by: Veronica Manski
Timely planning around the handling of assets after death is a responsible and honourable way to help your loved ones. It eliminates much of the stress that can accompany the death of a parent, spouse or sibling. Such planning becomes even more crucial for individuals who have a child designated as a “person with disabilities”.
The importance of creating disability trusts for persons with disabilities cannot be overstated. For instance, having no will or a will that does not include a disability trust can cause the beneficiary to lose disability benefits and face unfavourable tax consequences. With timely advice, the beneficiary may be able to avoid these outcomes by settling the assets into a trust within 3 months, however superior outcomes can be achieved when this planning is conducted during the settlor’s or will-maker’s lifetime.
Below are three factors to consider about disability trusts.
- Inter vivos or Testamentary?
Trusts are legal relationships in which a trustee (or multiple trustees) holds a legal interest in money or other assets on behalf of a beneficiary. In a trust set up by the parents of a person with disabilities, the parents would designate a trustee of their choice. The person with disabilities would be the beneficiary.
A disability trust can be created during one’s lifetime (inter vivos), or it can arise upon death (testamentary). Parents can hold money in an inter vivos trust for their disabled child for future care and support expenses. A testamentary trust, on the other hand, is created upon instruction in a will. It becomes effective when the will-maker dies. As will be discussed later, testamentary disability trusts present significant advantages.
- Discretionary or Not?
Depending on the type of disability and overall circumstances, a trust may be discretionary or non-discretionary. A pure discretionary trust gives a trustee (who is not a beneficiary) full decision-making powers to decide how and when to distribute money from the trust to the beneficiary, including no money at all. A non-discretionary trust is one in which the trustee is also a beneficiary or the trustee does not have full decision-making power over the management of the trust. A non-discretionary trust can arise where the will-maker has directed the trustee how and when to make payments from the trust, or the person with disability may be a trustee.
A discretionary disability trust, also known as a Henson Trust, should be used for disabled beneficiaries so that they do not lose government benefits. This is because assets left in a discretionary disability trust do not count towards the beneficiary’s own assets, which is one consideration for maintaining entitlement to disability benefits. The trustee must also carefully consider how funds from the trust are distributed so that the distributions will not be considered income of the beneficiary. This may be achieved by paying money directly to third-parties (such as a landlord or service provider), rather than place the money in the beneficiary’s own hands. An allowance paid from the trust to the person with disabilities might violate the beneficiary’s income limitations and cause the beneficiary to lose disability benefits.
In some cases, a parent may choose to establish a non-discretionary trust that either appoints the disabled beneficiary as one of the trustees or the trust includes specific rules for advancing money to the disabled beneficiary. These types of non-discretionary trusts may or may not disentitle the disabled beneficiary from government assistance. For instance, a non-discretionary trust settled with less than $200,000 for a disabled beneficiary does not violate the asset limitation rules for government assistance. A lawyer should be consulted when drafting the trust terms to ensure there will not be unintended consequences.
- Qualified Disability Trusts
Over the years, trusts have become increasingly less beneficial from a tax-optimization perspective. Unlike an inter vivos trust, for which there is no exemption from the application of the top marginal tax rate on income, there are exemptions available for some testamentary trusts. A testamentary disability trust may enjoy lower, graduated tax rates during the first 36 months of the will-maker’s death if it meets the requirements of a Qualified Disability Trust (“QDT”) under the Income Tax Act:
- The trust must be resident in Canada (i.e. the trustee or the majority of trustees must live in Canada);
- It must have a named beneficiary who qualifies for the federal Disability Tax Credit; and
- The trustee and the qualified beneficiary must jointly elect, annually, for the trust to be a QDT.
To be clear, in order to qualify as a QDT, the disability trust must have been established in a will and arise on the death of the will-maker.
A beneficiary can only have one QDT per year, but can elect a different trust to be their QDT each year. Where the parents of the person with disabilities are separated or divorced, each parent may wish to create a testamentary trust for their disabled child. However, only one trust may be a QDT in any given year. Sometimes parents also wish to establish an inter vivos disability trust, but such a trust cannot be a QDT and will not benefit from favourable tax treatment.
While trusts can be useful and indispensable legal and financial planning tools, there are a number of important considerations that should be fully explored with a legal professional. After the death of a parent of a person with disabilities, tax advice should be arranged to ensure the disabled beneficiary takes full advantage of any beneficial treatment under the Income Tax Act.
Consult a Legal Professional
The aforementioned challenges and requirements necessitate obtaining advice from a lawyer practicing in wills and estates when creating disability trusts.
The following insight from a leading Ontario case underscores the importance of careful drafting when establish a disability trust in a will:
The use of the words “…to pay the income to or for my son, Thomas, for his support, maintenance, medical attention and assistance as my Trustee in his uncontrolled discretion may decide,…” was held to be a non-discretionary trust. The Court interpreted the words used to mean that the trustee had to pay the income, which limited the discretion to decide how much was paid to the beneficiary and when. The Court stated that adding the words “to pay part or parts of the income” would have saved the clause, and the trust would have remained discretionary.
Ontario v Powell (Ont Div Ct),  OJ No 2310
Veronica Manski is a wills and estates lawyer with Bell Alliance LLP. She regularly assists clients with estate and incapacity planning, including drafting and settling disability trusts.