Doug McLarty
For those families fortunate enough to accumulate multigenerational wealth, testamentary trusts – trusts that come into effect after the death of the contributor – can be an important vehicle for minimizing the tax impact of inheritance income, says chartered accountant Doug McLarty.
"For example, let's say that Dad is the second of the two spouses to die, and that he has a net worth of $1 million and four children, all beneficiaries, so each is entitled to $250,000. If one or more of the adult children is doing fairly well financially and doesn't need the capital, and the will allows the executor to create a testamentary trust, then that money can go into a trust. The beauty of the situation is that the trust is a separate legal entity, with its own tax return."
A testamentary trust has graduated tax rates just as individuals have graduated tax rates. "When an individual files his or her tax return, he or she pays one rate to approximately $40,000; at $80,000 you're paying the next rate, and there are progressively higher rates until you get beyond the top tax bracket of about $125,000."
If the trust earns 10 per cent, or $25,000 in investment income, the trust would pay 20 per cent or up to $5,000 tax on that income, he says. "If the beneficiary were to receive it personally, and is in the top tax bracket, he or she would pay as much as 46.4 per cent, or approximately $11,600 in tax."
"When we are doing planning with our clients, we often review wills as part of that exercise, and may recommend that the executor have the ability to create trusts for the beneficiaries. Sometimes it doesn't make sense, because the inheritors may need all the capital right away. But for others, it is really a wonderful planning opportunity, and it isn't difficult to incorporate it into the will."
But like many tax mitigation strategies, it's important to implement trusts as part of an overall estate planning process and with professional counsel, he advises. "These strategies can benefit anyone who has accumulated significant wealth, but they should be part of a broader process. For our owner-manager clients, for example, it is also essential to have an inventory of assets and a plan in place for the point at which they may not be able to continue operating their businesses. We review all of the necessary components, including wills and insurance, to ensure that they are all in place and work together."
Professionals such as physicians or dentists may also want to consider a complementary strategy, says Mr. McLarty. "Here in Ontario, where we have probate fees that are higher than in some of the other jurisdictions, duals wills are commonly used. For example, if you own shares in a professional corporation, one will could cover all other assets and a secondary will could cover the shares in the corporation. Only the primary will would be submitted for probate, saving the probate fees on the value of the professional corporation shares."