Inter vivos trusts are often used in the estate planning process to manage and preserve family wealth across generations. Within that broad framework, such trusts are used for a variety of reasons. Parents or grandparents may want to establish a vehicle for funding the education costs of future generations. A parent may be concerned about a fraudster taking advantage of an adult child with diminished mental capacity. A business owner may want to fix the value of her interest in the business at its current value, and have the future growth in value accrue to subsequent generations through a trust. Whatever the motivation, what happens if a beneficiary is not married at the time the trust is created, and subsequently marries?
In a prior blog, I provided a brief outline of how, in the event of marriage breakdown (which includes the death of a married spouse), the Ontario Family Law Act (“FLA”) equalizes the increase in each spouse’s respective net worth during the marriage through a cash payment from the spouse with the greater increase to the spouse with the lesser increase. In a subsequent blog, I described the concept of “excluded property”, the value of which is excluded from the equalization calculation. Both of those concepts are relevant when a beneficiary of a trust marries.
Under the FLA, “property” is defined very broadly. The income and capital interests of a beneficiary in a trust are property interests for purposes of the FLA. That is to say, if an individual is a beneficiary of a trust on the date of marriage, that individual has a property interest in the trust on that date such that it is included in the calculation of that individual’s net worth on the date of marriage in the same way as the value of any other property. That is the case even if the individual acquired the interest in the trust as a gift (which is generally the case). Recall that gifts and inheritances are “excluded property” only if they are received during the marriage. If a gift or inheritance is received prior to marriage (such as a pre-existing trust), the increase in its value is subject to equalization upon marriage breakdown unless it is specifically excluded by a marriage contract.
This can create a number of problems in the context of trusts. First, how do you value the beneficiary’s interest in the trust on the date of marriage and on the date of marriage breakdown, in particular in the case of a discretionary trust? The family courts have developed different approaches to valuation, the simplest but also the crudest being to simply divide the capital value equally among the number of beneficiaries. However, the courts may also look at such factors as the actual history of distributions from the trust during the marriage, and who exercises control. The takeaway is that there is considerable uncertainty in valuing the interest of a beneficiary in a discretionary trust.
Second, if a beneficiary’s interest in a trust has increased significantly during the marriage, that increase in value is part of the equalization calculation. Yet, the beneficiary may not have ready access to the capital of the trust to assist in financing the equalization payment; for example, if the assets of the trust are illiquid or the purpose of the trust was to hold the assets for a longer term (e.g. common shares of a family business). This may, in turn, put stress on the beneficiary’s other assets, which would have to be used to satisfy the equalization payment. It can also put the trustees in an uncomfortable position.
At the end of the day, if a family trust has been established for the purpose of managing and preserving family wealth across generations, the creation of the trust is not the end of the story. To avoid frustrating, or at least complicating, that purpose, once unmarried beneficiaries start to form relationships and marriage becomes a possibility, it is prudent to discuss the idea of using a marriage contract to exclude the trust interest from equalization.
 The equalization regime does not apply to unmarried spouses.