Alter Ego and Joint Partner Trusts and a Life Insurance Policy

Turning 65 brings a long list of letters from governments and institutions. For some people it also brings a conversation with a lawyer about something called an alter ego trust. The idea sounds tidy. You move your property into a trust while you are alive, you keep the income and the control you want, and at your death the property passes under the trust deed instead of through your will.

Then the life insurance question comes up. You own a policy. Should it go into the trust too? The honest answer surprises many people. A life insurance policy follows its own tax rules, the rollover that makes these trusts attractive does not cover it, and a policy that names a beneficiary may already do most of what the trust is meant to do.

This page explains what alter ego and joint partner trusts are under the Income Tax Act, how property moves into them, what happens at the death of the settlor, how a life insurance policy fits or does not, and what is different in Quebec. It is general information from a licensed insurance professional, not tax, legal or investment advice. Every decision here belongs to your accountant and your lawyer or, in Quebec, your notary.

Start with the definitions, because they are narrower than most people expect.

What is an alter ego trust, and what is a joint partner trust?

Both are trusts created after 1999 by a person who was 65 or older when the trust was created. In an alter ego trust, the settlor alone is entitled to all the income for life. In a joint partner trust, the settlor and a spouse or common-law partner share that right until the later of their deaths.

The Income Tax Act defines both terms in subsection 248(1). It does so by pointing to paragraph 104(4)(a), which sets the day a trust is treated as selling its property. A trust fits the alter ego definition when the conditions in clause 104(4)(a)(iv)(A) are met. A trust fits the joint partner definition when clause (iv)(B) or (C) is met, which covers a married spouse or a common-law partner.

The conditions are strict. The trust must be created by the taxpayer during his or her lifetime, after 1999. The taxpayer must have reached 65 when it was created. The taxpayer, or the couple, must be entitled to receive all the income that arises before the death, or the later death. And no other person may receive or otherwise obtain the use of any income or capital of the trust before then. A deed that lets a trustee pay something to a child during the settlor's life does not fit.

The CRA uses the same terms on its list of trust types. It gives code 336 to the alter ego trust and code 335 to the joint spousal or common-law partner trust.

One detail matters later. An alter ego trust can elect out of the status in its T3 return for its first tax year. The election changes how the trust is treated, both on the way in and at the death. Whether to make it is a question for the accountant, at the start, because it cannot be made later.

How does property move into the trust?

Most capital property moves in at its tax cost, with no gain taxed on the way in. Section 73 of the Income Tax Act allows this rollover when both the settlor and the trust are resident in Canada. The settlor can elect out of it. A life insurance policy is not covered by this rule.

Subsection 73(1) is the rollover. It applies to the capital property of an individual, transferred to a trust described in subsection 73(1.01). The individual is treated as selling the property at its adjusted cost base, or a share of undepreciated capital cost for depreciable property. The trust takes it at that same amount. The built-up gain is not taxed at the transfer.

Subsection 73(1.01) lists the trusts that qualify, including a trust under which the individual alone is entitled to all the income for life, and one shared with a spouse or common-law partner. Subsection 73(1.02) adds the conditions for those two kinds. The trust must have been created after 1999. The individual must have been 65 or older when it was created, or the transfer must involve no change in beneficial ownership. And an alter ego trust must not have made the election out of its status.

So the rollover is the main tax feature on the way in. It is also where life insurance parts company with the rest of the plan, as a later section explains.

Why do people set one up?

Mostly for reasons that are not about tax: lower probate fees outside Quebec on property that would otherwise pass through the estate, a plan for incapacity, privacy, and fewer grounds to contest a will. Each reason is real for some people and small or absent for others.

The first is probate fees. Outside Quebec, provinces charge a fee or tax on the value of an estate when a court confirms the will. Property that truly belongs to a trust at the death is not part of the settlor's estate, so it does not count. How much that saves depends on the province and the property. The figures, province by province, are on beneficiary or estate and probate fees by province.

The second is incapacity. If you lose capacity, a power of attorney lets someone act for you, but some institutions are slow to accept one. A trust already has trustees with written powers. If you are a trustee and can no longer act, the deed names who carries on.

The third is privacy. A will that goes through probate can end up in a court file. A trust deed is usually not filed with a court.

The fourth is challenge. A will can be contested on several grounds. A trust that has run for years, with property already in it, can be harder to attack, although nothing makes a plan immune. Your lawyer can tell you how much weight this carries where you live.

Tax savings are rarely the reason. The rollover only postpones tax, and the next section shows that the bill still arrives.

What happens to the trust when the settlor dies?

On the day the settlor dies, or on the later death for a joint partner trust, the trust is treated as selling its capital property at fair market value. That replaces the usual first 21-year date. The gains are taxed in the trust, at the top individual rate, and a new 21-year cycle starts.

Paragraph 104(4)(a) sets that day of death. For most other trusts created during a lifetime, the first deemed sale comes 21 years after the trust was created. For these trusts it comes at the death instead. Paragraph 104(4)(b) then sets a further deemed sale every 21 years after that day, if the trust keeps going.

Where is the gain taxed? In the trust. Subsection 104(6) normally lets a trust deduct income paid or payable to beneficiaries. In the year of the death, it does not allow a deduction for amounts included in income because of the deemed sale. Under subsection 122(1), most trusts pay tax at the top individual rate on what they keep. So the trust itself needs money to pay that tax, often before the property is distributed.

Compare that with property you keep in your own name. The Act has its own rule for that property at your death, explained on the deemed disposition at death and where the death benefit sits. The trust does not make the tax on built-up gains disappear. It moves it to the trust's return, at the trust's rate. How the two compare for your estate is a calculation for your accountant.

The trust also files a T3 return every year while it exists. The CRA says an express trust resident in Canada, other than a listed trust, must file annually even with no income, usually with Schedule 15 on beneficial ownership. That is a yearly cost, and it lasts as long as the trust does.

How does a life insurance policy fit, or not?

Awkwardly. The section 73 rollover covers capital property, and a transfer of a policy is governed by section 148. Moving a policy you own into your own alter ego trust can be a disposition at the greatest of three values. And a policy that names a beneficiary often already passes outside the estate.

Start with the transfer. Subsection 148(7) applies when an interest in a policy is disposed of by gift, or to a person the policyholder does not deal with at arm's length. Under paragraph 251(1)(b), a taxpayer and a personal trust are deemed not to deal at arm's length when the taxpayer is beneficially interested in the trust. In an alter ego trust, the settlor is the beneficiary for life. So a transfer of your policy to the trust is likely to fall under 148(7). Whether it does in your case is for your accountant.

Under 148(7), you are treated as receiving the greatest of the value of the interest, the fair market value of anything the trust gives you, and the adjusted cost basis. The trust takes the policy at that amount. Any excess over the adjusted cost basis is income to you in the year of the transfer. The section 73 rollover does not change that, because section 73 does not speak about life insurance at all.

There is a spousal rollover for policies, in subsection 148(8.1). It covers a transfer to a spouse or common-law partner, or to a former one in settlement of rights. A trust is not named in it. Do not assume it reaches a joint partner trust; ask your accountant.

Now the purpose. Many people set up the trust to keep property out of the estate. A life insurance policy on your own life, with a named beneficiary, already does that outside Quebec. Ontario's own page on its estate administration tax lists insurance paid to a named beneficiary among the assets generally excluded. So the probate reason, which drives many of these trusts, often does not apply to the policy.

What about a policy you own on someone else's life, such as a spouse or an adult child? Then the policy has value at your death and passes as property, under your will, to a successor owner, or under a trust deed. That is where a trust or a successor owner can matter. Successor owners are explained on joint owners and the successor owner. How the trust's deemed sale at your death treats a policy interest, given the separate rules in section 148, is a technical question. Leave it to your accountant.

Finally, the trust can be the beneficiary instead of the owner. You keep the policy, and you name the trustee of your trust to receive the death benefit. The difference between those two roles, and what each changes, is on a trust as the beneficiary or as the owner.

Which arrangement does what?

The table sets the usual arrangements side by side. It describes what each one involves under the rules read today. It does not rank them, and none is right for everyone. Each row ends with the question to bring to your accountant and your lawyer or notary.

What is different in Quebec?

The tax rules are federal, so the definitions and the age 65 test are the same. The civil law is not. A Quebec trust is a patrimony by appropriation that no one owns. A settlor acting as trustee needs an independent co-trustee. And a notarial will does not need verification, which weakens the probate argument.

Under article 1260 of the Civil Code of Québec, a trust results from an act by which the settlor transfers property from his or her patrimony to another patrimony, appropriated to a purpose. Article 1261 says that patrimony is autonomous and distinct from that of the settlor, the trustee and the beneficiary, and none of them has a real right in it. That is a different idea from the common law split between legal and beneficial ownership, even if the result in daily life can look similar.

Article 1275 matters for an alter ego trust in particular. The settlor or a beneficiary may be a trustee, but must act jointly with a trustee who is neither. In an alter ego trust the settlor is both settlor and beneficiary. So a Quebec deed needs at least one other trustee, and that person's role and cost should be planned.

The probate reason is also weaker in Quebec. The Québec government explains that a holograph will or a will made before witnesses must be verified after the death, by a notary or the Superior Court. A notarial will need not be, because it is an authentic act. Families who already use notarial wills save little on that front. The process is described on will verification in Quebec and the death benefit.

Quebec also has its own rules on beneficiary designations, including when a spouse's designation is irrevocable and when the rights under a policy are exempt from seizure. A trust, as owner or as beneficiary, can change that position. Ask your accountant which Quebec trust return applies as well. Your notary and your accountant should review the deed, the designation and the filings together.

What does it cost, and where are its limits?

There are legal fees to draft the deed and retitle property, a T3 return every year, possible trustee fees, and tax at the top rate on what the trust keeps. The trust postpones tax rather than removing it, and it adds little for a life insurance policy that already names a beneficiary.

The set-up cost is not only the deed. Each asset has to be moved: real estate retitled, accounts reopened in the trustee's name, and records updated. Assets left outside the trust still go through the will, so most people need a will as well.

The running cost lasts. Someone prepares the T3 return and its schedules each year, and records must be kept for the trustees. If a trust company acts as trustee, it charges for that. In Quebec, the independent co-trustee may charge as well.

The limits are real. The gain at the death is taxed in the trust at the top individual rate. Only the settlor, or the couple, may benefit during life, so the trust cannot help a child before the death. Property you will still need to buy, sell or refinance often is awkward to hold in a trust. And the trust does not, by itself, protect anything from your own creditors, because you remain its beneficiary.

For a policy, the main limit is the one already set out. The rollover does not cover it, and moving it can create income. Some people also overlook the policy entirely and leave its designation unchanged, so it pays the old way while the rest of the plan runs through the trust. That is not always wrong, but it should be chosen, not forgotten.

What should you ask the accountant and the lawyer or notary?

Bring the deed, or the draft, your will, a list of what you plan to move, and the insurer's statement for each policy. The questions below keep the meeting on the points that cost money. They are questions for qualified people, not answers.

For your accountant:

• Does the trust meet the definition in subsection 248(1), and should it elect out of the alter ego status in its first T3 return?
• Which of my properties qualify for the section 73 rollover, and which do not?
• If I transfer a policy to the trust, does subsection 148(7) apply, and what income would arise on the planned date?
• How will the deemed sale at my death be taxed in the trust, compared with keeping the property in my name?
• Where will the trust find the money to pay that tax?
• What will the yearly T3 return and Schedule 15 cost, and which Quebec return applies?

For your lawyer or notary:

• Does the deed meet every condition, including that no one else may receive income or capital during my life?
• Who are the trustees now, and who replaces me if I cannot act? In Quebec, who is the independent trustee?
• Should my policy name a person, my estate, or the trustee, and does that match the deed and my will?
• What property will still pass through my will, and what will probate cost on it?
• How does the plan affect any designation that is irrevocable or exempt from seizure?

Who this does not suit

An alter ego or joint partner trust is not available to someone under 65. It is a poor fit for a person who wants a child to benefit during life. It also does little for estates with modest property or low probate fees. It rarely helps a life insurance policy that already names a beneficiary.

It also suits poorly the person whose property is mostly registered plans and insurance with designations. Those usually pass outside the estate already. It suits poorly someone in Quebec whose wills are notarial, if probate was the main reason. And it suits poorly anyone who will not keep up the yearly filing and the records. The deed, the will and each designation must also be kept in step.

A plain will, a power of attorney or protection mandate, and current beneficiary designations already do a lot. For many households that is enough. The wider question of who should own a policy is mapped on who can own a life insurance policy. The other estate questions around a policy are gathered under estate planning.

What this page will not tell you

This page will not tell you whether to set up an alter ego or joint partner trust, whether to move your policy into one, or what tax a transfer would create for you. Those answers depend on your property, your province and your family, and they belong to your accountant and your lawyer or notary.

It will not give you probate fee figures, tax rates or trustee fees. Those change, and the probate figures by province are kept on their own page. It does not cover trusts created by a will, which are explained on a death benefit and a testamentary trust, and it does not repeat the general guide to what a trust is for a policyowner or the page on a family trust as the policyowner.

What it can give you is the shape of the decision. These trusts move most property in at cost and postpone the tax to the death. A life insurance policy follows section 148, not section 73. And a beneficiary designation often already does the job the trust is meant to do. Take those three points to the people who will draft and review your plan.