In 1980, the Ontario Court of Appeal was asked to decide whether Leonard Henson’s daughter, Audrey, who was receiving provincial disability benefits, should be cut off from such benefits because she had inherited money from his estate, albeit through a trust.
The Court decided that because the terms of the trust gave the trustee complete discretion over if, when and what amount of payment should be made from the trust, Audrey had no control over her inheritance, and therefore her provincial benefits should continue.
Thereafter, the innovative terms of Audrey’s trust became the standard template for the tens of thousands of trusts created by parents with a child who qualified for provincial disability benefits. Not surprisingly, this special trust became affectionately known as a “Henson Trust”. So sacred are its terms that few estate planning lawyers dare to modify them.
Since 1980 so much has been written about Henson Trusts, owing mostly to the confusion around the rules and regulations contained in Ontario’s disability benefits legislation – known as Ontario Disability Support Program Act (“ODSPA”).
Today, the confusion has never been greater owing in large part to the federal government’s recent income tax pronouncements affecting such trusts – also known as testamentary trusts. The vast majority of Henson Trusts are testamentary trusts, which means they are a creature born from a Will and funded by the assets of a deceased person.
For decades prior to January 2016, testamentary trusts enjoyed favorable income tax treatment in that they were taxed at the same graduated rates as individual taxpayers. Beginning January 2016, the taxable income of a testamentary trust have been taxed in the same manner as a living
trust, meaning that any taxable income retained in the testamentary trust is taxed at the highest marginal rate, presently 53%!
Qualified Disability Trust – Marginal Tax Rate Applies
There are a few exceptions to this new tax law. If the testamentary trust meets the definition as a “qualified disability trust” (“QDT”), then the graduated tax rates will still apply. So, if a Henson Trust is designated to be a QDT, then the Henson Trust will enjoy favourable income tax treatment.
Most Henson Trusts that are active today may find it difficult, if not impossible, to become a QDT. Now is the time to revisit the Henson Trust in your estate plan to be sure it will also be a QDT.
Before we address the terms a trust must possess to be considered a QDT, let’s be clear that whether or not a Henson Trust is also a QDT does not matter at all for the purposes of determining whether the beneficiary of the Henson Trust will continue to qualify for benefits under the ODSPA. If a trust is both a Henson Trust and a QDT, then not only will it have favourable income tax treatment, but the beneficiary will continue to qualify for health and dental benefits and financial support provided by the province. These benefits are definitely worth planning for.
In order to qualify as a QDT, a trust, including a Henson Trust, must meet the definition under subsection 122(3) of the Income Tax Act (Canada) (“Income Tax Act”) which includes the following attributes:
a) The trust must be a “testamentary trust” which means that the trust must have been created as the result of an individual’s death – which, for the most part, means drafted into someone’s Will and funded with estate assets;
b) The trust must be resident in Canada for the tax year, which generally means that the trustees of the trust must live in Canada;
c) In each taxation year, the trustees must file a joint election form with a “qualifying beneficiary” -– a beneficiary who has qualified for the disability tax credit under the Income Tax Act. It should not be presumed that a beneficiary collecting a disability pension has completed the necessary forms with CRA to allow them to claim the disability tax credit;
d) Electing beneficiary must be “named” as a beneficiary in the terms of the trust; and,
e) Each electing beneficiary may only make one QDT election. If an electing beneficiary is named as a beneficiary in multiple trusts, then that beneficiary may only make one QDT election. So, if multiple family members have died and established Henson Trusts in their Wills, then only one of those Henson Trusts can be a QDT.
f) Only an electing beneficiary can receive payments from the trust’s capital during the taxation year of the trust, otherwise, there will be a repayment of tax savings previously enjoyed.
For an electing beneficiary who is a minor or whose disability inhibits their ability to make financial decisions, making the joint election to be a QDT could be difficult. In such a case, a Court- appointed guardianship application by their parent may be required in order to allow them to make the election on behalf of their child.
Selecting a Trust
In previous articles on Henson Trusts, I have raised the issue that a Henson Trust may not be appropriate for all persons who are disabled and collecting provincial benefits. Aside from preserving the beneficiary’s provincial disability
benefits, a second motivation for establishing a Henson Trust should be to protect the beneficiary from themselves and from others. Without a trustee controlling the inheritance, the beneficiary may find themselves vulnerable to financial abuse, or even worse, enabling a beneficiary with a substance abuse issue to cause more harm to themselves.
Other equally important considerations include: (1) Are the provincial disability benefits likely to continue in the future, and for how long? (2) The nature and value of the assets comprising the inheritance; and (3) Could the inheritance support a significantly better lifestyle for the disabled beneficiary than remaining on disability assistance, and if so, will that beneficiary’s disability allow for the full enjoyment of that enhanced lifestyle?
In Ontario, the province employs a series of tests to determine eligibility for ODSPA support. In very general and simplified terms, benefit recipient’s liquid assets cannot currently exceed $40,000 in value. Certain funds and assets are exempt from this calculation. For example, an automobile, the home in which the disabled person lives, a prepaid funeral, an interest of any kind in a trust whose capital is less than $100,000 including an Exempt Inheritance Trust (“EIT“) (discussed below), an interest in a trust whose capital exceeds $100,000 but which trust qualifies as a Henson Trust.
The ODSPA support recipient can also receive gifts from any source, or payments from an EIT or Henson Trust, up to $10,000 per 12 month period without affecting their support payments. If gifts, or payments, from an EIT or Henson Trust, are made for items or expenses considered “disability related expenses” (i.e. basic needs of housing, food, and medical expenses) or if the gift or payment is used to purchase a principal residence, an exempt vehicle or applied to first and last month’s rent, then these gifts or payments will not count toward the current $10,000 limit. It is important to become familiar with these exempt expenses.
In selecting the type of trust that is most appropriate several factors should be examined. First, not surprisingly, each situation is different and should be customized, however, I can offer some general guidelines. Since a person collecting a disability pension is allowed to have less than $40,000 in liquid assets, arguably, a trust is not needed if the gift or inheritance is below $40,000.
Exempt Inheritance Trust
If the inheritance to which your disabled family member would become entitled to is valued between $40,000 and $100,000, you should consider either an Exempt Inheritance Trust or a Henson Trust.
Not all persons with a disability require a Henson Trust. If the inheritance is expected to be less than $100,000 (and remain less) then the parent can leave that money to a trust that mandates that all investment income generated by the trust investments be paid out each year to the disabled beneficiary. Even if the trust’s net income exceeds $10,000 per year this income will not cause a claw- back of ODSPA assistance. Since the payments are mandated and there is no discretion given to the trustee, this type of trust is technically not a Henson Trust. So to distinguish this trust from a Henson Trust I call it an “Exempt Inheritance Trust” (“EIT”). Some parents may find the absolute and unfettered discretion afforded to Henson Trust trustees to be unsettling and may worry that their disabled child will have to plead for money from the trustee. Whereas if an EIT is used, the terms of that trust can eliminate the trustee’s discretion and demand payment of income.
Henson Trust
If your estate would yield an inheritance above $100,000, and say, less than $500,000, then a Henson Trust is likely the best solution. The reason is that the ODSP pension ($12,000 max) and related benefits are worth preserving as the capital of the trust would be substantially depleted if it had to pay all the beneficiaries expenses entirely on its own with no government assistance.
It is also worth canvassing whether a combination of both an EIT and Henson Trust could be used for those whose inheritance falls within the $100,000 – $500,000 range, but whose parents also want the security of a scheduled payment from the EIT. Remember that in this instance, the most that the ODSP recipient could receive would be a combined $10,000 in income for non “disability related expenses” per 12 month period and only one of the trusts would qualify as a QDT.
Customized Non-Henson Trust
If the inheritance is expected to be above $500,000, depending on the age of the beneficiary, the trust can take on several forms which may not be a fully discretionary Henson Trust. As discussed, the primary purpose of the Henson Trust is to preserve the ODSP benefits which basically means that the beneficiary cannot receive more than $10,000 in total payments per year (excluding exempt payments used for disability related expenses). It may not make sense to have the beneficiary living at or slightly below the poverty line (collecting $10,000 from the trust plus $12,000 in disability pension) when a non-Henson Trust can support a much higher standard of living ($500,000 x 5% = $25,000). This simple analysis ignores the health and dental benefits that ODSP provides which should be a major consideration depending again on the disability afflicting the beneficiary.
In some cases it may not make sense to fund a trust with capital sufficient to enhance the beneficiary’s lifestyle if the nature of their disability inhibits that beneficiary’s ability to enjoy that enhanced standard of living. In that case the parent would be better off allocating more capital to other family beneficiaries in need. Everyone’s circumstances are different and consulting with an advisor experienced in trust matters is critical.
Selecting a Trustee
Choosing the proper trustee is a crucial decision especially with regard to Henson Trusts as the trustee holds a lot of power when deciding if, when and how much money to pay to the trust’s beneficiary.
When selecting a trustee, be sure that person is familiar with the needs of the beneficiary and has a genuine concern for their health and welfare. If the trust is a Henson Trust the trustee must also be able to understand ODSP rules and how payments from the trust could affect the beneficiary’s ODSP benefits. Additionally, the trustee should be someone whom you feel will exercise good judgment, and will be prudent enough to seek sound investment, legal and accounting advice when needed.
Perhaps most critically, the trustee must be capable of acting completely impartially when it comes to deciding how much to pay out of the trust. In many cases, parents choose one of their other children as the trustee of the trust and that child– trustee may also be named as the “residual beneficiary” of the trust (meaning the trustee is entitled to a portion of the Henson Trust left when the child with the disability dies). In this situation, you must feel confident that the chosen trustee will not be tempted to restrict payments from the Henson Trust in an attempt to benefit personally.
One way to avoid such a conflict of interest is to name a non-family member as a trustee or to name at least three trustees and require that a majority vote is needed for all decisions concerning the management of the Trust. Family members together with an outside professional, such as an accountant, financial advisor or a lawyer, may be an ideal choice. In many cases where the trust capital is expected to be greater than $500,000, a trust company is the best solution.
Ultimately, choosing a trustee will set your financial worry at ease and adequately secure your family member’s future. Make sure you plan carefully by getting professional help.