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Wendy Seet

Tax Principal at Manning Elliott Burnaby
by Wendy Seet
March 11, 2024

Estate Planning for Beneficiaries with Disabilities

Estate planning  ensures that your wishes are carried out when you pass away, with respect to your assets and liabilities. Traditionally, this involves the preparation of a Will where assets could be bequeathed directly to a beneficiary or to a trust that benefits that person.

Estate planning when you have a beneficiary with disabilities is especially important to ensure their financial security. It should ensure that they will continue to receive provincial disability assistance such as the Person with Disabilities (PWD) benefits in BC, and should consider both tax-efficiency as well as non-tax goals. Specific planning includes one or more trusts set out in a Will, the Registered Disability Savings Plan (see The RDSP – A Hidden Gem?), rollover of RRSP/RRIFs, and/or life insurance.

Dying without a Will results in the province determining who the beneficiaries are and the proportion they are entitled to. The Public Guardian and Trustee may also be involved in the inheritance for those who lack legal capacity such as minor children or beneficiaries with disabilities. Having a Will therefore ensures that beneficiaries are fairly and adequately provided for, that the appropriate person administers the estate and manages funds held in trust, that charitable intentions are carried out, and that other persons or pets are provided for.

Trusts

Trusts are a useful tool for decision making where a person lacks capacity and for preserving capital where vulnerable persons are involved. A large part of its success lies in appointing a trusted and knowledgeable person as trustee(s) to protect the interest of the beneficiary, typically a family member but sometimes professional trustees who are remunerated for their services.

Discretionary trusts allow beneficiaries to benefit from the income and capital of the trust, without giving them control of the amount and timing of the income paid to them or the acquisition or disposition of the assets. It may also provide protection from third-party claims, as the beneficiary will not be entitled to any of the trust property unless and until the trustees exercise their discretion in that beneficiary’s favour.

Henson Trust

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

This trust is a discretionary trust designed so that a person with a disability does not lose entitlement to provincial disability assistance by exceeding asset and/or income thresholds that are typically imposed.

For example, in BC, PWD benefit recipients are subject to an asset exemption limit of $100,000 (or $200,000 for a couple) but certain assets such as those held in a Henson-style trust approved by the province are excluded. Trust payments will not reduce PWD benefits if they are used for exempt purposes.

A Henson trust  must contain specific elements to ensure that the beneficiary does not have an enforceable right to the assets of the trust.

For example, the trustee should have absolute, ultimate, and unfettered discretion to determine distributions to a beneficiary, i.e., the beneficiary cannot compel the trustee to make payments. In addition, the assets of the trust should not vest in the beneficiary and the beneficiary may not unilaterally collapse the trust.

Henson trusts created on death can also be a qualified disability trust (QDT), life insurance trust, RRSP/RRIF trust or lifetime benefit trust – these are discussed further below.

Henson trusts can also be formed during a person’s lifetime, most commonly with proceeds from the settlement of a lawsuit or motor vehicle injury claim, and sometimes when named as the beneficiary of a life insurance policy, RRSP or RRIF – these are reversionary trusts, also discussed below.

Qualified Disability Trust (QDT)

A QDT is a trust available for persons with disabilities. It can only be created on and as a consequence of death of an individual and  must be resident in Canada. In addition, the beneficiary (referred to as an “electing beneficiary”) must have a disability tax credit certificate, make an election with the trustee and other electing beneficiaries (if any) in the trust’s income tax return to be a QDT in a particular year, and not benefit from any other Qualified Disability Trust in that year.

A QDT  is taxed favourably on its income at graduated rates. This means that it pays the lowest tax rate at the first income bracket and progressively increasing rates as the amount of income rises into successive brackets. Apart from the Graduated Rate Estate[iii], all other trusts are taxed at the highest rate for individuals. 

Another benefit of the Qualified Disability Trust, in contrast to most trusts, is an exemption from filing a trust income tax return when it has no tax payable, no capital gain, or has not disposed of capital property. It is also not subject to the enhanced trust reporting requirements for most trusts starting in the 2023 taxation year.

Lastly, the QDT will maintain the beneficiary’s entitlement to provincial disability assistance if it contains the required elements of a Henson trust.

Note however that a recovery tax could apply if any of the QDT conditions are not met, or an amount is paid by the trust to a beneficiary who is not an electing beneficiary. This tax is meant to claw back tax savings for income (taxed at graduated rates) that is later paid to a non-electing beneficiary (that should have been taxed at top rates).

One QDT Only

Where there may be more than one trust for the same beneficiary, advance estate planning should be made.

For example, multiple parents or stepparents with different wishes may each leave funds for the same child on their respective deaths. Other individuals such as grandparents, aunts or uncles may include the disabled beneficiary in their estate planning when one or both parents have already planned for a Qualified Disability Trust upon their death(s).

It will be preferable to make choices prior to death where the existence of multiple trusts is known, rather than leaving these to the executors or trustees after death. In deciding which trust should be the QDT, consider the various wishes, dollar values, and types of properties to be held.

For example, a trust set up to hold a residence for personal use will not generate any income and will not materially benefit from QDT status, unless it is anticipated that the principal residence exemption will be claimed by the trust rather than by a beneficiary.

Disability Tax Credit

Eligibility for the Canadian disability tax credit certificate has more stringent tests than for provincial disability benefits, therefore it is possible to receive the PWD in BC but not be eligible for a QDT. Application to the CRA for the disability tax credit should be made as soon as possible, in order to assist in estate planning for persons with disabilities.

Tax Election

The electing beneficiary’s conditions may be so severe that they do not have the capacity to make the required tax election. A power of attorney, representation agreement or committee needs to be in place to authorize an appropriate representative. Where an existing representative is the deceased, this process would need to be expedited to ensure a replacement representative is in place prior to the filing deadline of the QDT’s trust return.

Created On and As a Consequence of death

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

It can also lose its status if loans are made by beneficiaries or anyone not at arm’s length with beneficiaries (including trustees), such as when payments are made on behalf of a trust for expenses or taxes owing.

An exception will be available if the loan is:

  • repaid within one year, and
  • it is reasonable to conclude that the lender would have been willing to make the payment in an arm’s length arrangement.

To maintain and support the latter, the loans should contain arm’s length terms such as interest (and security, if necessary) and be documented to include the one-year repayment timeline. If arm’s length terms are not achievable, then the QDT should fund expenses with its own assets or borrow from an arm’s length party. There is also an option to request, before the one-year repayment timeline has passed, for a longer period that the Minister would consider reasonable in the circumstances.

When estate planning to benefit persons with disabilities, care must be taken to ensure that a QDT does not receive additional contributions, and that any loans received meet the exceptions, in order to maintain QDT status.

Residential Home

Access to the principal residence exemption[iv] is only available to QDTs settled by a spouse or parent. There is an option to transfer the home on a tax-deferred basis[v]  to a beneficiary to utilize the beneficiary’s exemption instead; however, it must be done prior to sale.

Life insurance & Other Trusts

When estate planning to benefit persons with disabilities in provinces that levy a more than nominal probate fee, it may be beneficial to place the proceeds of a life insurance policy within a trust outside of the estate in order to save on probate fees.

In this case, the trust could be a QDT if the conditions are met[vi] but it could result in two trusts, only one of which can be a QDT. Naming the estate as a beneficiary of the policy will allow the proceeds to form part of QDT in the Will, however the probate savings will be lost.

Similarly, RRSP or RRIF trusts can be set up outside of an estate as part of probate fee planning but may result in more than one trust and having to make a choice on which will be the QDT.

There is also an option to roll an RRSP over to a “lifetime benefit trust”[vii] that will defer tax payable by the deceased on death (in addition to probate fee savings). The criteria for this trust are complex and beyond the scope here.

In making a choice of which trust should be the QDT, compare the probate fee savings against the additional tax payable of one trust paying tax at the top rate. Where the life insurance policy payout or RRSP/RRIF balance represents all or most of the assets bequeathed to an electing beneficiary, a trust set up outside of the estate is the clear choice to be the QDT.

Reversionary Trust

A beneficiary who receives funds directly can settle them into a trust to protect the asset and/or to maintain provincial disability assistance. This creates a reversionary trust[viii] which results in all the income being taxed in the beneficiary-settlor’s hands. In this case, the primary objective would not be tax savings.

Preferred Beneficiary Election

 The “preferred beneficiary election”[ix] allows tax to be paid at the beneficiary’s graduated marginal rates without having to pay the corresponding income to the beneficiary. This election can be made with respect to more than one trust for the same person, unlike the limit that QDTs are subject to.

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

In addition, the beneficiary must also either be a settlor of the trust, the spouse[x] or former spouse of the settlor, or the child, grandchild, or great-grandchild (or their spouses) of the settlor.

Where another person subsequently contributes property to the trust that has a value greater than the original contribution, the settlor may cease to be a “settlor”[xi] which could lead to the loss of preferred beneficiary  status. This requires ongoing monitoring of contributions to the trust to preserve access to the election.

The preferred beneficiary election is beneficial when the beneficiary does not have significant income outside of the trust and the trust is subject to the top tax rate such as a trust that does not qualify as a QDT or another trust has already been designated as the QDT. Consideration should be given to whether the election will impact provincial disability benefits outside of BC.

A QDT may wish to make this election even though it is taxed at graduated rates, as overall tax savings may be gained where the beneficiary has not fully utilized the disability tax credit.

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).