What Are Trusts? What Are the Different Types of Trusts and How Are They Used in Canada?

WHAT ARE TRUSTS?

The concept of trust is difficult to define. One should think of a trust as a relationship between three individuals; namely, the settlor (the person creating the trust), the trustee (the person holding title to the trust property on behalf of beneficiaries) and the beneficiaries (i.e the person(s) who benefit from the trust). Technically, the same person can hold all positions (not if they are sole trustee and sole beneficiary). The beneficiaries hold equitable interest in the property while the trustee holds legal title to the trust property.

My simplest definition of a trust is as follows: A trust is a legal arrangement where one person (the settlor) gives assets to another person or entity (the trustee) to hold and manage for the benefit of someone else (the beneficiary). The trustee must follow the rules set out in the trust agreement and act in the beneficiary’s best interest.

There are several misconceptions about trusts in Ontario, particularly regarding their legal structure, taxation, and benefits. Some of these are noted below:

1. Trusts Are Only for the Wealthy – Many assume trusts are only useful for high-net-worth individuals. In reality, trusts can benefit individuals at various financial levels, especially for estate planning, asset protection, tax minimization.
2. A Will Eliminates the Need for a Trust – While a will distributes assets upon death, a trust can be used during a person’s lifetime (inter vivos trust) or upon death (testamentary trust).
3. Trusts Avoid Taxes – Many believe trusts offer absolute tax avoidance, but this is misleading. Trusts are subject to taxation, and under Ontario and Canadian tax laws, trusts generally pay tax at the highest marginal rate unless they qualify for income splitting or a tax exemption.
4. Once You Set Up a Trust, You Lose All Control – While certain types of trusts (e.g., irrevocable trusts) limit control, the creator (settlor) of the trust can still retain some influence through their choice of trustees, trust terms, and conditions on distributions. There may be adverse tax consequence to a settlor retaining control.
5. Family Trusts Always Provide Tax Benefits – Not all family trusts provide tax savings. The “kiddie tax” (TOSI – Tax on Split Income) rules limit income splitting with minors and certain adult beneficiaries. Additionally, capital gains attribution rules may cause tax liability to revert back to the settlor in some cases.

WHAT ARE THE DIFFERENT TYPES OF EXPRESS TRUSTS?

There are many different types of trusts, but all trusts fall under one of three categories of trusts which are express trusts, trusts by operation of law and statutory trusts. When most people refer to trusts, they are referring to express trusts. As such, we will place the focus of this article on express trusts. Below you will find some of the different types of express trusts:

1. Fixed Trusts – A fixed trust specifies exactly how the assets will be distributed among beneficiaries, leaving no discretion to the trustee.

2. Discretionary Trusts – A discretionary trust gives the trustee full authority to decide how, when, and in what amounts beneficiaries receive assets.

3. Bare Trusts – A bare trust (or nominee trust) holds assets in the name of a trustee, but the beneficiary has full ownership rights and can demand the assets at any time. It is often used for tax planning or real estate holdings.

4. Testamentary Trusts – A testamentary trust is created through a will and only takes effect upon the settlor’s death. It is commonly used to manage assets for minor children, disabled beneficiaries, or long-term estate planning.

5. Inter Vivos Trusts (Living Trusts) – An inter vivos trust (or living trust) is set up during the settlor’s lifetime and can be either revocable, allowing changes, or irrevocable, meaning it cannot be altered. It is often used to avoid probate and manage assets efficiently.

6. Protective Trusts – a type of trust that comes to an end if when a beneficiary becomes bankrupt. This is typically used for asset protection purposes.

7. Spendthrift Trusts – This is a trust that prevents beneficiaries from direct access to funds or transferring their interest in order to protect against financial mismanagement.

8. Charitable Trusts – This type of trust is created to support a specific charity or the public good, offering tax advantages and ensuring that assets are used for philanthropic purposes rather than private gain.

HOW ARE TRUSTS USED IN CANADA? 

In Canada, trusts are used for various purposes, including estate planning, tax planning, asset protection, and business structuring. Here are some common ways trusts are utilized:

1. Estate planning and probate avoidance – Trusts help individuals control the distribution of assets after death, avoiding the delays and costs of probate. Inter vivos trusts (living trusts) allow assets to pass directly to beneficiaries without going through the courts, reducing probate fees and maintaining privacy.
2. Protecting assets for minors and vulnerable beneficiaries – A testamentary trust (created through a will) can hold assets for minor children until they reach a responsible age or for beneficiaries with disabilities who may need long-term financial management. This ensures funds are distributed in a controlled manner.
3. Tax planning and income splitting – Family trusts allow income to be allocated among beneficiaries, reducing overall tax liability. However, due to Tax on Split Income (TOSI) rules, income splitting with minors and non-active family members is restricted.
4. Business succession planning – Trusts help transition ownership of a business while minimizing tax consequences. A family trust can hold shares of a corporation, allowing future capital gains to be split among beneficiaries to maximize the Lifetime Capital Gains Exemption (LCGE).
5. Asset protection and creditor protection – A properly structured trust can protect assets from creditors, divorce settlements, or legal claims. For example, discretionary trusts can prevent beneficiaries from directly owning assets, reducing exposure to potential lawsuits.
6. Holding real estate and investments – Trusts are commonly used to hold and manage real estate investments, particularly for tax-efficient succession planning. They can also be used for investment income management, ensuring structured payouts to beneficiaries.
7. Philanthropy and charitable giving – A charitable trust allows individuals to donate assets to charity while benefiting from tax deductions. This can be structured to provide income to the donor or their family before passing assets to the charity.
8. Avoiding dependence on a will – Since a trust exists outside the will, it can be used to ensure continuous asset management without the risk of legal disputes, will challenges, or delays in estate distribution.
9. Special needs planning – A Henson trust is a discretionary trust designed for individuals receiving Ontario Disability Support Program (ODSP) benefits, ensuring they continue to receive government support while benefiting from an inheritance.
10. Retirement and long-term financial planning – Trusts can help individuals manage pension assets, personal investments, or life insurance proceeds to ensure long-term financial security and structured withdrawals over time.
11. Confidentiality and privacy – Unlike wills, which become public records once they go through probate, trusts remain private. This makes them an effective tool for individuals who wish to keep their estate distribution confidential and avoid public scrutiny of their assets.

Trusts are a powerful tool in estate and business succession planning, offering benefits such as probate avoidance, asset protection, tax efficiency, and confidentiality. Whether used for family wealth management, protecting vulnerable beneficiaries, or structuring business ownership, trusts provide flexibility and control over how assets are managed and distributed. Understanding the different types of trusts and their implications under Canadian law is essential to making informed decisions that align with your long-term goals.

At Jahanshahi Law Firm, we understand that effective estate and business succession planning is crucial for protecting your assets and ensuring a seamless transition to the next generation. We work closely with your accountants or connect you with trusted professionals to develop a tailored strategy that aligns with your financial and legal goals. If a trust is to your advantage, we can structure and implement it to optimize tax efficiency, safeguard assets, and maintain confidentiality. Contact us today to discuss your estate or business succession planning needs and take proactive steps to secure your future.

ABOUT THE AUTHOR:

Shahriar Jahanshahi is the founder and principal lawyer at Jahanshahi Law Firm with a practice focus on representing business star-ups and entrepreneurs in the province of Ontario. For further information about Shahriar Jahanshahi, click here.

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