A family trust is an arrangement between three parties used to split income with lower income family members.

The parties involved in a family trust are:

1. Settlor – generally the grandparent/great grandparent who settles the trust by providing/giving a coin or other settled property to the trustees.  The settlor has no further involvement with the trust.
2. Trustees – the trustees administer the trust, make decisions re investments and income allocations.
3. Beneficiaries – the beneficiaries receive the income/capital allocated to them from the trust.  The goal in most situations is to allocate the income to the beneficiaries with low/no other income.  This causes a tax savings realized by declaring the income at a lower rate.
4. Lender/Parent – this family member loans funds/wealth to the trust at the Canada Revenue Agency prescribed rate.  The lender/parent declares income at the prescribed rate on this loan.  Any remaining excess income earned above this rate is allocated to the beneficiaries.  The calculations below summarize the tax costs/benefits.  As assumptions change such as amount invested, rate of return and prescribed rates, the net benefit will change. 

The prescribed rate is set on a quarterly basis by the Canada Revenue Agency.  As of March 2010 the prescribed rate was 1%.

Once a loan is made to a trust at a given date, the prescribed rate that must be charged on the loan is fixed at that date.  If there are increases or decreases in the prescribed rate thereafter, the rate in effect for this loan does not change.

There are costs to this structure:

1. Legal fees to set up – one time cost of approximately $2000.
2. Banking fees to keep trust chequing account active.
3. Accounting fees for the preparation of T3 Trust tax returns.

Assumptions

1. $200,000 capital to invest  (non registered personal wealth - outside a corporation)
2. Rate of return 8%, arm’s length loan
3. “Prescribed” rate 1%
4. 1 child or grandchild as beneficiary
5. Taxpayer at top marginal rate (46.4%)
6. Beneficiary has no other income

1. Current Situation

Interest earned                                    $16,000      ($200,000 X 8%)

Tax at 46.4%                                          7,424

Net amount retained                             $8,576

1. Introduce Family Trust

(a)     Interest paid to Family Trust      $16,000      ($200,000 X 8%)

         Interest paid to taxpayer               (2,000)

                                                             14,000

              Accounting fees                          (700)

              Tax paid by beneficiary              (800)

              Retained By Trust                 $12,500

(b)     Interest paid to taxpayer              $2,000      ($200,000 X 1%)

         Tax at 46.4%                                    928

         Net amount retained                    $1,072

         Total retention (a) + (b)              $13,572

         Increased retention per year         $4,996      ($13,572 - 8,576)

         (due to tax savings)

1. Benefit Over 10 Years

Tax savings                                         $49,960

(not compounded)

Funds accumulated for grandchild    $125,000

“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."

[Updated - February 20, 2010]