October 2000 volume 4, issue 2 

When a cook has the right ingredients and conditions, he can make an exceptional meal. Similarly, given the right conditions, a testamentary trust can save tax dollars.

Let's assume that Mr. and Mrs. Taxpayer have $800,000 in investments. They know that if the investments are held jointly in both of their names (joint tenancy), this will avoid probate fees and legal costs when the first spouse dies. In this specific case, this would represent approximately $11,750 in savings on probate fees. But what would be the other tax consequences of such a decision?

Unfortunately, the surviving spouse will incur in many cases a tax liability greater than when both spouses filed their personal tax returns. This is due to several reasons, including the reduction to only one personal tax credit rather than two. If both taxpayers are seniors and one has a disability, the personal tax credits are significant. This means the surviving spouse can be pushed into a higher marginal tax rate and, to add to the injury, there may be a reduction of Canada Pension Plan or other pensions. Quite often, the overall disposable dollars are reduced significantly due to the lack of income splitting.

However, if Mr. and Mrs. Taxpayer were to prepare their Wills, after death leaving their assets to each other in trust (hence the name testamentary trust), the testamentary trust is taxed at its own individual tax rates — although they do not qualify for personal tax credits. If structured properly, these testamentary funds can be distributed to the spouse tax-free, and additional taxable income earned by the spouse — such as pensions/Canada Pension Plan and Old Age Security — will be taxed utilizing personal tax credits and his or her individual tax rate.

In effect, by carefully arranging their estates, they can enjoy income splitting and potentially save $11,000 in tax each year. However, the ingredients and conditions have to be right to maximize significant savings.

Like any tax-driven strategy, there are some drawbacks to this approach, such as:

• A spousal trust cannot be the beneficiary of an RRSP or RRIF.
• Some costs, which need not be onerous, are involved with the establishment and maintenance of the trust.
  
• Family Law implications should be considered.
• The Will must be carefully drafted by a solicitor to ensure the trust qualifies as a spousal trust.
• Probate fees, such as the joint tenancy strategy which saved $11,750 in this scen- ario, cannot be avoided. This cost must be measured against future tax savings, which can vary significantly, to a maxi- mum of $11,000 each year.

This strategy is obviously not for every taxpayer, and professional help should be sought to weigh the tax savings, if any. But keep in mind that should conditions be favourable, substantial savings could be realized.

Bob Yager, CA, RFP, CFP, TEP, is a Client Services Partner and Certified Financial Planner with Wilkinson & Company LLP. He is currently completing his Registered Financial Planners certification. He offers wealth planning and financial coaching services to owner managers, executives, and high net worth individuals.