(From the April 2021 Edition of eFORUM)
By Kevin Wark
After a year of writing, editing, and more editing, the first edition of The Essential Canadian Guide to Estate Planning was published in April 2017. Shortly after its launch, the federal government announced a review of the tax rules governing private corporations, many of which were enacted in 2018. At the same time, our neighbours down south undertook the largest overhaul of the U.S. tax code in over three decades. This quickly led to the release of a second edition in May 2018.
The second edition now includes a discussion of the tax on split income (TOSI) rules, the updated U.S. estate tax rules, as well as new commentary on special types of estate property, including digital assets. It is now approaching three years since the last update, and plans are underway for another refresh in early 2022. This and future articles will highlight changes that will be addressed in the next edition, starting with an update on lifetime benefit trusts (LBTs).
Lifetime Benefit Trusts – What Are They?
Generally, when an individual passes away, the fair market value of an RRSP or RRIF will be included in the deceased’s terminal tax return. However, an exception is provided where the deceased’s RRSP or RRIF is transferred to a spouse or a financially dependent child (including a grandchild). In this case, the proceeds will be taxable to the spouse or children as received. The spouse, or a child who is financially dependent on the deceased due to mental or physical infirmity, can claim a deduction to the extent the RRSP or RRIF proceeds are transferred by the recipient into an RRSP, RRIF, or a registered payout annuity. More restrictive transfer rules apply to children who are financially dependent on the deceased but not physically or mentally infirm.
Concerns may arise where the beneficiary of the RRSP or RRIF (whether a spouse or child) is mentally infirm. There can be practical as well as legal issues with these beneficiaries properly managing the gifted funds, as well as the potential for intestacy issues on their death. To deal with these concerns, it is possible to direct through a person’s will that the RRSP or RRIF proceeds be held in an LBT for a mentally infirm spouse, or a child who was financially dependent on the deceased due to their mental infirmity. The spouse or child does not necessarily need to qualify for the disability tax credit to be considered mentally infirm.
Under this arrangement, the trustees of the LBT must use the registered funds to acquire a qualifying trust annuity on behalf of the mentally infirm family member. The trust will be the recipient of the annuity benefits and the trustee has discretion in terms of retaining the funds or making payments to the mentally infirm beneficiary based on the needs of that person. However, no person other than the mentally infirm person may obtain the use of the trust capital or income while that person is alive.
There are a number of tax and non-tax benefits to establishing a lifetime benefit trust:
- The trustee can act on behalf of the mentally infirm beneficiary in purchasing the annuity and administering the distribution of funds to the beneficiary
- The deceased is not taxed on the value of the RRSP or RRIF and the value is not immediately taxable to the LBT or the beneficiary, provided the appropriate election is made by the beneficiary or legal representative
- While part or all of the annuity income can be retained in the LBT, the income is attributed to the beneficiary and taxed at that person’s marginal tax rate (rather than the highest marginal tax rate normally applicable to income retained by a testamentary trust)
- Amounts received by the LBT are not considered to be income or capital of the beneficiary for purposes of provincial social assistance benefits
- While any capital remaining in the LBT on the death of the beneficiary will be taxed to the beneficiary, the after-tax amount can then be distributed to the capital beneficiaries, avoiding an intestacy with respect to these amounts
CRA Provides Their Views
A recent Canada Revenue Agency (CRA) technical interpretation has provided some additional insights into the availability and use of LBTs, as follows:
- The provision does not apply to a physically infirm dependant unless there is also a mental infirmity. It must also be possible to demonstrate a causal connection between the mental infirmity and the dependence of the child or grandchild for support
- In determining mental infirmity and dependency, the CRA will consider all of the facts of the particular situation rather than apply a standardized set of tests
- The payment of funds from an LBT to a separate discretionary trust known as a Henson Trust might, depending on the circumstances, disqualify the status of the trust as an LBT. This is because one of the requirements is that the no person other than the beneficiary may receive or obtain the use of the income or capital of the LBT while the beneficiary is alive
The technical interpretation also explores other issues, and is well worth the read for those planners who work in this area.
As evident from the above discussion, an LBT can be an important planning tool for individuals who wish to pass on RRSP or RRIF assets to a mentally infirm spouse, or to children who are dependent on the deceased due to mental infirmity. However, as is typically the case with tax provisions, proper advice and compliance with the legislative rules and CRA’s interpretations is critical.
Kevin Wark, LLB, CLU, TEP, is the author of The Essential Canadian Guide to Estate Planning, 2nd Edition. For a limited time, Advocis members can get a signed version of his book for a special price of $20 plus HST including delivery. Please contact email@example.com for ordering details.