Trust Distributions: What Beneficiaries and Trustees Need to Know

Trusts are a common estate planning tool. They can help families transfer wealth, provide for loved ones, and protect assets. But when the times comes to distribute money or property from a trust, things can become complicated. Trustees and beneficiaries both need to understand the rules to avoid unexpected taxes or legal issues.

This article explains the basics of how trust distributions work and highlights some of the issues that can arise.

1. How Trust Distributions Work

A trust deed or will sets out who will benefit from the trust, what they may be entitled to, and when they will receive it. The trustee is responsible for making sure these instructions are followed. Distributions may be discretionary or non-discretionary depending on the type of trust.

There are generally two types of distributions:

  • Income distributions – such as interest, dividends, or rental income earned during a year. These amounts can often be taxed in the beneficiary’s hands instead of the trust’s, which may save tax overall.
  • Capital distributions – when capital assets like real estate, investments, or cash are transferred out of the trust to a beneficiary.

Beneficiaries may have a capital interest or income interest in a trust, or both. It is important for trustees to understand when they may or may not make or must make distributions or they could be liable to the beneficiaries

2. When Is an Amount “Payable” to a Beneficiary?

Trusts are taxed at the top marginal tax rate unless a certain exception applies. However income and gains payable to beneficiaries are deductible. For tax purposes, income is only considered payable to a beneficiary if:

  • It is actually paid out during the year; or
  • The beneficiary has the legal right to demand payment.

In the case of discretionary trusts, income only becomes payable if certain conditions are fulfilled.

3. Rolling Property Out of a Trust

Canadian tax rules can sometimes allow property to move from a trust to a Canadian resident beneficiary without triggering immediate tax. This is often called a rollover. The beneficiary receives the property at its original cost, and tax is only paid when they eventually sell it.

This can also be a helpful way to avoid the “21-year rule,” which otherwise forces trusts to pay tax on capital gains every 21 years.

4. Distributions to Beneficiaries Living Outside Canada

Special rules apply if a beneficiary is a non-resident of Canada. For example:

  • Income paid to a non-resident beneficiary usually cannot reduce the trust’s taxes.
  • Property transfers cannot use the tax-deferred rollover.
  • Trustees may have to withhold and remit Canadian tax before sending funds abroad.

This makes professional tax advice essential when dealing with cross-border beneficiaries.

5. Special Situations

Beneficiaries with Disabilities

A Henson Trust allows a trustee to manage funds for a person with a disability without affecting their eligibility for government benefits. Another option, the Qualified Disability Trust (QDT), can be taxed at lower, graduated rates, offering tax savings for families.

Beneficiaries Who Are Minors

If a beneficiary is under 21, certain rules may treat income as if it were already paid to them, even if they cannot yet access the funds. This can shift tax into the child’s hands, often at lower tax rates.

6. Tax Liability for the Trustees

It is also important to know that trustees may be personally liable for the taxes of a trust if they make distributions when the trust has unpaid tax liability. Trustees should therefore be careful to get proper tax advice to ensure they are filing their taxes appropriately.

Conclusion

Distributing trust assets is not always as simple as writing a cheque. Every decision can have tax and legal consequences. Whether you are a trustee responsible for administering a trust, or a beneficiary waiting to receive your share, it’s important to understand the rules — and to get advice before taking action.

McLennan Ross has an experienced Trust Planning Team to assist you with your planning and related tax implications.