children of the first spouse to die).  Even if they do sign a new will, the second spouses’ new spouse will be entitled to a portion of the estate and the step-children could receive nothing;.
• The second spouse could decide to change their will after the first spouse dies and leave nothing to their step children.  Step-children have no recourse or remedy against their step parent under the Wills Variation Act of BC.

Issues: Assets Left to Children

Because of a concern that a child from a previous relationship will never see any part of their estate, many parents in blended family situations try to leave money directly to their children.  The issues are as follows:

• A spouse may be entitled to some or all of your estate under common law, the FRA and the Wills Variation Act of BC.  If you leave money to your children during your lifetime or upon your death, your second spouse may take action to undo or vary these transfers.
• Some people believe that an existing will leaving assets to children will stand.  Unfortunately, if a new will isn’t done in contemplation of marriage or right after the second marriage, any previous wills are invalid by virtue of the marriage.  If you die without a will, your assets will be distributed according to the Estate Administration Act of BC which will provide a significant benefit to the second spouse and may be a very different distribution of assets from what you would wish.
• Leaving assets directly to your children may result in significant taxes being triggered.  When assets are left to a spouse or common law partner, any unrealized capital gains can be deferred until they sell the asset or die.  In contrast, when assets are transferred to a child, an unrealized capital gain will usually be triggered on that date (the date of a transfer during your lifetime or upon your death if via a will).

Solutions

A Spousal Trust Will, also known as “qualifying spousal trust,” is where the spouse or common law partner of the settlor of the trust is entitled to all the income of a trust (and possibly capital) during their lifetime and, second, no other person can receive or otherwise the use of any income or capital from that trust during their lifetime.

Control of the Ultimate Destination of Assets

Spousal trusts are effective conduits to ensure capital passes to the next generation of beneficiaries or to otherwise control the ultimate destination of the capital in the trust.  This is particularly important for those in second marriages or common law relationships, with children from first marriages or relationships.

The benefits are that the surviving spouse or common law partner has access to income and/or capital during their lifetime, but when they die the capital will be distributed according to the will of the first spouse, not according to the will of the second spouse to die or the rules of intestacy.  This is because the assets never become the property of the surviving spouse – they are the property of the trust.  The terms of the spousal trust can provide that upon the death of the surviving spouse, all the assets are to be distributed among the children of the first spouse (or to trusts in favour of those children).

Spousal trusts can be used in conjunction with other solutions to meet your objectives such as leaving some assets directly to your children, insurance, registered investment beneficiary designations and joint tenancies.

If there appears to be a significant risk that a spouse or children will challenge your will or distribution of your estate after the time of your death, you may wish to consider using an alter ego or joint partner trust, which are trusts you create during your lifetime which set out the distribution of trust assets at the time of your death.

Tax Avoidance Benefits of Spousal Trusts

There are significant income tax advantages to setting up a qualifying spousal trust (whether created in a will or during someone’s lifetime via a trust deed).  First, capital assets can be inserted into a spousal trust on a rollover (i.e. tax deferred) basis.  Second, the 21 year deemed realization rule does not apply to a qualifying spousal trust during the lifetime of the spouse beneficiary.  These advantages provide significant planning opportunities.

Third, testamentary spousal trusts are frequently employed as part of an income splitting strategy to split income and capital gains between the trust and the surviving spouse.  The ability to do so exists because the qualifying spousal trust is viewed as a separate taxpayer and it enjoys progressive tax rates due to its testamentary status.  For a spouse trust to work well from a tax avoidance perspective, legal ownership of assets needs to be structured so that at least $300,000 of income producing assets will fall into the estate of the testator upon his or her death to adequately fund the spousal trust.

Finally, spousal trust can also be an effective stepping stone to successive trusts.  A spousal trust may, by its terms, be divided at the death of the spouse into a collection of successive trusts for the next generation of beneficiaries.  That is commonly done when children are involved.  If mom dies first, a spouse trust is established for dad.  When dad dies, any assets remaining in the trust established by mom for his benefit are then divided into many tax-planned testamentary trusts as there are children.  Dad’s will does the same thing, and any assets in his name are divided into tax planned trusts for the children.  Each of the children ends up with two trust, one from dates estate and one from mom’s.  Because each trust has a different settlor, each trust will attain separate taxpayer status.

This will result in each of the children having access to three taxpayers at graduated rates (themselves and testamentary trusts from each of their parent’s estates).  If the trusts are funded properly, that can give the children the opportunity to enjoy more than $100,000 of income at the lowest tax rates at the bottom tax bracket.

Drawbacks of Spousal Trusts

One downside of spousal trusts is that clients must rearrange their affairs so that they each own the assets they wish controlled by the trusts in their name alone. This can involve changing jointly held accounts into separate accounts, changing the designated beneficiary of their RRSPs to “estate” and transferring the house into their names as “tenants in common” from “joint tenants, if these assets are to form part of the spousal trust. This process can take some time and involve some expense.

A second drawback is that probate fees may be payable on some assets on the first to die rather than on the second to die.  That said, probate fees are 1.4% of the value of the estate, and the tax reduction offered by a spousal trust can far exceed the probate fees payable.

Example: Spousal Trust in a Will – Income Splitting

A testator dies and leaves an estate of $700,000 to his spouse.  The will instrument provides that the funds be contributed to a qualifying spousal trust, with the provision that all income and capital be payable only to his spouse, during the lifetime of that spouse, and the remaining capital to be distributed to his children upon his spouses’ death.  The $700,000 is invested in fixed interest- bearing securities yielding 5% per annum ($35,000 per annum).  The spouse has annual income from other sources of $35,000 per annum as well.

The spouse saves $4322 in taxes a year with the spousal trust.

Marriage Agreements (for Married Spouses)

Division of property between spouses on a marriage breakdown in B.C. is governed by Part 5 of the Family Relations Act, R.S.B.C. 1996, c. 128 (“FRA“). Without a marriage agreement, assets that qualify as family assets are presumptively owned and divisible equally between spouses. This presumption of equal ownership and division can be rebutted by a spouse who satisfies the Court that an equal division would be unfair, taking into account specific factors listed in s. 65 of the FRA.

It is possible for spouses to contract out of the asset division regime under Part 5 of the FRA by entering into a marriage agreement. Some typical property division arrangements in marriage agreements, which differ from the division arrangements under the FRA, are as follows:

• Parties retain their respective property as separate property during and after the marriage, except for any property which is specifically registered or recorded in joint names, which is divided equally or under Part 5 of the FRA;
• All property owned by either party before marriage is kept separate during and after the marriage, but assets acquired by either party during marriage are divided equally, or under Part 5 of the FRA;
• All property is kept separate except that a graduated percentage share is acquired over time in property such as the matrimonial home and/or RRSPs by the non-owning spouse (eg. 3% per year to a maximum of 50%); and
• All property is kept separate but there is a graduated lump sum compensation to less affluent spouse on a marriage breakdown instead of a share of property.

Marriage agreements can also include provisions which address issues such as obligations for spousal support and responsibility for living expenses.

Effectiveness of Marriage Agreements

In 2004, the Supreme Court of Canada decided the case of Hartshorne v. Hartshorne, [2004] 1 S.C.R. 550 (“Hartshorne“) in which the Court enforced a marriage agreement in a long-term traditional marriage where the wife’s entitlement to property was significantly less than what she would have obtained under the FRA. The Court emphasized that an agreement does not need to reflect the 50/50 entitlement provided by the FRA to be substantively fair.

The Supreme Court of Canada decided that, provided that certain requirements are met, the terms of prenuptial agreements will be enforced in all but the most unusual of cases. The Court reasoned that it should avoid substituting its idea of what is fair for what the parties believed would be fair at the time they entered into the agreement. Although the courts do reserve the right to set aside or overrule any terms in a prenuptial agreement which they believe to be unfair, in the post Hartshorne environment, courts are less likely to vary prenuptial agreements.

Cohabitation Agreements (for Common Law Partners)

As mentioned above, only married couples can claim for the division of assets under the FRA.  Since unmarried couples cannot apply for the division of assets under the FRA, they can only make a claim against assets owned by the other spouse under the common law of constructive trusts, express trusts or resulting trusts, or under the Partition of Property Act if they jointly own real property together.

Trust claims, based on common law, are more difficult to make than claims under legislation such as the FRA.  If a trust claim is successful, the amount awarded is generally less than what the property award would have been had the couple been legally married and the FRA governed.  It is possible for common law spouses to contract out of common law trust claims for property division by entering into a cohabitation agreement in advance.

Effectiveness of Cohabitation Agreements

Unmarried spouses (people who have lived in a marriage-like relationship for at least two years) can “opt-in” to the FRA property division scheme by making an agreement under s. 120.1 of the FRA. Some lawyers feel that this section of the FRA can be interpreted to mean that the FRA property division rules apply to any cohabitation agreement between unmarried spouses, even if the cohabitation agreement specifically provides that the FRA does not apply. The risk is that a common law partner, seeking a property award in the future, could ask a court to rely on the more preferential FRA rules and find that the cohabitation agreement was unfair.

As a result, there is some uncertainty with respect to whether or not a cohabitating couple should enter into a cohabitation agreement, if the agreement is meant to protect property. Since the Hartshorne case noted above, it is less likely that courts will impose FRA statutory property rules where a cohabitation agreement itself attempts to preclude a property claim. Of course, the FRA property division rules will still apply where a cohabitation agreement indicates that this is what the parties wish.

A cohabitation agreement is also a good option if children are being brought into the relationship, if one party wants to ward against the chance of a spousal support claim when the relationship ends or to deal with allocation of and responsibility for living expenses.

A trust is a relationship among 1) a settlor (or testator in the case of a trust contained in a Will) who sets up the trust; 2) one or more trustees who hold legal title to assets; and 3) one or more beneficiaries who are entitled to the benefit of assets. Unlike a corporation, a trust itself is not a legal entity. However, the Income Tax Act of Canada (the “Act”) treats a trust like an individual for income tax purposes.

The Act has a graduated income tax rate structure. The first $26,500 of earned income for individuals in BC is subject to a combined (federal and provincial) income tax rate of approximately 24.9%. The tax rate jumps to 31% between $36,000 to $68,000, 34% for income from $68,000 to $73,000, and 38-41% for income from $73,000 to $118,000. The highest rate of approximately 44% is for income over $118,000.

Income Splitting Benefits of Testamentary Trusts

Income splitting is one of the cornerstones of tax planning. It is the process of shifting income from the hands of one family member to another, who will pay tax at a lower rate. This produces significant tax savings.

A testamentary trust, a trust created under the terms of a Will or possibly a separate document for a life insurance trust, is an effective tool for splitting income. A testamentary trust allows any investment income earned to be taxed in the trust, rather than in the hands of the beneficiaries themselves, who may have separate taxable income. The trust is considered to be a separate taxpayer in the family for tax purposes, and will be taxed at the same graduated tax rates as any individual. Therefore, the total income earned by the family can be split by having the trust pay tax on some of that income, instead of the beneficiary directly.

1. Life Insurance Testamentary Trusts

The proceeds of an insurance policy can be used to fund a trust separate and apart from the estate of a deceased person, thereby establishing a testamentary trust (allowing income splitting) while providing further benefits of probate avoidance, confidentiality and creditor proofing. On a $1 million dollar life insurance policy, the probate fees savings in BC will be $14,000.

The terms of the trust can be set out in a separate trust declaration or trust agreement, distinct from the person’s Will. If a separate trust declaration is used, the insurance details do not need to be disclosed when applying for probate and thus the proceeds, their destination and the terms of the trust do not become a matter of public record.

An insurance trust can also be set out in Will, provided that the provisions establishing the insurance trust are kept distinct from the provisions that govern the estate. For the insurance trust to be a qualifying spousal trust (discussed below), the terms of the insurance trust must be set out in a will.

The key to using an insurance trust for creditor proofing is to keep the insurance proceeds and the insurance trust separate from the estate. Section 54(2) of the BC Insurance Act provides that insurance proceeds payable to an insured’s spouse, child, grandchild or parent is exempt from execution or seizure provided there is a designation in effect (If creditor proofing is the only objective at hand, the same result can often be attained without the requirement of a trust by having the insurance proceeds paid directly to the intended recipient without the need for the trust.)

To qualify as a testamentary trust for the purposes of income splitting, the beneficiary designation cannot be irrevocable, it cannot be corporate owned or group insurance and the policy must be owned exclusively by the life insured (i.e. not owned jointly, such as a joint first to die or joint last to die policy).

An insurance trust funded by proceeds under a contract of life insurance at the death of the life insured has two components. The first is the beneficiary designation that governs the destination of the insurance proceeds on the death of the settlor. The second is the collection of terms that will govern the trust while the insurance proceeds are held in trust.

The beneficiary designation is a written instrument that designates the beneficiary of the proceeds under the policy. This beneficiary designation can be done on forms furnished by the life insurance company or set out in a Will. The terms of the trust is the collection of terms that will govern the trust while the insurance proceeds are held in trust. These terms can be set out in the designation form provided by the insurer (uncommon), the Will (required if the trust is to qualify as a spousal trust) or a separate trust declaration document.

Examples: Insurance Testamentary Trust for Income Splitting

A husband has a $500,000 insurance policy. He has a wife and two minor children. The husband dies and the wife receives the family home as a joint tenant, their jointly owned investments, the husband’s RRIF and the $500,000 insurance proceeds. See below for the different tax consequences of naming his wife the beneficiary versus designating a trust as the beneficiary of the of the life insurance proceeds.

Example #1: Insurance Proceeds Payable Directly to Spouse

The wife invests the $500,000 at 6% and earns $30,000 income per year, in addition to income from investments and employment. The wife is now in the top tax bracket (49%). Of the $30,000 in income from the insurance proceeds, almost half ($15,000) goes to tax.

Example #2: Insurance Proceeds Payable to Testamentary Insurance Trust

The wife receives the $500,000 insurance proceeds as sole trustee in trust for her and her children. The wife invests the $500,000 in the trust at 6% and earns $30,000 per year. The trust reports the $30,000 and pays 24% tax. Of the $30,000 the trust earns, less than one quarter ($7,500) goes to tax. This is a savings of over $7,500 per year compared to example #1.

Example #3: Insurance Proceeds Payable to Testamentary Insurance Trust, with Income Splitting with Children

Same as example #2 except that the wife elects to allocate income to her minor children to offset expenses (which can include any amounts paid for the support, maintenance, care, education, enjoyment and advancement of the child). The trust earns $30,000 per year. The wife, as trustee, chooses to allocate $7,500 to each child. The trust pays no tax. Each child files a tax return with $7,500 in taxable income but is entitled to the personal exemption of $7,100.

Total tax paid: $400 (less if any education credits are available). This saves almost $15,000 per year compared to example #1.

2. Testamentary Trust Wills

Wills can be drafted with multiple testamentary trusts (a separate testamentary trust created for every beneficiary) to achieve a significant degree of income splitting by multiplying the benefits of the graduated tax regime in respect of each and every beneficiary, whether an adult or minor. This strategy can significantly expand the low tax base accessible to a family.

The taxation year of a testamentary trust is generally the trust’s fiscal period, not exceeding 12 months in duration, which need not coincide with the calendar year. A testamentary trust is not required to pay installments of tax, and instead can pay its tax payable within 90 days after the end of its taxation year. The testamentary trust will be deemed for tax purposes to have disposed of all of its capital property every 21 years. The first deemed disposition will occur 21 years after the death of the settlor whose will established the trust. However, this deemed disposition and the resulting taxation of accrued gains can be avoided by distributing the assets of the trust prior to the expiry of the 21 years.

Other Benefits of Testamentary Trust Wills

Testamentary trusts also provide some insulation for claims against a beneficiary, including from potential creditors or claims that might arise in a marital property settlement.

A beneficiary of a discretionary testamentary trust can be said to have no beneficial interest in the assets which is subject to execution by the creditor. Similarly, for disabled beneficiaries, such as trust interest will not be included as an asset when calculating any means test to determine entitlement to government benefits.

Drawbacks of Testamentary Trust Wills

There will be modest administrative costs of filing a T3 trust return for each of the testamentary trusts by March 31^st each year.

Example: Separate Testamentary Trusts for Adult Children

A father has an estate with a fair market value of $1.5 million and three adult children. The adult children beneficiaries are in the top marginal tax bracket. The father makes provision in his will for the creation of three separate testamentary trusts, one for each of his adult children. Testamentary trusts are taxed at the progressive rates and therefore afford an opportunity to income split, particularly where the beneficiary would otherwise be in a top tax bracket:

The total annual tax savings to the three children amounts to $15,186.

Additionally, where the trust is structured to allow for income splitting to any children the beneficiary may have (the father’s grandchildren), the tax savings can be further magnified if the opportunity presents to take advantage of the personal exemption and low progressive tax rates of the grandchild. This strategy does not depend on retaining the income, as it can be paid out to the beneficiary while making a subsection 104(13.1) designation to tax it in the trust. This is a huge advantage and an excellent means to facilitate family wealth transfer and preservation.

3. Testamentary Spousal Trusts

A spousal trust can be testamentary (i.e. created in a will) or inter vivos (i.e. created during someone’s lifetime by way of a trust deed). To create a “qualifying spousal trust,” the spouse or common law partner of the settlor of the trust must be entitled to all the income during their lifetime and, second, no other person can receive or otherwise the use of any income or capital from the trust during their lifetime.

There are two significant income tax advantages to setting up a qualifying spousal trust. First, capital assets can be inserted into a spousal trust on a rollover (i.e. tax deferred) basis. Second, the 21 year deemed realization rule does not apply to a qualifying spousal trust during the lifetime of the spouse beneficiary. These advantages provide significant planning opportunities.

Income Splitting for Surviving Spouse

Testamentary spousal trusts are frequently employed as part of an income splitting strategy to split income and capital gains between the trust and the surviving spouse. The ability to do so exists because the qualifying spousal trust is viewed as a separate taxpayer and it enjoys progressive tax rates due to its testamentary status. For a spouse trust to work well from a tax avoidance perspective, legal ownership of assets needs to be structured so that at least $300,000 of income producing assets will fall into the estate of the testator upon his or her death to adequately fund the spousal trust.

Income Splitting for Successive Trusts for Children

A spousal trust can also be an effective stepping stone to successive trusts. A spousal trust may, by its terms, be divided at the death of the spouse into a collection of successive trusts for the next generation of beneficiaries. That is commonly done when children are involved. If mom dies first, a spouse trust is established for dad. When dad dies, any assets remaining in the trust established by mom for his benefit are then divided into many tax-planned testamentary trusts as there are children. Dad’s will does the same thing, and any assets in his name are divided into tax planned trusts for the children. Each of the children ends up with two trust, one from dates estate and one from mom’s. Because each trust has a different settlor, each trust will attain separate taxpayer status.

This will result in each of the children having access to three taxpayers at graduated rates (themselves and testamentary trusts from each of their parent’s estates). If the trusts are funded properly, that can give the children the opportunity to enjoy more than $100,000 of income at the lowest tax rates at the bottom tax bracket.

Other Benefits of Spousal Trusts: Control of Ultimate Destination of Assets

Spousal trusts are effective conduits to ensure capital passes to the next generation of beneficiaries or to otherwise control the ultimate destination of the capital in the trust. This is particularly important for those in second marriages with children from first marriages.

Spousal trusts also may be of interest to first marriage couples if they are concerned about possible second marriages after the first spouse passes away, with a view to ensuring that at least some of their assets ultimately go to their children.

Drawbacks of Spousal Trusts

One downside of spousal trusts is that clients must rearrange their affairs so that they each own the assets they wish controlled by the trusts in their name alone. This can involve changing jointly held accounts into separate accounts, changing the designated beneficiary of their RRSPs to “estate” and transfering the house into their names as “tenants in common” from “joint tenants, if these assets are to form part of the spousal trust. This process can take some time and involve some expense.

A second drawback is that probate fees may be payable on some assets on the first to die rather than on the second to die. That said, probate fees are 1.4% of the value of the estate, and the tax reduction benefits offered by a spousal trust can far exceed the initial probate fees payable.

Example: Spousal Trust in a Will – Income Splitting

A testator dies and leaves an estate of $700,000 to his spouse. The will instrument provides that the funds be contributed to a qualifying spousal trust, with the provision that all income and capital be payable only to his spouse, during the lifetime of that spouse, and the remaining capital to be distributed to his children upon his spouses’ death. The $700,000 is invested in fixed interest- bearing securities yielding 5% per annum ($35,000 per annum). The spouse has annual income from other sources of $35,000 per annum as well.

A testamentary trust is a trust that is set up in a will and takes effect after the death of the settlor. A discretionary trust is a trust set up where the beneficiary doesn’t have control over the money in the trust. The trustees make all of the spending decisions. The trustees can be family members, friends, professional advisors or corporate trustees.

Not only will a discretionary trust for a disabled beneficiary in a Will allow for the assets to be managed on the beneficiary’s behalf by a trustee of your choosing, it will also reduce the likelihood that the disabled beneficiary will lose access to government services or benefits. Because the beneficiary of a discretionary trust has no right to demand any of the income or capital of the trust, the person is not considered to own any of the trust property or to be entitled to any of the trust income.

Only the amounts actually distributed out of such a trust to a disabled person will be included in the disabled person’s assets and income in determining whether the disabled person is entitled to government services and benefits. There is no limit to the amount of money that can be inside a discretionary trust.

Allowable Assets for People Receiving Disability Benefits

Asset Limit:

If a beneficiary is designated as a Person With a Disability (PWD) pursuant to the Employment and Assistance for Persons With Disabilities Act and is receiving disability benefits, they are allowed to have a certain amount of assets in their name before they become ineligible for benefits. For example, if a beneficiary is a single person with no dependants, their assets cannot exceed $3000. Benefits can be discontinued or clawed back if the asset limit is exceeded.

Asset Limit Exemptions:

The following list includes items which someone can own and not exceed their asset limit. (All the current asset exemptions are listed under Section 6 of the Employment and Assistance Regulations, which accompanies the Employment and Assistance for Persons With Disabilities Act. An electronic copy of the regulations is available at: www.qp.gov.ca/statreg/list_statreg.html)

• $3000 for a single person with no dependants;
• A person who has a dependant is allowed a maximum of $5000;
• A $400 earning exemption per family per month;
• Clothing and necessary household equipment;
• One motor vehicle;
• A primary residence;
• money received from a mortgage or the sale of the residence as long as the money is used to buy a new home or to pay rent on a place of residence;
• Tax credits and income tax refunds;
• Government settlements for example: compensation for thalidomide victims and Hepatitis C victims etc.;
• Non-discretionary trusts up to $100,000. A non-discretionary trust, which exceeds the $100,000 limit, is considered to be an asset; and
• **A discretionary trust is not considered to be an asset because the beneficiary has no ownership over the assets.

Items a Trust Can Pay For:

Money can be spent on the following items without a deduction to the beneficiary’s monthly disability benefits:

• Purchasing a home for the beneficiary;
• Purchasing a car for the beneficiary;
• Medical aids or supplies;
• Education or training;
• Home renovations required to make the residence more accessible for the beneficiary ;
• Home maintenance and repairs; and
• Home support and caregiver services.

There is no limit to the amount of money that can be spent on the above items. In addition, there is an annual limit of $5,484 which can be spent on any goods or services that will help the beneficiary live more independently. If the trustees are unsure if an intended expenditure falls within the independent living category, they can check with the Ministry of Employment and Income Assistance before spending the trust money on it. However, the trustees have the final say as to how the money in the trust is disbursed even if it means that the beneficiary’s disability benefits may be deducted.

Other Benefits of a a Discretionary Trust Created in a Will: Creditors and Family Law Claims

This planning may also provide some insulation for claims, including from potential creditors or claims that might arise in a marital property settlement.