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How To Leave Your Heirs a Tax Shelter And Other Benefits Rather Than Just An Inheritance

Most Wills are designed to distribute your estate to your heirs as simply as possible and to plan against a number of different contingencies.   Unless some of the heirs are children or young adults, most Wills merely instruct the executor to pay the debts, tidy up your estate and then write cheques to your heirs.  This may be all that is required in some situations and does save on your costs when getting your Will done.  On the other hand, you may be able to maximize the value of what you leave behind to your heirs and decrease the chances of problems or unintended results by spending a bit more and leaving assets to a “trust” rather than to your heirs directly.  A little bit more effort now can mean a huge difference later!  Although every situation is different, the tax savings can easily be in the tens of thousands of dollars in many circumstances!

Most people who have minor children already use trusts in their Wills and likely didn’t notice too big a difference in complexity when getting them done.  They use trusts in this situation  so someone they trust (the “trustee”) will manage the money rather than the public trustee (who will be in charge if a trust is not set up for a minor) and perhaps because they don’t think their children (the “beneficiaries”) could manage a big amount of money without any restrictions even if they are no longer minors.  There are, however, also significant tax advantages and potential creditor benefits that can arise while the trusts are in force if properly constructed.  Rather than collapsing the trusts and paying all of the money to the beneficiaries at a set age, I suggest keeping the trusts intact so the savings and protection can continue.  If you are concerned about paying endless trustee fees or worried about someone else controlling the child’s inheritance, the trust can get set up so the child becomes his or own trustee or can appoint others at any point to take over.  In other words, the benefits can continue while many of the draw-backs can disappear.

I will go into more detail on the tax advantages and potential creditor protection in my June 2011 newsletter but, for now, I will merely identify some situations where trusts in a Will or for life insurance proceeds or the money from a registered plan may be the way to go:

  • Blended Family Situations.  If you want to ensure that your new spouse has enough money for life but want some control over whatever is left on his or her death, then a trust that provides exclusively for your spouse for his or life but then divides whatever is left between your chosen heirs may be the way to go.  As an added benefit, this may protect the inheritance if your spouse subsequently remarries and will save on probate fees when your spouse does pass.
  • Life Insurance Proceeds.  The same benefits of setting up a trust in your Will can apply if you leave your insurance proceeds to a trust than directly to your heirs.  When leaving insurance to minors, most people commonly designate a trustee on the form provided when you get your insurance.  Unfortunately, that doesn’t provide any guidance to your trustee, all the money goes to your children when they turn 19 and you can’t do much in way of contingency planning.  Even if the funds will likely be used to pay down debts,
  • Registered Plan Proceeds.   It usually makes sense to designate your spouse as the beneficiary directly on the plan to avoid paying a bunch of tax immediately.  If you don’t have a surviving spouse and have a lot of registered assets, consider leaving the proceeds to a trust rather than directly to an heir for some reasons you might set up a trust in your Will or for life insurance proceeds.
  • High Income Heirs Who Own Companies or are Professionals. Even if you don’t have a large estate to pass along, you can still pass along a ton of tax savings.   There are restrictive tax laws (such as the ‘kiddie tax’) that make it difficult for business owners to pass along dividends from private companies to minors.  One way around this problem is if a trust that is funded at death owns such shares.  It is usually possible to reorganize private companies so they can pay dividends to a special class of shares owned by such a trust.  The trust may be able to buy these shares for as little as $1.  Accordingly, $1 and a trust can provide enormous tax savings for your heirs.  If your children are professionals, they will often be able to incorporate down the road even if they haven’t yet so that they can take advantage of this opportunity.
  • When You Want to Control Who Gets When Child Dies.  You may have no concerns about your child’s money-management skills or marriage, but may want to make sure grandchildren or your other children inherit some or all of the money if a child dies after inheriting.  If you leave money directly to a child, his or her Will will likely determine who gets what is left when the child passes.  If your child is childless or has children from a previous relationship, you may want to take steps to ensure that your child’s current spouse doesn’t inherit all or some of what is left of your child’s inheritance.  People often take steps to deal with this contingency if their child dies before them but don’t usually address what is to happen if their child out lives them.  It may also head off some of the Will Challenges that could arise on your child’s death.
  • Potential Divorce Protection.  Although there are no iron-clad guarantees, leaving a child’s inheritance increases the odds of him or her keeping more of what you’ve left behind if a marriage fails.  If the money is kept in a trust and not mixed with the couple’s other assets, there is a better chance that a judge will determine that it is not a family asset subject to division and, even if it is to divided, that it should at least not be divided on a 50-50 basis.  One way of increasing the odds further is to set up several trusts per child and for the child to draw down one trust at a time so that it is easier to argue that any of the untouched trusts are not family assets.  This might work even better if someone other than your child is the trustee, such as if other siblings take on the role.
  • Potential Creditor Protection.  It may be possible to defeat a child’s creditors by leaving his or her inheritance in a trust that also names a bunch of other potential beneficiaries and there is the discretion to determine who gets what from the trust.  Although any money paid out of the trust might be fair game, assets kept in the trust might be saved.  Perhaps payments can be made to a child for a grandchild’s benefit so the money can still be accessed in some situations.
  • Disabled Beneficiaries.  Beneficiaries receiving government benefits may have these benefits eroded when they receive an inheritance and any subsequent investment income.  Trusts can be set up to maximize government benefits.  Moreover, the trust can determine who gets what if the beneficiary dies, which avoids the problems that can arise if the beneficiary isn’t able to write a will or his or her own.
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