“Trusts are a very valuable tool, but they have to be used with caution both during lifetime and on death situation. There are a lot of moving parts, and the selection of the trustees and other factors really have to be considered”
- Elena Hoffstein, Lawyer with Miller Thomson, LLP
Transcript
Intro Speaker:Hello, and welcome to Matters Beyond Wealth with your host, Leanne Kaufman, President and CEO of RBC Royal Trust. For most of us, talking about subjects like aging, late life, and estate planning isn't easy. That's why we're going to help get the conversation started on this podcast while benefiting from the insights and expertise of some of the country's top experts. We want to bring you information today that will help to protect you and your family in the future. Now, here's your host, Leanne.
Leanne Kaufman:Hello, I'm Leanne Kaufman, and welcome to RBC Wealth Management Canada's Matters Beyond Wealth.
I'm so pleased to introduce our guest today, my longtime colleague and friend, Elena Hoffstein. Elena is a lawyer with Miller Thomson, LLP. Her practice focuses on all areas of estate planning, family business succession, and corporate reorg. She also advises on cross-border and international matters, trusts, our topic for today, and marriage contracts. Elena also assists with Will challenges, mental capacity matters, and other matters tied to contentious estates and litigation. She's recognized as a leading expert in charity and not for profit law, and in recognition of all of her leadership and career contributions, Elena received the Ontario Bar Association's Award of Excellence in Trusts and estates. She's also a recipient of Lexpert's Zenith Award and has earned the preeminent AV rating in Martindale Hubble's Peer Review Ratings. She's a frequent speaker and a sought after contributor and an all around knowledgeable and lovely person.
Elena, thank you for joining us today to talk about trusts and why they matter beyond wealth.
Elena Hoffstein:Well, thank you, Leanne, for such an amazing introduction. And what I like the best about it is that you said you were my friend. Which is absolutely true.
Leanne Kaufman:It is, and I'm proud to call myself that. So Elena, we're going to talk about trusts today. And despite the Hollywood depictions of trusts and trust fund babies, I don't know if you watched Succession the way that I watched Succession, but it's a great example. Despite those depictions of trusts as tools for the ultra-wealthy, the use of trusts here in Canada has really evolved. I would say from, my own perspective, a move from a largely patriarchal tool for widows to then what became maybe more of a tax planning tool to where we are today. And I will still say, pardon the pun, but in my opinion, trusts are definitely not dead in Canada. And there are lots of great ways families can use the flexible tool to meet their succession planning needs. But Elena, maybe you and I can start just by taking a step back, and in its simplest form, how do you describe what a trust is to a client?
Elena Hoffstein:Yeah, the concept of a trust is unique to common law jurisdictions. It's not in the civil law jurisdictions. And they have great difficulty understanding this concept because what it does is it separates legal title from beneficial ownership. So, a trust is not a legal entity, although under the income tax act it's treated as an individual for tax purposes. It's a relationship where a trustee holds legal title but is not the absolute owner of the assets. He or she or they hold title for the benefit of others who are called beneficiaries. And they have fiduciary obligations to administer the trust assets in the best interests of the beneficiaries. And I always like to say at the core of a trust relationship is accountability. The trustees are accountable to the beneficiaries for their administration of the trust and in the decisions that they make regarding distributions of income and capital. If the trust terms deal with these matters or other matters, then the trustees must adhere to the terms of the trust. So, legal title isn't the end of the story.
Leanne Kaufman:Right, and for those of our listeners who maybe aren't as familiar, the common law jurisdictions in Canada are all the jurisdictions, all the provinces, and territories outside of Quebec. And Quebec is the civil law that you mentioned. So, the fiduciary obligation being the highest level of obligation, a trusteeship comes with a huge degree of responsibility. What do you think are the top three reasons that you see for clients considering trusts as part of their estate planning today?
Elena Hoffstein:Yeah. So, I had to be careful about restricting it to three because there are so many reasons, but here goes.
I think just in thinking about that question, trusts are used, firstly, to start the discussion, trusts are used in estate planning during lifetime and to deal with assets after death, and death is the defining moment. So, trusts are used, to a large part, to eliminate or defer tax on death. That's the relevant factor, so, I always deal with death as the starting point for the discussion. It's to reduce or eliminate income tax or US estate tax to the extent it applies or in jurisdictions, such as Ontario, that have high probate tax to reduce or eliminate probate tax. What the main objective is to pass wealth to the next generation in a tax efficient manner. And just by way of example in the inter vivos, or lifetime planning, situation would be a common one is an estate freeze where a client wishes to freeze the value of his or her assets with the future growth going to be held by a trust where the beneficiaries include the next generations. So, you're skipping over the tax on the future growth of the ‘freezor’, and passing it on in an efficient manner. I think that's the most important reason why we use trusts.
The second reason, and they're all kind of intertwined, is to deal with successive interests. An example, especially more prevalent in this day and age, is the blended family where the desire is to ensure that the current spouse is well looked after, but also the desire to ensure that the estate passes to children of either that relationship or that relationship and prior relationships on the death of the spouse. Another testamentary reason would be to, when the next generation receives those assets, depending on the values, is to delay distribution for the children to a certain age beyond age 18.
And the third one as a means to provide financial protection for vulnerable family members, such as family members who are subject to drug addiction or who are spend thrifts and don't know how to manage money, or family members who have mental issues or age restrictions as I mentioned earlier.
Leanne Kaufman:Or potentially other kinds of disabilities, as well.
Elena Hoffstein:Other disabilities, as well, exactly. And so, where the trust is so helpful is that control is in the hands of one person, but the financial benefit is for others.
Leanne Kaufman:Now, I guess it depends on which type of trust we're talking about, whether you're talking about the estate freeze, which tends to be done for tax purposes when someone is still alive, or if you're talking about this successive generation trying to plan for or planning for someone with disabilities. But in general terms, how long should someone expect a trust to last? Or, would you typically think that you could suggest that a client might see a trust last?
Elena Hoffstein:That's a question I often get asked with respect to, "I want to reach back from the grave as long as I can." Or, "I want to defer the tax forever." And that's not quite how it works, at least in Ontario and other jurisdictions in Canada, there are legal and tax answers to that question. Talking about the legal answer, legally a trust can last as long as the perpetuity period, and the length of that period of time depends on the relevant jurisdiction of the trust. In Ontario, the perpetuity period is, what is called, a life in being plus 21 years. So, that begs the question, well, what's a relevant life? One has to determine the relevant life or purposes of the trust. For example, the trust could provide that the trust is to terminate no later than 21 years after the death of whichever beneficiaries are alive at the beginning of the trust. So, that's one relevant life. Other people have said that the relevant lives are what they call the royal lives. So, it's all the successors of Queen Victoria who are alive at the inception of the trust plus 21 years. That's a pretty long period of time. I myself don't use that, but I know that other counsel have.
Leanne Kaufman:Perhaps a less relevant life to the trust.
Elena Hoffstein:Yeah, I try to use relevant lives. And often, you'll find that trusts can terminate earlier if the trustees so determined. So the trustees are given the power to terminate the trust earlier than the perpetuity period, but that's the outside limit.
Leanne Kaufman:Right.
Elena Hoffstein:And if there are trusts that attempt to exist beyond the perpetuity period, they vest the assets in the beneficiaries or there could be other consequences. So, it's something you really have to pay attention to. The other factor here, though, however long the legal perpetuity period is, the reality is that, in Canada, the income tax act has provisions that a trust is deemed to have disposed of and reacquired its assets every 21 years.
Leanne Kaufman:Right.
Elena Hoffstein:So, let's say you have a trust that can last a hundred years under the legal definition of perpetuity period. But the reality is every 21 years there has to be a tax realization. And so, what typically happens is trusts are terminated just prior to the 21st anniversary, and the assets distributed to the beneficiaries because of the tax reason, not because the trust can't continue legally. And just to add a personal factor, I'm a trustee of a trust that has gone through 3, 21 year periods because of the facts are such that it's not helpful to terminate the trust. So, we pay the tax and move on.
Leanne Kaufman:So, sometimes the term of the trust is driven by tax purposes, but that's not always the most appropriate factor to consider.
Elena Hoffstein:Exactly.
Leanne Kaufman:And then, of course those ones that are set up until someone reaches a certain age, I guess that would be the definitive time that it would typically end. And then, you've taught us that perpetuity doesn't always mean perpetuity, but those are those longstanding trusts for people who want to continue with something slightly more dynastic, I would suggest.
Elena Hoffstein:That also just imagine that in the United States, they do have trusts called dynasty trusts because their tax rules are different.
Leanne Kaufman:Right, and so, they can continue dynastically for generations, potentially.
Elena Hoffstein:Right.
Leanne Kaufman:So, you've mentioned a couple of times some of the tax rules and the tax reasons and the 21 year rule is that deemed disposition of having to act as if you've sold all the assets, pay the tax as if you sold all the assets, and then reacquire them. Are there any other tax rules in regards to trust that you find clients don't know about and are surprised by?
Elena Hoffstein:Yeah. One of the factors is that when assets are transferred to a trust, that's a disposition for tax purposes with the exception of a number of trusts that rule doesn't apply. For example, alter ego trusts or joint partner trusts or spousal trusts where there is a rollover of the assets into those types of trusts. But generally, in the absence of those types of trusts, there is a deemed disposition of assets being transferred to a trust.
Leanne Kaufman:So again, that says, "If you've sold it, so you have to pay capital gains tax or deal with the deal with the tax immediately on transferring those assets in at that time."
Elena Hoffstein:Correct.
Leanne Kaufman:Yeah, that's a big one. There's so many different tentacles and rabbit holes we could fall down, Elena in this conversation. So, we're really just scratching the surface. And I know that lots of people will probably have questions about some of these tax and other implications. But let's move away from tax just for a minute.
Assuming that a trust is set up for maybe those more generational issues we talked about for children or for grandchildren, and you want it to continue for years past your own death, obviously, in that instance. But it seems to me that sometimes when people are making their Wills, they're choosing executors and trustees who could be their own age. So, for example, friends or siblings. Or sometimes I've even seen people naming executors and trustees who are older than they are at the time they create their Will, which doesn't really align with then creating a role for someone that's got to continue for a generation or two after that person who's creating their Will has passed away.
So, give me a little bit of your advice that you give clients regarding who should be a trustee and who might make a good choice. And of course, that longevity factor is one, but it may not be the only factor that you talk to clients about.
Elena Hoffstein:Yeah, those are all excellent points. And I must start by saying that I never talk about who the trustees of a trust should be until I have a good understanding of what the role of that trustee is, and how long, as you say, how long the trust is to last and who the beneficiaries are and what the family dynamics are.
So, the discussion about executors or trustees is one of the last things I talk about, although often, it's the very first thing that client wants to talk about. We have to manage the expectation and the discussion. So, your point about, "Well, I want to long term trust, and I want to name my parent has the trustee for the children or whatever," that obviously doesn't work very well in the long term. And so, we need to walk the client through that scenario. So, the age and the stage of the proposed trustee and the duration of the trust is a very relevant factor, and one needs to consider if you have a parent that you've selected, who would the alternatives be? If the parent dies or the parent becomes incompetent, who is the replacement? And if there isn't a replacement, or maybe we are crystal ball gazing too much by trying to make decisions today when the decision is going to have to be made later on, that's something we have to think about, too. And we have to build in mechanisms for who the next trustees are to be, who makes the decision, who selects them.
So, the other factor to consider is if trusts are to last a long time, tax rules change. And it may be that a particular tax consequence, or tax rule change, will impact who on the identity of the trustees. So, these are all factors that need to be considered.
A couple of other factors to think about is the ability of a person to stay impartial when they're requested to do that.
Leanne Kaufman:Right.
Elena Hoffstein:Going back to the accountability point, the accountability is for all the beneficiaries, not just a lifetime beneficiary or a residual beneficiary, but all beneficiaries’ rights and interests have to be considered by the trustees. So, they've got to be impartial, they've got to maintain an even hand. And that goes into the depths of a trust, including investment decisions, as well as distribution decisions. The impact on family harmony is extremely relevant. I've had situations where a parent has selected, let's say, the good sibling or the responsible sibling to look after the affairs, the financial affairs of a sibling who may be more challenged for a variety of reasons, and that just is a recipe for disaster, I've seen it happen time and again. It's not a favor that you're doing a person to name them as trustees, it's really an obligation. And couple of situations where I've had one sibling being tasked with responsibility for the other sibling, it's led to a lot of strife. And we've had to look at alternative trustees because the sibling who was the trustee was extremely unhappy at being criticized all the time by the sibling who resented that type of control, and neither sibling wanted that situation. It really destroyed the family harmony and was very, very upsetting for everyone involved. This is where professional trustees come into the picture because sometimes professional trustees play an important role. They are there to take over and be considered where that is the best alternative. In my situations where we had these sibling issues, the professional trustee was where we went for a solution because they were impartial, neutral, they weren't taking sides in that way. The sibling who was controlled, if I might say that, really had to deal with a professional trustee, and it just made the family situation a little bit better.
Leanne Kaufman:The professional trustee helps with the longevity issue, too, in many instances.
Elena Hoffstein:Right, and also in cross border situations where we don't have Canadian resident trustee, family members, or relatives, professional trustee in the relevant jurisdiction is a good solution.
Leanne Kaufman:I think that's a really important point that very few people listening would be aware of, that if you have a non-resident trustee, you could impact the tax residency of that trust, and it could become resident in the US or somewhere else and become a taxpayer of an entirely different jurisdiction. I think that's probably a little known fact that's worth mentioning, as well.
Elena Hoffstein:Yes, and the other one is that if you have a Canadian resident trustee who goes non-resident. They could make the trust have a departure tax issue. So, these are all factors to consider seriously. The other one is, I talked about a trust for a spouse with a gift over to children of that or another marriage. Naming a child as a trustee in that trust is a recipe for disaster, as well, because in a situation with a blended family, for example, while everyone gets along when one spouse is alive, that isn't always the case when that spouse dies.
Leanne Kaufman:And we've seen that happen, I'm sure, in both of our practices. Well, Elena, look again, we've just barely scratched the surface on what is really a complex topic. One that definitely begs professional advice of the kind that you offer, and I think we may have to consider coming back and tucking into some of these topics with a little more detail. But for today's purposes, if there was just one thing that you would want our audience to remember when it comes to trusts, what would that one thing be? And I know it's a hard question to answer.
Elena Hoffstein:I would say that the one thing is that they are a very valuable tool, but they have to be used with caution both during lifetime and on death situation. There are a lot of moving parts, and the selection of the trustees and other factors really have to be considered. So, I love trusts, they're my life, but again, you have to be careful.
Leanne Kaufman:And not only for the wealthy, or the uber wealthy.
Elena Hoffstein:Not only for the wealthy, and also, you talked about trust fund babies? We want to make sure that we don't create trust fund babies. And that's a whole other topic that is gone into in great detail in the literature, as well. How do you transfer wealth without creating a trust fund baby?
Leanne Kaufman:A topic for another day. But thank you so much, Elena, for joining us today, for sharing your deep insights on trusts and why these matter beyond wealth. You can find out more about Elena and her legal practice at millerthomson.com
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