Wealth Transfer Strategy 7
A trust provides a method for a person (the settlor) to give property to another person (the trustee) for the benefit of a third person (the beneficiary) while still maintaining some form of control over the property. If the intention is to provide a guaranteed income stream to an adult beneficiary, Manulife PensionBuilder® or Manulife RetirementPlusᵀᴹ might be worth considering.¹
Depending on the terms of the trust and the investment goals, Manulife PensionBuilder or Manulife RetirementPlus may be an appropriate investment. This could be a case where the trustee would like a guaranteed income stream to flow through to the trust beneficiary to help fund their retirement income. Take for example the situation where a parent sets up a trust to provide an income stream to a spendthrift adult child.
What is a trust?
A trust is not a legal entity; however, it’s treated as an individual for income tax purposes and taxed separate from the settlor and the beneficiaries. Both testamentary trusts and inter vivos (living) trusts are taxed at the top marginal rate², which can exceed 50 per cent in some provinces. Generally, trusts report any income earned but are entitled to an offsetting deduction for amounts paid or made payable to the trust beneficiary in that year. The beneficiary would then report this income on their tax return.
If appropriately designated by the trustee, these amounts — including return of capital, capital gains, taxable dividends, interest, and foreign source income — retain their character for tax purposes in the hands of the beneficiaries.
Does Manulife PensionBuilder or Manulife RetirementPlus in a trust make sense?
Trust assets should be invested in something that’s consistent with the terms of the trust and that’ll fulfill its objectives. If one of the objectives is to provide a guaranteed income stream to a beneficiary, then these products may be appropriate.
On the other hand, these products will probably not be appropriate for a minor beneficiary, where the investment will need to be cashed in and distributed to the beneficiary, or in a situation where the trust assets will eventually be transferred to the beneficiary who will most likely collapse the investment.
Can you do it?
Provided the trust document doesn’t prohibit an investment into a segregated fund contract, then an investment like Manulife PensionBuilder or Manulife RetirementPlus is generally permissible. The trustees are guided (or restricted) in their investment selection by the terms of the trust. If the trust is silent, or where no trust document exists,³ the applicable provincial trustee legislation would apply. All provinces have adopted the prudent person rule, which provides wide discretion in investing, if certain tests are met.
How do you do it?
It’s important that the contract provisions are consistent with the terms of the trust. The trust should be entered as the owner. If the trust has been named (e.g., The Smith Family Trust), then that name should be used. If the estate, which is a testamentary trust itself, is purchasing Manulife PensionBuilder or Manulife RetirementPlus, then the estate should be identified as owner (e.g., The Estate of John Smith).
Given that the contract setup should correspond with the distribution under the trust, in most cases the annuitant under the contract would be the trust beneficiary.
The beneficiary under the contract shouldn’t be confused with the trust beneficiary. The beneficiary under the contract would typically be the trust, so that on the death of the annuitant, the funds would be paid back to the trust and would be distributed according to the terms of the trust. Where the trust document specifies who should receive the funds from the trust on the death of the annuitant, that person can be named as a beneficiary under the contract.
Beneficiaries under a trust are income beneficiaries (where they are entitled to only the income of the trust), or capital beneficiaries (where they would be eligible to receive the capital from the trust), or both.
It’s important to realize that what may be considered income for tax purposes may not be considered income for trust-law purposes. From a trust law perspective, income normally includes interest, dividends, and foreign income but not capital gains, even though 50 per cent of capital gains are included on a tax return. Capital gains and return of capital are considered capital and belong to the capital beneficiary. This divergence on what’s considered income between the legal principle and the tax rules creates an additional complication that must be considered.
The payment stream from a non-registered Manulife PensionBuilder or Manulife RetirementPlus contract is funded by redeeming units and will be comprised of a capital gain or loss and return of capital.⁴ From a trust law perspective, the payment stream is all considered capital and belongs to the capital beneficiary. If the income and capital beneficiaries are different individuals and the trustee doesn’t have a right to encroach on capital for the benefit of the income beneficiary, then the income beneficiary would only be entitled to any interest, dividends, or foreign income that the trust earns (e.g., year-end fund allocations reported on a T3). This amount may be very small, resulting in the income beneficiary receiving very little income. This may not be the desired outcome and may be inconsistent with the objectives of the trust. In such a situation, these products are probably not appropriate.
If the income beneficiary and the capital beneficiary are the same person, or if the trustee can encroach on capital for the benefit of the income beneficiary, then these products are still worthy of consideration. However, keep in mind that the trustee has a fiduciary duty to make sure that distributions from the trust are allocated fairly between the income and capital beneficiaries, unless the trust document dictates otherwise.
Trustees who are:
- looking for a guaranteed income stream for adult beneficiaries
- administering a trust where an investment into Manulife PensionBuilder or Manulife RetirementPlus isn’t prohibited by the trust and is consistent with the trust objectives
- administering a trust where the income and capital beneficiaries are the same person or where they can encroach on capital for the benefit of the income beneficiary
- administering a trust where the intention isn’t to cash in the contract
- Determine the amount of guaranteed income you’re looking for from these funds.
- Consider using Manulife PensionBuilder or Manulife RetirementPlus to fund part or all of that guaranteed income stream need.
1 A thorough review of all the issues relating to trusts is beyond the scope of this piece. You should speak to your tax and legal advisor about your specific situation. 2 Qualified disability trusts (QDTs), which are testamentary trusts resident in Canada where the beneficiary is eligible for the disability tax credit, and graduated rate estates (GREs) continue to be taxed at graduated tax rates. 3 In Quebec, only formal trusts are recognized, as the concept of an informal trust (e.g., an “in trust for” contract) doesn’t exist. 4 For more information on the taxation of the payments from Manulife PensionBuilder or Manulife RetirementPlus, see “Tax treatment of Manulife PensionBuilder” (MK3041 — login required) or “Tax Treatment of Manulife RetirementPlus” (MK2872 — login required).
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. Any amount that is allocated to a segregated fund is invested at the risk of the contractholder and may increase or decrease in value. The Manufacturers Life Insurance Company is the issuer of the Manulife PensionBuilder and the Manulife RetirementPlus insurance contracts and the guarantor of any guarantee provisions therein. Age restrictions and other conditions may apply. Manulife, Manulife Investment Management, the Stylized M Design, and Manulife Investment Management & Stylized M Design are trademarks of The Manufacturers Life Insurance Company and are used by it, and by its affiliates under license.