Blended Family Trusts in Ontario: Protecting Your Children's Inheritance

If you have remarried and have children from an earlier relationship, you probably want to look after your new spouse and also make sure your children still receive something. Without a plan, one goal can easily swallow the other. A trust is one tool people use to balance them.

This article explains how a trust of this kind generally works in Ontario after a death: what the tax rules say, what a trustee must do, and what can go wrong. It is general information, and the right structure depends on your family, your assets and your tax position.

Why blended families use trusts

The usual worry is simple. If everything goes directly to your spouse, your spouse decides who inherits next, and your children may receive nothing. A trust lets one person enjoy the property for a time while the people who receive it afterwards are already set.

Before relying on a trust, look at how your assets are actually held. Assets with a named beneficiary, such as RRSPs, RRIFs and TFSAs, and jointly owned assets that automatically go to the surviving owner, pass outside the estate. A trust in your estate plan will not control them unless they are arranged to fit with it.

How a spousal trust works

In a typical blended family plan, property is left by will to a trust for your spouse or common-law partner, with your children named to receive what remains later. For tax purposes, a trust created on and because of a person's death is a testamentary trust.

There is a tax-deferred rollover available for this arrangement. Property left by will to a spouse or common-law partner trust can pass at cost, but only if the survivor is entitled to all of the trust's income for life and no one else may receive or use the trust's income or capital during their lifetime. That condition matters for your children: under a rollover trust, they generally cannot receive capital while your spouse is alive.

The property must also vest indefeasibly in the spouse or the trust within 36 months after the death, although the Minister may allow a longer period if a written application is made within that time.

When your spouse dies, the trust is generally deemed to dispose of its property then, not on the usual 21-year date. A tax bill may arise at that point, so the trust should be planned with that in mind.

Tax points that affect what your children receive

A graduated rate estate must designate itself as one on its first T3 return, and there can be only one for a deceased person. It has a deemed year-end on the day it stops being a GRE.

Some people use a trust during their lifetime instead. An alter ego trust is a living trust created after 1999 by a settlor aged 65 or older, who must be entitled to all the trust's income during their lifetime. A joint spousal or common-law partner trust works similarly, with the settlor and their partner entitled to all income until the later of their deaths. Whether either fits your situation is a question for a lawyer and an accountant.

Who keeps the trust honest

Your children are only protected if the trustee does the job properly. In Ontario, a trustee investing trust property must use the care, skill, diligence and judgment of a prudent investor. A trustee is not liable for an investment loss if the conduct followed a plan or strategy a prudent investor could adopt.

In a blended family, trustee choice is delicate, because a surviving spouse and the children may want different things. The usual tools if things go wrong are:

• A person who appears to have a financial interest in an estate may bring a motion to require the estate trustee to pass accounts.
• The Superior Court of Justice may remove an estate trustee on any ground on which it could remove any other trustee and appoint someone else.
• A trustee may apply to the Superior Court of Justice for its opinion, advice or direction on managing trust property.
• A trustee is entitled to fair and reasonable compensation fixed by a judge, unless the trust document fixes it.

The general limitation period in Ontario is two years from when a claim was discovered, or should reasonably have been discovered. If you think something is wrong, do not wait.

What to do next

• List every asset and note how it is held: your name alone, joint, or with a named beneficiary.
• Decide who should be trustee, and whether a neutral person or professional is better than your spouse or one child.
• Ask a lawyer whether a spousal trust, alter ego trust or another structure suits your family.
• Ask an accountant how the rollover, the 21-year rule and the deemed disposition on your spouse's death affect the plan.
• Explain the plan to your spouse and children so it does not come as a surprise.

Frequently asked questions