What Is a Spousal Trust and When Is It Used in Ontario?

When you have a second spouse and children from an earlier relationship, two worries often collide: you want your spouse looked after, and you want your children to receive what is left. A spousal trust is one tool people consider for that balance.

This article explains in general terms how a spousal trust works in Ontario and what the tax rules require. It is information, not advice, and the details of any trust depend on the wording used and on your family and finances.

What a spousal trust is

A spousal trust is a trust that holds property for a surviving spouse or common-law partner. Instead of leaving assets to your spouse outright, you leave them to a trustee, who manages them for your spouse's benefit.

This is why the tool suits blended families. The surviving spouse can be provided for, while the trust document names who receives what remains afterward. For the tax rollover, the tax rules require that your spouse be entitled to all of the trust's income for life and that no one else receive or use the trust's income or capital during your spouse's lifetime. How the trust fits with your spouse's own estate plan depends on the wording and the facts, so it is worth confirming with a lawyer.

The tax rules that make it work

Under Income Tax Act s. 70(6), property left by will to a spouse or common-law partner trust can pass at cost, which is a tax-deferred rollover. To qualify, the surviving spouse or partner must be 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.

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

• Income: the spouse must be entitled to all of it for life.
• Capital: no one else may receive or use it during the spouse's lifetime.
• Timing: vesting within 36 months, unless a longer period is allowed.

These conditions are strict, so the wording of the will matters. A trust that lets someone else, such as a child, receive capital while the spouse is alive may not qualify for the rollover.

What happens when the spouse dies

A rollover defers tax; it does not erase it. Generally, a trust is deemed to dispose of its capital property at fair market value every 21 years. For spousal, alter ego and joint partner trusts, the first deemed disposition happens on the day the beneficiary spouse dies, or on the later of the two deaths, rather than on the usual 21-year date.

Trust income is also taxed differently from an individual's. Under Income Tax Act s. 122(1), a trust's taxable income is generally taxed at the top personal rate. Graduated rate estates and qualified disability trusts are excluded from that rule. A graduated rate estate is the estate that arises on an individual's death, and it can only have that status for up to 36 months after the death. Because income and gains rules interact, an accountant should model the result for your assets.

Spousal trusts and similar living trusts

A spousal trust created by will is a testamentary trust, which is a trust created on and because of a person's death. Two related trusts are created during life instead, and are easy to confuse with it.

These living trusts share the rule that the first deemed disposition comes at the death of the beneficiary spouse, or the later of two deaths.

Practical steps and next steps

A spousal trust needs a trustee, and that choice matters in a blended family. A trustee who is also a child may face a conflict between the spouse's income and the children's eventual share. A trustee must use the care, skill, diligence and judgment of a prudent investor when investing trust property, and the Trustee Act's investment powers do not authorize or require a trustee to act inconsistently with the terms of the trust. Some people choose a neutral or professional trustee, or co-trustees.

• List your assets, who holds them and how they are owned.
• Decide who should receive income during your spouse's lifetime and who receives the remainder afterward.
• Ask a lawyer to check that the wording meets the s. 70(6) conditions.
• Note the 36-month vesting timeline.
• Choose a trustee who can act fairly between your spouse and your children.
• Ask an accountant how the 21-year and spouse-death rules apply.
• Review the plan after major changes such as remarriage, a move or a new child.

Frequently asked questions