Terry Tang, Investment Advisor
January 10, 2020
The term “shirtsleeves to shirtsleeves” is commonly used to describe the phenomenon that wealth accumulated in one generation will be lost by the third.
Taxes, poor investment decision, and spendthrift children - burning through assets among generations of heirs, are the most common causes for this phenomenon. And it’s a headache for parents wanting to leave some assets to their children or grandchildren. If you don't feel it's wise to simply pass a big cheque along, you’re not alone. Many parents want their children to “earn” their money in stages and learn to deal with money responsibly.
The solution? A well-designed family trust may be just what you need to ensure your heirs won’t burn through the inheritance.
But wait a minute, isn’t family trust only for the wealthy? The idea that family trusts are reserved for the super wealthy is only a misconception. The reality is that there are many six-figure family trusts out there, and it makes sense to set it up. But how does a family trust work?
One generation plants the trees, another gets the shade. No doubt it’s a blessing for the next generation, but if irresponsibly done it could turn into a curse. Let’s say you want to pass on some assets to your children or grandchildren, but you’re worried that they will live above their means, or maybe you just don’t trust your son-in-law and want money put aside and paid directly to your grandchildren when they reach a certain age.
"The idea that family trusts are reserved for the super wealthy is only a misconception."
The idea is that when setting up a family trust, you have full control as to when, how much, and what conditions must be met before the assets are distributed to your children. For example, a distribution will be made to your daughter when she completed a University degree before 25. The distribution will be 10% of the asset value at the time. Another distribution will be made when your grandson’s employment income reaches $100,000 CAD, distributing 15% of the asset value at the time. Moreover, you can also set conditions or prohibitions around how the money can be used, like buying a vacation home or spend it on a Porsche.
A family trust is a separate legal entity and there are three main roles for setting up a family trust in Canada - Settlor, trustee, and beneficiary. The settlor establishes the family trust and contributes assets. The trustee is responsible for managing and administering the trust, and the beneficiary is the person receiving the benefits from the trust.
The assets in the family trust will stay invested and continue to grow, and any income that is distributed to the beneficiaries is taxed in the hands of the beneficiaries and not the trust, potentially at a lower tax bracket.
Managing investment in a family trust can be no different than a regular investment account. The assets can be managed by a professional and invested in a diversified portfolio of stocks, bonds, mutual funds, ETFs, and structured products. Imagine you could hold an investment for decades before distributing to your grandchild, the power of compounding puts your money to work. For example, if you invest $100,000 in Nasdaq Composite in 1995, your investment would be worth more than $1.2 million today.
Then there is the estate planning element. Because the family trust is a separate legal entity, it continues to exist and operate even when the settlor passed away, thus avoiding probate, protecting assets against creditors, and provide privacy too.
The views and opinions expressed are those of the author and may not necessarily be those of Aligned Capital Partners Inc. The content is for informational purposes only and not meant to be personalized investment advice.