Estate Lawyer
Joanna Ringrose
 

Protecting your Inheritance


3 Things That Should be Included in Parents’ Wills

Most parents wish to leave an inheritance that will benefit their children to the greatest extent possible. If that inheritance is provided as an outright gift, e.g., a payment of money or a transfer of investments, it is too late to undertake certain tax planning or creditor protection strategies.  These strategies can only be put in place at the time a Will is drawn.

This article outlines three will-planning strategies that can result in tax savings to beneficiaries, as well as help protect an inheritance from creditors and ex-spouses.

1) Tax savings through Testamentary Trusts

A “trust” is an interest in property held legally by one person (the trustee) for the benefit of another (the beneficiary). A “testamentary trust”, is a trust established by the terms of a “last will and testament”; thus the term“testamentary trust”. Often testamentary trusts name a beneficiary the sole trustee of the trust, thus giving that beneficiary maximum control over the inheritance, including the right to wind-up the trust and transfer all of the property out of the trust for his or her own use or the use of his or her children.

Under new rules, effective January 1, 2016, with the exception of certain “Graduated Rate Estates” (GRE) and “Qualified Disability Trusts” (QDT), testamentary trusts are now subject to tax at the top federal tax rate of 29%. (For an explanation and discussion of Graduated Rate Estates and Qualified Disability Trusts, see “Changes to the Taxation of Testamentary Trusts” here.) The combined top marginal federal/provincial rates can range as high as 54%, depending on the trust’s province of residence. The potential tax savings available to a trust qualifying for graduated rate taxation, as opposed to being taxed at the top marginal tax rate, has been estimated to exceed $15,000 per year. Graduated rates will continue to apply for the first 36 months of an estate that qualifies as a “testamentary trust” under the Income Tax Act; i.e. it is a trust that arises on and as a consequence of an individual’s death. The 2014 Tax Measures Supplementary Information states that “this recognizes that estates require a period of administration and that estates are generally administered within their first 36 months. If the estate remains in existence more than 36 months after the death, it will become subject to flat top-rate taxation at the end of that 36-month period.” To qualify as a “graduated rate estate” (GRE) the estate must designate itself as the deceased individual’s GRE in its trust tax return in its first taxation year that ends after 2015. (The estate will be deemed to have a year-end when it ceases to be a graduated rate estate [at the end of the 36 months] and it is then required to select a December 31 taxation year-end.)

From a tax perspective, the benefit in using a testamentary trust, which qualifies as a GRE or a QDT, lies in the fact that the income from an inheritance does not have to be added to the beneficiary’s employment or other income and be taxed at the beneficiary’s highest marginal rate. Rather, it can be taxed in the trust separately at the trust’s own graduated rate.

When a testamentary trust has several beneficiaries (children, as well as grandchildren, for instance), however, further income tax savings are possible beyond the 36 month period; i.e. throughout the existence of the testamentary trust.

2) Creditor Proofing Through Testamentary Trusts 

It is well known that incorporating a business provides some personal protection against creditors. Nevertheless, it is often necessary for a business owner to provide personal guarantees to lenders, especially when starting a business.  As a director, a business owner can also be held liable for certain other corporate obligations.  

Prudent business owners, therefore, protect their personal assets by reducing the number of assets they own in their own name.

An inheritance received by a person in business (whether the business is incorporated or not) may be protected from claims of creditors, if the inheritance is received through a testamentary trust.  To maximize the creditor protection, the choice of trustees is critical.  In particular, the business person should not be the sole trustee of the trust of which he or she is a beneficiary.

3) Protecting your inheritance in case of separation or divorce

The laws of Ontario generally provide that your spouse is not entitled to any inheritance you receive after the date of your marriage. These laws, however, do not adequately protect the growth of the inheritance, or assets purchased with inherited funds.  Therefore, there should be a clause in a parent’s Will stating that not only the inheritance, but all growth and property acquired using the inheritance is protected from claims of a spouse in a divorce.

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These simple measures included in parents’ Wills can help ensure that children and grandchildren (rather than the government, creditors or ex-spouses) will receive and retain more of parents’ hard earned money in years to come.






Joanna Ringrose has written articles on the law for the Oakville Beaver in the Legal News & Views section.

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