Navigating the world of trusts is essential to robust and efficient estate planning. A trust is a legal relationship in which a settlor transfers assets to a trustee, who holds and manages those assets for the benefit of one or more beneficiaries. The three key roles are the settlor (who creates the trust and transfers assets to it), the trustee (who holds and manages the assets, with a fiduciary duty to act prudently and for the beneficiaries' benefit), and the beneficiary (who holds equitable rights to the assets within the trust).
Within that simple framework sit some of the most useful tools in Canadian tax and estate planning. This guide explains the main trust types, the income-splitting and exemption-multiplication that trusts make possible, the attribution rules that constrain them, and the asset-protection role trusts play.
The basic types of trust
Trusts come in several forms, each with a different tax profile:
- Living (inter-vivos) trust. Created during the settlor's lifetime, it offers flexibility and control over asset distribution and potential tax benefits. Assets held in an inter-vivos trust are not part of the deceased's estate and pass outside the will.
- Testamentary trust. Established through a will, it comes into effect on the settlor's death and is subject to probate fees.
- Bare trust. The trustee holds legal title but has no independent powers, duties, or responsibilities beyond transferring the property to the beneficiary on demand.
Trusts used in estate planning
Several trust types do specific estate-planning jobs:
- Family trusts are used for income splitting and tax reduction, providing tailored control over how assets are distributed within a family.
- Spousal or common-law partner trusts ensure the spouse or partner benefits from the trust assets during their lifetime, with the remaining assets passing to other beneficiaries on their death.
- Alter ego and joint partner trusts are available to individuals 65 years or older, allowing assets to transfer into the trust without immediate tax implications and offering probate-fee avoidance and estate-planning efficiency.
- Cross-border trusts are used by Canadians with U.S. assets to manage cross-border asset holding and distribution.
- Henson trusts protect the interests of a beneficiary with a disability without compromising their eligibility for government assistance.
Income splitting through a trust
Income splitting is a notable tax-planning strategy in Canada, enabling income to be distributed among family members to take advantage of lower tax brackets. The strategy hinges on the progressive nature of the Canadian tax system, where rates rise with income. By directing income to family members in lower brackets — through a family trust holding the right assets — a family can reduce its overall tax liability and improve after-tax income for the household as a whole.
The strategy is particularly useful for higher-income families, but it must be approached with care and in compliance with the tax rules. Since 2018, the tax-on-split-income (TOSI) rules tax certain dividends and gains received by family members at the highest marginal rate unless an exception applies, so a trust that pays dividends to adult children or a spouse needs to be designed with those rules — and their exceptions, such as the active-engagement and age-65 exceptions — squarely in view.
Multiplying the capital gains exemption
One of the most valuable uses of a discretionary family trust is to multiply the Lifetime Capital Gains Exemption across several beneficiaries. Because the exemption is available per individual, a trust holding shares of a qualified small business corporation can allocate a capital gain on a future sale among multiple beneficiaries, each of whom claims their own exemption against their share. For a family with several beneficiaries, the sheltered amount can be a large multiple of what the owner could shelter alone. The requirements are exacting — the trust deed must permit capital-gains allocation, the beneficiaries must be Canadian residents, and the shares must qualify — and the structure must be put in place well before any sale. We cover the mechanics in our guide to multiplying the LCGE, and the freeze that usually accompanies it in our estate freeze guide.
The attribution rules: the trip-wire to watch
The attribution rules exist to stop a taxpayer from shifting income to a lower-taxed family member while keeping the substance of ownership. They can quietly send income and gains straight back to the person who set up the structure. The rules apply most directly to gifts to a spouse or to minor children, where income or gains from the gifted property are taxed in the hands of the donor rather than the recipient — so, for example, income on an investment gifted to a spouse is taxed as the donor's income.
There are well-understood workarounds. One is to lend rather than gift the asset, charging interest at the prescribed rate, which avoids the attribution rules. Another is to transfer assets that do not produce income but are expected to appreciate, such as growth stocks or real estate, because capital gains are not subject to the same attribution. Trust design choices — an unrelated settlor who provides only a nominal initial settlement, an independent co-trustee, and a trust deed that keeps reversionary powers out of the contributor's hands — are the standard ways to keep a family trust onside.
Asset protection and the wider benefits
An invaluable feature of trusts is asset protection. A well-structured trust can shield assets from creditors, legal judgments, and other financial risks, because assets held within the trust are generally beyond the reach of the settlor's and beneficiaries' creditors. Beyond protection, efficient trust structures can reduce the administrative and legal costs associated with estate management and distribution, and they provide tailored control over how and when beneficiaries receive their entitlements.
How the work is done
A trust engagement starts with the family's objectives and the planning the trust is meant to support — most often an estate freeze and a future sale or succession. From there, the work is drafting the trust deed to fit those objectives, settling the trust correctly with an appropriate settlor and trustees, coordinating the trust with the corporate share structure and any shareholders' agreement, and setting up the annual compliance. A family trust is not free — it carries set-up costs and ongoing obligations — so it earns its keep where there is a clear job for it to do. Done at the right time and documented properly, it is a flexible foundation for a multi-decade plan.
This guide draws on Dale Barrett's book Holistic Tax & Estate Planning.