How to Effectively use Trusts in Estate Planning for Blended Families[1]

You may recall I previously blogged about Common Pitfalls in Estate Planning for Blended Families. In this blog post, I will discuss considerations when using trusts in estate planning for blended families.

Trusts are a useful tool in the blended family context to manage the varying and often competing interests of a surviving spouse and children of a prior relationship. For example, a spouse may wish to provide an income stream or the right to remain in the matrimonial home to a surviving spouse but also ensure that the assets devolve to the children of a prior or current relationship on the death of the spouse.  Where the assets of an individual are significant and a second or third spouse and the children of a prior relationship are particularly close in age, consideration could be given to using a combination of a qualifying spousal trust, the sole benefit of which is for the spouse, and a fully discretionary trust, the benefit of which could include the spouse and the children.

Tax vs. Non-Tax Considerations

There are both tax and non-tax considerations that need to be considered. On one hand, transferring assets to a qualifying spousal trust will have the effect of deferring the capital gains tax on assets going to such a trust until the death of the spouse or such earlier time as the assets are disposed of during the lifetime of the spouse.[2]   On the other hand, if the spouse is close in age to the children, who are the ultimate beneficiaries, putting all the assets into a qualifying spousal trust will have the effect of delaying the children’s inheritance until the death of the spouse.  A discretionary family trust may be beneficial in this circumstance.  As always, tax benefits should be weighed against non-tax considerations.

Nature of the Assets

The nature of the assets will also impact on whether a spousal trust is appropriate. For example, assume a testator’s assets consist of shares of a family business.  Assume that in order to defer tax on the deemed disposition of such shares on the first death, the shares are to be distributed to a spousal trust.  In order to obtain the “rollover” into the spousal trust, it must meet certain criteria:

• 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.

Where private company shares form the bulk of the assets of a spousal trust, consideration should be given to providing directions to the trustees on such matters as the desired quantum of income to be made available to the spouse by way of dividends being distributed to the trust and instructions about getting themselves appointed to the board if possible and appropriate.

Depending on the extent of the guidance that is given to the trustees, it may or may not be advisable to permit the trustees to encroach on capital in favour of the spouse without restriction. Consideration should be given to limiting the encroachment power to specific needs of the spouse, or only after taking into account the separate assets of the spouse, or entirely eliminating the encroachment power so as to preserve the capital for the children. The latter ought to be weighed against the risk that the spouse may effectively “break” the trust by claiming an equalization of net family property if he or she is not satisfied with what he or she is entitled to under the will.

The choice of trustees in such situations is also important. Where the second spouse and children of a prior marriage do not get along, consideration should be given to appointing an independent person to administer and manage the trust.

Another asset that may pose complications if it is put into a trust is a family home. “Possibly the highest barrier to overcome is the ability for the surviving spouse and children from a prior relationship to maintain the property together. For example, if the surviving spouse is given a life interest in the family home, with the children of a previous relationship being entitled to receive the home upon his or her death, how will expenses (both ongoing maintenance expenses and capital repairs) on the home be paid while the surviving spouse is residing in it? Generally, unless the terms of the trust provide otherwise, the life tenant (spouse) would be responsible for ongoing maintenance costs, while the capital beneficiaries (children) are responsible for capital improvements. What ought to occur if the surviving spouse does not pay his or her share of the expenses? If the children are not receiving any rent from the surviving spouse, which is often the case, they may not be pleased about making capital improvements to a home that they may not own for many years. Additionally, the children may not be in a position to maintain the home along with their own family residence.”[3] One option to minimize tension in dealing with these expenses is to set aside a fund in your will that is sufficient to satisfy maintenance and capital expenses.

Ownership of Assets

Typically, it is not recommended for the spouses of a blended family to hold assets jointly with right of survivorship, unless there are enough other assets to be left for the children of a prior relationship.   The reason is that assets that are owned jointly with right of survivorship will not form part of the estate of the first spouse to die, but rather will pass to the surviving joint-owner spouse by right of survivorship upon the death of the first spouse.

“If it is desirable to hold assets together with a spouse, consideration should be given to holding title as tenants-in-common as opposed to joint tenants with right of survivorship. This way, upon the death of one of the spouses, his or her interest in the property will pass through his or her estate and effectively through the trust, and will not automatically pass to the surviving spouse.”[4]

“Individuals are often concerned with trying to arrange their affairs in a manner to avoid or minimize probate tax. However, what they fail to recognize is that if the assets go through probate upon the death of the first spouse and are then held in a qualifying spousal trust, the same assets will not have to go through probate again upon the death of the second spouse. Probate planning is generally the least important concern in blended families.”[5]

As there are often complexities present when devising an estate plan for a blended family, it is the role of the estate planner to offer various alternatives and suggestions on how to appropriately manage the interests of all the parties involved.

[1] This blog was adapted from the following paper, which was presented at the Ontario Bar Association Professional Development: Estate Planning for Blended Families:  Hoffstein, Maria Elena and Sud, Brittany, “Effectively Using Trusts, Mirror Wills and Mutual Wills”, October 29, 2018.

[2] Income Tax Act, RSC, 1985, c 1 (5th Supp) at subsection 70(6).

[3] Christine Van Cauwenberghe, Wealth Planning Strategies for Canadians 2019 (Toronto: Thomson Reuters 2019).

[4] Ibid.

[5] Ibid.