What are Alter Ego Trusts? A Powerful Tool for Estate Planning

Estate Planning and Litigation

When it comes to estate planning, you’ve probably heard about making a Will.  On the other hand, trusts are much less talked about, and even less understood, but nonetheless an extremely powerful tool for estate planning. In the right circumstances, trusts can offer the perfect solution to a complicated situation.  Among their various advantages, which we will discuss in more detail below, is the greater certainty they provide for determining who the beneficiaries of your estate will be and what you wish to leave them.

There are many different forms of trusts including testamentary trusts, family trusts, Joint Partner Trusts and Alter Ego Trusts. This article will speak to Alter Ego Trusts. Stay tuned for further articles on the other forms of trusts used in estate planning.

What is an Alter Ego Trust?

Let’s begin by explaining what a trust is.  A trust is a legal relationship between three parties:

  • The Settlor – the individual who sets up the trust (through a document called a Trust Deed, which is also referred to as a Trust Agreement) and contributes certain property to it. The Settlor decides who will hold this property, how this property will be managed and used, and to whose benefit the property is intended;
  • The Trustee – the individual who is appointed by the Settlor to hold and manage the trust property under the instructions provided in the Trust Deed;
  • The Beneficiary – the individual (or individuals) to whom the Trust property is to benefit.

Alter Ego Trust is a special type of trust permitted under the Income Tax Act (Canada) (the “Act”), under which you are the Settlor, Trustee and Beneficiary for as long as you are living.  The main criteria to be able to set up an Alter Ego Trust is that you must be 65 years of age or older.

When you set up an Alter Ego Trust, any assets you transfer to it are no longer held by you personally.  Instead, the Trust holds the assets, and you hold and manage them in your capacity as Trustee, for your own benefit. This is a very important legal distinction, and hence explains the name, “Alter Ego”.  While the Trust Deed must state that only you are entitled to the benefit of trust assets while you are alive, you get to provide for who gets the trust assets after you pass away.  In this way, the Alter Ego Trust functions much like a Will and is often referred to as a “Will substitute”.

As mentioned above, note that there is also a similar kind of trust called a Joint Partner Trust, which is also permitted under the Act and involves both you and your spouse.  Many of the same advantages and disadvantages discussed below for Alter Ego Trusts also apply to Joint Partner Trusts.

Advantages of Alter Ego Trusts

Having your eventual “estate” held in an Alter Ego Trust rather than by you personally can offer a number advantages:

  1. Probate is not required

Since Alter Ego Trust assets are held by you in your capacity as Trustee and not personally, they do not form part of your estate when you pass away.  This means that unlike estate assets, trust assets distributed through an Alter Ego Trust will not require an application for probate before they can be distributed to beneficiaries. Since probate is not required, this means that probate fees are not payable.  Where your estate assets are sizable, the potential savings of having an Alter Ego Trust (approximately 1.4% of the gross value of your estate) can be quite significant.   As probate fees are paid from the estate assets, not having to pay these will allow a greater overall amount of assets to be shared between your beneficiaries.

  1. Privacy is maintained

A filed probate application concerning a Will becomes a matter of public record at the probate registry.  This means that anyone can go down to the Courthouse to view these documents, which include the Will; a listing of the Will-maker’s assets and their values; and information about the Will-maker’s beneficiaries and family members.  In contrast, the terms of an Alter Ego Trust remain private.

  1. Beneficiaries can receive their inheritance with less delay

When dealing with assets in an estate, it can often take upwards of a year for your beneficiaries to eventually receive their inheritance after your death.  Probate applications take time to prepare.  Once submitted to the probate registry, it can take up to several months to review and approve the application, and issue a grant.  After the grant is obtained, the law then prohibits an executor from distributing estate assets within the next 210 days unless all beneficiaries (both under the Will and under intestacy rules) consent.  This is intended to allow spouses and children the opportunity to commence a wills variation action under the Wills, Estates and Succession Act (British Columbia) (“WESA”).

On the other hand, an Alter Ego Trust Deed usually provides for a replacement Trustee upon your passing.  The Trust Deed should have similar terms to a Will which usually first requires the trustee to pay off any estate debts and liabilities.  Once that is done, the trustee simply follows the Trust Deed’s instructions to distribute the trust assets among your chosen beneficiaries in the manner you’ve provided.

  1. Professional fees are reduced

Where executors are required to apply for probate of a Will they will usually require legal advice and assistance with respect to probate application, and possibly other professional advice.  While the replacement trustee of an Alter Ego Trust may require legal and other professional advice where appropriate, there will likely be some professional fee savings due to not having to apply for probate.  Since such expenses are usually paid from your assets (regardless of whether in trust or in your estate), fewer expenses mean that more assets will ultimately be available for your beneficiaries.

  1. Some incapacity planning is achieved

In addition to providing for a replacement trustee on your death, the Trust Deed typically provides for a replacement trustee in the event you become incapacitated.  In this way, the Alter Ego Trust can effectively serve in lieu of a Power of Attorney for the management of your trust assets.  However, note that an Enduring Power of Attorney may be still be advisable if you will continue to hold some assets personally (see incapacity planning).

  1. Special income tax treatment

Alter Ego Trusts receive a special treatment under the Act.  For other types of trusts, the Act provides that when you transfer property to the trust there are usually income tax consequences; that is, such transfers will be treated as though you had sold this property to an unrelated party for fair market value, known in tax terms as a “deemed disposition”.   Further, the Act says that every 21 years, there will be another deemed disposition, likely resulting in further income tax being payable.

In comparison, Alter Ego Trusts receive a rollover treatment which means that there is no deemed disposition when you transfer your property into these kinds of trusts.  Instead, the deemed disposition is deferred until the time of your death (which similarly occurs with personally held assets when you pass away as well).  Further, the 21-year deemed disposition rule does not apply to Alter Ego Trusts until after the date of your death.

  1. Wills variation risk is reduced

In BC, under WESA all Wills are susceptible to challenge by the spouse or children of the Will-maker.  In other words, after a Will-maker passes away, their spouse or child(ren) can seek to change the terms of the Will by demonstrating to the Court that the terms of the Will do not provide fairly for them.  Even if Will-makers have their own personal reasons for their decisions, a legal challenge can result in the Court deciding to effectively rewrite their Wills.  Regardless of whether the challenge is ultimately successful or not, families often become entrenched in bitter disputes and estate assets become diminished as a result of costly litigation.

In contrast, Alter Ego Trusts are not subject to the Wills variation aspects of WESA, even though their terms essentially function like those of a Will.  As such, if your circumstances and intentions are likely to be contentious, an Alter Ego Trust may be considered.

Disadvantages of Alter Ego Trusts

While Alter Ego Trusts can provide a number of advantages, the following are some disadvantages to consider as well:

  1. Tax returns will need to be filed

You will need to file annual tax returns for your Alter Ego Trust, which may require the assistance of an accountant and therefore additional accounting fees.

  1. Income retained in the Trust will be taxed at the highest marginal rate

Any income generated by the trust assets and retained in the trust (i.e., rather than paid out to yourself as the beneficiary) will be taxed at the highest marginal tax rate.  Any capital gains that have accrued on trust assets will be subject to the deemed disposition on your death at the highest marginal rate (rather than at the graduated rate, if held personally at death), unless any exemptions apply.

Is an Alter Ego Trust Right for You?

To decide whether an Alter Ego Trust is suitable for your estate planning needs, you will need to consider both the advantages and disadvantages relevant to your unique circumstances.  You will also need to take into account what your personal priorities are; for instance, to some individuals, the top priority at all costs is to avoid future estate litigation.  In any event, tax advice is always recommended so that any tax implications can be understood and planned for accordingly.  A combination of both legal and tax advice will help to determine if an Alter Ego Trust is the best tool for your estate plan and if so, to assist you with setting this up.

For more information on how we can assist, please contact one of the Trusts and Estate law practice group lawyers.

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