A family investment trust might be right for you if you have a substantial amount of cash and investments that are not needed to fund your own lifestyle and retirement needs, plus a desire to either:
- create an investment fund for the next generation, or
- tax efficiently pay for private schooling or other non-essential expenses for children or grandchildren.
How does a family investment trust work?
Properly structured, trusts allow parents and grandparents to retain control over investments while at the same time shift the tax reporting of income and/or capital gains to the beneficiaries of a trust. As each beneficiary is a separate taxpayer, a young beneficiary with no other source of income could be allocated over $26,000 in capital gains, or over $61,000 in eligible dividends, before paying any Federal tax (whether there is a provincial tax liability depends on the beneficiary’s province of residency).
The types of investment trusts
An investment trust can be structured as either a separate trust for each beneficiary or as a single discretionary family trust for multiple beneficiaries. Each structure has its advantages and disadvantages, so clearly identifying your goals is an important step in the process. To be legally effective, all trusts require at least a small gift of property. To avoid potential tax problems, this small gift is typically a non-income producing property (a $20 bill for example) and is made by a friend or relative who will have no other involvement in the trust.
Funding the trust with a loan
The primary source of funding is generally in the form of a loan made to the trust by the parent or grandparent. Using a loan allows the parents/grandparents advancing the funding to also be the trustees (the persons with control over investment and distribution decisions of the trust) with no adverse tax consequences. A loan also allows them the ability to demand repayment of the loan at any time.
How ‘prescribed rate loans’ can be incorporated for tax-efficiency
The terms of the loan have tax implications. If the loan to the trust is interest free, or the rate of interest is below the rate prescribed by the CRA, all investment income must be reported by the lender. However, if the trust is obligated to pay to the lender the CRA prescribed rate of interest in effect at the time the loan is advanced, all income and capital gains allocated to the beneficiaries can be reported in their hands. The interest payments on the loan would also be tax deductible to the trust.
For the three-month period starting July 1, 2020, the prescribed rate of interest will be at the historically low rate of 1%. This means that, as long as the annual interest payments are made by January 30 of the following year, the rate of 1% can be locked in for the life of the strategy.
Find more information on prescribed rate loans here.
Establishing and maintaining a trust does come with associated costs and complexity, so it is important to work with your IG Consultant to determine whether a family trust is the right strategy for your personal circumstance and overall financial plan.
Written and published by IG Wealth Management as a general source of information only, with information from the CRA, believe to be accurate as at the date of publishing. Not intended as a solicitation to buy or sell specific investments, or to provide tax, legal or investment advice. Seek advice on your specific circumstances from an IG Wealth Management Consultant. Trademarks, including IG Wealth Management and IG Private Wealth Management are owned by IGM Financial Inc. and licensed to its subsidiary corporations.