Inter Vivos Trust vs Testamentary Trust: Key Differences in Ontario

If you are comparing trusts, you will keep running into two Latin labels: inter vivos and testamentary. They sound technical, but the idea is simple. One kind of trust is set up while someone is alive, and the other comes into being because someone has died.

The label matters because it affects how the trust is taxed, what special rules it can qualify for, and what it can do for a family. This article explains the difference in plain terms. It is general information, and the right choice depends on your facts, so a lawyer or accountant should confirm how it applies to you.

What each label means

For income tax purposes, an inter vivos trust is any trust that is not a testamentary trust. In everyday terms, it is a trust created during a person's lifetime, which is what the Latin phrase means.

A testamentary trust is generally created on and as a result of an individual's death, for example under a will or an estate.

Side-by-side comparison

The key point many people miss is that an ordinary trust of either type pays tax at the top individual rate, with no graduated brackets. Any lower-rate treatment comes from a specific category, not from the label alone.

Special testamentary categories that can lower tax

Two testamentary arrangements are taxed differently from an ordinary trust. A graduated rate estate is taxed at the same graduated rates as individuals while it qualifies, and it can last up to 36 months after death. To qualify it must be a testamentary trust and meet other conditions.

A qualified disability trust must, at year end, be a testamentary trust arising on a particular individual's death and resident in Canada, and its return must include an election made jointly with one or more beneficiaries. It is elected on Form T3QDT and is taxed at graduated rates, unlike an ordinary trust.

• Each electing beneficiary must be named by the deceased in the instrument creating the trust.
• Each must qualify for the disability tax credit for the year.
• A beneficiary cannot jointly elect with any other trust for a year ending in the same beneficiary year.

Inter vivos trusts used by older families

Some inter vivos trusts are built for people aged 65 or older. An alter ego trust is set up by a settlor aged 65 or older who is the only person entitled to income or capital during their lifetime. A joint spousal or common-law partner trust is created after 1999 by a settlor aged 65 or older, and the settlor and spouse or partner receive all the income until the later of their deaths.

These trusts have their own tax and property rules, and they can raise Ontario questions such as how real estate is transferred into them. Those details depend on the facts, so get advice before moving a home or investments into one.

Trusts generally face a deemed disposition of their non-exempt capital property at fair market value on the day 21 years after the later of January 1, 1972 and the trust's creation, and again every 21 years after that. Moving property between trusts does not simply postpone that date. Alter ego and joint partner trusts use the death of the settlor or last beneficiary instead.

Which suits which family situation?

There is no single better choice. The question is what you are trying to accomplish and when.

• You want to set up a trust during your lifetime: for tax purposes it is an inter vivos trust if it is not a testamentary trust. Whether that suits your goals depends on your situation, so it is worth confirming with a lawyer.
• You want property held for children or others after a death: a testamentary trust is created because of the death.
• A beneficiary receives Ontario Disability Support Program (ODSP) benefits: an absolute discretionary trust, where the trustee has sole discretion over payments, is not counted as an asset, so its capital may exceed $100,000.
• A child will inherit money: if the child is to receive $35,000 or less, the money usually need not go into court, while larger amounts are paid into court unless a court-appointed guardian of property is in place.

Be careful with disability-related trusts. Other inheritance trusts available for maintenance are subject to a $100,000 combined limit, but that limit does not apply to absolute discretionary trusts. Payments from the trust may still count as income in the month received unless an exemption applies. A person entitled to an inheritance cannot put that inheritance into an absolute discretionary trust to avoid the asset test.

What to do next

• Write down what the trust is meant to achieve and who the beneficiaries are.
• Note whether the trust would start during your life or only after a death.
• List the property involved, such as a home, investments or a business.
• Check whether any beneficiary receives disability benefits or is under 18.
• Ask a lawyer and an accountant how tax and the 21-year rule would apply before you sign anything.

Frequently asked questions