My name is Mark Goodfield. Welcome to The Blunt Bean Counter ™, a blog that shares my thoughts on income taxes, finance and the psychology of money. I am a Chartered Professional Accountant and a partner with a National Accounting Firm in Toronto. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. The views and opinions expressed in this blog are written solely in my personal capacity and cannot be attributed to the accounting firm with which I am affiliated. My posts are blunt, opinionated and even have a twist of humor/sarcasm. You've been warned.

Wednesday, October 16, 2013

Qualifying Spouse Trusts – How do They Actually Work? -Part 2

Today, in the conclusion of her two part guest post on Qualifying Spousal Trusts, Katy Basi discuses how these trusts actually work. I thank Katy for her excellent posts.

Qualifying Spouse Trusts - How do They Actually Work? 
By Katy Basi

In Part 1 of this blog, BBC aficionados were introduced to the idea of leaving their estate to their spouse using a “qualifying spouse trust” or QST ("QST"). This week we look at the degree of protection that a QST can provide to non-spouse beneficiaries, and at methods of ensuring that a QST functions effectively.

In Monday's post, Fred’s will left the residue of his estate to his wife Wilma by way of a QST. The QST provides that any property remaining in the QST upon Wilma’s death is equally divided among Fred and Wilma’s children. How confident are we that the children will actually receive anything from Fred’s will? How protective is this QST?

The degree of protection afforded by the QST to the children (and any other non-spouse beneficiaries) will depend on two main factors:

1) The trustee’s ability to encroach on the capital of the trust for the benefit of Wilma.

2) The identity of the trustee.

The QST must provide that all income be paid or payable to Wilma. Of course, the trustee can invest the QST in assets producing high amounts of income, or no income at all. (In the latter case, the trustee should be cautious about a potential claim by Wilma.)

As to capital, the QST can provide that:

(i) no one is entitled to the capital of the QST during Wilma’s lifetime (very protective but also very inflexible),
(ii) the trustee can encroach on the capital for Wilma’s benefit under limited circumstances (eg for medical reasons), or
(iii) the trustee has full discretion to encroach on the capital for Wilma’s benefit, even if the encroachments exhaust the trust prior to Wilma’s death.

Clearly, the broader the encroachment power, the greater the likelihood that there will be minimal property remaining in the trust upon Wilma’s death.

A broad encroachment power can still be protective, depending on the identity of the trustee. If Wilma is the sole trustee of a QST with a broad encroachment power, we are back in “just trust me” territory. We are relying on inertia/laziness for protection – Wilma can pull all of the funds out of the QST, but we’re hoping that she doesn’t get around to it!

It would be more protective to name an independent trustee, or Wilma and an independent trustee, jointly, to manage the QST and make encroachment decisions. In my view, some flexibility is necessary re capital encroachment – Wilma could have major medical needs and require some (or even all) of the capital of the QST for very legitimate reasons.

At this point in my explanation of QSTs, many of my clients revert back to the “just trust me” option (no doubt thanking their heavenly stars that they didn’t go to law school), while others go ahead with the QST structure.

For the latter group, it is imperative to note that only assets falling under the will are grabbed by the QST. Therefore, joint assets (which are inherited by right of survivorship, and not under the will) and assets with completed beneficiary designations (eg RRSPs, RRIFs, TFSAs, life insurance, pensions) do not fall into the QST.

It is often necessary to split joint investment accounts (ie create two investment accounts, one in Fred’s name, and one in Wilma’s name) in order to make the QST structure viable. There is often no point in having a spouse trust containing only $20,000, as a trust tax return must be filed every year, and the QST funds must be held in a separate, segregated account which may also incur fees.

Splitting joint accounts is viewed with horror by the probate tax-avoidance crowd, as Wilma may have to then probate Fred’s estate and pay probate tax on his investment account. I am not terrified by this concept, as I view it more as a prepayment of half of the probate tax bill when Fred dies. If the account were maintained as a joint account, probate tax would be payable on the entire account upon Wilma’s death in any event – so we’re just paying half of the probate tax early (this is a very simplified analysis, of course!)

Finally, let’s get to the income splitting benefits of a QST. QSTs are often recommended not for any of the protective reasons mentioned above, but because the QST is a separate taxpayer that has access to the marginal rates of tax. In other words, Wilma can elect to have some or all of the income of the QST taxed in the QST, and essentially income split with her QST (which seems only fair, since she can no longer income split with dead Fred).

However, the federal budget in March of this year indicated that marginal rates for testamentary trusts (which would include QSTs) may soon be a relic of the past. We are waiting for draft legislation to be released, but the idea of inserting a QST purely to income split may be dying a slow, tortured death – we will have to wait and see. [Mark comment: As per this government consultation paper, it is proposed that testamentary trusts will only be allowed a low rate of tax for 36 months].

Income splitting aside, if you or your clients like the idea of their cold, dead hands controlling their assets long after their death, and can live with some complexity in their estate planning, a QST may be just the ticket.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs. 

Katy Basi is a Barrister and Solicitor with her own practice, focusing on wills, trusts, estate planning, estate administration and income tax law. Katy practiced income tax law for many years with a large Toronto law firm, and therefore considers the income tax and probate tax implications of her clients' decisions. Please feel free to contact her directly at (905) 237-9299, or by email at katy@katybasi.com. More articles by Katy can be found at her website, katybasi.com.


2 comments:

  1. The problem with a trust is that everything depends on the identity of the trustee. With many people having no siblings, or only one who has moved away, who do you put as a trustee?

    A friend? (So old Joe will dictate what money your wife gets?)

    A professional trustee? (how much does *that* cost?)

    Your adult child? (I hope he gets along with the wife!)

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    1. Hi Anon

      It can be problematic in some cases. But besides spouse, child or friend, maybe your accountant or lawyer if they are willing. But as you note, not always easily accomplished.

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