What is a Trust?
In simple terms, a trust is an arrangement whereby the assets of one person (the “Settlor”) are transferred to another person or institution (the “Trustee”) to be managed for the benefit of another person(s). A trust is not actually a separate legal entity but for the purposes of Canada Revenue Agency, it is a taxpayer and must file an annual Income Tax Return.
Generally, there are two classifications of trusts that are available for use in Ontario. A trust that comes into effect during the lifetime of the settlor is called an Inter-Vivos Trust. An Inter-Vivos trust has the advantage of operating while the settlor is alive but its major drawback in planning for a person with a disability is that income earned in this trust is taxed at the highest marginal tax rate. As such, the Inter-Vivos trust is not as commonly used in planning for people with disabilities. A trust that comes into effect after the death of the settlor is called a Testamentary Trust. It receives more favourable tax treatment from 2016 onward if it is established for a person who qualifies for the Disability Tax Credit. If the beneficiary does not qualify for the DTC then the income earned in the trust is also taxed at the highest marginal rate. When planning for the well being of our sons and daughters with disabilities, we are usually attempting to protect their entitlement to government support programs. Two distinct types of trusts are used for that purpose. They are what we call the Inheritance Trust and the Absolute Discretionary (Henson) Trust.
The Henson Trust Tax Update
The 2014 Federal budget introduced some changes that have the potential to affect how Henson Trusts are taxed. The budget states that all trusts; inter-vivos trusts or testamentary trusts over 36 months old, will be taxed at the highest marginal tax rates effective January 1, 2016. All trusts that is, except for Qualified Disability Trusts (QDT) which may continue to attract tax at the lower, graduated rates. Many Henson Trusts established via the parents’ wills for a person with a disability will be considered to be Qualified Disability Trusts.
In order for a trust to be considered to be a Qualified Disability Trust it must meet the following criteria:
- It must be a testamentary trust (i.e. created as the result of the death of the settlor)
- It must be resident in Canada for the entire year
- It must have at least one beneficiary that is eligible for the Disability Tax Credit
- It must be the only QDT
To establish the trust as a QDT, an annual election must be made on the tax return by both the Trustee and the Beneficiary who qualifies for the Disability Tax Credit. The QDT status can be terminated if the election is not made, if the electing beneficiary dies, if the trust ceases to be resident in Canada or if a capital distribution is made to a non-electing beneficiary. When the QDT status is lost, a recovery of taxes may result.
These new rules have created problems for some people with disabilities. Some Henson Trusts have been established for people who may not qualify for the Disability Tax Credit. As an example, people who have cyclical conditions may not meet the strict definitions required for the DTC and so the income in their Henson Trusts will be taxed at the highest rates. In addition, there may be more than one Henson Trust for a person. For example, both parents and grandparents may establish a trust in their wills but only one of them would qualify as a QDT. There are also some concerns relating to the legal capacity of the electing beneficiary. These concerns have been presented to government and we await their response. In the meantime, we recommend that people contact a competent Tax Accountant and Lawyer for clarification.
It is our belief that with proper planning, most testamentary Henson Trusts will be able to continue to take advantage of the lower, graduated tax rates.
The Inheritance Trust
The Ontario Government has heard a great deal of comment from parents regarding the issue of ODSP entitlements and the $40,000 asset limits imposed on them. On August 1, 1993, the Government installed what we call the Inheritance Trust. It was modified effective June 1, 1998 to state that a person receiving ODSP benefits was allowed to directly inherit up to $100,000 without having their benefits terminated as long as those funds were placed into a trust within six months of the funds being received. The money is considered to be income in the month that it is received and an exempt asset thereafter subject to the $100,000 limits. At first glance, this seemed to be a move forward however upon further examination of the legislation, it became apparent that the use of this kind of a trust is not always advisable. Money received from the Inheritance Trust will not affect the recipient’s entitlement to ODSP benefits if they are follow the income rules which exempt the first $10,000 in a 12 month period or if the funds are used for disability related items. If they don’t follow these rules then they will be deducted from the person’s ODSP cheque dollar for dollar over the next 12 months. In addition, the Ministry of Community and Social Services has stated that if the Inheritance Trust is at the maximum level of $100,000, and it earns interest which is not spent in the given year, then that interest amount will be deducted from the ODSP cheque over the next year. This means that the Inheritance Trusts are not allowed to accumulate income once it reaches its $100,000 level. The Inheritance Trusts is created by the person with a disability and as such, it is considered to be an Inter-Vivos Trust which attracts tax at the highest marginal tax rates as outlined above.
Because of the above mentioned reasons, we do not usually recommend the use of The Inheritance Trust as an effective planning tool. Rather, it is suggested that using the Absolute Discretionary Henson Trust may be a better alternative.
The Absolute Discretionary (Henson) Trust
In Ontario, perhaps the best way of leaving an inheritance for our sons and daughters with disabilities while at the same time preserving their entitlement to the Ontario Disability Support Program funding is by the use of an Absolute Discretionary Trust following the Henson format. The terms “Absolute Discretionary Trust”, “Discretionary Trust” and “Henson Trust” are often used interchangeably but all three when used in the context of planning for a person with a disability refer to a very specific type of trust. The Henson trust can be established either as an Inter Vivos or a Testamentary Trust. The most commonly used type of Henson trust is the Testamentary Trust established in a parent’s or caregiver’s Will.
History of the Henson Trust
The Henson trust had its origins in the city of Guelph, Ontario. During the early 1980’s, a gentleman by the name of Leonard Henson lived in the Guelph area and he had a daughter named Audrey. Audrey was a person with a developmental disability and she lived in a group home managed by Community Living in Guelph. Leonard knew that if he left his estate directly to his daughter, it would exceed the allowable asset limits as set out by the Family Benefits Allowance (now called the Ontario Disability Support Program). He also realized that having assets in the hands of his daughter directly would not be to her advantage and that her benefits would be terminated until the assets were “spent down” to a level below the threshold amount. In addition, Leonard’s wife had pre-deceased him and he had no other family. Therefore, Leonard went about to find a way to leave his estate to his daughter without interfering with her entitlement to government supports. He conferred with a number of legal people and advocacy organizations and even investigated what was going on in other jurisdictions within and outside of Canada. Eventually, he discovered a technique that would allow Audrey to retain her government benefits while at the same time allowing her to receive quality of life enhancements from his estate. That technique was the use of the Absolute Discretionary Trust to be created in his Will as a Testamentary Trust. Leonard updated his Will with his lawyer. Unfortunately, he then died. At that point, the Will required the creation of an Absolute Discretionary Trust which appointed the Guelph Association for Community Living as Trustee and his daughter Audrey as beneficiary of the trust. Once Audrey died, his Will instructed that the remaining funds in the Trust were to be passed on to the Guelph Association for Community Living. The Ministry of Community, Family and Children’s Services, the ministry which controls the FBA (ODSP), determined that Audrey had inherited the estate of her father and since it was in excess of the allowable amount of assets, they terminated her benefits. The Guelph Association for Community Living challenged this decision and to make a long story short, the Ministry took the trust and the Trustee to court. The first court found that the funds contained in Audrey’s trust account did not meet the FBA (ODSP) definition of assets and therefore, it ruled in favor of the Trustees. The Ministry was not at all impressed with this decision and so they launched an appeal. The appeals ultimately reached the Supreme Court of Ontario and in September of 1989, the appeal was dismissed. The Government lost and what that decision did for families with a son or daughter with a disability was to provide us with a vehicle in which we can place assets for our children without disqualifying them from receiving the ODSP payments to which they would otherwise be entitled.
Trustees play a very important role in planning for our sons and daughters with a disability. Very often, they are required to replace us in handling the financial decisions that affect the person with a disability’s well being and quality of life. Some factors which must be considered are:
The Trustee(s) is given the responsibility of overseeing assets you have left in trust for your child. The Trustee(s) responsibilities continue over a long period of time and usually end when the trust is terminated. In the case of an Absolute Discretionary Trust created to provide for your son or daughter with a disability, the Trustee(s) job will usually continue until the death of your child.
The Trustee(s) job is not a simple one. It must be remembered that this position will continue after your death for a period of as much as 40 or 50 years. Therefore the selection of a Trustee(s) is a very serious issue indeed.
The Trustee(s) has the absolute discretion in terms of spending the funds contained in the Henson Trust on behalf of your son or daughter with a disability. Therefore you must take the selection process seriously in order to select the best people for the job.
The overall guiding principle to be adhered to by your Trustee(s) is that they must act in a way that is consistent with what a prudent individual would do. The trust money is not theirs and as such they must manage it with the utmost integrity and responsibility with particular reference to the fact that they will be scrutinized for their work.
The Trustee(s) must do the following:
Use their discretion in releasing funds from the trust
Manage, and invest the assets of the trust
Maintain records of transactions in the trust
Oversee the preparation of Tax Returns for the trust
Maintain real property owned by the trust
Act as keeper of your son or daughter’s well being
Act within the ODSP regulations and the Trust Act
We expect a great deal from our Trustee(s) and therefore, it might be a good idea to list the qualifications which we would expect from our Trustee or group of Trustees if they are to do an excellent job for us. Mr. Harry Van Bommel, in his book: Trusts and Endowment has prepared a very useful list of items which should be considered when selecting a trustee or group of trustees. In a Perfect World, these people would be able to:
Know and understand the needs of the person with a disability either from first hand knowledge or have access to that information.
Live up to a standard of diligence and care which represents the legal standard of what a reasonable and prudent person would do in carrying out their duties.
Make unbiased decisions in the best interest of the beneficiary consistent with the parents’ wishes
Understand why the Absolute Discretionary Trust was created
Understand investment alternatives and make sound investments
Understand basic financial management (e.g., be able to balance accounts, understand compound interest etc)
Hire agents or advisors to help in managing, investing and distributing funds from the trust while recognizing that the final decision belong to the trustees
Live near the person with a disability to facilitate swift access in case of need
Commit time and energy to manage the trust, invest its assets and distribute the funds while also spending time with the person with a disability as needed
Live a long time to fulfil their duties e.g. don’t select an elderly person if the trust is expected to last many years
Understand and apply the rules and regulations of the Trust Act
Act in a way that is not profitable to the trustee and detrimental to the person with a disability
We are expecting a great deal from our trustees and to find the Perfect Trustee is not often possible. However a group of trustees could meet the challenge. Whether it is a single trustee or a group of trustees that we appoint, it would be wise of us to ensure that there is a support team in place to assist them.
Funding a Trust
Once we have determined that we wish to provide for our son or daughter with a disability through the use of the testamentary Henson Trust, we need to turn our attention toward how we are going to provide money to the trust. There are a variety of resources within the reach of most families which can be used to fund the trust. They are:
Savings. The establishment of a regular savings program may be able to provide adequate funds to Henson Trust when we die.
Parent’s Estate. Provided that the parent’s estate is sufficiently large, it could provide for their own needs in their elder years, as well as having enough left over to fund the trust when they die.
Family Members: Siblings, Aunts and Uncles, Grandparents could be willing and able to provide money to fund the trust.
Life Insurance: For the average family, life insurance may be the only way that they can leave a large lump sum to the trust by making small monthly payments. It is also possibly the only way of funding a trust that is guaranteed to provide the money when it is needed. The other resources mentioned above may not always be available but a paid-up life insurance policy can guarantee future funds.
Families of people with disabilities should examine the benefits and pitfalls of each of the funding methods mentioned here. A review of these resources with an Estate Planning Professional who specializes in planning for people with disabilities would be an excellent starting point.
To find out more about how to fund the Henson Trust using life insurance products, click here