Many individuals and small business owners consider building trust to protect their assets from excessive taxes, creditors, and future family law claims in the event of a marital breakdown. Trust protects your assets by taking legal ownership of the asset. The estate owner creates a trust as a separate legal entity and transfers the ownership of the assets to the trust, thereby protecting assets from creditors and family lawsuits.
Types of Canadian Trusts
Canadians can create different types of trusts depending on their requirement.
Family trusts allow Canadians to pass on their estate to their family members in a tax-efficient manner. It is mostly used to cover the education costs of children, split income with family members in a lower tax bracket and provide for the family after you are gone.
Spousal trusts are structured to transfer assets to your common-law partner or spouse tax-free upon your death and pass the assets to the next generation upon the death of the spouse. It is used by families in their second marriage to protect assets from potential claims arising from previous relationships.
Irrevocable trusts are permanent and cannot be changed once they are created. It provides strong protection against claims but should be set up cautiously, with guidance from legal and tax experts, as it has a complex structure and rules that cannot be undone.
Limitations to Trust Protection
While trust can protect your assets, it has limitations. Trust protection depends on the trust’s structure and the beneficiary’s interaction with the trust’s assets. Hence, you need to understand the nitty-gritty of creditor laws and family laws while setting up the trust structure and administering it.
Was the Trust Created Solely to Avoid a Potential Claim?
If you set up trust just before a legal dispute, trust protection can be challenged under fraudulent conveyance laws. Hence, don’t wait until your assets are in danger to build trust. The trust is like insurance you buy to protect yourself from risk, not after the contingency has occurred.
Does the Beneficiary Have Control Over Trust Assets?
Trust can only protect your assets if they have control over them. If the trust is proven to be a sham and the settlor controls the assets as if he/she owns them, the court may allow creditors to access the assets.
Solution: A solution to this is a fully discretionary irrevocable trust structured so that beneficiaries have no absolute right to the assets.
Is The Beneficiary Relying on The Trust for Living Expenses?
Even if trust controls the asset, the court can give creditors access if it is established that the beneficiary has been relying on the trust for regular income.
Solution: This requires smart administering of trust. Instead of making direct cash payments to beneficiaries, the trust can pay for specific purposes such as education and medical expenses.
Family Law Exceptions That Can Limit Trust Protection
In case of family disputes and divorce, family laws can get tricky and require careful consideration of trust assets. Family law allows the division of property accumulated during the time they were married. The court excludes assets that are not owned directly by the beneficiary from equal distribution. However, there are exceptions in which the court may grant the spouse access to trust assets at the time of divorce.
1. Matrimonial Home: Purchasing or even maintaining a matrimonial home using trust assets could prove to be subject to division in a divorce.
2. Tracing and Attribution: Apart from a home, even if a person co-mingles their trust funds with assets that are personal or co-owned with their spouse, for instance, a joint investment account, the funds received could be subject to family law claims.
Solution: Keeping any funds received from the trust (by either spouse or beneficiary) separate from marital property is a wiser strategy. If you happen to use trust assets to buy a matrimonial home or any other asset, structure it like a loan that has to be repaid, instead of as a gift, to avoid any claims from the spouse during divorce proceedings.
3. Constructive Trust Claims: Claims on marital property bought using trust funds are one thing, but a spouse can also argue that they have worked equally hard and contributed to the value of the trust assets, and thus, have a claim on the trust. In such cases, the court could order the other spouse to pay the requisite compensation.
Setting up a trust is more than writing a trust document. You must structure the trust carefully, right from selecting the assets to be transferred to how you use the trust income. You should review your trust structure with legal and tax experts at regular intervals to understand the implications of any changes in family and creditor laws. Trust can be effective when structured and administered appropriately, taking into account your situation and applicable laws.
Contact Black and Gill LLP in Etobicoke to Help You Effectively Use Trust
Talk to a professional estate planner, as well as a legal expert, to help you set up a strong trust structure that can protect your assets from potential claims you could face. At Black and Gill LLP, our tax advisors and estate planners can provide services such as setting up and administering a trust and trust accounting. To learn more about how Black and Gill LLP can provide you with the best accounting and estate planning expertise, contact us online or call us at 416-477-7681.