Trusts with Lee Fernandes | E013
The basics of trusts and use cases.
In this episode of Financial Planning for Canadian Business Owners, Jason Pereira, award-winning financial planner, university lecturer, writer, talks with Lee Fernandes, Senior Wealth Consultant at Cidel. Cidel is a company that helps high-wealth Canadians establish structures and planning to help them meet their needs. Lee Fernandes discusses one of Cidel’s core offerings, trust services. This episode provides a general education on what trusts are, how they can be used, common use cases, and why they are beneficial to people.
Episode Highlights:
● 01:12 – Lee Fernandes describes what Cidel is and does.
● 01:53 – What is a trust?
● 03:28 – Jason Pereira provides a simple example of an irrevocable trust.
● 04:20 – They discuss the perception of trusts being scandalous.
● 06:31 – Lee discusses asset protection trusts.
● 09:09 – What questions do Lee’s clients often have?
● 11:51 – Lee clarifies the trustees’ and settlers’ duties.
● 18:17 – How many trustees should you have?
● 22:11 – What is a graduated real estate (GRE)?
● 25:22 – What are the advantages and disadvantages of inheriting?
● 30:53 – Henson Trust is only available to beneficiaries that have disabled needs.
● 33:33 – What are spousal trusts, alter ego Trusts, and foundations?
● 40:00 – Individuals try to set up a private foundation after the beginning August, it’s not going to happen that year.
● 43:58 – Trusts are very useful tools that can be very dynamic.
3 Key Points
1. The three certainties that a trust needs to meet is the certainty of intent, certainty of subject matter (what), and the certainty of object (for who).
2. Trusts come down to wealth protection and control versus taxation.
3. Trusts now pay the highest marginal tax rate in Canada.
Tweetable Quotes:
● “Cidel is a Canadian-based global financial services company. We are a private bank, so we deal with private clients, both globally and domestic, and the objective is really to work with families to preserve wealth.” – Lee Fernandes
● “If you are setting up a structure, and the true intent of that trust is to asset protect, then look at a different jurisdiction. An asset protection trust doesn’t cross any tax lines. It is tax-neutral.” – Lee Fernandes
● “‘What is it that I need to have to qualify for a trust?’ And it isn’t really about net worth. It is around, what do you need to have the trust for? Let’s have a more meaningful discussion around the use of a trust.” – Lee Fernandes
Resources Mentioned:
● Facebook – Jason Pereira’s Facebook
● LinkedIn – Jason Pereira’s LinkedIn
● FintechImpact.co – Website for Fintech Impact
● jasonpereira.ca – Website
● Linkedin – Lee Fernandes’s
● cidel.com – Website for Cidel
Full Transcript:
Speaker 1: Welcome to the Financial Planning for Canadian Business Owners podcast. You will hear about industry insights with award winning financial planner and entrepreneur Jason Pereira. Through the interviews with different experts with their stories and advice, you will learn how you can navigate the challenges of being an entrepreneur, plan for success and make the most of your business and life. And now, your host, Jason Pereira.
Jason Pereira: Hello and welcome to Financial Planning for Canadian Business Owners. I'm your host, Jason Pereira. Before we get started today, just a reminder to sign up for my newsletter at jasonpereira.ca, where you'll be informed of all updates to my various media channels. So on today's show, today I brought an old friend, Lee Fernandes of Cidel. Cidel's a company that helps high net worth Canadians set up structures and planning to help meet their needs. I brought him in specifically today to talk about one of the core offerings, which is trust services. So this is kind of a basic education on trusts, how they can be used, and some use cases, and why they're a benefit to people. So I hope you enjoy this interview with Lee.
Jason Pereira: Lee, thanks for coming in.
Lee Fernandes: You're welcome. Good morning.
Jason Pereira: Oh, good to see you as always. So, Lee Fernandes of Cidel, tell us about Cidel. What is it that you guys do?
Lee Fernandes: So, Cidel is a Canadian based global financial services company. We're a private bank.
Jason Pereira: Mm-hmm (affirmative).
Lee Fernandes: And so we deal with private clients both globally and domestic. And the objective is really to work with families to preserve wealth and ensure that the next generation reap the benefits of that preservation.
Jason Pereira: And you guys get into a lot of advanced structure planning and that oftentimes involves trusts. And that's why I brought you in today. We wanna cover the topic specifically of trusts. What are they, how can they benefit people? What are some of the use cases and how can you guys support that? So, let's start off there. Uh, so let's tell the listenership what is a trust?
Lee Fernandes: So, a trust is first and foremost not a legal entity in Canada.
Jason Pereira: Yeah, it's because weird little gray areas.
Lee Fernandes: Right, right. And so, with a trust, essentially what it is, it's when someone has an asset and the intention is to leave that asset for someone else. And that someone else is known as the beneficiary. And the technicality of trusts is there needs to meet three certainties.
Jason Pereira: Mm-hmm (affirmative).
Lee Fernandes: So a certainty of intent. So, if me as an individual, my intention is to set up this vehicle to leave assets to someone else. And that's the certainty of intent. And then the second is certainty of subject matter. And so essentially, what is it that I'm going to leave-
Jason Pereira: Mm-hmm (affirmative).
Lee Fernandes: ... for someone else?
Jason Pereira: Money, assets, shares, whatever it is.
Lee Fernandes: Correct, correct. It could be hard assets. It could be monetary assets. And then the third is certainty of object.
Jason Pereira: Mm-hmm (affirmative).
Lee Fernandes: And so, in terms of object is who is the beneficiary? Who's going to benefit? And that's a technicality of a trust. So it needs to meet those three certainties. And so when we are dealing with clients, the first thing that we ask is do you have a trust? And if you do, let's look at the trust deed or the indenture.
Jason Pereira: Mm-hmm (affirmative).
Lee Fernandes: And let's see what the trust states and let's determine whether those three certainties are there. So essentially what it is, it's a vehicle that's set up that I am able to place my assets into it and then leave it for someone else.
Jason Pereira: Mm-hmm (affirmative).
Lee Fernandes: And in terms of the types of trust that you can have and set up, it's a revocable trust. So one would during my lifetime I can change the terms of the trust. And then an irrevocable trust, where trust that's set up you, they essentially, it's cast in stone in a sense that it's now set up and you can't change the terms of this trust.
Jason Pereira: Yeah. And a simple example of a revocable trust, and a lot of people have seen this is, they wanna open up an account or savings investment vehicle for their children. So they will typically be opened in their name in trust for the child. But there's, that's a very loose kind of arrangement, right? Like you've named that. Oftentimes that money can be taken back. But regardless, the formal trust, or the formal trust, the not irrevocable trust, basically that is essentially typically drafted by a lawyer. I mean, you can have revocable trusts also drafted by a lawyer, but there's a trust document outlining who's in charge of what, what the terms of the contract are, and what that person is responsible for and who benefits it. As well as making sure those three certainties are hit.
Lee Fernandes: Correct.
Jason Pereira: Basically, so essentially what we're doing is we are making sure that something's being taken care of on behalf of someone else.
Lee Fernandes: Right.
Jason Pereira: And a trustee is appointed to do that. Someone who's responsible for it.
Lee Fernandes: Correct.
Jason Pereira: So before we dive into what they're responsible for and, and what some of the other parties involved in this are, let's just deal with the elephant in the room every time trusts come up. This is often thought of as a tool for the wealthy to basically plan. And oftentimes due to some economy scandals and things that have happened internationally, oftentimes it carries a bad name sometimes. People think someone's up to tax evasion. So that specifically happens when we start talking about domestic versus international trusts. And let's address that. I'll let you talk about your viewpoints first and I'll jump in.
Lee Fernandes: So, it's a good thing I'm African. So I'm very familiar with elephants and how to handle them.
Jason Pereira: How do you handle an elephant?
Lee Fernandes: Carefully. With a lot of care. So, the perception exists.
Jason Pereira: Yes.
Lee Fernandes: And it's real purely because when there's a scandal that breaks out, invariably, there is some trust that's been set up in a tax haven, and there are allegations of tax evasion. So as I understand that perception in the market, the reality is that the use of a trust has it's so broad and generally speaking in our business, we do see application of trusts for wealthy individuals because of the multi generational aspect of their planning. And so, that needs to be said. However, we also deal with individuals where there is a need, irrespective of the amount of wealth that's involved, a need to protect a beneficiary. And the protection could be in the form of a disabled beneficiary or it could be discourse among family members. And they want to make sure that when the matriarch, patriarch are no longer around, that certain siblings aren't going to cost the other members of the family. So there are very real benefits to a trust outside of the wealth investments.
Jason Pereira: At the end of the day, it's not something that's benign or malignant. It's just something that exists and it really comes down to the intent in which you design it to basically-
Lee Fernandes: Yeah.
Jason Pereira: Yeah. You can try to obfuscate, you can try all sorts of stuff. Or even the most simple case, where someone doesn't have a lot of wealth, has an insurance policy, has a minor to take care of, disabled or not, you're not going to put large amounts of money in the hands of a child. So that's the responsible thing to do, is a trust.
Lee Fernandes: Right. But you mentioned domestic and [crosstalk 00:06:30].
Jason Pereira: Yes, that's hit that point.
Lee Fernandes: So the use of international trusts, it's law prevalent but it's more around in terms of what we see in the realm of asset protection. Not to say that you can't have an asset protection trust in Canada, but there's a school of thought that, if you are setting up a structure and the true intent of that trust is to asset protect, then look at a different jurisdiction as opposed to your home jurisdiction. So an asset protection trust does not cross any tax lines.
Jason Pereira: It's tax neutral.
Lee Fernandes: It's tax neutral.
Jason Pereira: So I'm paying the same tax.
Lee Fernandes: CRA. You declare that and they're aware that the structure has been set up. So from a CRA perspective, that trust essentially doesn't exist because it's attributed back to the individual that set up the trust. But in terms of the legal standing, where now the trustee is the owner of those assets and the assumption has that it's an irrevocable trust that's been set up, there are jurisdictions that have cure periods or limitation periods that essentially protect those assets in the event of a creditor coming out of the woodwork down the line.
Lee Fernandes: Let me preface this by saying, when you set up an asset protection trust, if you set it up with the intent of defrauding someone or ensuring that you are now going to-
Jason Pereira: Not going to be exposed to that creditor?
Lee Fernandes: You're absolvent as a result of setting up the asset protection trust, then there's no jurisdiction that will deem that a valid asset protection trust. So it's got to be a true intent.
Jason Pereira: Let's be clear. These things have to be reported to CRA.
Lee Fernandes: Right.
Jason Pereira: So I often say that to have an offshore trust and to not report that is the equivalent of some other non reported offshore stuff I see done. So for example, maybe there is a rental property in the home country of the person comes from and they're not reporting that income to CRA.
Lee Fernandes: Right.
Jason Pereira: You're just as guilty there as if you had set up some elaborate structure involving trust in a foreign [crosstalk 00:08:21].
Lee Fernandes: Correct.
Jason Pereira: Also, and I think we take this for granted in Canada specifically when we talk about international trust, it's that we come from a position of privilege. We're in a very stable country, when you look at other countries. But many other people who come here are coming here from countries that are not stable. Where they have to worry about governments suddenly deciding one day that, you know what, we're going to take it all or a big chunk of it.
Jason Pereira: So people in those scenarios are far more sensitive to this sort of thing because they get it. Even if they come here, they still don't necessarily trust governments to not do that one day. So there's a reason to want to protect assets and again, not from a tax standpoint specifically. Because we need to do things ... Everything we're talking about here is all above board and it's all reported.
Lee Fernandes: Yeah. So you speak about individuals' past and what families have gone through. In my career and coming from South Africa having dealt with individuals who have lost everything, it's very prevalent in the thinking. And so a lot of clients that I deal with, it's not a net worth discussion. I have 10 million, do I qualify for a trust? I get asked that question often.
Jason Pereira: Qualify for a trust? Yeah.
Lee Fernandes: What is it that I need to have to qualify for a trust? It's really not about a net worth. It's around, what is it that you need the trust for. Let's have a more meaningful discussion around the use of a trust and what it's going to offer you. It's generally a discussion around estate planning.
Jason Pereira: Exactly.
Lee Fernandes: Outside of the realm of asset protection, and just to put that aside, most recently we did an asset protection trust for a client that is selling his business. And his business is in a very litigious environment. He's just concerned what the new owners will end up doing with the business. I understand that he's selling it. He just wants to protect what he has spent 35 years building.
Lee Fernandes: One of the thoughts that was put to the client was to set up an asset protection trust. That's the way it works, is that he wants peace of mind. That's what it comes down to. It's peace of mind that during the rest of his life, that those assets have an opportunity to be protected for the next generation and the generation thereafter.
Jason Pereira: Again, I think these international scandals do us all disservice because general public, they kind of put a tarnish on this. But really the reality is, to my experience. I'm sure you'll say the same thing. Trusts are not put in place as, the underlying thinking is not taxation 99% of the time. It comes down to protection is one of the things we talked about. Whether that be protection from potentially losing it all or protecting the beneficiary from themselves because they're incapable. But also, control.
Jason Pereira: If I have shares of my company owned through a trust where all my family owners, I want to give them all shares. I want them to all be shareholders, that's great. But at the same time I don't want to lose my voting rights. I want to control that. So that sort of dimension of control and protection typically ends up being the driving factor behind so many of these trusts that I see put in place versus taxation.
Lee Fernandes: Yeah. I agree to a point. The control issue is the biggest stumbling block, because when you set up a trust-
Jason Pereira: There's a certain way it has to be done.
Lee Fernandes: ... you essentially are relinquishing control of those assets to the trustee. And that's where we spend most of our time with clients, is understanding this concept of control and what does it really mean? Because ultimately, when assets go into a trust, you no longer have control of those assets.
Jason Pereira: Yeah. Let's talk about that. Let's talk about there's three different roles involved specifically with trust. So we talked about the beneficiaries. We talked about the trustee. Let's clarify what their duties. Are.
Lee Fernandes: The trustee's duties.
Jason Pereira: Yeah.
Lee Fernandes: So the trustee has a fiduciary obligation. That is the entity that essentially owns, and I'm doing the air quotes.
Jason Pereira: [crosstalk 00:12:01].
Lee Fernandes: Yeah. So they own the assets, but they also the entity that will be sued by the beneficiary or beneficiaries, and whether it's in five years or 10 years or 30 years time, if there is an incorrect application of their fiduciary duty.
Jason Pereira: There's some very famous lawsuits in that regard. Anyone who wants to look up the [Pritzker 00:12:19] case. That's an interesting one.
Lee Fernandes: So, the role of the trustee is to take a decision with the beneficiaries in mind always. That's what the role of the trustee is. And it must also be prefaced by saying that when the trustee is applying the fiduciary duty or their decision, they need to look at the deed, the trust deed. Because some trust deeds are very prescriptive. And so that's just thought in point. What does a deed say? Does a trustee have this discretion? Are we able to apply funds in this particular way? And if so, how does this impact the beneficiary now or down the line? That's what the trustee essentially does.
Lee Fernandes: So let's speak about the trustee in the realm of costs, because that's where it comes in. When we speak about fees surrounding a trust or the trust that was set up, that is really where the factor comes in as the risk factor. So there's the work that needs to be done and there's the administration behind the trust. But how do you factor risk? I can be setting up two trusts with completely different purposes and completely different risk factors and you've got to look at type of beneficiaries, number of beneficiaries, jurisdictions. So that all comes into play.
Jason Pereira: [crosstalk 00:13:29] most of the US that just becomes a nightmare. But yeah.
Lee Fernandes: So that all comes into play. So the trustee is essentially the individual or the entity that takes a decision on behalf of the beneficiaries.
Jason Pereira: Yeah. They're responsible for acting in their best interest. So those responsibilities are the management of the assets in order to meet that responsibility that they have an obligation to those people to live up to the contract that has been put in place for the trust, and just the regular routine maintenance. So the reporting, the tax filings and everything else.
Lee Fernandes: Right.
Jason Pereira: The one we didn't talk about yet was the settlers. So what's the role of the settler of the trust?
Lee Fernandes: That's the certainty of intent, the individual or entity that wants to set up this vehicle for the benefit of the beneficiaries. So the settler, when setting up a trust, settles the trust. That concept, there needs to be a settlement property. We've had settlement properties that are a silver coin bill, whether it's 10 or 100. That is retained in the trust file and that is the settlement property.
Jason Pereira: It's proof that this criteria is checked off and we actually have a physical proof of it.
Lee Fernandes: Correct. So a settler, we have trusts where a settler does just that. They settle the trust and there's a lot of involvement.
Jason Pereira: They walk away.
Lee Fernandes: And we have other trusts, certainly in the case of a revocable trust, where the settler is very involved. And we have irrevocable trusts, where during the settler's lifetime they have the ability to communicate with the trustee and guide the trustee in terms of certain decisions that need to be taken. One concept in particular is a concept of a protector. And it's something that's becoming a lot more popular in my-
Jason Pereira: And necessary.
Lee Fernandes: Yeah. Well in my 15 years in the trust business, internationally we've always seen the application of a protector and within Canada, very little of it has been done. And we're seeing more and more of it. Essentially, a protector could be an individual, it could be a corporation. There are companies out there that offer professional protector services. That's what it is. How does it protect anyone? Well it protects the settler and the beneficiaries in that for example, a protector can have the power to hire or fire trustees.
Lee Fernandes: So if the beneficiaries are unhappy with what the trustee's doing or the protector's unhappy with what the trustee's doing, they are able to terminate that appointment and then replace the trustee.
Jason Pereira: Even in cases where the trustee becomes basically incapable or dies, of handling that trust. They have the power to then name someone else, which is ...
Lee Fernandes: Well, now you're entering into the realm of who do you appoint as a trustee?
Jason Pereira: Exactly.
Lee Fernandes: Should it be an individual, individuals, or should it be a corporation as opposed to an individual? There's no right or wrong.
Jason Pereira: Yeah, it just meets whatever needs you have.
Lee Fernandes: Right. But at a high level-
Jason Pereira: We can get into that later. Let's talk about that now. So an individual can do the job or a company such as your own, a corporate trustee can do the job. So, let's talk about-
Lee Fernandes: Or a combination.
Jason Pereira: Or a combination of the two.
Lee Fernandes: Right.
Jason Pereira: So let's talk about the trade offs between these different ones.
Lee Fernandes: It's longevity. That's what it comes down to. It is the fact that if you are concerned ... So let me take a step back. Lee sets up a trust for his family.
Jason Pereira: Yes.
Lee Fernandes: He's got his buddy Jason, who's the trustee.
Jason Pereira: Not the actual case, but.
Lee Fernandes: Right.
Jason Pereira: Might be one day. We'll see.
Lee Fernandes: Same ages and right now it may make a lot of sense. Why? Because Lee knows that Jason is really fluent in financial matters and knows that his family is going to be in good hands. And both live to a ripe age of 70 or 80. At that stage, it becomes clear to Lee that having an individual such as Jason as a trustee may not be such a good idea. Because the reality is there is no guarantee that when Lee dies, that Jason's going to be there to act as a trustee. And that's what we mainly see as the primary reason for individuals contacting a corporate trustee.
Lee Fernandes: The second is just understanding the business. Knowing what needs to be done. There are so many changes that really come through, whether it's a budget announcement or legislative changes that have an impact on-
Jason Pereira: Or a pressing case in the media or in the courts. That happens.
Lee Fernandes: Right. So it's just understanding the business. And when a decision needs to be taken that you know that as a trustee, let's speak about liability again, as a trustee you're reliable for the decision you're taking. So don't think that by me, or Lee, appointing Jason, I'm doing Jason any favors. It's certainly not the case.
Jason Pereira: Like I say about executorship. Stop fighting over it. It's not an honor.
Lee Fernandes: Unfortunately, a lot of individuals do not see it that way.
Jason Pereira: I know, unfortunately. Until they get the job and they're like, what did I just sign up for? Okay. So that's-
Lee Fernandes: Can I speak about-
Jason Pereira: Of course.
Lee Fernandes: ... the should you have one individual, two individuals, multiple as trustees and the combination?
Jason Pereira: Yes. Let's talk about that. How many trustees you need.
Lee Fernandes: So, the disadvantage of a corporate trustee is a cost factor, because it costs many.
Jason Pereira: But the longevity, the professionalism, and the competency. Those are the benefits.
Lee Fernandes: I agree with that. My experience is that, where individuals are appointed as trustees, its cost is a big factor. But when ends up happening is, when they need to act as a trustee is uncertainty on what their rights are or what the right thing to do is. And now they seek legal opinion and ultimately-
Jason Pereira: And the cost rises back up.
Lee Fernandes: ... the trust ends up paying for that. So it's penny wise, pound foolish. Down the line, do what's right for the family and there's certainly an element of gut. A gut feeling. What makes sense over here?
Jason Pereira: But also eliminates issues like family dynamics, right? Like one sibling gets named a trustee, the other ones don't. There's conflict there.
Lee Fernandes: Don't underestimate that.
Jason Pereira: Yeah. It's a huge factor.
Lee Fernandes: Why do you have to now decide when I get many, when mom and dad died we should have been equal in this and-
Jason Pereira: I had this conversation two days ago.
Lee Fernandes: Right. It's real. It's a reality. Unfortunately, many [inaudible 00:19:26] people do strange things.
Jason Pereira: Very strange.
Lee Fernandes: So if you are going to appoint an individual as a trustee, it's commonsense that don't have one trustee or if you are, have at least a successor trustee in the event of something happening to that individual and they are no longer able to act as a trustee. So, you can have one or two, three.
Jason Pereira: If you have one, typically it's three. You want a tiebreaker somewhere right?
Lee Fernandes: Right. But at the end of the day, also think about successor appointments. Because life is life. There are no guarantees.
Jason Pereira: Absolutely.
Lee Fernandes: There are no guarantees.
Jason Pereira: Actually, there's some use cases where if you don't have three, it calls the entire thing into question. So, getting advice on how a trust is properly structured is hugely, hugely ... Do not cheap out and go to the cheapest lawyer you can find. This is an area that has a fair degree of complexity and you have to make sure you get this right, because otherwise it's just money spent for nothing quite honestly.
Lee Fernandes: Yeah. I agree with the notion that, first and foremost get advice.
Jason Pereira: Absolutely.
Lee Fernandes: But isn't it bizarre that individuals spend most of their working life aiming to retire financial secure, and at that time, and we deal with clients that during that process they want to set up these structures to look for, for estate planning purposes. But how often we sit down with individuals and they haggle over whether it's price or intent, and it's bizarre to me that this is what you worked your whole life for. You've now amounted a certain net worth. This is what you should be doing to protect that net worth, not only for you and your spouse but for-
Jason Pereira: Generations to come hopefully.
Lee Fernandes: ... the next generation. So, I'm not saying that that's generally the case. But we've had experiences where we have those discussions with the clients.
Jason Pereira: I have also had that conversation the last two weeks. So yeah, we jumped ahead from where I wanted to go. But this is good because we covered a lot of ground. Let's actually start talking about the use cases. So very quickly, all trusts fall into one of two categories. Inter-vivos set up while you're alive and testamentary, set up while you're dead. But there's a number of use cases or other terms for trusts, or labels that get slapped on them for very good reason. But all have different implications or different use cases. One thing I actually want to tackle before we go any further, and I should have said this early on, a lot of people don't realize this. They think trusts are this big tax way and you and I both know, there's only really two types of trust in this country that have any kind of tax preference whatsoever. Otherwise, people are usually surprised to find this out. Trusts pay the highest marginal tax rate in this country.
Lee Fernandes: They do now.
Jason Pereira: Back in the beautiful golden days, there was definitely some more advantages to testamentary trusts through your will. But those are largely gone. So actually, let's talk about the ones that happen while you pass away and how they can be tax adventitious. So the two, the first one kind of a trust, it's a graduated rate estate. So let's talk about what a GRE or graduated rate estate is.
Lee Fernandes: Yeah. This has to do with the taxation of trusts. Ultimately, it's the obligation of the trustee is ensuring that when they file income tax returns of the trust, the taxation of trusts that has gone through some significant changes.
Jason Pereira: That's putting it lightly.
Lee Fernandes: So, ultimately there's no benefits generally speaking in a trust holding onto its income. Because it is going to be subject to the maximum or the highest marginal tax rate. Where we see application for a lot of the trusts, and certainly for business owners, it involves an element of loaning funds to a trust, where they apply prescribed rates. So individual loans-
Jason Pereira: Are rates set by the government.
Lee Fernandes: It is set by the government. The most attractive that it's been is 1%. So you'll take $10 million to a trust-
Jason Pereira: Those were good days.
Lee Fernandes: ... the individual by the 30th of January, the first 30 days in the year, they would get their interest on that loan. So that's to avoid the element of attribution back to the individual. Then what it allows the trust to do is, let's say the 10 million is invested and the beneficiaries are wife and kids. It allows for the trust to then pay for the kids, where there's activities or education or any expenses related to the kids. And whether it's a matriarch that sets up the trust or patriarch that sets up to trust, the spouse is generally beneficiary. It also then allows for the spouse to receive income from trust or capital.
Lee Fernandes: But the intent is that there's some element of splitting, income splitting, that takes space, utilizing the trust. That's a huge tax advantage.
Jason Pereira: To be clear, that actually with the spouse doesn't require trust. It can do a loan through the trust.
Lee Fernandes: It can, it can.
Jason Pereira: This is something that does not require this level of complexity. However, with the kids it becomes an issue because basically, the kids are minors. Who is in charge of that money? Again, this is the control aspect of this. So that's why especially when we're doing ... I actually just did the accounting for this recently. When you're doing a case like this that involves money to the benefit of children, you don't want to ... You need to have something like this set up because of the control aspect. So yeah. It's good we tackled that.
Jason Pereira: There is a degree of income splitting. So there can be a tax benefit. However, that tax benefit depends on how many kids you have. And there's limitations. You can't just go having half a million dollars in gains per year paid to a child and pay far lower rates. They come down very hard on that. This is done for the maintenance of the kids. Where is your proof that you paid all this in expenses? So things like contributions to education funds are fine. Things like paying for their camp are fine. But they've got in particular, I've seen ones where I've heard of cases where they try to put through family vacations. The kid had to pay their own way on the family vacation. CRA's saying, you're going on a family vacation. You're not getting that. Congratulations you went to Aruba. You spent two grand on that. The kids, no. That doesn't qualify.
Lee Fernandes: Right.
Jason Pereira: So can't live the lavish lifestyle in the trust.
Lee Fernandes: I hope my parents listen to the podcast. Mom, dad, where's my trip to Aruba?
Jason Pereira: There you go. So I mentioned graduated real estates. So what happens with those? You pass away. Your money goes into estate and everybody things of course, okay let's pay out to the beneficiaries. But there's an advantage to not paying out to the beneficiaries for a couple years.
Lee Fernandes: So, let me ask you. When you're dealing with clients and when you're specifically dealing with graduated rate estates, where is it that is a stumbling block? Where is it that they see the light in saying, this is where the benefit of a trust is?
Jason Pereira: That's a good question. So, the benefit to the graduate rate estate is that they pay, quote/unquote, graduated rates. So they pay as if you do. So, you are allowed a certain amount. You pay more taxes the more money you make. So you get to take advantage of lower tax rates.
Lee Fernandes: Right. It's a graduated rate.
Jason Pereira: Everything's not taxed at 53. They get taxed at 20 and then 30 and whatever else. So, there is a savings. So where is it? The reality is, and these are still relatively new, but the issue is that the intent is I want to wrap this thing up. My father, mother, whatever it is passed away. Let's just get this thing settled. I've got loans to pay. I've got whatever else to do. I just don't want to deal with the headache of this.
Jason Pereira: You have to say, now wait a sec. There's an advantage. So there's an advantage here. If the estate is $50,000, it's probably not worth doing this.
Lee Fernandes: Fair enough.
Jason Pereira: But let's just use a round number of a million bucks. A million dollars is in the estate and that estate is even at let's just say 5% it earns for the year. Now we're talking $50,000 in income. We have to look at who the beneficiaries are. If the beneficiaries are low income and it's multiple beneficiaries, say five of them, 10 grand is not going to make a big dent. It's not really necessarily worth it. But if there's say one beneficiary and that person already earns top level income, so you're looking at 50,000 that would be taxed at let's say [crosstalk 00:26:50].
Lee Fernandes: In addition to it.
Jason Pereira: Now the difference between what they would pay in the trust versus what they would pay personally is a tax advantage. One that is blessed by the government for that matter. So, there is a cost of keeping this open because you have to file the taxes every year. But if we're talking 10, 14, $20,000 in tax savings per year for three years, hey that's an advantage, especially if you have a bunch of beneficiaries and larger amounts. So, that's really the play there. The stumbling block is congratulations, you inherited this money. Unfortunately someone died for it. But you can't touch it for three years.
Lee Fernandes: We encounter the difficulty in, you've inherited but there's some benefit in holding back on when you receive the funds from the trust. But in all honesty, it's a discussion and-
Jason Pereira: It doesn't have to be all or none, right?
Lee Fernandes: Right. So it is a discussion around the time value of money and here's the implication of receiving the funds now versus waiting down the line.
Jason Pereira: Sometimes we'll draft this into the will with their intent. So sometimes, often a lot of procedures in wills in people will worry they're going to worry their kids with too much money in one shot, even if they're adult. So sometimes you'll see phase roll outs of disbursements. So instead of getting it all upfront, I'm going to give you a quarter per year for the next four years. Well that by nature, by its very nature, creates the opportunity for the graduated rate estate to take advantage of those tax brackets. It is entire, especially when they're expecting the money, to say, "Well you might not want to take it now." There's an old statistic that says that when someone picks up a lottery check because they won it, 50% of the money's gone already. Just on average. Unfortunately, the inheritance I'm willing to think is probably about the same.
Lee Fernandes: Yeah. Sticking to the benefits of inheriting and along the lines of taxation, the one trust which we described prior to the podcast is trust that's set up for beneficiaries with the disabilities.
Jason Pereira: That's a big one.
Lee Fernandes: So we've been contacted on a regular basis to act as a trustee for what is commonly known as a Henson Trust. I'm not sure what the general school of thought is amongst corporate trustees. So here's the one benefit of a corporate trustee, is that you want to make sure that whatever happens, that not only is there someone that's going to look after the funds because it's intended for an individual with a disability. And whether it includes a physical or a cognitive disability, it's both but when it comes to cognitive disabilities, there's a greater importance on who you appoint as a trustee.
Jason Pereira: Especially in cases where maybe it's a small family. They don't have anyone else that they know. I've had this encountered where it's like, I don't have anyone I can name.
Lee Fernandes: Right. So there it's not so much how much is going into the trust. It's not a net worth discussion. It's a necessity. And in an environment, I myself am an immigrant. But we're dealing with a population where there's so many immigrants. The reality is that there are a lot of individuals that just don't have the support or the next of kin in the country they live or the province they live to act as a trustee. It does not help appointing Brother Joe, who lives whether in the US or Brother Joe who lives-
Jason Pereira: Especially if it's in the US.
Lee Fernandes: ... in another country. It doesn't work.
Jason Pereira: No.
Lee Fernandes: So from Henson Trust point of view, that's I was saying earlier the general school of thought for us, our preference is to act as a co-trustee. And why we do that is, and I think there's a logic to this, if you're dealing with an individual, certainly with a cognitive disability, there's no way a corporate trustee will develop that type of relationship with that beneficiary to truly understand that beneficiary's needs. That's where there's a co-trustee. Or stating it differently, if corporate trustee is a sole trustee, who is the individual or entity that they can discuss the beneficiary's needs so that-
Jason Pereira: The caregiver.
Lee Fernandes: Right.
Jason Pereira: Whoever's there to support their day to day requirements.
Lee Fernandes: The reason why we start the discussion saying we need a co-trustee is to put this front and center.
Jason Pereira: Yeah, because you're not the one overlooking them and their needs.
Lee Fernandes: Absolutely not, right.
Jason Pereira: So Henson Trust specifically exists in the law, specifically available only to people, to beneficiaries, who have disabled needs.
Lee Fernandes: Right.
Jason Pereira: First, I'll tackle to tax issue. So this actually allows for graduated rates as well.
Lee Fernandes: Yes, it does.
Jason Pereira: This is the only other exemption we have under Canadian tax code right now.
Lee Fernandes: Correct.
Jason Pereira: Frankly, I don't think anyone's going to get too fussed about someone who's disabled basically getting this benefit. This is a paramount importance because this protects a number of other benefits they may be entitled to.
Lee Fernandes: Yeah, the Ontario Disability Support Program. So the reason why a Henson Trust is considered is so that the assets that are in the trust do not form a part of the net worth of the disabled beneficiary.
Jason Pereira: Exactly.
Lee Fernandes: So it still allows the beneficiary to tap into some of the grants that are available out there. So what the trust does, it just lends financial support. So this has been contested. It's gone to courts.
Jason Pereira: There's a recent BC case where they-
Lee Fernandes: That's correct.
Jason Pereira: ... wanted to, was it subsidized housing wanted to say, you're disqualified because you have this trust to support your lifestyle.
Lee Fernandes: Correct, correct. It was the BC court that ruled against the Henson Trust. But the supreme court-
Jason Pereira: Upheld it.
Lee Fernandes: ... upheld it. I think that's the testament to any type of planning, is where there is actual case study and you're able to-
Jason Pereira: It's all hearsay until it goes through the supreme court.
Lee Fernandes: Right. But I think it's good that it was upheld. So to echo your point, the supreme court ultimately saw this as a viable planning tool for individuals with disabilities.
Jason Pereira: Again, let's keep in mind, I'm sure some people are going to jump to the conclusion, well that's not fair. There's like $10 million in this trust then maybe they shouldn't qualify for government services. Well yeah. That's an extreme case. But it's also very, very, very, very minor case. We're talking about the typical planning I do around this involves households that are far more modest.
Lee Fernandes: I agree.
Jason Pereira: And frankly, there's enough money left behind to hopefully take care of that person. Maybe they buy a small insurance policy to help insure that, or maybe it's a large one. It might be. But we're not talking about making sure that basically billionaires' children are going to be taken care of and be able to take government's money. We're talking about people where hey they can live the most baseline life that the government subsidies will permit them, which is not very much, or they can live one that actually has some semblance of normalcy.
Lee Fernandes: Once again, the starting point with the Henson Trust is the fact that you're dealing with the beneficiary with a disability. That's the starting point.
Jason Pereira: That's it. Frankly, we should not be too fussed about graduate rates for those people.
Lee Fernandes: Right.
Jason Pereira: So those are the ones that are tax advantageous. Everything else, again top marginal. But there's still lots of really good reasons to use some of these. So I'll let you pick whatever one you want to talk next about, because I've got a short list here myself.
Lee Fernandes: Yeah. We see a fair amount of planning utilizing spousal trust. So spousal trust and alter ego trust. So alter ego trust, you need to be 65. Essentially what it is, it is a tax play in that your role-
Jason Pereira: Different type of tax play.
Lee Fernandes: ... you throw your assets into the trust and the individual who settles the trust during their lifetime, they are able to utilize the income in their trust. On their death then, the funds then flow over to the spouse on a tax efficient basis. So, ultimately tax is paid. It's just a deferral makes-
Jason Pereira: So, let's specify on the alter ego in particular. So again, over 65. One thing that's unique about this one is that when you move assets that have gains into a trust, you're typically going to trigger that tax. However, with an alter ego you don't.
Lee Fernandes: Correct.
Jason Pereira: Really, when you talk about a tax play, the real tax play there is that this is no longer part of the estate. So therefore, because it's a separate legal entity and it has beneficiaries after that, but it flows through to the beneficiaries without probate. Let's not get too fussed about probate. It's 1.5% in Ontario, more or less elsewhere depending on where you are. But still something. And frankly, we can plan around it.
Lee Fernandes: Right, absolutely.
Jason Pereira: The spousal trust is an interesting one. I always talk about this. Let's talk about the intent of that. I have my own funny story for that, but.
Lee Fernandes: Well now I'm interested.
Jason Pereira: Basically, whenever I teach financial planning I give examples of trust. I said, this solves what I call the quote/unquote cabana boy problem. The spouse who's in a sensitive situation and ends up basically, the joke is they end up marrying the much younger spouse or whatever it is. And that younger spouse is going to try to quote/unquote, screw the kids out of the deceased, hard earned money. So really, let's talk about how-
Lee Fernandes: And by implication, the deceased, the beneficiaries are the next generation.
Jason Pereira: Exactly. So my wife will probably never do this, probably. But my wife ends up being a very wealthy individual because I died, left all kinds of money behind, and marries a much younger man who's basically got his sights set on frauding my children. He tries to get all the money and runs off. That's the fear that happens. It's not one that's undue because God knows, you're in a sensitive situation. Paul McCartney's second marriage didn't go that well. These sort of things happen. So tell us how spousal trust helps prevent that from happening.
Lee Fernandes: Well essentially so, with the spousal trust if you take the principles of an alter ego trust, the spousal trust, it allows the husband and wife, or allows the common law partners to benefit from the income and capital of their trust during their lifetime. On their death, then like any trust deed, it will have who the beneficiaries of the trust is or are. It could be individuals, and the one thing we haven't touched on is it could be a charitable foundation. So there's a list of beneficiaries that would ultimately benefit from the trust.
Lee Fernandes: So, to paraphrase, the cabana boy problem yeah. What it does, it has that framework where it clearly stipulates who can benefit from those assets during the spouse's lifetime and on the death of the last surviving spouse, then there's a list of beneficiaries.
Jason Pereira: Yeah. So that spouse could be entitled to just say the income from those assets.
Lee Fernandes: Correct.
Jason Pereira: But the capital's got to be preserved for the kids.
Lee Fernandes: Correct.
Jason Pereira: So thereby foiling the cabana boy's evil intent.
Lee Fernandes: Correct. Right.
Jason Pereira: So yeah, you touched upon one just now, charities. So let's talk about the concept of a charitable remainder trust. Are you seeing many of these, because I'm not seeing many of these.
Lee Fernandes: What we're seeing is, if you take the concept of inter-vivos and testamentary, we're seeing a lot of foundations that are being set up during individuals lifetime.
Jason Pereira: The natural trust foundation.
Lee Fernandes: So it's an actual foundation that's being set up and there are a number of ... Let's take a step back and why would the concept of charity and philanthropy and giving back. We have families that they've done well or we have families that have taken out a life policy and they feel very passionate about a certain cause and they want to make sure that certain funds are left to a particular charity. In that instance, it's generally structured through a rule where there's a policy and a policy's intended for A, B or C charitable initiative.
Jason Pereira: I plan on bringing Mark on a talk about that.
Lee Fernandes: Fantastic. So, in terms of the foundations, we have families that have sold businesses and there's a desire to give back. That desire is usually fulfilled through a community foundation of some sort or setting up a private foundation. There's also the concept of what's known as a donor advised fund. This is essentially where there's, think of it's an umbrella and clients and individuals can open up a family foundation in the family's name under this umbrella. And benefits of donor advised funds, it's that it generally allows for the family to get involved in what the true intent is, which is gifting. So it's an opportunity for families to sit around the table and discuss the fun part of philanthropy. Who's going to benefit from the funds that are in the foundation?
Lee Fernandes: And what the donor advised funds' responsibility is, like a trustee, so we have a lot of donor advised funds out there that are set up as trusts. They could be set up as corporations. So the one benefit of a donor advised fund is that it takes care of the administrative and regulatory obligations. Foundations in Canada have a minimum distribution requirement of three and a half percent. So the obligation of the trustee of the donor advised fund is to ensure that the family meets that minimum requirement.
Jason Pereira: Those are useful because when you start talking about charitable foundations, normally you're talking about pretty sizable dollars. Donor advised funds, there's organizations in this country that will start these as low as 25,000.
Lee Fernandes: Right.
Jason Pereira: Right.
Lee Fernandes: So the important point there, you wouldn't be setting up a private foundation for your family, in my mind, unless you're really looking to put aside two million plus. Doesn't really make a lot of sense.
Jason Pereira: When you start looking at the cost of actually administering that, it's sizable. You got to set up an operation for that.
Lee Fernandes: Right.
Jason Pereira: But that being said though, two million's a high bar. I've seen some smaller to moderate sized charities basically roll themselves into a donor advised fund to basically create this kind of pooled outsourcing mechanism for-
Lee Fernandes: Right. So, what we have seen is individuals, notwithstanding their desire to give back. So notwithstanding their philanthropic desire. If they want to set up a foundation and if there's a tax element to that because they're going to get a taxed receipt, if they try and set up a private foundation any time after, I would say beginning of August, it's just not going to happen.
Jason Pereira: Yeah, no.
Lee Fernandes: You need to apply to CRA and they need to approve it and you get a charitable number. It's just not going to happen. So it's not uncommon for us to have clients that walk through the door and say, "Look, my advisor said this is something that I need to do or-"
Jason Pereira: Or I want to do this. [crosstalk 00:40:38]. Yeah.
Lee Fernandes: My family wants to do this, but we just don't have the time. Can we set up an account under the donor advised fund, with the intent that down the line when we set up our private foundation we'll then transfer that? We can because once that private foundation is set up, it is a registered charity. So it's a move from donor advised, which is a charity, to a registered charity in a private foundation.
Jason Pereira: Yeah. It's great because it's basically for lack of better term, off the shelf. You can basically set these things up. Forget August, you can set these things up in December. It's a little bit of paperwork and a donation and you're off to the races. Then you can get the rest of this stuff taken care of.
Lee Fernandes: Right. Now must be said that generally, once the donor advised fund is set up, that families see the benefit of having someone partner with them and take care of the administrative burden and leave the gifting part to the family.
Jason Pereira: Exactly. I often talk about that sort of strategy. I talk about the estate planning or I talk about the tax planning, we talk about how if your goal is to have responsibility or social responsibility conversations with your kids and try to instill upon them a sense of responsibility towards giving to the outside world, then these types of things are wonderful, because especially donor advised funds. You have the flexibility to basically give money to any charity that's registered.
Lee Fernandes: Right.
Jason Pereira: So they can have a conversation around the dinner table about, we have this much money to allocate this year. What do we feel strongly about? Who are we going to give it to?
Lee Fernandes: Yeah. You're right when you say registered charity, but registered domestic charity.
Jason Pereira: Domestic charity.
Lee Fernandes: Right. We often, with the fires in Australia we had clients that asked us to transfer funds to an Australian charity. And we had to find a local charity that ultimately was a conduit for that.
Jason Pereira: That supported that.
Lee Fernandes: Yeah. Let me touch on an experience that I've had with a number of clients around donor advised funds and the value of donor advised funds, or foundations just generally irrespective. We have a family. They've taken the opportunity with their foundation to hold regular family meetings. What they've allowed each of their three kids, including wife and husband, to do, is every year they are able to gift $25,000 to a charity of their choice. With every dollar that is gifted, that dollar goes into a common pot. The intent of the common pot is that at the end, or prior to the end of the year, there needs to be unanimous decision amongst family members where the common funds go to, charitable cause.
Lee Fernandes: The reason it was done is that there was discourse amongst family members. It was an incredible tool to bring family members around the table and to resolve, not only the good of gifting, the philanthropic intent, but also to resolve issues among family members. It also allowed the next generation to witness how mom and dad, how they carry on a conversation with the advisory team with their foundation. It was just spectacular.
Jason Pereira: It's a great mechanism for kind of getting them involved in the family operations.
Lee Fernandes: Right. So, make no mistake that the intention was for good but there was an element of trying to resolve issues amongst the family members.
Jason Pereira: Excellent. So before we wrap up, I just want to sum it up. I mean, end of the day, trusts are incredibly valuable and useful tool that can be very dynamic and used any number of ways. We covered only a bit of what can be done. We talked about charity, we talked about people with disabilities, we talked about protecting money for the next generation, protecting money from spend thrift kids to some degree. Then also they can be used in [inaudible 00:44:18]. In a previous episode, we talked about how to structure with a trust in order to basically, for various tax optimization strategies. But incredibly valuable, and unfortunately in current media, misunderstood tool.
Lee Fernandes: Very much so.
Jason Pereira: Very misunderstood. So do not demonize. Educate and they can be incredibly useful to any business owner out there, and even non business owners. So before we wrap up, where can people find you, Lee?
Lee Fernandes: They're able to go to Cidel's website, cidel.com, and contact details are there.
Jason Pereira: Excellent.
Lee Fernandes: We have offices in Toronto and Calgary. So we definitely have an actual footprint.
Jason Pereira: And how many other countries?
Lee Fernandes: We have two other countries.
Jason Pereira: Two?
Lee Fernandes: Yeah, two. Two other countries and various offices.
Jason Pereira: But especially I will say, you guys are my go-to. Any time it starts crossing borders, you guys are the first ones I call.
Lee Fernandes: Thank you.
Jason Pereira: Excellent. Thank you very much.
Lee Fernandes: You're welcome.
Jason Pereira: So that was my interview with Lee Fernandes. I hope you enjoyed that. If we were to talk about everything a trust could do, we'd be here for days. So, hopefully like I said, you took away that these are dynamic structures that can be used in planning and can benefit you and your family and help you meet your goals. So until next time, I'm Jason Pereira. Take care.
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