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Tax Managed Strategy 13
Alter ego and joint partner trusts have been gaining in popularity as ways to avoid probate, but are there alternatives?
What are they?
Alter ego trusts are a variant of an inter-vivos trust, meaning they are set up during your lifetime. You must be 65 or older and be the sole beneficiary of all income or capital of the trust during your lifetime. While you can appoint a third party as trustee or co-trustee, you can also appoint yourself.
A joint partner trust is similar except that both spouses or common-law partners must be entitled to receive all the income of the trust and must be the only persons entitled to receive the income or capital of the trust. This continues until the death of the surviving spouse or common-law partner.
Assets are transferred to an alter ego trust at cost, allowing you to defer taxation of capital gains until the assets are sold or you pass away. You may elect to transfer assets to the trust at market value, which can be advantageous if you have significant capital losses or if you own certain qualifying shares. While individuals may claim a capital gains exemption on the sale of qualifying business shares, an alter ego trust cannot claim the same exemption.
Upon your death, the disposition of trust assets avoids probate and legal fees. While probate is a public process, the disposition of trust assets is private.
Most trusts are subject to the deemed disposition rule. Capital assets are considered sold every 21 years, which can generate a substantial tax bill. With an alter ego trust, there is no deemed disposition until your death (unless you elect otherwise).
Transferring assets to a trust can also provide potential creditor protection.
So why doesn’t everyone set one up? As a formal trust, initial setup costs alone could amount to thousands of dollars. Additional costs for accounting, filing tax returns, and trustee fees are ongoing and could be substantial.
During your lifetime, trust income can be attributed back to you and taxed at your marginal rate. The deemed disposition of trust assets on your death is taxed within the trust at the highest marginal tax rate. However, both the trust and the deceased’s graduated rate estate can file a joint election to have the deemed disposition taxed on the deceased’s final tax return, at the deceased’s marginal tax rate rather than taxed in the trust at the top marginal tax rate.
Alter ego trusts are sometimes touted as a substitute for a will since the trust document directs the disposition of trust assets on your death. Care must be taken in drafting the document. If it looks too much like a will — and assets are substantial or their disposition contentious — the document could be open to legal challenge, the same as a will!
Alter ego trusts offer the avoidance of probate and legal fees on death, potential creditor protection, and the ability to transfer assets to the trust without taxation of capital gains. Other available options, such as a segregated fund contract or insurance company guaranteed interest contract (GIC), provide similar benefits with substantially less cost and administration.
A segregated fund contract or insurance GIC with a beneficiary of the family class¹ offers the potential for creditor protection. When a beneficiary other than your estate is named, assets bypass your estate and are paid to the beneficiary on your death without payment of either legal or probate fees. Their disposition also remains a private matter.² Distribution of assets directly to a named beneficiary is almost always faster than settling an estate.
Unlike an alter ego trust, a trust established on your death with segregated fund contracts or insurance GIC assets can be a testamentary trust.
In addition, a segregated fund contract or insurance GIC is easy and free to set up, unlike an alter ego trust, and as the owner of the contract, you maintain complete control. Changing a beneficiary simply requires completion of a form rather than altering the trust document. The accounting work is done for you and summarized on your tax slip; all you need to do is simply add the income when filing your tax return.
Lastly, capital losses of an alter ego trust can only be used within the trust, while those of a segregated fund contract are allocated to you. This allows immediate application against other capital gains.
While alter ego and joint partner trusts offer some attractive features, segregated fund contracts and insurance GICs offer most of the same advantages, as well as some others, without the additional costs.
Investors should consider segregated fund contracts or insurance GICs as alternatives to alter ego, self-benefit, or joint partner trusts if they want:
- low costs
- potential creditor protection
- tax efficient disposition of assets at death
- the ability to set up a testamentary trust at death
- capital guarantees on maturity or death.
If you are looking for the features listed above in an investment:
- Contact your advisor.
- Decide how much you want to invest.
- Name your beneficiaries and consider testamentary trusts.
- Decide what funds or insurance GICs meet your investment goals.
Investment options with Manulife
Manulife Investment Management provides a range of investments and services:
- Segregated fund contracts combine the growth potential offered by a broad range of investment funds with the unique wealth protection features of an insurance contract. Through Manulife segregated fund contracts, investors can help minimize their exposure to risk through income, death, and maturity guarantees; potential creditor protection features; and estate planning benefits — all from a single product or insurance contract.
- Guaranteed Interest Contracts (GIC)
Investors benefit from a guarantee on their principal investment and from several different investment options that can diversify and add flexibility to their portfolio. GICs can be an ideal solution for conservative investors looking to help grow their wealth but who are also concerned about minimizing risk.
1 In provinces other than Quebec, a family class beneficiary is any spouse, child, grandchild, or parent of the annuitant. In Quebec, a family class beneficiary is any married or civilly unified spouse, descendants, or ascendants of the owner. 2 In Saskatchewan, jointly held property and insurance policies with a named beneficiary are included on the application for probate but do not flow through the estate and are not subject to probate fees.
The commentary in this publication is for general information only and should not be considered investment or tax advice to any party. Individuals should seek the advice of professionals to ensure that any action taken with respect to this information is appropriate to their specific situation. Manulife Funds are managed by Manulife Investments, a division of Manulife Asset Management Limited. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the fund facts as well as the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. The Manufacturers Life Insurance Company is the issuer of all Manulife Investments Guaranteed Interest Contracts, the Manulife Segregated Fund Contracts and the guarantor of any guarantee provisions therein. Age restrictions and other conditions may apply. Any amount that is allocated to a segregated fund is invested at the risk of the contractholder and may increase or decrease in value.
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