Estate Planning for Beneficiaries with Disabilities

Estate planning ensures that your assets are distributed according to your wishes when you pass away. Traditionally, this involves preparing a Will through which assets may be left directly to a beneficiary or transferred into a trust for their benefit.

When a beneficiary has a disability, estate planning becomes even more important to protect their long-term financial security. The primary goal to maintain eligibility for provincial disability assistance should be accompanied by tax-efficiency and broader non-tax goals. This planning may involve one or more trusts created under a Will, the use of Registered Disability Savings Plan (see The RDSP – A Hidden Gem?), the rollover of RRSP/RRIFs, and/or the use of life insurance.

If someone dies without a Will, the province determines who the beneficiaries are and what they inherit. The Public Guardian and Trustee may also become involved when beneficiaries who lack legal capacity, such as minor children or individuals with disabilities, are not adequately provided for.

Having a Will ensures that beneficiaries are fairly provided for, that the appropriate person manages the estate and any trusts, that charitable wishes are honoured, and that provisions can be made for other dependents and even pets.

Trusts

A trust is a valuable decision-making tool for a person who lacks capacity and an effective way to protect and preserve assets for vulnerable beneficiaries. Its success depends largely on appointing trusted, knowledgeable trustees to safeguard the beneficiary’s interest – often a family member, but sometimes a professional trustee who is compensated for their services.

Discretionary trusts allow a beneficiary to benefit from the income and capital of the trust without having control over the amount or timing of distributions, or decisions about acquiring or disposing of assets. They can also offer protection from third-party claims because the beneficiary has no entitlement to trust property unless and until the trustees exercise their discretion in that beneficiary’s favour.

A. Henson Trust

The term “Henson trust” originates from a 1987 Ontario court case^[i], later confirmed by the Supreme Court of Canada in a 2019 case^[ii].

A Henson trust is a fully discretionary trust designed to ensure that a person with a disability does not lose provincial disability assistance due to asset and/or income limits.

In BC for example, the Person with Disabilities (PWD) program allows a recipient to own up to $100,000 in assets (or $200,000 for a couple) without affecting their benefits. Certain assets, such as those held in a Henson-style trust approved by the province, are excluded from this limit. In addition, payments from the trust will not reduce disability benefits if used for exempt purposes.

A Henson trust must contain specific terms to ensure the beneficiary has no enforceable right to the trust assets. In particular,

• The trustee must have absolute, ultimate, and unfettered discretion over distributions, i.e. the beneficiary cannot compel the trustee to make payments.
• The assets of the trust must not vest in the beneficiary.
• The beneficiary must not be able to unilaterally collapse the trust.

Henson trusts created on death can also qualify as one or more of: a qualified disability trust (QDT), a life insurance trust, an RRSP/RRIF trust or a lifetime benefit trust – more details below.

Henson trusts can also be established during a person’s lifetime, most commonly using proceeds from a lawsuit or motor vehicle injury settlement, or direct beneficiary proceeds from life insurance, an RRSP or an RRIF. These are reversionary trusts, which will be discussed in D. Reversionary Trust below.

B. Qualified Disability Trust (QDT)

A QDT is a testamentary trust that benefits a person with a disability. It can only be created on and as a consequence of an individual’s death and must be resident in Canada. The beneficiary (the “electing beneficiary”) must:

• Have a disability tax credit certificate,
• Jointly elect with the trustee (and any other electing beneficiaries) in the trust’s tax return to be a QDT in a particular year, and
• Not be an electing beneficiary of any other QDT in that same year.

A QDT is taxed at graduated personal rates, meaning it pays lower rates on initial income brackets and higher rates as income increases. With the exception of a Graduated Rate Estate^[iii], all other trusts are taxed at the top personal rate.

Unlike most trusts, a QDT does not have to file an income tax return if it has no tax payable, no capital gain, and has not disposed of capital property. It is also exempt from the enhanced trust reporting requirements that apply to most trusts starting in the 2023 taxation year.

A QDT that contains the terms of a Henson trust can preserve the beneficiary’s entitlement to provincial disability assistance.

If QDT conditions are not met, or if an amount is paid to a non-electing beneficiary, a recovery tax can apply. This effectively removes the tax savings associated with graduated rates where amounts are later paid to someone who would otherwise have been taxed at the top rate.

One QDT Only

Advance planning is essential when multiple trusts may exist for the same beneficiary.

For example, different parents or stepparents may each plan for the same child in their Wills, and other relatives (e.g. grandparents, aunts, uncles) may also include the beneficiary.

Where multiple trusts are anticipated, it is better to decide before death which trust should be the QDT, rather than leaving the decision to executors or trustees after death. Consider:

• The testator’s wishes and distribution terms,
• The dollar values expected in each trust, and
• The type of property to be held.

For example, a trust set up to hold a personal-use residence may generate little or no income and thus gain minimal benefit from QDT status; however, see Residential Home below.

Disability Tax Credit (DTC)

Eligibility for the federal DTC is assessed under different criteria than provincial disability benefits. It is possible to qualify for one and not the other. Apply to the CRA for the DTC as soon as possible, as the DTC often serves as a gateway to other estate planning tools for persons with disabilities.

Tax Election

The electing beneficiary’s conditions may be severe enough that they lack capacity to make the required QDT election. A power of attorney, representation agreement or committee (as applicable) should be in place to authorize a representative. If the deceased was the existing representative, the appointment of a replacement should be expedited to meet the QDT return filing deadline.

Created On and As a Consequence of death

A QDT can lose its status if property is contributed by someone other than the deceased.

It can also lose its status if loans are made by beneficiaries or by non-arm’s length persons (including trustees), such as paying expenses or taxes on the trust’s behalf. An exception exists if the loan:

• Is repaid within one year, and
• It is reasonable to conclude the lender would have made the loan in an arm’s length arrangement.

To support this, loans to a QDT should use arm’s length terms (e.g. interest and if necessary, security) and be documented to include the one-year repayment timeline. If arm’s length terms are not feasible, the QDT should pay expenses from its own assets or borrow from an arm’s length party. It is also possible to request, before the one-year deadline, a longer repayment period that the Minister considers reasonable.

Careful administration is required to avoid additional contributions and to ensure any loans received meet the exception, so that the trust maintains QDT status.

Residential Home

Access to the principal residence exemption^[iv] is only available to QDTs settled by a spouse^[x] or parent. A QDT settled by someone else can transfer the home on a tax-deferred basis^[v] to a beneficiary to access their own principal residence exemption, but the transfer must occur before a sale.

C. Life insurance & Other Trusts

In provinces that levy more than nominal probate fees, it may be advantageous to direct life insurance proceeds to a trust outside the estate to save probate fees.

Such a trust could be a QDT if conditions are met^[vi], but this may result in two trusts (in addition to a  trust created by the Will), only one of which can be designated as a QDT. Naming the estate as the life insurance beneficiary allows the proceeds to form part of the Will-based trust, thereby combining all bequests into one QDT, which maximizes tax savings but forgoes probate savings.

Similarly, RRSP/RRIF trusts can be created outside the estate for probate fee planning but may create multiple trusts, again requiring a choice of which trust is designated as the QDT.

There is an option to roll an RRSP into a “lifetime benefit trust”^[vii], deferring the deceased’s terminal tax (and potentially saving probate fees). The criteria are complex and further discussion is beyond the scope of this blog.

When choosing which trust should be the QDT, weigh the probate fee savings against the additional income tax if another trust must pay tax at the top rate. If the life insurance or RRSP/RRIF proceeds represent most of what is left to the electing beneficiary, a trust outside the estate is often the clear choice for QDT designation.

D. Reversionary Trust

A beneficiary who receives funds directly can settle them into a trust to protect assets and/or preserve provincial disability assistance. This is common with lawsuit settlements, injury claims, or when the beneficiary is a direct recipient under a life insurance policy, RRSP or RRIF. Doing so creates a reversionary trust^[viii], under which all income is taxed in the beneficiary-settlor’s hands. In such cases, tax savings are typically not the primary objective.

E. Principal Residence Trusts^[xii]

In addition to QDTs, the principal residence exemption is available to an inter vivos trust that benefits a Canadian-resident individual who is eligible for the DTC. It is critical that no one else benefits from the trust’s income or capital during this individual’s lifetime. The individual must be:

• The settlor of the trust,
• The child, grandchild, great-grandchild, parent, grandparent, great-grandparent, brother, sister, uncle, aunt, niece or nephew of the settlor (or of the settlor’s spouse), or
• The spouse of any of the above.

Preferred Beneficiary Election

The “preferred beneficiary election”^[ix] allows trust income to be taxed at the beneficiary’s graduated rates without paying the corresponding amount to the beneficiary. Unlike QDTs (limited to one beneficiary per year), this election can be made for more than one trust benefitting the same person.

A preferred beneficiary is generally a resident of Canada who has a DTC certificate. They can also be a person aged 18 or over who is dependent on another individual due to mental or physical infirmity, and whose income is below the basic personal tax credit amount.

The beneficiary must also be:

• A settlor of the trust,
• The spouse or former spouse of the settlor, or
• The child, grandchild, or great-grandchild (or their spouses) of the settlor.

If another person later contributes property to the trust with a value greater than the original contribution, the original “settlor”^[xi] status and thus preferred beneficiary status may be lost. Ongoing monitoring of all contributions is therefore necessary to preserve access to the election.

The election is particularly useful where:

• The beneficiary has little income outside the trust, and
• The trust is otherwise taxed at the top rate (e.g. it is not a QDT, or another trust has already been designated as the QDT).

A QDT may choose to make this election even though it already benefits from graduated rates, where overall tax savings can be gained from maximizing the beneficiary’s DTC.

The preferred beneficiary election may reduce tax payable, but the possible impacts on provincial disability assistance (outside of BC) should be evaluated first.

Final Thoughts on Disability Estate Planning

Trusts when implemented and administered correctly, can be a powerful tool for estate planning to benefit persons with disabilities. As there are many options and each beneficiary’s circumstance is unique, advice should be sought as part of an effective estate plan.

Still Have Questions About Disability Estate Planning?

Please contact one of our Manning Elliott tax experts if you need help with estate planning to benefit persons with disabilities.

Manning Elliott regularly posts new blogs and up-to-date articles on the most recent BC and federal taxation changes.

NOTE: Tax laws are complex and are subject to frequent change. The contents of this Manning Elliott article are not intended to represent legal or tax advice. Please consult your tax adviser before employing any strategies that may have been discussed within this article.

[i]  Ontario (Director of Income Maintenance, Minister of Community & Social Services) v. Henson

[ii] S.A. v. Metro Vancouver Housing Corp.

[iii] Generally means an estate where a person died not more than 36 months ago and other specific criteria is met (such as not having a contributor other than the deceased, not having received a loan from a beneficiary or non-arm’s length person unless certain exceptions are met, and certain information is included or designation criteria is met in the trust income tax return

[iv] Which allows the capital gain on the sale of a principal residence to be exempt from tax.

[v] Subsection 107(2) of the Income Tax Act.  Unless otherwise noted, all statutory references hereinafter are to the Act.

[vi] CRA Document 2009-0350811E5.

[vii] Section 60.011.

[viii] Subsection 75(2).

[ix] Subsection 104(14).

[x] Includes common law partner.

[xi] As defined in subsection 108(1).

[xii] Clause 54(g)(i)(B) and(C) (in the definition of “principal residence”)