What You Need to Know About Family Trusts in 2024
Family trusts have long been a useful tool for many Canadians, offering benefits in estate planning, privacy, and asset protection. However, recent changes in federal tax policy may affect whether a family trust remains the best option for some families. While trusts still hold value in various situations, the new reporting rules and rising compliance costs make them less advantageous in certain cases.
Here are some of the benefits and downsides of family trusts, in light of these changes.
Benefits of Family Trusts
Income Splitting & Tax Benefits: Family trusts can allocate income to Canadian resident beneficiaries who can then take advantage of their lower tax rates. This can provide substantial savings, particularly for families with multiple beneficiaries. Additionally, trusts can access the lifetime capital gains exemption (LCGE) when owning shares in a qualified small business corporation (QSBC).
As of June 25, 2024, the LCGE is set at $1.25 million, up from approximately $1.02 million (Trotta, 2024). While a trust itself cannot claim the LCGE, it can distribute the capital gain on QSBC shares to multiple beneficiaries, maximizing their individual exemptions. This can significantly reduce the overall tax burden on the sale of QSBC shares.
Asset Protection: Family trusts often serve as a vehicle to protect assets for minor, disabled, or financially irresponsible beneficiaries. By placing assets in a trust, families can control when and how these assets are distributed, safeguarding them from creditors, potential divorces, or other financial issues.
Flexibility in Planning: Trusts provide a great deal of flexibility for families with evolving financial needs. They can be useful tools for corporate planning, especially when structured as voting shareholders in family-owned businesses. Trusts can also offer more control in terms of asset management, ensuring family goals are respected even after the settlor’s passing.
Downsides of Family Trusts
Increased Reporting & Compliance: Recent changes to tax legislation impose new compliance burdens on trustees. They now need to disclose, in good faith, all known beneficiaries, trustees, settlors, and anyone who can potentially exert influence over the trust. This can be particularly cumbersome when beneficiaries include estranged family members or individuals who may never benefit from the trust.
The administrative effort to meet these new requirements, including contacting all beneficiaries, can be costly and time-consuming.
Increased Vulnerability to Creditor Claims: While trusts have traditionally been used for asset protection, new rules may make assets more vulnerable to family creditor claims, particularly in the case of a divorce or dissolution of a common-law relationship. If trust distributions are made to a family member in a strained relationship, the assets could become exposed to creditor claims.
Uncertainty Around “Exert Influence” Rules: The concept of “exerting influence” remains unclear in the new regulations. It’s ambiguous who may fall under this definition, making it difficult for families to comply without incurring additional legal costs. This uncertainty adds to the administrative burden and creates potential risks for trustees.
Higher Costs and Lower Tax Benefits: Trusts may no longer provide the same level of tax efficiency as they once did. The recent legislative changes have added to compliance costs and eroded some of the tax advantages trusts previously enjoyed. The cost/benefit analysis might not be as favorable for families that could have otherwise benefited from lower taxes.
Navigating the Changes
Given the complexity of these new rules, families should review their trusts with their financial and legal advisors. In some cases, the terms of the trust can be amended to reflect new legislation, such as clarifying who is or isn’t a beneficiary. However, changing trust terms could have unintended tax consequences, so it’s essential to proceed cautiously.
Even with these challenges, family trusts still offer valuable non-tax benefits like asset protection and planning flexibility. For many families, these advantages may outweigh the increased administrative and compliance costs.
What’s Next?
Estate and tax laws in Canada are constantly evolving, and the use of family trusts will likely face more regulatory scrutiny in the future. Families should maintain a balanced approach, regularly reviewing their financial strategies with qualified professionals to stay ahead of these changes.
If you’re considering setting up or maintaining a family trust, it’s essential to weigh both the benefits and potential downsides. While trusts are no longer the tax-saving vehicles they once were, they still serve as valuable planning tools in the right circumstances.
Disclaimers:
Trotta, Matt. “Pros and Cons of Family Trusts.” Advisor’s Edge, 25 Sept., 2024, https://www.advisor.ca/tax-estate/pros-and-cons-of-family-trusts/. Accessed 23 Oct. 2024.