Reference Guide - Spousal Trusts - 081005

1 August 2005 Although this material has been compiled from sources believed to be reliable, we cannot guarantee its accuracy or completeness. All opinions expressed and data provided herein are subject to change without notice. The information is provided solely for informational and educational purposes and is not intended to provide, and should not be construed as providing individual financial, investment, tax, legal or accounting advice. Professional advisors should be consulted prior to acting on the basis of the information contained in this Reference Guide .

2 2005 United Financial Corporation. All rights reserved. 1 Reference Guide Spousal Trusts Contrary to what many people believe, Trusts are not only for the wealthy. In fact, Trusts , and especially testamentary Trusts , are an important estate planning tool for a broad range of individuals and can save on taxes and provide peace of mind. This Reference Guide discusses testamentary Trusts in general and focuses on a specific form of testamentary trust , the Spousal trust . WHAT IS A trust ? A trust is an obligation that binds a person (the trustee ) to deal with certain property (the trust property ), which the trustee controls, for the benefit of specified persons (the beneficiaries ).

3 To create a trust , a person, referred to as a settlor , transfers legal ownership of property to the trustee(s) and provides instructions to the trustee(s) regarding how the property is to be used for the benefit of the beneficiaries. This arrangement can be made either in a trust agreement (in the case of a lifetime or inter vivos trust ) or in a Will (in the case of a testamentary trust ). A testamentary trust can, in some circumstances, also be created in other documents that take effect on an individual s death. A testamentary trust is a trust that arises on and as a consequence of an individual s death, so it only becomes effective on the death of the person making the Will (the testator ).

4 Most often, a testamentary trust is created with funds or assets from the estate, but it can also be funded with life insurance proceeds. An example of a testamentary trust is where a testator s Will states that some or all of the estate is to be held and invested by a trustee to be used to provide for the benefit and support of the testator s spouse. This is known as a Spousal trust . Note that if a Spousal trust may have trustees or beneficiaries resident in Quebec, please refer to our Reference Guide on Spousal Trusts in Quebec. THE Spousal trust A Spousal trust is a form of testamentary trust typically created in a person s Will to provide for a surviving spouse.

5 To qualify as a Spousal trust for income tax purposes, the Spousal trust must meet the following criteria: August 2005 2005 United Financial Corporation. All rights reserved. 2 Reference Guide The surviving spouse must be entitled to receive all the income of the trust during his or her lifetime; and No person other than the surviving spouse can receive, use, or have the benefit of the capital of the trust during the surviving spouse s lifetime. Note that the tax laws applicable to spouses also apply to common-law partners.

6 In general, opposite sex and same sex partners are considered to be common-law partners for tax purposes after a period of 12 months Accordingly, all references to a spouse in this Reference Guide apply equally to a common-law partner. The Spousal Rollover The use of a Spousal trust offers the opportunity to defer taxes through the Spousal rollover. Generally, on death, a person is considered to have disposed of all of his or her capital property at the fair market value of the property. This deemed disposition may result in the realization of taxable capital gains.

7 However, where the assets are transferred to a surviving spouse or to a qualifying Spousal trust , the tax on capital gains is deferred until the death of the beneficiary Generally, the Spousal rollover will apply to transfers of property to a Spousal trust if all of the following requirements are met: The deceased spouse was resident in Canada immediately before his or her death; The Spousal trust was resident in Canada immediately after the property was transferred to it; and The property vests indefeasibly in the Spousal trust within 36 months after the deceased spouse s death.

8 An extension of this vesting period may be granted by the Minister of National Revenue within the 36-month period. 1 Note that this definition applies only for income tax purposes. Each province and territory also has its own laws governing the rights of common-law partners for other purposes, such as property sharing on the breakdown of the relationship or on death. 2 Different rules apply for registered plans. To have a registered plan transfer on a tax-deferred basis to the spouse s plan at death, the proceeds of the registered plan must be designated directly to the spouse as beneficiary (rather than to a trust ).

9 Alternatively, the estate must be designated to receive the proceeds and the spouse must be a beneficiary of the estate or named in the Will as beneficiary of the plan proceeds. The executor and spouse must then file an appropriate election under the Income Tax Act to have the plan benefits rolled to the surviving spouse s plan. August 2005 2005 United Financial Corporation. All rights reserved. 3 Reference Guide Property that passes to a testamentary trust that does not meet all of the requirements of a Spousal trust will not be eligible for the rollover.

10 Instead, the usual rules will apply, so that the property will be deemed to have been disposed of at its fair market value immediately prior to the death of the first spouse, with any resulting gains being taxed in the deceased spouse s final tax return. WHAT ARE THE BENEFITS OF A Spousal trust ? The benefits of using a Spousal trust can be summarized as follows: 1. Reducing the income tax that the spouse will pay on the future income earned on his or her inheritance; 2. Helping to protect the spouse s inheritance from claims from his or her present and future creditors, and possibly from marital or family property claims; 3.