MARKET COMMENTARY

Trust Myths Up Close

lost in the popular news mix. Decide how myths—such as trusts are only for very wealthy people or only designed to dupe tax departments—stand up to the test.

08.03.2021 - Thomas E. Junkin, Senior Vice President, Personal Trust Services and Operations

Some myths about trusts stubbornly linger even today. Here are the top three on my list: Trusts are only for very wealthy people; are shady vehicles designed to dupe tax departments; and are obsolete in Canada due to 2016 changes to the Income Tax Act. Before tackling these myths with the truth, here is some useful background on trusts that helps explain why they have been called “…the greatest and most distinctive achievement performed by Englishmen in the field of jurisprudence…”[1] 

What is a trust?

A trust is a legal relationship among three parties. The settlor creates the trust terms and formally gives assets to the trust. The trustee becomes the legal owner of those assets and agrees to use them for the purposes set out in the trust. The beneficiary is entitled to enjoy the benefits of the property according to the trust terms but does NOT own the trust assets.

The first trusts were created in the Middle Ages during the Crusades. Wealthy English landowners, who embarked upon a Crusade, would be away from their estates for lengthy periods. During that time, their wives and children (who could not legally own property) would need the estate’s income. A departing Crusader would sign over his property to someone else on the understanding that the new owner would use the estate’s ongoing income to support the Crusader’s family and would return the property upon his return. Over centuries, the English trust concept has taken root in the legal systems of countries around the world.

Why are trusts useful?

Here are a few reasons:

  • A trust separates the legal control of wealth from the enjoyment of wealth. Beneficiaries who do not want or should not control wealth can have financial security without the risks, duties and obligations that go with legal ownership.
  • Trusts have thrived for hundreds of years because they are flexible and work in so many situations. Keep in mind, trust directions are as flexible or as rigid as the settlor who creates them.
  • Because beneficiaries do not have legal ownership of trust property, their interest can be protected from creditor claims, including a former spouse. Trust property is also safe from settlor and trustee creditors.
  • Well-designed trusts can adapt to changes in the beneficiary’s circumstances, economic conditions, or law.
  • A trust can act as a container for wealth, allowing future generations to allocate wealth from the trust in ways that are tax-effective and fair at the time.
  • Trusts often encourage responsible stewardship of wealth, respecting the values of the person who created it.

Now let us put those myths to the test. 

Myth 1: Changes to Canada’s Income Tax Act in 2016 Made Trusts Obsolete for Estate Planning

As of 2016, certain trusts that previously paid tax at the same marginal tax rates as individual taxpayers began to be taxed at the top marginal tax rate. Doomsayers predicted trusts would no longer be useful for estate planning. The fact is trusts are very seldom created solely for tax-planning purposes. There are almost always other important reasons to create a trust, such as:

  • Protecting vulnerable people, including young people.
  • Allowing parents to control how their estate will be distributed despite surprise future contingencies.
  • Protecting family assets from depletion by claims from non-family members.
  • Making meaningful gifts to charity.

These reasons remain as worthwhile as ever. The 2016 changes did require estate planners to rethink some strategies, and trustees of some existing trusts to change how they distributed funds. However, the use of trusts in Canada as a tool for the orderly transfer of wealth from one generation to the next is very much alive today.

Myth 2: Trusts are Only for the Very Wealthy

We can disprove this myth simply by looking at common types of trusts that are part of almost everyone’s financial lives. 

Do you participate in a company pension plan or contribute to a Registered Retirement Savings Plan?  If so, you are very likely the beneficiary of a trust. Do you invest in mutual funds? Again, most mutual funds sold in Canada are trusts.

Those are some commercial uses. Now, let us turn to some ways that people of modest wealth might use trusts as part of their personal estate plan. Nearly every Canadian who has a will has probably created a trust of some kind in their will. For example, your will might leave your estate in equal shares to your adult children. If one of your children dies before receiving their share, your will might pass on that child’s interest to their children (your grandchildren). Very likely, your will states that if those grandchildren are very young, their share should be held in trust until they reach a specific age.

People also commonly use trusts through their will when wanting to provide for a child or adult who lives with a disability that makes it difficult to achieve financial independence. Such trusts can be practical with as little as $100,000, though given inevitable operating costs, in most cases, $250,000 is a more realistic benchmark.

As a final example, an alter ego trust (created by a person over the age of 65) can be advantageous for many people who want to reduce estate administration costs and plan for potential incapacity as they grow older.

Myth 3: Trusts are Primarily a Means for Wealthy Families to Avoid Paying their Fair Share of Income Tax

Is it true that an unscrupulous person might use a trust, particularly one located in an exotic tropical island, to hide money from taxation, or to launder money from criminal enterprises? Yes, this happens from time to time. Tabloid-style reporting of these cases can cause readers to feel a sense of injustice when it comes to trusts.

In recent years, partly because of high-profile leaks of typically confidential information such as the Panama Papers,[2] international trusts have come under tight scrutiny by international lawmakers. In truth, the complicated and poorly understood offshore trust industry, which emerged in the late 20th and early 21st centuries, is a response to families’ increasingly global realities. It is a trend that applies to families of all wealth profiles. Young adults travel to other countries to further their education or their professional careers, where they meet and marry and begin to raise their own children as citizens and residents of that country. The question then becomes: How do you effectively transfer wealth to the next generation without repeatedly paying tax in multiple jurisdictions? Families do take completely legal steps to answer this question. This is plainly sensible and some countries like the Cayman Islands have created favourable tax laws to facilitate this kind of planning.

Are these trusts “secret”?  Only in the sense that a trust is a private arrangement among the trust parties, and like other private financial arrangements that we all make, are closed to public scrutiny.  However, every developed country in the world has very clear tax regulations regarding trusts and as a result, most trusts, or their beneficiaries, will pay tax in one jurisdiction or another.

The private nature of trusts is also rapidly changing in Canada, the United States, and many other countries. International agreements now require trustees to disclose information about the beneficial ownership of property held in trust, providing transparency and identifying the beneficiaries.[3]

Trusts are part of the global financial structure, but many authorities agree that compared to shell corporations (companies that exist as an address only), trusts are at a relatively low risk of being used for criminal purposes.

The Value of Breaking Down Myths

Sometimes it is easier to believe a myth versus seeking the truth, but in the case of trusts, individuals and families across Canada continue to prove that actions do speak louder than words. As a result, trusts remain an integral tool in creating legacies and futures for generations to come.

 

FOOTNOTES:

  1. F.W. Maitland, Selected Essays eds. H.D. Hazeltine, G. Lapsley and P.H. Winfield (Cambridge, Cambridge University Press, 1936).
  2. The Panama Papers, confidential documents from the Panama law firm, Mossack Fonseca, were leaked to a German newspaper in 2016. They exposed a network of 214,000 tax havens involving wealthy people, public officials, and entities from 200 nations. However, it was not prominently reported that most of the leaked documents showed no illegal actions, and the relatively few transactions that were illegally used for fraud, tax evasion or avoiding international sanctions involved shell corporations, and not trusts.
  3. In Canada, every trust must file an annual Trust Tax and Information Return. Beginning in 2021, this information return must disclose the names and addresses of all trust beneficiaries, even those who have not received any money from the trust.

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Thomas E. Junkin, Senior Vice President, Personal Trust Services and Operations

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