Alter-Ego Trusts: Effective Will Substitutes

Alter ego trusts make it easier for individuals over the age of 65 to use an inter vivos trust as an alternative to a Will.

Canadians have traditionally used a Will to distribute assets owned at death. However, a number of problems can arise when assets pass under a Will. For example:

1. The probate process can be expensive. All of your assets are subject to probate fees. Although arguably these are minor by themselves, being a maximum of 1.4% of the gross value of the estate, they are always subject to being increased by the acting Provincial government of the day. As well, since we are dealing with a legal process, there are the necessary legal and accounting fees, which vary, depending on the nature of the assets involved. Altogether, the amounts involved to the estate can be significant.

2. The probate process can be time consuming. There are required waiting periods of six months to a year before assets can be distributed, depending on the circumstances. This time period only starts to run after probate is even granted, and it may be frustrating to get to this point, delays being common.

3. The probate process is a public process. All of the assets of a deceased are required to be listed and valued, and a breakdown of the final distribution to the Will beneficiaries is also shown. This disclosure statement is available to any member of the public, who is free to obtain a copy of the documents for a small fee.

4. Everything that passes through a Will, and therefore goes through the probate process, is subject to creditors of the estate. The creditors always have a "first charge" on these assets. Conversely, assets which "bypass" the estate will also avoid the reach of any creditors.

5. In British Columbia, a child or spouse of a deceased individual who is unhappy with their share under a Will may apply to Court to have the Will altered, pursuant to the Wills Variation Act (the "Act"). A "child" includes all natural or adopted children, and a "spouse" includes someone you may have been living with for over two years in a common law relationship. This Act causes uncertainty as to how an estate may be divided. There are many similar fact patterns which have very different outcomes, and so it is very difficult to predict what the eventual decision will be with a specific case. As well, the practical effect of any such action, win or lose, is greater legal fees payable by the estate, and the freezing of the estate assets until the case is resolved, which could take years.

In order to avoid these problems, the utilization of Will substitutes should be strongly considered. One option is to use an inter vivos trust. A person would thereby transfer, during his lifetime, assets to a trust. The Trustee would then hold the assets for the listed beneficiaries, according to the terms of the trust deed. Since the assets are gifted before the person's death, and are no longer owned by the person, those assets do not pass through that person's estate when they eventually pass away. Accordingly, the assets would not become involved in the probate issues listed above.

Traditionally, it has been difficult to use this option, for tax reasons. This is because the revenue authorities deem there to be a disposition at fair market value whenever assets are transferred to a trust. Therefore, if a person wanted to transfer capital assets which had appreciated in value, such as stocks, mutual funds, or real estate, there was disincentive to do this in the recent past, as there would be a tax hit in the year of the transfer.

The revenue authorities have recently changed the rules with respect to alter ego trusts. People 65 years of age or older are now permitted to transfer assets to an alter ego trust on a rollover basis. Any income tax payable on any gain of the assets will still be payable at the person's death, just as it would be payable if it had not been transferred to a trust. However, there will be no tax payable at the time of the transfer itself. The great advantage obtained is that at least the assets at issue will now bypass your estate, and avoid the probate fees, delays, and other problems referred to above.

For there to be a true alter ego trust, so that the rollover provisions will be effective, the requirements during the person' s lifetime are that he or she must be entitled to receive all the income of the trust prior to his or her death, and also must be the only person able to receive income or capital of the trust prior to his or her death. After this person's death, the trust would be used just like a Will, with the distribution of the remaining assets being carried out as stated in the trust deed. Again, since these are terms from an inter vivos trust, and not a Will, the Wills Variation Act would have no application to it.

For example, assume John Smith, age 65, wishes to plan for the orderly and efficient transfer upon his death of his assets to his two children. If he were to transfer his assets to an alter ego trust, he could do so on a rollover basis, meaning that there would be no tax payable at the time of these transfers. Mr. Smith would be the first beneficiary, and entitled to all of the income (and capital, if desired), just as he would if he still owned the assets outright. He could also be the first trustee, while he was alive, so that he would be guaranteed to have full control. Upon his death, the alternate trustee would be appointed, who would carry out the further terms of the trust deed, which may direct, for example, to pay out any remaining amounts to his two children, equally, and wind the trust up.

What has the alter ego trust accomplished in this scenario? Income taxes will still be due and payable by the trust upon the growth in the assets when Mr. Smith passes away. However, the trust is now the owner of the property, and not Mr. Smith, so none of the those assets will go through Mr. Smith's estate. Accordingly, the results achieved are as follows:

1. No probate fees payable, or legal fees related to probate.

2. No legislated time delays. The new Trustee is appointed, and transfers the assets when ready.

3. All of the assets of the trust can remain private as between the beneficiaries and prying third parties.

4. Creditors of Mr. Smith's estate will generally have no recourse against the assets in the trust (aside from spousal claims or fraudulent conveyance issues).

5. Finally, there are generally no Wills Variation Act concerns for the trust beneficiaries of Mr. Smith, as this Act cannot be applied against the assets in the trust.

Please note that the benefits of utilizing an alter ego trust as a Will substitute always depend on one's goals and objectives. One disadvantage is that the use of such trusts preclude the use of testamentary trusts (or trusts arising from a Will or an insurance declaration), and therefore you may be foregoing advantageous tax rates. Each individual case is different, as the underlying factors in specific situations are always unique. As always, a cost benefit analysis is imperative.

We would be happy to review your estate plan and discuss how alter ego trusts could be of benefit to you and your family. Please contact Tim H.R. Brown, Rick Montens or Silvana Facchin at (604) 682-3664 if you think that you may be able to avail yourself of this particular estate planning tool.