The first article in this series discussed practical considerations for updates to wills. This second article goes beyond basic wills planning to explain the fundamentals of alter ego and joint partner trusts, including descriptions of common family situations where these trusts can be used to enhance an estate plan.
Alter Ego and Joint Partner Trusts
Could these trusts be beneficial to you and your family?
The usefulness of alter ego and joint partner trusts is worth considering for individuals or couples who are aged 65 or older, as well as individuals with parents aged 65 or older who anticipate becoming responsible for managing their parents’ estates in the future as executors or trustees.
The various benefits of these trusts are described below but generally, these trusts can be particularly effective in the following family scenarios:
- “Blended families”: Namely, families comprised of a spouse and children from a previous relationship where there are inherent risks of estate litigation between the surviving spouse and children or perhaps the respective children of each spouse. Often an individual wants his or her spouse to remain financially secure after the individual’s death but also wants to ensure that the assets remaining on their spouse’s death will be passed on to the individual’s children. In these circumstances, having assets managed and distributed out of an alter ego or joint partner trust can provide the individual with greater control of how his or her assets will be distributed among family members by reducing the likelihood of estate litigation among the surviving family members.
- Business owners: A business-owning individual or couple with significant value in assets, such as private company shares (particularly after an “estate freeze” of their business) or shareholder loan receivables, can use alter ego or joint partner trusts to achieve the transfer of these assets to the next generation without attracting probate fees.
- Elderly parents whose assets are managed by their adult children: Individuals or couples who are at or nearing the point of having their adult children manage their assets and financial affairs for them (whether due to advanced age or concerns of future incapacity) can use alter ego or joint partner trusts to enable such adult children to manage their parents’ assets and continue to do so in the event of the parents’ incapacity.
- Family assets now owned by last surviving spouse (or parent): An individual who has survived his or her spouse and is now the sole owner of the couple’s assets is facing potentially significant probate fees on his or her death. In this circumstance, the individual may consider transferring his or her assets into an alter ego trust to reduce the probate fees that would otherwise be payable if the assets remained owned personally. This probate minimizing strategy tends to have far fewer pitfalls than potentially disastrous addition of an adult child as a joint owner of assets.
Overview and Requirements
Alter ego trusts are set up for one individual and joint partner trusts are set up for a couple. These trusts are commonly used by individuals looking to enhance their control and protection over assets in the event of their incapacity or after death, when the assets are passed to the individuals’ intended beneficiaries. As described below, transferring assets into these trusts can also simplify the distribution of assets on death by reducing the delays and expenses of probate which would otherwise apply if the assets were owned by the individuals personally.
A qualifying alter ego or joint partner trust must meet certain conditions, including the following:
- The individual(s) creating the trust (called the “settlor“) must be resident in Canada and aged 65 or older when the trust is created;
- For an alter ego trust, the settlor is the only person entitled to receive any of the income arising out of the trust and receive (or otherwise use or benefit from) any of the income or capital of the trust until the settlor’s death – in other words, no other person is entitled to any income or capital of the trust until after the settlor has died; and
- For a joint partner trust, the settlor and his or her spouse are the only persons entitled to receive any of the income arising out of the trust and receive (or otherwise use or benefit from) any of the income or capital of the trust until the death of the last surviving spouse – in other words, no other person is entitled to any income or capital of the trust until after the last surviving spouse has died.
Qualifying individuals can generally transfer assets into their alter ego or joint partner trust on a tax-deferred basis so that no tax is triggered on the transfer of such assets. Capital gains tax is typically deferred and triggered in alter ego trusts on the death of the settlor and in joint partner trusts on the death of the last surviving spouse.
- Minimizing probate fees (and maximizing value of assets): In B.C., assets owned personally by a deceased individual at their death are generally subject to probate fees which are currently assessed at 1.4% of the asset value (approximately $14,000 in probate fees on every $1 million of value). By transferring qualifying assets (such as private company shares, non-registered investment accounts, loans receivable and certain real estate properties) out of personal ownership and into an alter ego or joint partner trust, these assets can be distributed to beneficiaries without being subject to probate fees.
- Enhanced privacy and confidentiality: Assets that are subject to probate must also be disclosed to the B.C. Probate Registry in documents that include sensitive information like asset values. These documents can be accessed by the public. Alter ego and joint partner trusts are commonly used to prevent the disclosure of such information as part of the probate process.*
- Greater protection against estate litigation: Under B.C.’s Wills, Estates and Succession Act, any spouse or natural or formally adopted child of a deceased has the right to challenge the distribution of assets out of the deceased’s estate in order to increase their share of such assets – such claims are known as “wills variation claims”. There is a heightened risk of estate litigation in the “blended family” situations described above and in situations where an individual has disinherited a child or has otherwise left unequal distributions of value between their children. Alter ego and joint partner trusts are used to hold assets that would otherwise be at greater risk of litigation if left in an individual’s estate. These trusts are also used to reduce a claimant’s motivation to litigate by decreasing the overall value of the estate that would be subject to a wills variation claim.
- Planning for incapacity: Where a settlor appoints him or herself as the trustee of an alter ego trust, the trust terms typically contemplate the appointment of replacement trustees to manage the trust in the event of the settlor’s incapacity. With a joint partner trust where both spouses are trustees, the trust terms can be tailored to enable a spouse to continue to manage the assets despite his or her spouse’s incapacity. Trust terms also allow for the appointment of future trustees to act after the death of a settlor or couple.
- Costs of set up and ongoing administration: Any potential benefits (such as probate fee savings or reduced risk of estate litigation) must be weighed against the cost of setting up an alter ego or joint partner trust and ongoing maintenance costs such as filing annual tax returns. An important consideration is the value of assets to be held by the trust.
- Income tax considerations: Alter ego and joint partner trusts are not for income-splitting and any income left to be taxed in these trusts is taxed at the highest marginal rate. As such, income arising in the trust is typically distributed out or otherwise taxed in the hands of the beneficiaries who are taxed at graduated rates. After death, it is important to note that these trusts, unlike certain estates, do not qualify as “graduated rate estates”. However, the adverse impact of not being able to access the favourable income tax treatment that graduated rate estates enjoy varies.
- Impact on post-mortem tax planning for shareholders: These trusts are eligible to claim valuable exemptions like the principal residence exemption but they cannot claim the lifetime capital gains exemption on the disposition of assets like qualified small business corporation shares (including on the deemed disposition of these assets on the death of a shareholder who is a settlor or surviving spouse). It is therefore critical to consult with tax advisors to consider the impact of moving certain assets into these trusts and to consider what post-mortem tax planning strategies are available when private company shares are held in an alter ego or joint partner trust.
Our expertise with alter ego and joint partner trusts also includes navigating complexities including, but not limited to: B.C. Property Transfer Tax and Foreign Buyers’ Tax considerations, beneficiaries who have ties to the U.S., and charitable donation planning.
Despite the introduction of federal income tax rules that have severely affected the practicality of family trusts, the effectiveness of alter ego and joint partner trusts as estate planning vehicles remains strong. We recommend having your personal circumstances reviewed to determine whether either of these trusts would be suitable for you and your family.
* Although useful for the preservation of privacy for probate purposes, we note that as of January 1, 2021, the Canada Revenue Agency will be implementing enhanced trust reporting rules requiring the disclosure of trust information such as the personal information of settlors, trustees and trust beneficiaries.