From the 19th century to about 1990, the testamentary charitable trust was an important estate planning structure. These trusts are part of the will and are funded after death from estate assets. At one time, testamentary trusts were the primary way for an individual to support one or more charities or charitable purposes after death. But they have been replaced by more modern and effective charitable planning structures.
What happened to bring about this change? There are several reasons. Some relate to changing goals, legislation, and charitable ambitions; others arise from the inherent inflexibility of trusts.
Perpetuity & Income
Charitable trusts were traditionally drafted to protect capital and distribute income annually for the purposes. The capital was protected, and the aim was for the trust to exist in perpetuity. That is, forever – however long that may be.
Trust restrictions may not be changed without a cy-près to court, that is, the court needs to determine a purpose that was “as near as possible” to the testator’s original intention. This legal process is quite onerous, and courts are limited by common law in their interpretative power. The testator may take comfort that the trust will carry out their wishes, but the long-term reality is more complex.
The problem with the “income-only” trust drafting formula is that the investing world changed, but older trusts were stuck in time. Once income-only trust historically held agricultural land as capital property. Of course, traditionally the land would never be sold. Land was replaced with bonds and even GICs, but then yield rates plummeted. Balanced, equity-driven portfolios became the new standard of the prudent investor. Modern drafting can provide flexibility, but in my experience, it is the rare testamentary trust that anticipates future needs and investment environment.
Funding After Death
Testamentary trusts are funded only after the death of testator. In previous generations in Canada, there was a culture of donating at death. The idea of combining lifetime giving with testamentary giving in a single charitable structure was almost unknown. This changed with the use of incorporated private foundations, which are a US invention, but were slow to be adopted in Canada in the early 20th century. Now, giving habits are different, tax benefits more generous, and planning sophistication has increased. There is a greater urgency to give in a structured way.
In Canada, testamentary charitable trusts with exclusively charitable purposes can registered a charity. This is a post-mortem process. Registration provides tax receipts for estate donations and tax-exempt status – including exemption from the 21-year disposition rule.
Starting in the 1990s, some, but not all, existing testamentary charitable trusts were registered as private foundations with CRA. Why? This was due to rising equity markets and capital gains in the trust. The capital gains became irrelevant once the trust became tax exempt. The process of registering a trust post-mortem, however, is fraught. It’s labour intensive, time consuming, and there is no guarantee that CRA will register the trust and the estate will get tax savings. Structures like donor advised funds provide greater certainty and are simpler.
As mentioned, charitable trusts are difficult to change. A charitable purpose that was pressing at the time of drafting becomes outmoded and irrelevant. I recently reviewed a testamentary trust from the 1970s, which has an intervening life interest. The charitable purposes are specific, and none are relevant and achievable today.
This was the problem that the community foundation was invented to solve. It all started in Cleveland in 1914. The Cleveland Foundation’s founder, Frederick Goff was “concerned about wills and trust funds with no provision for changing circumstances. He based the community trust on Sir Arthur Hobhouse’s philosophy (London, 1880) that property be managed by the “living hand” through public tribunal rather than by the “dead hand.””
For example, in the early 20th century there was a fashion – and a real need – for charitable trusts to fund water troughs for work horses. And then the work horses were replaced by cars. The public need changed, the trust did not. The community foundations invented flexible cause funds and, ultimately, donor advised funds. These are significant charitable innovations.
Donor Advised Funds
The widespread availability of “legacy” donor advised funds at public foundations have now pretty much replaced testamentary charitable trusts. They are generally cheaper, more flexible and, if the foundation has strong governance and integrity, provides a high level of certainty that the donor wishes will be carried out.
Charitable structures, like cars, have improved over time. Technologically, a 1963 Morris Minor just can’t compete against 2023 Tesla.