Avoiding Trust Issues - Hull on Estates and Succession Planning #202
Listen to: Avoiding Trust Issues - Hull on Estates and Succession Planning #202
This week on Hull on Estate and Succession Planning, Ian discusses ways to avoid the trouble a trust creates by using insurance products.
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Welcome to
Ian Hull: Hi and welcome to Hull on Estates and Succession Planning. You’re listening to, and probably watching, episode 202.
Welcome back. It’s Ian Hull here alone again, but that’s okay. We’ve got Suzana out in the…she’s actually on vacation this week in the wild blue yonder.
Alright, so we’d spent some time in our last podcast talking about a really interesting creative tool that we’d heard about at the conference…that I’d heard about at the CALU conference that I had attended in Ottawa. And the idea was, how do we avoid the trouble that a trust creates by using insurance products? And the idea that we put forward was, as a suggestion, take a million dollars that the trust is going to be settled with or created with in any event during your lifetime, take some of that money and buy an insurance policy on yourself so that on your death, the grandchildren are gonna receive something for sure. And take the rest of it and buy an annuity, so that during lifetime or even on your death, depending on what kind of annuity you buy, the income beneficiaries. and in our example it was the surviving wife and your children, would enjoy an income and a fairly, and what I would suggest a very tax efficient way of dealing with it.
So that idea seemed a bit novel. It’s used lots of times in planning but what came of it and why the idea was resonated in my mind was that it addresses – doesn’t solve all your problems – but it addresses that ongoing tension that exists between income beneficiaries and capital beneficiaries whenever you establish a trust. Establishing a trust is a great idea in the right circumstances. Obviously in our example that we used in the last podcast, we have a million dollars that someone wants to use and they want to put it into a trust and they want it to go out, in part, to the income beneficiaries and then at a certain point in time, down to the what our example said, the grandchildren. The tool is tax efficient, it certainly creates tremendous protection from creditors and so on for those who are not going to actually receive the money. For example, if one of your children had some creditor issues and the money is to flow out on a discretionary basis, the trustees decide well, if they’ve got money issues and there’s creditors haunting that child, maybe they don’t give that child any money. And it’s a creditor protection technique. Tax efficiencies are created there as well and it’s a conventional tool, the trust tool, as a domestic tax planning issue but as a conventional estate planning tool.
We just throw out the idea of why would you want to get around that? What’s the problem…what are some of the problems with that trust arrangement? And why would we go so far as to, for example in our example, create an insurance result, an insurance solution, to avoid a trust? Well let me tell you a couple of things that we’ve ran into. One of the great tensions between any trust is, of course, the idea that in most trusts they say in the terms of the trust they say, you’re entitled to encroach on the capital. So you’re entitled to use some of the grandchildren’s money from time to time, should your surviving wife or children need more money than the income is producing. And in these low interest period times, that’s a possibility. In our example of a million dollars, a million dollars is not gonna create necessarily enough interest income to assist all of your children plus your wife. So the trustees are typically given the power to encroach. And that power to encroach, and we talked about this at the CALU conference, brings with it its own dynamics. And interesting dynamics because the Courts for hundreds of years have said, if you’re a trustee and you have to decide whether or not to give more, take some capital up into the hands and hand it to the income beneficiaries. If you decide to eat away at the capital as a trustee, you’re supposed to do that and make that decision judiciously. So you’re like a judge in that situation. Well, like a judge, you have to consider all of the circumstances. You have to…in my view we recommend to our clients, take lots of good notes. Make sure that you are making a judicious, sensible decision before you start eating away at the capital and feeding it to the income beneficiaries.
The other thing the Courts have said is that you can’t have what we call
male fides. You can’t have bad intentions when you make this decision. So your decision has to be motivated by all good intentions. Again, it sounds sort of silly that we…of course, every trustee should make their decisions and not be motivated by bad intentions. But it can happen and one of the interesting twists is a trustee, in some of the case law, has said also a trustee is not supposed to consider the financial circumstances of the income beneficiary. They’re not supposed to look at whether or not the surviving spouse or wife has money before you feed an encroachment payment. Now it all sounds sort of complicated and a little counter-intuitive but the point is is that the Courts have created some parameters of what it means to encroach on the capital and when you’re gonna take that money out of there, take capital and give it to the income beneficiaries.
Where is the obvious tension? Well the obvious tension is that the capital beneficiaries are gonna say hey, there’s now less money in the pool for me because you trustee encroached. And that tension is always there because if there is a power to encroach, the truth is, the income beneficiaries…there’s never enough for them. And they’re gonna put tension on the trustee to go encroach. And the capital beneficiaries are gonna put pressure on the trustee to say don’t touch the capital, they don’t need it, there’s not gonna be enough for us at the end of the day. So an easy tension which is identifiable…it’s intuitively identifiable where the trick was and what we spoke about at the CALU conference intensely was, is that because that tension exists, litigation can and unfortunately often ensues. So we thought as we were talking through it at the workshop, is there a way to get around this? Is there a way just to simply avoid any of that tension? And that solution…that insurance solution was put on the table as an option. It doesn’t work for everyone. But it eliminates the chance of someone complaining as between the income beneficiaries and the capital beneficiaries because they are buying an annuity. It’s a fixed payment. There’s no debate as to what that person is gonna get and you’ve bought an insurance policy which comes into play. So the capital beneficiaries know someday a fixed amount is gonna come their way. So as I say, interesting, creative tool to avoid that ongoing tension as between the income beneficiaries and the capital beneficiaries.
And I don’t want to understate what that tension can bring about. And it can bring about literally thousands…tens of thousands of dollars’ worth of litigation just to balance out those two interests between the income beneficiaries and the capital beneficiaries. In the Courts, the interesting test there is the Courts are saying that the trustee up here has to act with an even hand. And I talked about earlier, they have to act making judicious decisions. But they have to act, subject to some nuances that depend on the terms of the trust. You always want to look at the terms of the trust. But typically the Courts say you have to act. You Mr. or Mrs. Trustee have to act independently, even-handedly, judiciously when trying to balance these two interests. So the trustee is stuck in the proverbial rock and a hard place. It is a tough job and quite frankly, can be underpaid in many respects because of the amount of work that has to go into trying to balance these interests. And so we started to look for other alternatives beyond just the simple trust arrangement, for the right family for the right circumstances.
Alright, well in terms of the solutions that we talked about at CALU, we also talked a little bit about what were some of the Canadian domestic tax planning issues in the context of Estates. And I’m gonna save that for our next podcast because we came up with some more interesting thoughts and some really fun ideas that came out of a group of really highly-charged professionals.
So thank you again for joining me and we will look forward to our next podcast.
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