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Testamentary Trusts

Nov 10, 2015

Testamentary trusts and the new rules to know

Effective January 2016, Tax rules to these trusts are going to change effective and Tim Cestnik of The Globe and Mail shares some important facts to know.


There are three types of testamentary trusts :

  •  Graduated Rate Estate(GRE)
  • Qualified Disability Trust(QDT)
  • and all other testamentary trusts (OTTS).

It used to be that all the trusts were taxed in the same way – a graduated tax rate as with any individual.
Starting Jan.1,2016 the OTTS will be taxed at the highest federal tax rate.

GREs – when you pass away the assets you leave form your estate. Your executor or administrator distributes the assets to your beneficiaries but this can take time. Between the date of death and the distribution of the last of your assets, your estate still exists and considered under our tax law to be a testamentary trust. This is a GRE. It is automatically established when your estate is started after your death and is eligible for graduated rates of tax for up to 36 months after your death and then the trust will be subject to the highest tax rate.

How are taxes saved?

The assets in your estate may generate income which in turn is distributed to your heirs and they will pay taxes on that income.
But during the time while the GRE exists and holds your assets the estate itself can pay the tax at graduated rates so your heirs can split income. The savings are not a reduction in taxes due at the time of your death, but taxes saved by your heirs splitting income with the GRE in years after you are gone.

QDTs – this is a testamentary trust set up for one or more beneficiaries eligible for the disability tax credit.. A QDT is eligible for the same graduated tax as a GRE but without the 36 month maximum time. This means the income splitting can continue indefinitely which can create continuing tax savings.

OTTs – these include any testamentary trusts which are not GREs or QDTs. Apart from the trust being subject to the highest federal tax on Jan.1.2016 they will also be eliminating of the exemption from tax instalments for OTTs and adding the requirement of a calendar tax year. Should OTTs then be avoided?
No. There are still many benefits:

1) If all or some of your assets are in a testamentary trust you can have the trustee allocating income that can minimize taxes. For example the trustee could allocate income to beneficiaries with little or no income including grand children or allocate income to “top up” to utilize tac credits.
2) The assets you leave in a testamentary trust are protected from creditors or marriage breakdowns.
3) A testamentary trust empowers the trustee to manage the assets for the beneficiaries and protect your assets under certain circumstances. A few examples where this would be applicable would be if a young adult may not be mature enough to manage the assets, disabled individuals who may receive provincial social benefits that you want to protect, heirs who have addiction problems or spend-thrifts.
4) If your assets are subject to probate fees on your death and your assets go to your heirs directly and then pass away, probate fees could be payable again. The assets held in a trust avoid fees and the probate process.
5) If you have children from a first marriage and are in a second marriage you could leave certain assets to a spousal trust to provide income to your second spouse and upon their death the capital could then go to your children from the first marriage.
6) If you have heirs who are U.S. citizens leaving assets in a trust can help avoid U.S. estate tax.
7) Life insurance proceeds can be put in a trust after your death therefore avoiding probate fees while providing the benefits listed above.