In estate planning, testamentary trusts and inter vivos trusts (also called living trusts) are the two most common types.
- Testamentary trusts
- These trusts are created upon the death of an individual and are generally outlined in a will. These trusts do not come into effect until the testator’s death.
- Examples:
- Spousal Testamentary Trust: Provides income or support for a surviving spouse while protecting the remaining assets for other beneficiaries (such as children).
- Minor’s Trust: Ensures that inheritance left to a minor child is managed by a trustee until the child reaches a specific age.
- Inter vivos trusts
- These trusts are established during the lifetime of the settlor (the person who sets up the trust). They are designed to manage and distribute assets while the settlor is still alive and offer the advantage of avoiding probate upon death.
- Examples:
- Alter Ego Trust: A trust designed for individuals aged 65 or older, allowing them to transfer assets into the trust without triggering immediate capital gains taxes. The settlor receives all the income during their lifetime, and assets are distributed upon death without probate.
- Henson Trust: This type of trust is often used to provide for a person with a disability without disqualifying them from receiving government benefits. The trustee has full discretion over the distribution of assets, so the beneficiary does not legally “own” the assets, preserving their eligibility for disability benefits.
Both types of trusts play important roles in managing and distributing assets, but they serve different purposes and are subject to distinct legal and tax rules.
Key Differences Between Testamentary and Inter Vivos Trusts:
Creation
- A testamentary trust is created as a result of a will and only comes into effect after the death of the testator.
- An inter vivos trust is established during the settlor’s lifetime, with assets transferred into the trust before their death.
Taxation
- Testamentary trusts used to benefit from graduated tax rates, similar to individual taxpayers, but after 2016, most of these trusts are taxed at the top marginal rate, unless they qualify as a Graduated Rate Estate (GRE) or a Qualified Disability Trust (QDT).
- Inter vivos trusts are generally taxed at the highest personal marginal tax rate (53.53% in Ontario). However, income can be distributed to beneficiaries, who may be taxed at a lower rate.
Probate
- Assets in a testamentary trust are subject to probate, meaning the will must be validated by a court before the trust is created.
- Inter vivos trusts bypass probate, as the assets are already placed in the trust during the settlor’s lifetime, leading to faster and less costly asset distribution after death.
Control
- In a testamentary trust, the assets are managed after the testator’s death by a trustee who follows the terms of the will.
- In an inter vivos trust, the settlor can maintain control over the assets during their lifetime (if it’s a revocable trust), but once they die, control passes to the appointed trustee.
Important Notice:
This blog series offers readers a basic understanding of the concept of “Trust.” It does not constitute legal advice from our firm. If you encounter any trust-related matters, it is essential to consult your lawyer. As always, it is best to leave professional matters to the professionals.
