Joint Tenancy vs Testamentary Trusts


 

Testamentary trusts are documented in one’s will and are used to hold assets for your survivors.  These trusts accrue income after one’s death and have access to a separate set of marginal tax rates, similar to that of a living person.  These marginal tax brackets can cause tax savings on income earned post death vs. the tax that would accrue on the same income had it been taxed on a survivor’s personal income tax return.  Additional savings can be realized when testamentary trusts accrue portfolio income and the income is allocated to minor children and grand children.

Joint tenancy is a term used to describe ownership of property by two or more parties.  In the event of death, the deceased’s name is removed from ownership leaving the survivor(s) to own the interest in the property. If Mr. X and Mr. Y owned a property in joint tenancy and Mr. Y died, Mr. X would become the 100% owner of the property, regardless of the provisions in Mr. Y’s will.

Probate fees are also referred to as “probate tax”.  They are a liability of the deceased’s estate payable to the province of Ontario based on the value of the estate at date of death.   In Ontario, the rate is 0.5% on the first $50000 of estate assets, and 1.5% on the value of assets above $50000.  For ease of calculation we refer to probate at 1.5% of assets.

It is common in the investment industry to advise clients to put assets into joint tenancy to avoid probate fees.  Where assets are in joint tenancy they flow outside the administration of an estate and therefore can not form part of any testamentary trust. 

In the spreadsheet that follows, we have illustrated the tax savings that can occur from testamentary trusts being used to hold estate assets.  The key assumption is that the survivors will leave the wealth invested and not require it for lifestyle expenditures immediately after the passing.  The longer the inherited wealth is invested, the greater the tax savings.  Even with legal fees and accounting fees for the trust returns, the tax savings by the end of the second year can outweigh the cost of probate.  This spreadsheet does not factor in any additional savings realized by allocating income to low income family members through the trust, or the cost of the legal fees in documenting the will and administering the probate.   There are additional benefits afforded to trusts from a creditor and family law protection point of view that are not afforded to joint tenancy.

With these calculations there is obviously a strong financial argument to consider testamentary trust planning over joint tenancy based probate fee avoidance techniques.

“Information contained herein is of a general nature. No action should be taken without seeking professional advice that takes into account current developments and the specific facts of a particular situation."

                   
  Tax Savings of Testamentary Trust vs. Joint Tenancy  
                   
  Sample Estate             
  Two Children, Ontario Residents.        
  Each receiving $600,000 of assets after probate, income tax    
  Wealth to be invested, not spent.        
  Investment rate of return 5% – interest        
  Children are above $82,000 of income annually each before inheritance.  
                   
                   
  Assuming no tax planning  done / no trusts in wills      
              No Trusts Trusts Net Savings
  Income to survivors            
  Investment Assets per surviving adult child   600,000 600,000  
  Number of children       2 2  
  Investment Assets for survivors in total   1,200,000 1,200,000  
                   
  Investment rate of return – Interest   5.00% 5.00%  
                   
  Interest Earned in the year     60,000 60,000  
                   
  Personal tax rate       43.41% 20.05%  
                   
                   
  Tax payable on interest     26,046 12,030 14,016
                   
                   
  After tax Interest earned in the year   33,954 47,970  
                   
                   
  Pure tax savings          14,016  
                   
  Probate on the estate            
  Assets passed to next generation   1,200,000    
  Probate on the estate       18,000    
                   
  Net Savings per year     14,016    
                   
  Number of years investments must be held for      
  tax savings to cover the cost of the probate fees         1.28    
                   
  Savings can be greater if income is allocated to grandchildren who earn  
  less than $10,000 per annum.          

Effective early June 2013, The Department of Finance Canada has invited the public to provide comments on proposed measures affecting trusts.  These proposed trust rules indicate Finance's desire to change the tax rules that apply to testamentary trusts.  If these consultation papers become law, the tax benefits of testamentary trusts will be virtually eliminated.  We will update this web page after proposed legislation is announced.  Readers should take this into account with their advisor before they finalize their estate plan.

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