The ABCs of Trust Funds
A trust fund is an arrangement by which a person entrusts the management of property to an intermediary for his or her own benefit or for that of a third party. Trust funds involve 3 parties: the transferor, the trustee, and the beneficiary.
Transferor (or purchaser)
The transferor is the person who sets up the trust. In Québec, a trust can only be set up either during the transferor's lifetime (inter vivos trust) or upon the transferor's death (testamentary trust, treated like an estate, until all property in the trust has been distributed to the heirs).
The trustee holds and manages the property placed in trust and reports to the transferor, beneficiary, and any other party involved. The trustee also ensures strict compliance with the provisions of the trust act that protect the rights of the beneficiary.
The beneficiary is the person designated in the trust act to receive the property, under certain conditions. Depending on the terms of the trust contract, the beneficiary may have the right, for example, to draw an income from the trust up to a certain age, then cash in the balance.
For tax purposes, a trust is considered a distinct entity separate from the transferor and beneficiary. As such, it is taxed at its own rate.
A testamentary trust is a legal entity separate from the estate.
Why Set Up a Trust Fund?
Trust funds are generally set up for the following reasons:
- To split up your income in order to minimize your tax bill (for a testamentary trust. In the case of an inter vivos trust, tax savings are not usually the main objective)
- To protect the capital placed in the fund
- To ensure proper control over the capital and income paid out to the beneficiary
- To protect certain categories of assets from possible legal action
Examples of Trust Funds
In a true spousal trust, the spouse must receive all income from the trust during his or her lifetime and be the only person who has access to the capital.
The transferor can bequeath property to his or her children through a trust contract that provides the children with the income once the transferor is deceased, then makes them owners of the property when they reach financial autonomy (e.g., at the age of 24).
Alter Ego Trust
With an alter ego trust, the transferor can withdraw certain assets from the estate without forfeiting their use during his or her lifetime.
Other Important Factors
- There are a number of other types of trusts, each with their own requirements. It's important to learn about them and consult a legal advisor, tax expert, and financial planner to help you use this strategy to its best advantage.
- In some cases, setting up a trust can be expensive (legal fees, annual administration fees, tax advice, etc.). Because testamentary trusts are created only upon the transferor's death, the fees apply when the trust expires.
- Find out about the attribution rules that determine who will have to pay taxes on the income and capital gains from the property placed in trust.
- Writing up a trust act involves major, specific legal and tax restrictions.
- When setting up a trust fund for a person with a disability, you can use the "preferred beneficiary" option for substantial tax savings.
- Trusts are eligible for the same tax credits as an individual, with the exception of personal tax credits (spouse, dependent child, age, disability).
- In some cases, property transferred into a trust is subject to the same tax treatment as a disposal of property, and the tax impact can be substantial.
- Different tax periods apply for declaring testamentary and inter vivos trusts.
- In some cases, there may be more than one transferor, trustee, or beneficiary.